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Fannie Mae Strategic Plan
2007-2011
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"Deepen Segments - Develop Breadth"
~ FanirieMaer.
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Table of Contents
Page 1
Introduction/ Executive Summary
Section I
Where We Are - Current Realities
Page 11
Section II
Who We Are-· Our Purpose, Mission, Vision
Page 17
Section III
Where We Are Headed- Our Strategic Path
Page 19
Section IV
How We Will Get There Business Plans, Mission Impact ·
Page 41
Section V
How We Will Measure SuccessNew Financial Measures and Metrics
Page 58
Section VI
The Reintroduction of Fannie Mae Writing the Next Chapter
Page 72
Summary and Conclusion
Page 78
Appendix: Where We Have Been- A Brief History
Page 80
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Introduction
This Strategic Business Plan outlines the next chapter of the Fannie Mae story. This
next chapter will be familiar in Fannie Mae's basic mission and business of bringing global
capital to U.S. housing, but different in the company's tone, manner and approach to the
market. That familiarity makes sense, given that we have reestablished a sound enterprise that
serves a strong and growing market. The challenge now is to do more with our charter,
mission, business and market opportunities - and in the end, put more families into housing
affordably.
This Strategic Plan maps the course that Fannie Mae's management envisions taking
the company over the next three to five years. Our strategy is built on several important
conclusions:
1. We have a solid business and franchise- so we are writing a growth plan to deepen
our strongholds in the guaranty and capital markets businesses while extending
the breadth of the markets and instruments we touch.
2. We have opportunities to grow, in addition to pacing a growing market, by
· emphasizing securitization and credit risk management, and operating as One
Fannie Mae. Following this strategy will result in solid earnings growth over the
next five years.
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3. For some time, our business has been perceived as being driven overwhelmingly by'
our portfolio business. We propose a fundamental shift in terms of the
economics of the company. For the next five years, our guaranty businesses will
produce more than 70 percent of our total net income while the portfolio will
contribute 30 percent.
4. We are also proposing to the Board that we enunciate some things we are NOT:
We are not a consumer company; we are not commencing a privatization plan; we
are not defining mission as high risk/low return; and we are not unlike other
corporations.
Together, these conclusions, which are discussed, analyzed and measured in this
document, form the basis of a standard strategic plan. We thought, as we emerge from a few
"non-standard" years, it would be important to undertake a comprehensive process, and to
write it down. Two years ago, our plan was limited to the fundamental changes, critical
investments and hard work the company needed to repair and rebuild the Enterprise on a
stronger foundation. Our strategic planning process last year entailed a relatively targeted
examination of new business initiatives as we focused our priority efforts on completing the
restatement. This year our goal is bigger- to map out Fannie Mae's course for the next three
to five years, leading l!P to 2012, our 75 1h birthday.
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Executive Summary
At its core, we have a solid, successful franchise that earns billions of dollars a year by
helping lenders put millions of working families into houses and apartments. Our business
model- investing in and guaranteeing home mortgages -is a good one, so good that others
want to "take us out." We play a large role in our market, and since our market generally grows
faster than the economy, we have room to grow. We do, sometimes, refer to Fannie Mae as a
franchise, which reflects the complexities (or even contradictions) of running a for-profit
business with a public mission, in the confines of a Congressional charter.
One of our key strategic challenges in growing value given a franchise like Fannie
Mae's is balance: of mission and business; of charter advantages and limitations; of
. competition and partnership. Our charter, while it imposes limits and obligations, also gives us
unique and powerful competitive advantages. Our mission gives our work meaning and
motivation. And the name Fannie Mae still carries significance to customers, partners, the
market and communities.
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That said, we do face tough new challenges- a weakening housing market; a slowergrowing mortgage debt market; stiffer competition from new entrants and old customers;
lender consolidation creating larger, stronger market players with more pricing power.
Internally, while we have put the customer on top, we struggle to provide the service, products
and solutions they need, when they need them. We are not as competitive as we need to be.
Our systems are too complex and too lacking in flexibility. We have, therefore, a set of
strategic challenges not unlike those faced by most large organizations; how to take the
competitive advantages we have, apply them to the realities of the market, and obtain the best
results for our owners and shareholders.
Starting with these realities, we have begun the next chapter of Fannie Mae's history by
formulating a new strategic plan. After months of research, analysis, discussion and
preparation, our senior management team met for two days in June in a college classroom near
Fannie Mae headquarters. We looked at where we've been and where we are now, as a
company where we are headed, how we will get there, how we will measure success, and how
we will reintroduce the company. We assigned teams to play devil's advocate, or to write
strategies for our competitors - to ensure we were looking at all sides of the problems. The
debate was vigorous- and we made progress.
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Where did we end up? After careful consideration, we made several major strategic
decisions:
1. Deepen and broaden businesses to maximize value. We believe the charter orovides
ample opportunity for growth and expansion over the next three to five years. We can
broaden - and deepen - our reach within the charter by pursuing both new business
opportunities and greater penetration in the areas where we can offer and derive value. The
seduction of losing current restrictions in trade for "a better deal" is becoming a distraction.
Our strategic approach shifts from taking a two-dimensional view, the exhibit below, to a
three-dimensional view of our opportunities within our charter, illustrated by what I call
"Deepen Segments- Develop Breadth," or less formally, the "3-D Egg," 1 which we
explain in Section III.
"The Egg"
Single
Credit Risk Assessment
Credit Risk Management
Distressed Asset Management
Product Development
Enhariced Data Analytics
Credit Risk Assessment
Credit Risk Management
Pipeline Management
Enhanced Data Analytics
Risk-based Pricing & Fees
Bulk Purchases
Small Loans
Financing
Broker Marketing
.
Technology Platlorms
· Capital Markets
Automated UnderWriting
Benchmark NoteseCOmmerce Tools
Callable Debt·
Appraisal
Structured Securities
MBS.
Lender Liquidity
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eCommit_ting
CJ= Occupied spaces
0= Emerging or Unoccupied spaces
CJ= Charter vs. Long~ term Strategy
· PriV3te l8bei"Securities Investments
Retail investors
MBS Liquidity'
Interest Rate Risk Assessment
lnter6st Rate RiSk Management
Enhanced Data Analytics
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"The Egg" was an idea from former Director Ann Korologos, who suggested we display the activities of the
corporation, overlaid on the bounds of the Charter. The "3-D Egg" expands that notion to reflect the fact that not
all activities have the same scale or value.
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The "3-D Egg"
Small market, low
shareholder value
Large market, high
shareholder value
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2. Add more credit-sensitive assets. Under our new strategy, we will take and manage more
mortgage credit risk, moving deeper into the credit pool to serve a large and growing part
of the mortgage market. A vast portion of this several hundred billion dollar market
includes families who would make successful homeowners (or renters) and save money if
we can draw them "into the egg." Helping reputable lenders serve emerging borrowers
provides an enormous opportunity for Fannie Mae to grow, provide value to customers, the
market and shareholders, and expand our affordable housing mission. In order to move
deeper in the credit spectrum safely, however, we will need to complete the build-out of
our new "Risk Transformation Facility" to give us the capability that our private-label
competitors have to slice off and distribute credit risk into the market.
3. Focus expansion on guaranty businesses. As we manage more credit risk, our guaranty
businesses- both Single-Family and Housing and Community Development- will offer
our greatest growth potential, as well as opportunities to deliver·on our affordable housing
and liquidity missions, by moving deeper into the credit spectrum in the single- and
multifamily mortgage assets we guarantee and securitize. We expect these businesses to
grow faster than the market, and provide double-digit net income growth.
4. Use Capital Markets capacity opportunistically. Our Capital Markets business is central
to our business strategy, as well as our mission and shareholder value. Having analyzed
market valuation and risk management scenarios under a variety of assumptions, we do not
believe the portfolio should be capped or reduced - but we do not expect growth rates as
high as in the recent past. It provides liquidity and price support for our mortgage-backed
securities; allows us to purchase mission-rich mortgage assets; and provides capital to the
U.S. housing finance system when the market needs a stabilizing source of funds. The
portfolio thus is "market dependent" - it will grow or shrink depending on what the market
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needs and offers in price spreads. The scenario outlined in this plan assumes the portfolio
grows from $700 billion to $800 billion and provides Fannie Mae with single-digit income
growth through 2011 with near double-digit adjusted rate of return on capital.
5. Mainstream our mission. We need to advance our mission: the stability and liquidity of
the secondary market, the financing of low- and moderate- and middle-income housing,
and select "big-ticket" investments. Our mission cannot be limited to a nice-to-do or a oneoff "boutique" operation. We deliver on our affordable housing mission every day through
normal business, by purchasing or guaranteeing mortgage assets that serve low-, moderateAND middle-class families; providing liquidity to underserved segments of the market;
and, in doing so, bringing quality standards to those segments. Our plan to take more
credit risk and broaden and deepen our reach - e.g., in the subprime market -- will bring
more liquidity to affordable housing and to meet urgent housing needs. We have been
somewhat defined by our critics, and have thus allowed our mission to become smaller and
constraining.
6. Regain competitiveness on cost and productivity. Cost control and greater productivity ·
are critical. doable and ongoing- since our business operates on a large scale, we can, and
must drive growth without dollar-for-dollar expense growth. In fact, we have committed to
reduce ongoing administrative expenses by $200 million in 2007 and enter 2008 with a run
rate of $2 billion. Controls and critical skills come first- but each $15 million in expense
savings is worth a penny per share. ·
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7. Align financial disclosures with how businesses are managed. We will demonstrate our
financial performance by providing an expansive suite of transparent financials for our
business segment results. These new measures and metrics will be aligned with how we
manage the business: Single-Family and Housing & Community Development (HCD)
results will be centered on GAAP net income; Capital Markets will be centered on adjusted
fair value net income; and the total business by a composite measure called "Adjusted Net
Income." We explain this in detail in Section IV.
8. Demonstrate shareholder value from organic growth. Finally, and most importantly for
our shareholders, we expect solid income and earnings growth from this strategy. As the
chart on the next page shows, we project 13 percent compounded annual adjusted net
income growth through 2011, from $4.5 billion to $7.3 billion, driven by revenue growth
and cost containment; and over 14 percent compound annual adjusted earnings per share
growth through 2011, from $4.39 to $7.49, driven by net income growth and stock
repurchases. While certain sources of earnings volatility- spread, credit cycles,
accounting impacts - are beyond management control, we think the overall shift toward
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guaranty fee income as a driver will be indicative of lower beta earnings.
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$8, unless noted
2007
2008
07-11
CAGR
2011
2010
2009
Adjusted Revenue
Single Family
$
Housing & Community De~~elopment
$
Elimination
7.8
$
8.8
1.4
1.2
Capital Markets
Total Company
7.0
$
9.6
$
10.7
11.1%
2.0
12.6%
5.7%
1.8
1.6
3.1
3.1
3.2
3.5
3.8
(0.8)
(0.9)
(1.0)
(1.0)
(1.0)
$ 10.5
$
11.5
$
12.6
$
13.9
$
15.5
10.1%1
$
$
2.8
$
3.4
$
3.7
$
4.2
17.3%
18.8%
Adjusted Net Income {1}
Single Family
2.2
Housing & Community De~~elopment
0.4
0.6
0.7
0.8
0.9
Capital Markets
1.9
1.8
1.9
2.0
2.2
4.9%
5.9
$. 6.5
7.3
12.9%1
Total Company
$
4.5
$
5.2
$
$
Financial Metrics
Adjusted EPS
$ 4.39
$ 5.18
$ 6.01
$
6.66
$
7.49
14.3%
Quarterly Cash Diliidends
$ 0.47
$ 0.55
$ 0.73
$
0.81
$
0.93
18.2%
$1.0
$0.4
Share Repurchases ($8)
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$0.6
$1.1
Adjusted ROE
12.2%
14.1%
15.5%
16.2%
17.2%
GAAP ROE
12.6%
13.2%
13.9%
14.8%
15.2%
(1) Excluding non-recurring admin expense I Catch-Up I Get Current and restructuring costs
With these decisions, taken together, how is our 2007-2011 strategic path different
from our strategic course prior to the remediation period beginning in 2005?
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By realigning business segments, we will grow earnings on the less capitalintensive guaranty side.
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We will manage more credit risk both on-and-off balance sheet over time through a
number of initiatives, including the expansion of our Risk Transformation Facility.
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Our approach to customers will be partnership, not oligopolistic or hostile.
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We will mainstream the mission with a "Big Tent" approach.
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Our financial numbers will be a scoreboard based on clear metrics and
transparency.
Specifically, our Single-Family and HCD guaranty businesses likely will grow
faster than the balance sheet, and the balance sheet will take on more credit-sensitive
assets. Interest rate risk is likely to remain modest. This. is a reversal from prior years,
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when adding high-grade MBS on the balance sheet and managing interest rate risk was a
prime driver of earnings growth. As a result, by the end of 2011, securitization and
credit will produce approximately 70 percent of our total net income, while investing in
non-credit-sensitive assets on balance sheet will contribute 30 percent.
Under this plan, we project that our Single-Family and HCD businesses will increase
net income from $2.6 billion today to $5.1 billion in 2011. This potentially would increase
Fannie Mae's total market capitalization by nearly 85 percent, from $65 billion currently to
$120 billion, as shown in the diagram below and detailed in Section V in our projected
financial results.
Grow Shareholder Value Through Expansion and Shift in Business Mix
Today
8
2011
Ma"<etCap
---------------
CAGR
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$2.28
$4.58
18.8%
Adjusted Nl
CM FV
4.9%
$1.98
70%
HCD
17.3%
Our strategy will require some major changes at Fannie Mae. We need to be more
competitive, entrepreneurial, market-driven, customer-focused, efficient and productive as a
company- we need to eliminate the remaining vestiges of bureaucracy. More specifically, we
need to take a more business-like, analytical approach to risk, especially credit risk. This is
paradoxical. For a company that specializes in managing mortgage risk, gets paid to manage
mortgage risk, knows more about mortgage risk because we simply have more data to mine,
and is very good at it, we're still remarkably risk-averse. Our total credit losses over the past
ten years were $3.1 billion versus net income of $44.2 billion, with 25 percent of those losses
in 2006. The average loss ratio for residential loans made by banks-is five times Fannie Mae's
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average; for non-residential loans, the bank average is upwards of 35 times Fannie Mae's
average.
Our competitors- especially commercial banks, Wall Street firms and hedge fundshave developed footholds - but also suffered major failures - in expanding credit segments.
With our competitive advantages, our mission quest, our high standards, our knowledge of
mortgages and our talent, Fannie Mae can help lenders extend mortgage credit to more
families, the right way, at lower cost.
* * *
Planning orocess steo bv step. This plan is the result of a strategic planning process
that began in 2005, when we envisioned moving the company forward in three overlapping
phases.
Phase I
Phase II
Phase Ill
Choose
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?
?
2oos·.
2006
2007 and beyond
• Recovery
• · Reniediatipn ·
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•
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Risk Transformation Facility
Subprime
CMBS
Portfolio Total Return
• What is the optimal portfolio
size?
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HCD Expansion
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Foundational S stems
• Capital ·
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· Project Phineas
• What is our "raison d'etre"?
• Is privatization an option?
Phase I was to "Stabilize" the company by completing the remediation and restatement
and becoming a current filer, and resolving legal and regu_latory "overhangs."
Phase II was to "Optimize" our business model by exploring new opportunities within
our charter, which resulted in the organizational changes and the new initiatives of 2006.
We have now begun Phase III, called "Choose." Now that we are close to operating
normally, we have the basics to think more broadly about our future, and make long-term
choices about our businesses, our markets, our customers and our capacity to increase
shareholder value.
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Our strategic planning process looks like several "trains" coming together, as shown in
this diagram:
Strategic
Repositioning
and
Reintroduction
Integrated Value
.Proposition
• Initiatives
• Brand
• Tone
• Metrics
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We examined our market and competitive environment; factored in what we heard from
our "listening tour" with customers and partners; reviewed the new business initiatives we
launched in 2006; and from there, developed a business strategy, a financial plan and the
metrics to show our performance. From these "trains," we developed our strategic path,
considered how to reintroduce the company with new initiatives, "brand," tone and metrics,
and worked to produce an integrated value proposition.
Pursuant to our one-on-one meetings with Directors, we also addressed a number of
important, foundational questions:
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•
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Is privatization an option?
What is the optimal portfolio size?
What is our raison d'etre?
The answers to these questions enabled us to answer broader questions of value add,
relevance increase, and capital allocation.
In this plan, we assess those questions and propose answers, forming the basis for our
· strategy. In turn, our strategy is the key pillar in the upcoming reintroduction of Fannie Mae as
we complete this chapter of our company's history- and write the next.
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Summary of Introduction and Executive Summary:
• Deepen and broaden businesses to add value- leverage charter capabilities.
• Add credit-sensitive assets.
• Expand guaranty businesses -look for capital markets opportunities.
• Mainstream the mission.
• Regain competitiveness on cost and productivity.
• Measure, disclose and explain metrics to increase value.
Process Drives Plan, Execution, Business Results
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Section 1: Where We Are- Current Realities
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•
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Recovery is proceeding, but more to do.
Making progress on 2007 objectives, including optimizing business.
We are ready to choose our strategic path for next 3-5 years.
We began our 2007 strategic planning process by taking stock of our current realities,
looking at several key indicators:
1) Progress on our corporate priorities for 2007;
2) Analysis of what our customers, partners, employees are telling us;
3) What our shareholders are telling us through our stock price, and a detailed valuation
analysis;
·
4) Our regulatory and legislative status; and
5) Status of the strategic business initiatives we launched in 2006.
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l. Priorities for 2007: The corporate priorities for the year reflect the remediation work that
remains to be completed, as well as business opportunities that lay fallow or untapped and the
improvements to our foundation (e.g., systems, culture) needed to become a more marketdriven, competitive company. The priorities are: 1) Grow revenues, reduce costs, exceed
mission; 2) Operate in real time, including modernizing our technology infrastructure, and
launching Lean Six Sigma operational efficiencies across the company; 3) Clean up, including
completing our financial filings for 2005 and 2006, and then, filing our 2007 results; and 4)
Accelerate culture change; with a strong emphasis on people management and instilling a
greater sense of enterprise and competitiveness in the market. At mid-year, we are on track to
achieve most of our 2007 corporate objectives, although we are deep in the hole on the HUD
goals. The table below shows where we are as of May against the target f~r each objective:
Corporate Objectives
YTD Results vs. Minimum Targets
SF Book Growth
165% vs. 90%
SF Return
86% vs. 70%
MF Book Growth
14.8% vs. 2.5%
MF Olarged Fees
24.8 bps vs. 21.8 bps
HCD New
ln~iatives
Total Return on Portfolio
$325MM vs. $298MM
619 bps vs. 400 bps over LIBOR
Administrative Expenses
$1, 138MM vs. $1 ,207MM YTD
HUDGoals
Several well below plan
Minority Lending Goals
On plan
All options to achieve the HUD goals are being evaluated and considered. In the event we
reach a viewpoint that achieving the goals this year is "infeasible," we will determine how best
to address the matter with HUD and will continue to keep the Board apprised accordingly.
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Management will formally report to the Board at year end on progress toward these
objectives. In the meantime, as noted previously, we've made measurable progress in
completing our financial filings by accelerating our previous timeline. We also are getting
close to reducing our 2007 expense run rate by an additional $200 million, toward our target
exit annual run rate of $2 billion.
2. Listening tour feedback: Prior to our strategic planning retreat in mid-June, I directed the
senior management team to conduct a systematic "listening tour" with customers, housing
partners, investors, emplo.yees and other stakeholders. The group conducted close to 300
interviews/engagements with internal and external customers, including large, small, and midsized lenders, investors, partners and officials. Their feedback was useful background for our
strategic work; in summary:
•
•
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Business partners continue to view Fannie Mae as a leader in housing and housing
policy; they would like us to behave more like a leader. That means pioneering new
technology; speaking to industry issues; initiating solutions with customers; driving
new product development; and helping to resolve the sub-prime and future market
. crises.
•
The company's tone and manner has changed noticeably. During the last companywide listening tour in January 2005, three comments we heard most often were: lose the
culture of arrogance (cultivate a new tone and manner in dealing with partners);
develop a stronger working relationship with OFHEO; and be more creative and open
to different approaches. Two years later, partners broadly acknowledge
improvements in tone; several note a dramatic move toward more respectful/less
dismissive interaction.
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However, some say that while we've lost the arrogance and we listen, we don't always
act, suggesting a corporate culture of the "slow maybe" (or maybe even "slow no").
Fannie Mae would better address customer concerns if we were more candid and
upfront; where we can'tsay "yes," giving a clear "no"- or at a minimum, timeframes
for getting back to our partners with a decision. On some specific issues partners found
us responsive to requests to innovate, take new approaches, and take risks; they cited
MyCommunityMortgage and the Low-Income Housing Tax Credit (LIHTC) sale.
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Partners said we need to do a better job of identifying single points of contact here so
they do not have to "surf' Fannie Mae and ask multiple points of contact to find an
answer.
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Employees echoed the "change, progress, more to do" messages that the management
team and I have shared through various internal communications (intranet, town hall
meetings, company-wide and targeted email), which suggests a good level of
engagement.
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We also heard a great deal of concern, even anxiety, about the cost-cutting,
productivity. and restructuring efforts- especially the impact on benefits. (I was
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surprised at the reaction to our reexamination of the ACE college aid program). Some
housing partners and former Foundation beneficiaries also expressed concern about
cutbacks.
Our takeaway from the customer feedback, then, is essentially: good progress on tone
and partner-like attitude; not happy with bureaucracy and unresponsive timing.
3. Customer positioning- Single-Family, HCD, Capital Markets
The turmoil in the subprime market has increased demand for Fannie Mae's
securitization business over our private-label competitors as the mortgage market moves from
"exotic," layered-risk loans to more traditional fixed- and adjustable-rate mortgages. At the
same time, rriajor lenders- both single-family and multifamily, including our longstanding
customers - have more options, including their own mortgage portfolio and securitization
operations, Freddie Mac's more aggressive pricing for market share, and a continued flood of
cheap capital in the multifamily market. So we have had to be more aggressive as well. Here
is a snapshot:
•
Single-Family: Wells Fargo, the second-largest mortgage originator, has increased the
share of its origination business coming to us for securitization, from 20 percent to 50
percent. We also signed agreements with JP Morgan Chase and National City to sell us a
majority of the loans they originate; previously they sold a majority to Freddie Mac. Netnet; we've won customers that had to have a strong value proposition beyond price
compared with competitors. However, Freddie Mac has made inroads with our numberone customer, Countrywide, boosting its share of the lender's business from about 10
percent to about 30 percent. The biggest challenge we face is whether large financial
institutions with mortgage lending operations and maturing private-label securitization
operations and mortgage portfolios with sophisticated hedging strategies build their own
"Fannie Mae." Our response is to strive for "best execution" in price and in service.
•
Multifamily: Stiff competition from conduits making debt investments in rental housing
(e.g., buying bonds to finance apartment developments) has lowered the profit margins for
this segment for the foreseeable future. HCD, which operates our multifamily lending
business, is moving to increase volume by being more responsive to our close network of
multifamily lender customers- "Delegate<;! Underwriting and Servicing," or DUS lenders.
For example, we are streamlining our DUS underwriting platform through "lean" process
redesign and product innovation, and creating integrated teams to provide rapid, flexible
response to customer needs. Also, we are expanding our source of multifamily investments
beyond our DUS lenders to include investment banks, regional small multifamily lenders,
intermediaries, equity funds and other commercial real estate investment partners.
•
Capital Markets: The mortgage portfolio team works closely with Single-Family and HCD
to support the competitiveness of their pricing in the market and liquidity of our MBS.
They support our purchase of multifamily loans and our multifamily MBS executions; we
need to ensure the portfolio can continue to support these MBS. We are also exploring
new securitization structures and finanCial instruments t~iibflfii~~~NlYet()NFIDENTIAL
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•
Collateralized Debt Obligations, and Credit Default Swaps. Our relations in the brokerdeal community remain a strong point. ·
4. Shareholder value: Fannie Mae's common stock price has recovered over the past two
years, notably in 2007.
Year-To-Date Stock Performance
Fannie Mae
Freddie Mac
S&P 500
S&P Financials
12/31/2006
6/27/2007
%Change
$59.39
$67.90
1,418
495
$66.18
$61.22
1,496
485
11.43%
-9.84%
5.45%
-2.12%
$65
$60
$55
•
-
~-
--
--
Fannie Mae
$50 - ' - - - - - - - - Jan
Feb
Mar
Apr
May
Jun
Starting the year just below $60 per share, on June 18 the price reached nearly $70, a
17 percent increase and three-year high. In comparison, the S&P 500 was up nearly eight
percent, the S&P financials were up almost two percent, and Freddie Mac's stock price was
down over five percent. Indeed, for the first time since December 2004, Fannie Mae's stock
price surpassed Freddie Mac's. Sell-side analysts have expressed significant interest; several
upgraded their price targets and guidance for reasons including our accelerated filing schedule,
prospects for our guaranty business, new subprime opportunities, strong 2005 disclosures and
business segment reporting, and, capital return. We have held over 100 investor meetings in
2007 ~the summary is short and sweet: They want current numbers, clear metrics and a clear
explanation of the business model.
5. Regulation/remediation/legislation: Fannie Mae has made progress in these areas. OFHEO
continues to hold the company under tight scrutiny as we comply with and/or complete the
terms of our consent agreements and our remediation efforts (accounting, controls and
systems). But while some disagreements occasionally arise, our efforts to build a more
normal, cooperative relationship have allowed us to work through some issues. I personally
conducted a listening visit with Director Lockhart, who at the time expressed satisfaction with
the state of the relationship. As for HUD, we believe that we met our affordable housing goals
and subgoals for 2006, but the agency will make the final determination later this year.
Meeting HUD's housing goals and subgoals continues to be challenging; particularly as the
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mandated levels for goals and subgoals continue fo increase annually and declines in housing
affordability during the past several years have reduced the share of available loans meeting
the goals. Our remediation continues apace as we issued our 2005 financial statements in May
and announced in June that we expect to file our 2006 financials during the third quarter of this
year, and become a current filer by the end of next February by filing our 2007 financials. On
legislation, the House of Representatives passed a GSE regulatory reform bill with an
amendment easing potentially harsh portfolio restrictions, but Senate action has stalled and
does not appear likely this year. The summary here is, essentially, we are not yet in position to
get the benefit of the doubt, so we have to stay absolutely consistent.
6. Progress on initiatives: In 2006, we identified and selected specific initiatives to pursue as a
result of the optimization phase of our strategy and presented the results to the Board of
Directors for review. Those initiatives were the result of our considering different potential
scenarios and possible futures for the company. We decided at the time to stay the course and
work within our charter with the current business model, rather than choose a "long ball"
strategy. The selected strategy- dubbed "The Egg"- depicts a circle (the current reach of our
business) within a larger oval (the extent of our charter), showing we have significant untapped
market opportunities to explore within our charter. After considering the relevant risks and
returns of several options, management decided on several strategic initiatives that have, in
fact, delivered sizeable dollars, as the table below depicts:
Acquisition Volume from Business Initiatives
•
2004 actual
2007 forecast
2011 forecast
($billion)
($billion)
($billion)
$0
$11.3
$26.4
Alt-A
$39.9
$114.4
$150.4
2nds
<$0.1
$4.0
*
Reverse Mortgages
$3.5
$6.2
$6.2
n/a
$2.2
$5.0
For·Sale/Rent Equity
$0.3
$0.6
$1.0
Community Lending
$0.5
$1.4
$4.3
<$0.1
$0.1
$0.4
CMBS
$0
$25
$95
<AAA Securities
$0
$1
$5
Initiative
Subprime
Small MF Loans
(incl. AD&C)
Mezzanine Financing
·,
• Not separately planned 1n the forecast
Overall, as you know, the recovery of Fannie Mae is proceeding apace. We are near
completion on Stabilization and have generated measurable value from Optimization. On the
"good" side of the ledger, the company is committed to doing more for customers and partners,
and growing as the market grows; doing more for affordable housing; doing more for investors
and shareholders; doing more with our people; and doing more to ensure that Fannie Mae
operates as a 21st Century financial"institution (e.g., competitiveness, speed, agility,
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efficiency). On the "bad" side of the ledger, the company has ongoing systems remediation;
regulatory limitations; lack of clear definition; credit losses on the upswing; the lack of a
market-competitive culture; strains to work, life, morale and our plant; and a continual stretch
to reach our HUD goals.
Summary of Section 1: Current Realities
• Substantial progress on 2007 objectives
• External relations improving
• Share price recovering
• Systems· remediation ongoing
• Market environment tougher
• Culture - ongoing challenge
•
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Section II: Who We Are - Our Purpose, Mission, Vision
•
•
Our purpose and mission is still reflected in "Our Promise."
Our vision going forward: We reach globally and act locally; we are a valued partner;
our business = our mission; we are a company where people can be proud to work;
and we bring measurable value to customers, partners, the market and housing.
After taking stock of our current realities, our strategic planning process then examined
our purpose and mission as a company, and from that, we set forth our vision. The following
section discusses how we addressed these questions.
Puroose, Mission, Vision
Towards the end of 2005, the Executive Committee worked through and agreed upon a
document called "Our Promise." In it we outlined the company's purpose and mission going
forward as the basis for the culture we wanted to create, and the construct remains relevant.
Our Purpose: We exist to expand affordable housing, to bring global capital to local
communities, and to exemplify high standards for the U.S. secondary mortgage market.
•
Our Mission: Shareholders own the company- our obligation is to maximize long-term
shareholder value. Customers and investors rely on us- our business depends on them.
Communities are why we exist- our mission is to serve them. Employees make it happen- our
commitment is to work together to make a difference for all our constituencies: shareholders,
customers, investors, and communities.
From this purpose and mission, I drafted a statement called "Our Vision for One Fannie
Mae," intended to capture the company's intentions and aspirations, and guide the strategic
options we consider and choose. I circulated the idea to the senior management team at our
June strategic offsite meeting, and we made changes and refinements to reflect the group's
views. Currently, the vision statement reads as follows:
Our Vision for One Fannie Mae
Reach globally, serve locally: Fannie Mae brings global capital to local communities to
finance affordable housing. The Fannie Mae Mortgage Backed Security is the leader in
the market- the most liquid, the best execution, the preferred collateral in the debt market.
We are a AAA issuer. We earn solid, reliable investment returns via broad understanding
of markets. We operate large scale, but we respond nimbly and decisively to seize
opportunities.
•
Valued partner: Fannie Mae is critical to U.S. housing finance. Mortgages are what we
do, our core competence. Quality lenders want our partnership and products, and
consumers benefit from what we do. Activists, advocates and policymakers value our role
and experience. What we do matters to people in housinR finance. Where we partner, wePROPlliETARV AND CONII'IDENTIAL
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and our partners - win. Where we compete, we play hard but fair. By bringing our high
standards to the market, we make it hard for bad actors to win.
Business= mission: Fannie Mae is a growing, competitive business on a mission. We
focus on a double bottom line: Business and Mission results both matter. We earn doubledigit ROE; we grow above the market. We produce a competitive yield among financials.
We actively manage capital: invest it when returns are good; return it to shareholders
otherwise. Likewise, we may keep risk, sell it, or avoid it, depending on our view. We are
more productive every year. Key processes operate at Six Sigma. We are urgent,
committed, and forward-looking. Our mortgages are the "fairest of them all" -you get
lower cost and better access with a Fannie Mae mortgage. We are known for delivering
results, not for hype.
Proud to work here: Fannie Mae strives to be a model workplace and corporate citizen.
We provide opportunities to work with talented, diverse people and make a difference.
Employees own their future here, both success and failure. Our company is known for
openness, honesty and transparency. We are not "special" or above the rules. We operate
as a normal company.
•
Measurable value: The numbers- not assertions- demonstrate our vision in action. Our
share price reflects the results of all three business segments. Our share price can reach
$120 as illustrated later in Section V. Our mission results can be counted beyond the HUD
goals. Our cost, productivity and returns can be measured. Our accounting can be
reconciled to our economics. The numbers add up to value creation.
Together, the statement of Purpose, Mission and Vision provided management with a
common basis to select - or reject - specific strategies.
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Section III: Where We Are Headed- 2007-2011 Plan
•
•
•
•
We looked at the environment around us -the housing market is turbulent and our
market is more competitive.
We answered three Board strategic questions: 1) Privatization is not a good option
right now; 2) the portfolio is crucial to our mission and business and should not be
reduced to an arbitrary target level; and 3) our primary raison d'etre- where our
business can center its activities - is in securitization and credit risk management.
We chose a strategic path- to broaden and deepen our reach within our charter.
This path will lead us to more credit sensitive activities.
The next step in our planning process was to choose a strategic path. After taking stock
of where we are, and our vision of who we want to be, we then made some key assumptions,
based on an analysis of the our external environment and the answers to three internal
questions: l) Is privatization an option? 2) Should we maintain, grow or reduce the portfolio?
and 3) What is our raison d'etre- the best purpose on which we should focus our business?
This section describes our view of the market and competitive environment, addresses the three
"big questions," and then describes the strategic path we recommend."
Global trends, industry/competitive environment
•
Over the next three to five years, we believe that the housing and mortgage markets
will regain traction and begin the next multiyear upturn. The negative trends of the past
several years will work themselves out over the next year or so (meaning that the bottom hasn't
been reached quite yet), and the positive underlying economic and demographic forces will
reassert themselves over the second half of the strategic plan period. Structural changes in the
competitive landscape, however, will continue and are likely to pose substantial challenges for
Fannie Mae.
•
Unsustainable Trends: Two primary forces boosted housing and mortgage market
activities to unsustainable levels in recent years: excess liquidity and investor demand
for housing. A combination of cheap credit (driven by Fed easing through mid-2004 in
response to deflation fears) and a surge in foreign investment in U.S. financial assets
(the flip side of the rising trade deficit) created an unprecedented flood of liquidity that
helped to spur record demand for housing and mortgage assets.
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Excess Liquidity Before
Less Liquidity Now
Percent
7 . ··--------·-·-----·-··-- ·-·----····-·---
$Millions
. --· -
-2lliXJ
6
Current Account Balance
(right axis - inverted)
5
""
4
-:mm
-15m)
3
-1CIXID
2
•
Source: Federal Reserve Board, Bureau of Economic Analysis
Investor Share Slipping From Record Highs ·
12%.
10%
6%
4%
2%-
0%
J
Note: Shares are based upon number of Prime Conventional Conforming Purchase loans
Source: LoanPertormance March 2007 data
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•
Near-term trends: Rising interest rates and tightening lending standards are finally
putting the squeeze on liquidity. We expect that strong foreign demand fo~ mortgage
· assets will moderate only slightly, but a larger pull-out is a risk.
Total Home Sales·
Thousands of Units
•
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
Source: Bureau of the Census, National Association of REAL TORS", Fannie Mae forecast
Fannie Mae House Price Index
and Inventory of Unsold Homes
Year/Year Percent Change
16°/o
---- ·----- ····-···-·· -·--·- -- ---·
14%
4000
12"/o
+-Total Inventory for Sale
NSA
(right axis)
10%
3500
8%
6%
3000
4%
2%
2500
0%
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
Source: Bureau of the Census, National Association of REALTORs®, Fannie Mae
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Moreover, investor demand for housing is slackening, as double-digit house
price gains are long gone. As result, the decline in housing and mortgage market
activity has not yet run its course. Total home sales will be down by nearly another 10
percent this year. Near-record unsold inventories continue to push house prices
downward, and we project national declines this year and perhaps in 2008 as well. This
combination of slower sales and lower house prices will pull purchase originations
down by more than 12 percent this year. With fewer home sales, a slowing in refinance
activity (in response to higher mortgage rates), and less mortgage equity withdrawal,
mortgage debt outstanding (MOO) growth should slow sharply to approximately 6
percent this year.
·
a
The Housing Market Has Shifted Significantly
Indicators
2005
Q1 2007
Home prices peaked'
+t5.3%
-2.9%
Hom.e sales declined
8.36M units
7:28M units
9.8%
tO.t%
22%
t4%
Credit losses increased'
t0.8%
t3.3%
ARM share of market declined'
31.4%
2t.O%
Private label securities market peaked'
54.8%
9.7%
Rental vacancy rate stable
Subprime industry meltdown
•
L
2.
3.
4.
5
•
,
Case-Shiller home price index; 01 2007 figure is an annualized rate
Subprime share of single-family market originations
Conventional subprime loans past due
MBA ARM share of mortgage applications
Growth in private label mortgage-backed securities
Long-term positives: Most analysts expect the overall economy and job market to
rebound modestly next year, with growth at around trend rates beyond that- which will
add to housing demand. Once investors end their retreat from the housing market, and
job growth rebounds, home sales should begin to grow again (albeit modestly)probably by early 2008. Beyond that, demographic trends suggest that home sales
should climb at around a 3-4 percent pace annually from 2009-2011. While we still
expect some house price weakness in 2008, house prices should rise in 2009 and
continue to grow through 20 ll - back to the long-term trend of around 4 percent.
MOO growth is projected to be a modest 5-6 percent over 2007-2011, as it was in the
1990-95 period, although growth should accelerate in the latter years of the plan as
home price gains and home sales increase.
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Mortgage Originations vs.
Single-Family Mortgage Debt Outstanding
Percent Change
Billions of Dollars
4500
16%
-----------------·----·-··-------~-·---·----··----·-·-··-~
Single-Family MOO .
(right axis)~
3500
12%
3000
10%
2500
8%
2000
6%
1500
4%
1000
2%
500
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
Source: Fannie Mae estima1es, Federal Reserve Board
•
•
Competitive challenges: The continuation of consolidation and disintermediation in the
U.S. mortgage finance value chain remain significant challenges to Fannie Mae's
business trajectory.
Top 10 Lender Share of Market
80%
70%
60%
50%
40%
30%
20%
10%
0%
11 Origination
• Servicing
1998 1999 2000 2001
2002 2003 2004 2005 2006
Source: Inside Mortgage Finance
· Market slowdowns tend to spur consolidations. Each round of industry
consolidation during the past 10 years has created larger and stronger market players
with increasing pricing power relative to the GSEs. The largest players are driving
decreasing profit margins in the industry, and margin pressure will likely continue as
the large firms squeeze costs across the housing finance industry.
Private label securitizations rose sharply in the 2004 to 2006 period along with
the expansion of new products for investing and managing mortgage credit risks. In
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addition, large banks and aggregators expanded their capital markets capabilities to
provide alternatives to Wall Street and the GSEs, eating into our market share.
Fannie Mae Reclaiming Market Share
Single-family: Acquisition Share Jan 05 to May 07
70%
60%
50%
44.3%
40%
32.3%
30%
20.0%
20%
10%
0%
~
~
0
0
~
~
~
~
~
~
~
~
0
0
0
0
,9 m z
0
~
~
~
~
~
0
0
~
~
~
~
0
0
~
m z ,9
~
9
~
~
0
~
Source: Bond Buyer, Inside MBS & ABS, Company reports
•
At the same time, new and existing investors in the mortgage space have a .
greatly expanded menu of tools to invest in and hedge mortgage-related risks (e.g.
credit default swaps, collateralized debt obligations, credit-linked notes, and covered
bonds).
Credit Derivatives Outstanding (notional)
$40
$34.5
$35
1/)
s::
$30
$25
~ $20
·;:
t::.
$15
$10
$5
$0
P:>lb
"Oj
P:>Oj
,...OJ
~~
'Vt::S
~n;,
~f>c
~~
~IV
'Vt::S~" 'Vt::S
'Vt::S
'Vt::S
'Vt::S
~ro
~
Source: British Bankers Association
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These innovations have occurred outside of Fannie Mae and they are not
without concerns about the risks they pose. At Bear Stearns, for example, two hedge
funds managed by the firm experienced severe losses on highly leveraged portfolios of
exotic subprime mortgage securities. Despite debacles such as the one at Bear Stearns,
the long-term trend is for the increased use of these tools and adoption by mortgage
investors.
Accordingly, we now face competition not just from Freddie Mac, but from a
broadening variety of investors, intermediaries, customers and others:
Broad Financial
Institutions
- Depositories
Specialized Financial
h1stitutions
- Mortgage Insurers
- Central Banks
-Financial
Guarantors
-FHLB
•
- Government Assisted
Most identifiable competitor - Freddie Mac - is neither the
nor the greatest threat
The choices we are making in our strategic plan take into account the competitive
pressures arising from both ongoing industry consolidation and disintermediation by the capital
markets. We believe that we should position Fannie Mae to move into higher credit-risk
arenas to offset the margin compression being forced on us in our traditional, low credit-risk
segments by our ever-larger customers. Managing more credit risk through risk transformation
and other creative methods will also strengthen Fannie Mae's competitive position as the
intermediator of choice for bringing capital to U.S. housing.
Winners in this market environment will have the capabilities to price and retain credit
risk they like and distribute the remaining risk to others that value it more. This requirement
means building stronger credit capabilities in both the Single-Family and HCD businesses.
While we have made modest steps in that regard, more ambitious ones are necessary and are
reflected in the strategic plan.
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Our 2007 to 2011 plan assumptions, therefore, include the following:
Strategic Plan Assumptions
Variable
2007
2008
2009
2010
2011
Real GOP growth
2.5%
3.0%
3.2%
3.3%
3.3%
Short-term rates
2
Long-term rates
4.88%
4.68%
4.50%
4.78%
4.6%
4.89%
4.6%
4.98%
4.67%
5.05%
lnflation
4
House price growth
3
3.1%
·-1.0%
2.5%
1.5%
2.4%
2.9%
2.4%
4.3%
2.4%
5.7%
5
-7.1%
$2.63
6.4%
1.3%
$2.33
5.4%
1.7%
$2.24
5.3%
3.1%
$2.35
5.5%
4.3%
$2.51
5.8%
1
Home sales growth
Originations ($ trillion)
MOO growth
1
2
3
4
5
Yield on 3-month Treasury bill.
Yield on 10-year Treasury note.
Consumer Price Index (total).
Fannie Mae house price index.
New plus existing sales .
•
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The Three "Big Questions"
As we solidified assumptions about market conditions for the plan period, we found
that we were stymied by three issues we called the "big questions." These questions, although
long-term in nature, presented near-term crossroads and therefore needed resolution. These
originally emerged from discussions with Directors during our preparation meetings. The first
and most profound is, should we consider relinquishing the charter, both in benefits and
requirements, and "privatize" the company? Second, what should we do with the mortgage
portfolio- is the size more trouble than it's worth, and should we- as some critics suggestreduce it? Third, as we determine where to take our business within the charter, what is our
raison d'etre- what do we do, and do well, that we should focus on more?
Question 1 - Is privatization an available path?
•
•
•
•
•
The charter delivers significant value to shareholders; no viable alternative during this
strategic period replaces that value.
Investing major resources in evaluating privatization does not make sense for the
planning horizon.
Privatization should be the subject of periodic updates or "fresh looks" as time or
events dictate.
The recommended strategy will build capabilities that would remain relevant under
either privatization or the charter.
This question is not new. We have asked it on and off for at least 20 years. Most
recently, the Board commissioned Citigroup and McKinsey & Co. to independently perform
"Project Phineas" in 2005 to look at the charter's value to shareholders. It again affirmed that
the charter's value was greater than any viable non-charter scenario.
Shareholder Value Derived from the Charter
(2005 Analysis)
$62.63
$59.06
$60
billion
billion
$so
$28.89
billion
$40
$33.74
c:
billion
.Q
i\5
$30
$20
$10
$0
Mkt
Price
7/11105
Sum of the
Parts with
Charter
Sum of the
Partswlo
Charter
We updated the 2005 analysis again this year and concluded that, in fact, there had
been no erosion in the $30-plus billion of shareholder value inherent in our charter and the
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capabilities we have built in order to fulfill that charter. While value creation is the purpose of
this plan, if it zero sums with value erosion (charter or otherwise), then we go back to the
drawing board.
The promise of privatization contemplates th~ notion of increased business
opportunities through both vertical growth and diversification of products and markets.
Vertical growth includes the prospects of moving into, for example, mortgage origination,
mortgage servicing, or asset distribution. Diversification includes moving into, for example,
jumbo mortgages, international markets, or asset management. While some of these
opportunities are technically permitted within the charter today, in practice they are not
pursuable without significant operational, financial, or political risk.
The promise of privatization also contemplates a greater ability to adapt to a changing
marketplace, which involves greater flexibility, creativity, and innovation.
Our analysis of privatization looked at three models: 1) Sallie Mae's transition from a
GSE to a hybrid public/private structure; 2) creating a separate company; and 3) creating a
GSE holding company.
•
1. Sallie Mae - In brief, Sallie Mae was a GSE established to provide a market in student
loans, which effectively relinquished its charter and formed a "Newco" after facing a
prohibitive user fee as the cost of keeping its status. There are important differences
between Sallie Mae during its privatization and Fannie Mae today. Size and market impact
is a major difference; Sallie Mae managed $80 billion in student loans; Fannie Mae's book
of business is $2.6 trillion and mortgage portfolio more than $700 billion. Sallie Mae's
market capitalization was $2.4 billion; Fannie Mae's is more than $65 billion. Sallie Mae's
primary constituents were student borrowers; Fannie Mae's are housing advocates, lenders,
developers, builders, debt and equity investors, and more. Congress passed legislation that
imposed costs on Sallie Mae that were greater than the value of its charter; Fannie Mae's
charter continues to have value greater than the costs. Sallie Mae was the only GSE under
its then charter; Fannie Mae's competitor, Freddie Mac, operates under the same charter
and, therefore, related decisions affect and require the agreement of both companies. Sallie
Mae's management had more freedom of movement, with both Congressional
acquiescence and virtually no market opposition; those conditions do not exist for Fannie
Mae. So, while we can learn from Sallie Mae, it~ experience is less useful as a blueprint
for us.
·
2. Creating a separate company- Liquidating the company, taking selected operations or
assets and starting a new Fannie Mae without its current GSE obligations and/or existing
assets is a concept that essentially would represent "turning in the Charter." This obviously
would be impossible without Congressional approval, which we judge unlikely absent a
crisis more severe than 2004-2005. Having experienced a full spectrum of political
alignments from the 1992 legislation until now, our assessment (and that of our advisors) is
that there has never been serious impetus toward "permissive privatization."
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3. Creating a GSE holding company- Allowing Fannie Mae to create new business entities
separated from obligations of the charter while retaining GSE status for some or all of the
current company essentially is a "bank holding model." For the reasons above, this concept
also is unlike! y to gain traction.
In summary, Congress decides whether we can privatize. If it ever seriously considered
this option, it almost certainly would seek an exit fee, a user fee on the total book of business,
severe portfolio limits, elimination of a critical securitization instrument - the TBA execution or other equally adverse steps. There might be a long lead time for the company to prepare, at
least 5-10 years.
In 2005, the market environment was at its peak for the prospects of Congressional
action. The politics of the Congressional majority, the Administration, and the Federal
Reserve were aligned. The voice of critics was fueled by the accounting crises at the GSEs.
Competitors were taking share while the market was hungry for capital and suppliers had the
appetite to take in increasing mortgage risks. Yet, amid "ideal dynamics" for privatization,
Congress could not enact reform legislation in which there was general agreement on key
provisions. And two years later, the market and policy response to the meltdown of the
subprime market indicates that the GSEs continue to be important to the stability of U.S.
housing.
•
Our conclusion is that Congress would rather have a regulated entity supporting U.S.
housing and does not fully trust the private sector to bear that responsibility alone.
Furthermore, the current draft legislation, which includes a provision for an affordable housing
fund, would potentially add new stakeholders to the GSEs .
However, so long as we retain any form of GSE status, we will no doubt be criticized.
We are too big and occupy too many mortgage crossroads to be out of sight or out of mind.
We will respond to fair criticism, and will have to bear some unfair or invidious commentary.
Oltimately, though, a big bet on privatization should be, in my view, about a big economic
return, not about paying for silence. In that regard, given our positive growth prospects,
neither alternative business model nor disinvesting the present one makes sense. The proposal,
then, is to execute the maximum potential of the strong model we have built.
We will continue to think about privatization creatively and monitor the economic
value of the charter. We will reassess the question regularly, but will not devote major
resources to it unless the math changes. That said, we also believe that the activities we need
to undertake to maximize in-charter opportunities basically are consistent with those we would
develop to operate without the charter. Under any scenario, completing remediation,
overhauling our systems and energizing a competitive culture are mandatory. We did not
uncover attractive business activities of scale- outside the charter. That made sense for us to
develop while skipping over as-yet undeveloped in-charter activities. For example, consumer
banking, mortgage origination, broker-dealer and financial assurance are all plausible activities
-but ones even well-established firms are struggling to rationalize .
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In conclusion, absent a clear proposition to garner $30 billion of market value to
replace the estimated charter value we would lose, we do not recommend a change for the
present.
Question 2: Should we reduce the mortgage portfolio?
•
•
•
Shrinking the portfolio poses serious risks to the credit guaranty businesses.
Size of the portfolio should be driven by economics of returns vs. cost of capital, not an
arbitrary level.
.
We will manage and measure the portfolio differently.
We tackled the proposition of reducing our $725 billion mortgage portfolio to, for
instance, $300-$500 billion, the size contemplated in legislative proposals by those critical of
the portfolio function. Put in strategic terms, we asked whether we should undertake a major
re-allocation of the company's capital.
We began with a set of "champion/challenger" questions about the portfolio:
•
•
Capital and returns. The portfolio consumes 55-60 percent of the company's regulatory
capital. While our 30 percent regulatory capital surplus is in effect, the portfolio is
projected to continue producing returns at around our 9-10 percent cost of capital.
GAAP income is forecasted to contract, with single-digit GAAP return on equity.
Would the shareholders rather have their money back, instead of seeing it earn at only
around our cost of capital?
•
Risk. An instantaneous 200 basis point change in interest rates produces a $9 billion
loss in the company's fair value. A 10 basis point widening of the mortgage/debt
spread produces a $3 billion loss in the company's fair value. The portfolio should earn
roughly $2 billion in fair value per year and $1.5. billion of GAAP net income. At those
returns, are the risks and reported volatility of the company's results worth it?
•
Political lightning rod. The Federal Reserve, OFHEO, the Treasury, the White House
and key members of Congress all take issue with the portfolio. Would it actually
provide value to shareholders to take this issue off the table?
•
Value proposition. Some say neither we nor Freddie Mac yet have been able to provide
investors with a compelling rationale (or understandable metrics) for the value
proposition of our portfolios. Could we remove a discount. on the stock by making the
mystery smaller?
•
Been there, done that. The $200 billion reduction in the portfolio in 2005 was a test
case- nothing negative appeared to occur to the company or to the market.
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•
•
We then ·pursued the other side of the hypothesis and looked at a second set of
questions:
•
Oooortunities arise: We know that exceptional double-digit growth opportunities arise
for the portfolio from time to time. If we diminish our portfolio infrastructure by
shrinking it, will we leave profit potential on the table when opportunities do strike?
•
Competitive position: How much downside is there to cede the liquidity advantage and
potential investor and dealer interest in our debt to Freddie? What unintended
consequences might occur, and spill over to our other businesses, if Freddie gains a
material leadership advantage?
•
Strategic reality. Our charter limits us to only two basic businesses: guaranty and
portfolio. Do we really want to get rid of a $500 billion business? Do we want to cast
our lot with only one business? Moreover, if the 30 percent capital surcharge goes
away, our expected returns clearly exceed our cost of capital.
•
Support to other businesses, including the "price spread": With a $300-$500 billion
portfolio, could we support the MBS, the key to our success in Single-Family and
support Single-Family and HCD whole loan purchases and support housing goals and
have capacity left over to earn good returns?
•
Administrative costs: Total direct costs for the portfolio are about $230 million, almost
all of which are fixed. Consequently, there is no "cost" advantage to shrink (while
conversely there are cost benefits to growing) .
Weighing these pros and cons, we decided that overall, there are significant "throw the
baby out with the bathwater" issues involved in shrinking the portfolio, while there are critical
benefits to maintaining its size and ability to grow when opportunities arise. These reasons
include:
1. Potential returns. When the 30 percent regulatory capital surplus is lifted, which we
believe could happen as early as next year, the returns on the portfolio would rise well
above our 9 to 10 percent cost of capital. While reducing the portfolio would produce a
somewhat larger return on equity, that benefit would be offset by the lost earnings
potential.
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The Returns of the Portfolio
The Economics of the Portfolio
Returns with 30% Suq~lus
0.30%
0.25%
0.13%
0.13%
-0.030%
-o.030%
0.35%
0.40%
OAS
Earnings on ln'-'3sted Capital
Less: Direct Admin Expense
Pre-Tax Income
After-Tax Income
0.23%
0.26%·
0.21%
0.24%
Less: Cost of Preferred:
-o.03%
-o.03%
-o.02%
-o.02%
Income Available for Common Shareholders
0.20%
0.23%
0.19%
0.22%
Regulatory Capital Requirement
Regulatory Surplus
Total Capital Required
2.05%
30%
2.67%
2.05%
30%
2.67%
2.05%
0°/o
2.05%
2.05%
0%
2.05%
20%
20%
20%
20%
2.13%
2.13%
1.64%
1.64%
% of Preferred in Capital Structure
Required Common Equity
==:>
·9.37% 10.89%
Return on Equity
Earnings Rate on ln'-'3sted Capital
Cost of Preferred Stock
Tax Rate
•
Returns without 30% Sur(!lus
0.25%
0.30%
0.10%
0.10%
-o.030%
-0.030%
0.37%
0.32%
5°/o
5.6%
35%
11.38% 13.36%
5°/o
5.6%
35%
5°/o
5.6%
35%
<===
5°/o
5.6%
35%
2. MBS price advantage. The market traditionally has priced Fannie Mae's MBS better
than Freddie Mac's;on a pass-through certificate yield, the difference has been 3 basis
points so far in 2007. This three-point advantage, when added to our guaranty fee,
comes to $600 million in annual revenue on a $2 trillion book (or a present value of
$2.5 billion). While hard to measure, it is clear that our portfolio's ability to purchase
·Fannie Mae MBS supports the demand and price of our security, so a smaller portfolio
would be less able to purchase our MBS and support our price spread.
The Price Spread:
• 2007 Average Fannie Mae MBS yield: 5.68%
• 2007 Average Freddie Mac PC yield: 5. 71%
• Fannie Mae price advantage: 3 bps
The Value of the Price Spread:
• Value of 3 bps price advantage, as addition to Guarantee Fee
Annual Revenue on $2 trillion: $600 million
Present Value: $2.5 billion
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3. Support for customers. The portfolio's ability to support our Single-Family and HCD
customers - and our affordable lending efforts -by purchasing whole loans and
securities is critical; shrinking the portfolio could pose serious risks to these businesses.
In addition, we may be asked to stabilize markets with additional capital. A $100
billion surge on a large portfolio (e.g., $700 billion) can be absorbed more readily than
on a small portfolio.
Therefore, we decided we should not have a bias to reduce substantially the size of the
portfolio, and at present do not have a compelling economic argument to shrink it. This
decision does not mean that the portfolio will never shrink; if returns are clearly less than our
cost of capital, we should shrink. If the returns are good, we should grow. ·The simple answer
about the portfolio, therefore, is we will "follow the economics." ·
Deciding that, we also believe the value proposition for the portfolio should include the
following elements:
•
•
•
•
•
•
•
Long-term growth expected to be on pace with mortgage debt outstanding,
projected above U.S. economic growth.
Expected adjusted rate of return on equity close to double digit with 30 percent
capital surplus, and in excess of double digit without the capital surplus.
These returns will be observable in the fair value metrics of the company.
The duration gap will remain close to zero, and other risk metrics on the low side of
typical market ranges.
Consistent with "Big Tent" Mission - reinforce liquidity and stability role .
Continue to work on market perceptions of the portfolio.
Question 3: What is our raison d'etre- where should we focus?
•
•
•
We should continue to be the most effective distributor of global capital to U.S. housing.
We should focus our business on the activities that deliver the greatest value measured by
risk/return.
·
Our best. opportunity for business and mission is in expanding securitization and credit risk
management.
After addressing and resolving the big questions about the charter and mortgage
portfolio, we asked an organizing question: Can we identify a central, unifying "theory of the
firm" to define our strategy?
We chose the term raison d'etre to emphasize the broader nature of the question, rather
than the practical reasons we exist (e.g., to provide affordability or liquidity). It is important
for established companies, as they map their future course, to step back and evaluate their
purpose in order to strengthen it. In our case, it means encompassing business and mission.
•
In doing so, we determined that Fannie Mae's business mission, in the broadest sense,
is to be the most effective distributor of global capital to housing in the United States. Our
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primary business supports middle-income homeowners but we also enable affordable housing,
and smooth out fluctuations in housing finance. We want to operate within the charter, and
believe that fulfilling our business mission should fulfill the charter mission.
With that broad reason for our existence, we then sought to determine the focal point of
Fannie Mae's business. A traditional approach to strategic planning looks at types of
companies that provide corollary business models to consider. In that regard, we determined
that Fannie Mae's actual business activities are comparable to three different business models:
•
•
A utility, or processor/securitizer, in that we convert loans into securities for
mortgage originators. This lowers mortgage rates, provides liquidity to the market
place. Here we are similar to Freddie Mac, Bear Stearns, Sallie Mae and Capital
One.
•
An investment company, in that we manage market risk by funding with agency
debt and investing in loans and securities, and we earn a spread for managing
mortgage cash flow, providing liquidity and taking market risk. Here we are
similar to JP Morgan Chase, Citi, Bank of America, real estate investment trusts
(REITs) and Freddie Mac.
•
An insurance company, in that we guarantee (or insure) mortgage payments to
investors, and accept mortgage default risk. Here we are like MGIC, PMI, Radian,
UGI and again, Freddie Mac.
Because no individual business model was a complete corollary to Fannie Mae, we,
instead, looked at the primary functions performed by those companies. Across the three
business models were four functions common to the three and to Fannie Mae - securitization,
interest rate risk management, mortgage cash flow risk management (also referred to as spread
investing), and credit risk management.
Which functions provide the highest returns for risk? The answer at a summary level is
as follows:
Different Corporations _~mphasize Different Functions
Functions vs. Returns Generated
Securitization
Interest
Rate Risk
Spread
Investing
Credit
Utility/Processor/
Securitizer
High
Low
Moderate
Moderate
Investment Company
Low
Moderate
High
High
Insurance Company
Moderate
Low
Moderate
High
Corporate
Comparisons
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Which function(s) should be the emphasis in Fannie Mae's strategy going forward? An
easy answer is that we should emphasize those functions with the highest returns for risk, and
create shareholder value. The harder questions, however, ar:e which functions have the best
return/risk ratio for Fannie Mae? Which functions can be expanded most? Where do we have
the greatest opportunities with the greatest competitive advantages?
To answer those questions, we first examined how much emphasis our corollary
companies - utilities, investment companies and insurance companies - place on each function
and why. Clearly, they emphasize particular functions that generate the highest returns.
Utilities emphasize securitization. Investment companies emphasize spread investing.
Ins.urance companies emphasize credit.
We examined each function as follows:
•
•
Securitization: This "fee for service" business has very low risks, mainly operational
in nature. It is a "scale" business, maintained by size. It is crucial to our charter
function to provide liquidity to the housing finance system .. And the diversification of
the mortgage originator base enhances our value to the market. However, given our
current 25 percent market share and leadership in the MBS market, it would be tough to
grow significantly. Our MBS business is most closely identified with 30-year
mortgages, which are now among a wide variety of consumer choices. Its relevance is
less tangible to communities. It must be buttressed by our portfolio balance sheet to
ensure its liquidity and stability. It also is sensitive to anomalous prepayment of loans
that comprise the securities and, therefore, reduce anticipated revenue streams.
· I Securitization provides good returns relative to risk, but can be tough to grow.
•
Interest rate risk management: In the past, Fannie Mae has achieved strong but also
variable returns on this function. As discussed, it is incidental or necessary to support ·
mortgage investment. We expect it to generate returns from owning the shape of shortto long-term rates (the yield curve) and, possibly, from selling long-dated volatility.
The variability can be quite high, and can be exposed to long-dated volatility from
prepayments. We believe there is little or no comparative advantage for a GSE in
managing interest rate risk, as it can be easily hedged in the market, and therefore the
stock market is unlikely to give it a high PIE premium for success. Finally, growing the
balance sheet as a GSE per se has become politically unattractive.
Interest rate risk management provides an ambiguous ratio of returns relative to risk.
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•
Mortgage cash flow risk management: This function, also known as spread
investing, provides consistently good returns, and indeed provides a strong ratio of
returns to risk over the long term. It has a reasonable PIE as a relatively low risk
strategy. It is driven in part by generating liquidity through selling agency debt to buy
mortgages, and so is another part of the liquidity business. Risk premiums historically
are higher than losses. However, it cannot be grown rapidly at attractive levels, and can
be reactive to the market and, therefore, undesirably subject to market vagaries. Also,
at Fannie Mae, this function has been driven by the "science" of generally reliable
models, with little reliance on individual decision making or judgment. It is not easily
hedged in the market; we must hold investments for several years; and it expands or
shrinks with market demand or supply, so it cannot grow with predictability.
Mortgage cash-flow risk management provides good long-term returns but is not easy
to grow.
•
•
Mortgage credit risk management: Generally will provide goodreturns, though with
increased volatility. Our credit risk profile can be expanded rapidly when market
opportunities exist. An expanded credit risk appetite increases affordable lending,
supports our securitization programs, and, most importantly, gives us more relevance
and tangibility with our lender customers. However, appropriate credit risk pricing
relies on the intelligent use of models in making business decisions and on the
intelligent use of business knowledge in building models. Moreover, the limited range
of available credit risk management tools restricts hedging opportunities, forcing a
strong reliance on a buy-and-hold strategy. We can, however, leverage our loss
mitigation and real-estate owned (REO) capabilities as well as our real estate market
knowledge to efficiently manage the credit risk portfolio. An expanded credit risk
appetite provides opportunities to grow by further leveraging our market position and
expanding our customer relationships.
Mortgage credit risk management provides good returns relative to risk over long-term
and is easier to grow than other options.
Four internal Fannie Mae teams each championed one model to evaluate and prepare a
set of recommendations that were discussed in depth at the senior management offsite. They
analyzed each against a common set of criteria, with the finding summarized in the table on the
next page.
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Our Comparative Advantages Across Options Going Forward
Securitization
Interest Rate
Risk
Management
Mortgage Cash
Flow Risk
Management
Credit Risk
Management
H
H
H
MIL
H
Do we have a market advantage?
• Liquidity
• Scale
• Expertise
H
H
H
M
H
H
H
What are the opportunities?
• Growth of market
• Growth of share
• Market pricing
M
M
L
M
L
L
M
L
MIL
H
M
H
Mil
L
M
L
H
M
M
L
M
M
How mission rich is the activity?
• Affordable housing
• Stabilization
• Tangibility to communities
L
H
L
L
L
L
M
H
L
H
M
M
What conflicts will the activity create?
• Commercial
• Regulatory
• Political
L
L
L
L
H
M
H
H
H
H
H
H
Can we generate value added to the
shareholder?
• Will the market pay us a premium
• Growth
• Consistency of earnings
• Risks
H
M
H
H
H
M
(H=High; M=Med1um; L=Low)
•
As our analysis showed, all four activities bring some degree of value to the company,
some a high degree. Therefore, we are not eliminating any one of these as a business activity,
but instead choosing which ones to emphasize during the course of this strategic plan.
From the chart above, it is clear that - on balance - securitization and credit risk
management, offer the most "High" and "Medium" comparative advantages for Fannie Mae
for the first four of the five categories above. Those results make analytical sense and common
sense. Our securitization business has produced the most highly valued, liquid mortgagebacked securities in the marketplace. Our credit risk management has produced unusually low
credit losses for our business year after year, and the 'average mortgage in our book has
relatively low loan-to-value ratios (less than 60 percent, weighted average) and high credit
scores (720 FICO). In both areas, we have a distinct competitive edge and room to do much
more.
Therefore, we believe that focusing more emphasis on credit risk management and
securitization should be an organizing purpose for our business and our mission, given:
1) our market advantages in these activities; 2) our opportunities to grow the business
through these activities; 3) the added value we can generate for shareholders; and 4) the
high value they offer for our affordable housing mission.
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The Strategic Choice- Broaden and Deepen
After determining where we are, who we are, our strategic opportunities and answers to
the big strategic questions, our strategic path for the next three to five years became much
clearer. We have a solid franchise- we can do more with it. We have room to grow within
the charter- we must find the most optimal segments to mine. Examining our raison d'etre,
we have determined that the greatest opportunities for our mission and business, in terms of
risk, return and value, are in securitization and credit risk management.
Therefore, we have chosen a strategy that rests on three pillars:
1. As we grow with the growing mortgage-debt market, we will also grow our share of the
market by going deeper into segments where we have only scratched the surface.
2. As we preserve the value and advantage of our securitization business, we will also expand
this business.
3. As we preserve and build up our credit risk management abilities, we will increase our
breadth in managing credit risk in areas where we have little presence. There are 11 areas
in particular- subprime, Alt-A and seconds; acquisition, development and construction
lending; multifamily equity; small multifamily properties; commercial mortgage-backed
securities; securities below AAA-rated; mezzanine debt; and reverse mortgages.
•
In other words, for the next three to five years, we will both deepen our reach in
traditional businesses that we hold leadership positions in already- credit guaranty,
securitization, Capital Markets- as we broaden our reach by finding new areas to develop. We
Will go from "The Egg," shown in Figure 1, to the "3-D Egg," shown in Figure 2.
Figure 1 - "The Egg"
HCD
Sihgle
DUS
Credit Risk AsSessment
Credit Risk Management
Distressed Asset Management
Product Oevi:llopment ·
Enhan::ed Data Anafytics
Pipeline Management .
Aisk·based Pricing & Fees
Bulk Purchases
Mflex· ·
MAE
LIHTC
Pools
·crBcit Risk Assessment
·
Credit Risk Management
. Enhanced Data Analytics
Small Loans
·
i
Rnanclng
Br~ker Marketing
Technology Platfoons
Automated Underwriting
eCommerce Tools
Appraisa!
MBS
Capitai Markets
Benchinark Notes
·Callable Debt
StrUctured Securities
Lender Uquidity
eCommitting
Private L.abet Securities Investments
RetaU investors ·
MBSUquidity
Interest Rate Risk Assessme'nt
=:J,. Occupied spaces
=:J= Emerging or Unoccupied spaces
=:J= Charter vs. Long-term Strategy
Interest Rate Risk Management
Enhanced Data Analytics
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Figure 2 - The "3-D Egg"
Small market, low
shareholder value
Large market, high
shareholder value
•
We believe there is tremendous opportunity in deepening our reach in traditional
businesses we are. leaders in, and broadening our reach to find new areas to develop, in ll
specific areas. Our forecast of the average annual incremental industry profit for each, where
estimates are possible, is shown in the chart below .
Industry Profit Pools
2007 forecast
($billion)
2011 forecast
($billion)
Subprime
$4.0
$3.8
Alt-A
$1.9
$1.6
2nds
$1.1
$0.9
Small MF
$0.2
$0.2
Equity
n/a
n/a
AD&C
$4.6
$4.6
CMBS
$0.1
$0.1
<AAA securities
$0.5
$0.4
Mezzanine debt
n/a
n/a
<$0.1
<$0.1
Reverse mortgages
Source: Fannie Mae Business Strategy
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Summary: The strategy process and- results
So far this strategic plan has outlined the steps we have taken leading to the choice we
have made about our strategic path for the next three to five years.
As the diagram below illustrates, we began the process by stating the purpose of Fannie
Mae, answering the question of why we exist. From there, we addressed our mission in the
context of what we do, and then provided a vision reflecting the aspirations we have fo~ the
company.
Summary: Multilevel Alignment
Mission
One Vision
•
Our Aspirations
Our Plan
Strategy
'Execution and Metrics
Measures
The sections that follow address our strategy to achieve that vision and the measures to
evaluate the progress against that strategy.
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Section IV: How We Will Get There - Business Plans, Mission Impact
•
•
•
We will expand capacity to securitize and purchase more credit-sensitive assets.
Single-Family and HCD will take the lead, supported by Capital Markets.
This strategy will provide greater access to mission-rich mortgage assets.
The next step in our strategic planning is to "operationalize" the direction by
formulating specific business strategies. Our plan to pursue more opportunities for
securitization and credit risk management will require each business- Single-Family, HCD
and Capital Markets.,.. to undertake new approaches, new investments, and a new mindset that
managing _mortgage credit risk is our sweet spot- we need to do more of it, and do it better;
for our business and our mission. The plan also demands that the three businesses operate as
One Fannie Mae.
•
•
What we are going to do: We will support the expansion of the breadth and depth of the
credit guaranty businesses. Single-Family and HCD will expand further across the credit
spectrum in securitization. Capital Markets will acquire more credit-sensitive loans for the
portfolio, and use the balance sheet to generate cash flow risk management earnings,
maintain MBS liquidity, and acquire and manage part ofour credit exposure. We will
manage the credit risk of our loans on balance sheet, our MBS off-balance sheet and our
investments in private label securities consistently. We plan to further improve the
risk/return ratio by creating an off-balance sheet credit risk execution. Overall, we plan to
build a best-execution mechanism to quickly bring in a broader array of credit-sensitive
assets; quickly size, process and value the credit risk; and keep what we like and distribute
out the risk we do not like through a variety of mechanisms. 2
•
What we expect to gain: This option offers market advantages, opportunities to grow and
generate value for shareholders, and mission benefits:
>>-
The market advantages include our access to capital and cost of funds, data
resources, and our broad access to mortgages through our nationwide customer
base.
The opportunities to generate value added to shareholders include: 1) the market
will pay us a premium for this function, since Fannie Mae most often is the
preferred market execution; 2) the market would welcome our growth into credit
segments that have more risk; and, 3) earnings would be stable and consistent
because this is a sustainable business proposition.
2
This plan will include completing the second and third phases of the Risk Transformation Facility launched in
2006 as a joint Single-Family/HCD/Capital Markets initiative. In Phase I, we developed the process to slice off
and distribute credit risk in bulk mortgage securitization deals from a single lender. Phase II will allow risk
transformation of bulk deals from multiple lenders. Phase III will allow risk transformation in "flow" business daily deliveries of mortgage product from all lenders. This will give us the same capability that our private-label
competitors· have to manage credit risk.
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);;>
);;>
•
The mission opportunities include: l) managing more credit risk would give us
access to more affordable housing products; 2) allowing us to play a stabilizing
force in these segments; 3) allowing us to provide tangible benefits to communities.
The projected financial results are attractive- the earnings outlook and key metrics
- are provided in Section V, "How we will measure success."
What we need to do: Pursuing this opportunity to grow credit risk on- and off-balance sheet
will create some conflicts to address. The greater challenge will be to create new
capabilities within the company to take on more and different types of risk. These
challenges include:
);;>
Credit models: We need to develop a better risk-based pricing methodology
consistent with a broader risk spectrum. Generally, credit models are less reliable
than our present prepayment models. Therefore, they must be transparent, not a
"black box," and the results must be internalized by credit decision makers, and
used as a guide to decision-making.
);;>
Credit culture: Fannie Mae historically has had a business culture of avoiding credit
risk; now we must take and manage more credit risk, and possibly accept losses that
exceed historical levels. We need to buy and build long-term expertise of what can
go badly in more credit sensitive sectors.
);;>
Competition and conflict: Taking more credit risk invariably means a changing
business dialogue with mortgage insurers and investment banks, which not only
creates competitive stresses with clients, but also political noise and resulting
scrutiny. Keeping more risk will also require regulatory coordination. Businesswise, we also must view assertions of originators and lenders skeptically; price
negotiations become increasingly critical in client relations. We will need to
continue to build external relationships with all these parties that can withstand the
like! y stresses.
);;>
Infrastructure and One Fannie Mae: We plan to develop the back office technology
to value, track and monitor our credit-sensitive assets, and build distribution
channels (e.g., broker/dealer-like capability). We also plan, under our Risk
Transformation Facility, to develop multiple outlets and strategies for risk we don't
want to hold. We will take an integrated business approach to reflect the market
price of credit. When market prices change, we will adjust prices accordingly or
risk losses in dollars or market share. We also need to tap into alternative market
executions and capabilities.
•
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Business Segment Plans: Single-Family, HCD, Capital Markets
The following sections describe how the three business units- Single-Family, HCD
and Capital Markets- plan to carry out their part of the strategy.
Single-Family Mortgage Guaranty
The Single-Family business plans double-digit growth over the next five years by
harnessing its inherent market advantages to increase credit risk-taking and distribution.
•
Market environment: The housing and mortgage market corrections described in Section
III trend favorably for our Single-Family business as mortgage risk pricing and
underwriting become more rational, and demand for fixed-rate products increases. At the
same time, the correction is causing many lenders to consolidate or move up the value
chain into our business, giving them more pricing power.
•
Strategy: We start in a strong position, having decided to step back from the surge in
"layered-risk" subprime lending in 2003-2005 (not to mention the good luck of timing).
As the market returns to rationality we are in an enviable position to assist our customers
and grow our guaranty business.
);>
Single-Family plans to regain and extend our market share and leadership, broaden
and deepen our credit appetite; increase our risk distribution and execution
capabilities; maintain our MBS "brand preference," and help lender customers
transform their processes via ease and speed of delivery, provide them with a
dependable source of liquidity; and provide low-cost and dynamic speed of
products to the market.
);>
We will carry out these strategies by harnessing our competitive advantages in
several areas: our nationwide distribution network of over 2,000 lender customers;
the liquidity, safety and price advantage of our MBS; our role as a capital-rich and
stable provider of funding; our integration with vendors and partners; and our data
from the 16 million loans we "touch" -e.g., borrower behavior and loan
performance we can use to build better scorecards; repeat sales data we can use to
test collateral valuations and reduce appraisal "bias," and prepay modeling for
pricing, as well as real-time model adjustments and forecastin.g.
);>
Our deep and broad lender relationships, when combined with our "business
distribution mechanisms" (agreements and technology like DU), allow for a great
deal of scalability. A new produ~t or idea, once validated and formed, can be
switched on readily and in size with almost every player in the mortgage market.
);>
Generating significant volume and driving it through toMBS securitization can be
done effectively. Additionally, this reach allows for a continuous market read in
•
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terms of trends, new products and credit. The scale and liquidity of our MBS and
the depth of our capital position ensure staying power in any cycle.
)>
Lenders see great benefit from the funding and capital advantage of our MBS; their
ability to maintain. "velocity" by quickly moving out pipelines into MBS and
replenishing their ability to lend again is essential.
);> As we ensure a high level of service and value and maintain our flow arrangements,
we maintain the flow into MBS to keep that security very liquid.
What changes if we succeed - Single Family Strategy
2007
•
2011
Credit Risk
Capable in conforming prime product, but
under-skilled in other sectors
Skilled acquiring, pricing and managing credit
across risk spectrum
Credit Losses
Low, little appetite; lots of back-end
enhancement without best-execution
Higher losses; optimized backend, focusing on
total return versus losses
Risk Distribution
Limited approaches, mainly Ml's; generally
buy-and-hold
Broad within the credit markets; buy, hold, and
sell
Speed-to-Market
Slow response to major requests and market
trends
Nimble, respond quickly to market changes
Operations
Older technology, labor intensive
More efficient systems and processes
Org design
Relatively silo-ed businesses
More cross-org activity
Housing and Community Development
HCD's business strategy is to increase the supply of affordable housing, primarily
rental housing, by providing capital at all stages of the property lifecycle through both debt and
equity investments.
Based on this strategy, the HCD business plans double-digit growth over the next five
·-years by expanding its customer base, streamlining processes and strengthening our ability to
take on more risk and price for it, including additional credi_t risk, construction risk, and risk
associated with small borrowers.
HCD will continue to focus on low- and moderate-income families, while transforming
a more mission-driven business into mainstream financing.
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.
L1fecycle
Land
)
Acquisition
• Acquisition
loans
Debt
- _\
. \
Pre. ) Permanent)
.
DevelopmenJ Construct1of Stabilization
Financing
Renovat1on
• Tax-exempt
bonds
• Construction
loans
• Permanent
debt
• Development
loans
Mezz
Mezzanine financing - - - - - - - - - - - Equity- For Rent and For Sale - - - - - - - - - +
• LIHTC"
• LIHTC
• Historic tax
credits
Equity
•
Market environment: The variety and volume of capital flows into U.S. commercial
real estate have increased dramatically over the past several years. Major factors
include the increasing role of private equity capital, the privatization of formerly public
REITS, conduits formed by Wall Street houses, and increased leverage. These changes
have resulted in a market much more favorable for borrowers than the historical norm.
Annual Investment in US Commercial Real Estate
10 Year CAGR: 17.46%
•
$400
$350
~
$250 + - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - -
...m- $200
+--------------------------
$50
$-
-. 1996
1997
1998
1999
2000
2001
---
• Private Debt
• Public Debt (CMBS)
2002
2003
-·~----------------
• Private Equity
..
2004
-----
2005
-----~
Public Equity (REITs)
i
"---------~-~-----------------------------'
•
Strategy: We will maximize our mature HCD businesses (multifamily and Low Income
Housing Tax Credits (LIHTC), through both our Delegated Underwriting and Servicing
(DUS) network and LIHTC fund manager partners.
);>
In 2008, our double-digit earnings projections are driven by our LIHTC and DUS
multifamily businesses. Right now, our LIHTC business brings in about 60
percent of HCD revenues while serving families earning 60 percent or less of the
area median income. Streamlining our DUS program and enha:ncing our LIHTC
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•
delivery platform will help maximize our income in these mature businesses. We
also will expand our customer base beyond our traditional business partners, to
include non-risk-sharing lenders, investment banks, regional small multifamily
lenders, intermediaries, equity funds and other commercial real estate investment
partners.
);>
For 2009-2011, our projected earnings growth is driven by our Community Lending
business and gains in our For Sale/For Rent equity business. In the For Sale/For
Rent business, the company invests equity capital and earns a return (1) when
completed homes are sold to homeowners, (2) when renovated or newly built
apartment buildings are sold to operators, or (3) when we hold an investment in an
operating apartment building and are entitled to a share of rental income. Our
Acquisition, Development and Construction (AD&C) lending, mezzanine lending
(involving loans subordinate to a first mortgage) and other new business initiatives
will require strategic product development and differentiated customer
management.
);>
Credit losses in HCD's business historically have been very low due to favorable
market conditions and strict underwriting procedures. The increased competition in
our market will require us to take on more risk, price it and transfer it to generate
incremental revenue. We will investigate expanding our risk management through
various types of financial instruments including our new Risk Transformation
Facility (RTF), Collateralized Debt Obligations, and Credit Default Swaps. We
expect modest increases in credit expense from a very low base due to growth and
diversification of HCD business beyond our traditional focus on debt secured by
first liens on operating rental properties. As depicted below, the incremental
revenue we forecast from this expansion significantly exceeds the additional credit
losses we expect.
HCD Revenue/Credit Expense Trade-off
$1,800
$1,300
:?
;!!!..
$800
$300
------------------------------------------
..
!
Iii Annual Forecasted Revenue
• Annual Forecasted Credit Expense
:,__----~- ------------------------------- ---- ----------~---------------------------------
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~
Threats to this strategy include our ability to scale infrastructure to take on
additional and new types of partners, a reduced company appetite or capacity to
hold multifamily debt in portfolio, adverse changes to corporate earnings which
impact our tax credit business, and a decline in market conditions for debt and
equity investment in rental properties.
HCD Lines of Business
2007-11
Forecast
Growth
Multifamily/
Small Loans
3.0%
LIHTC
8.3%
Opportunities
Risks
• Expand business through new
products and partners
• Streamline and strengthen
infrastructure (DUS Redesign)
• Channel conflict
• Capacity to manage additional
risk
• Further develop trading
capabilities
·Value of credits impacted by
corporate earnings volatility
------------------~-~~!9.~~!~_9_e:~i~e:~.P~~-~9!~-------····--·--·----------------------------Equity
(Non-Tax)
62.5%
• Expand customer base through
new partnerships
• Automate delivery platform
• High competition reduces
returns
• Market conditions prolong hold
periods
73.2%
• Expand product set
• Implement differentiated
customer management strategy
• Capacity to manage new types
of risk (e.g. AD&C)
•
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••
•
What changes if we succeed- HCD Strategy
2011
2007
Primary Competition
Conduits, Freddie, other LIHTC
investors
Same plus investment banks, insurance companies,
institutional equity investors, AD&C debt buyers
Customer Base Profile
DUS/Depository Lenders, LIHTC
Fund Managers
Investment banks, regional small multifamily lenders,
intermediaries, equity funds and other commercial real estate
investment partners
Product Line I Business
Line Mix
Permanent multifamily debt, lowincome housing tax credits;
emerging businesses in equity,
AD&C, and public finance
Same plus for sale/for rent equity, mezzanine debt, bridge
debt, product bundles across property lifecycle
Pricing strategy
(including capital usage)
Bifurcated into OAS, G-lee; driven
by regulatory capital
Unified pricing, driven by economic capital
Securitization versus
portfolio usage
Portfolio is dominant execution
Portfolio; actively manage liquidity to ensure MF MBS
remains viable; expand to new securitization structures and
financial instruments to lay off risk, including Collateralized
Debt Obligations, and Credit Default Swaps
Risk Layering and
Sharing
Focus on risk sharing
Increased capability to price and manage risk allows us to
acquire additional and new types of risk, holding it or
transferring it as appropriate
Distribution and
Customer service
DUS is major distribution channel
and servicer
Multiple distribution channels to reflect expansion of
permanent debt business, growth of new types of business
Technology Focus
Remediating by developing basic
front-end systems to replace EUCs
Common business architecture with shared data repository
Operational Priorities
Adapt current systems for broader
product sets, new types of partners
and lines of business
Flexible/adaptable infrastructure and selective outsourcing
Key Value proposition to lenders and partners
Reliable capital source based on big
balance sheet, for narrow product
range
Reliable, fast, and flexible capital source based on superior
risk management
Capital Markets
Capital Markets plans single-digit income growth through 2011 and near double-digit
adjusted rate of return on capital. The business will focus primarily on supporting the liquidity
and price advantage of our MBS; purchasing mission-rich mortgage assets; and providing
liquidity when the market needs it. The mortgage portfolio will grow opportunistically or
shrink depending on market needs and prices. Should a market dislocation or other
opportunity emerge, the Capital Markets group will respond profitably.
•
Market environment: We expect that demand and competition for mortgage assets among
investors will remain strong over the next three to five years, making the spreads between
the cost of funding mortgage purchases and the yield from holding mortgages to remain
tight. At the same time, these conditions may create additional opportunities to sell
mortgage assets we own at attractive prices. All told, we do not expect optimal economic
conditions for portfolio growth. However, demand for mortgage assets, especially
overseas, will create good conditions for Fannie Mae to fund our portfolio and match our
assets and liabilities.
•
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•
Strategy: Rather than pursue portfolio growth for its own sake, Capital Markets will work
in tandem with Single-Family and HCD to support the company's overall strategy of
expanding securitization, credit risk management and affordable housing impact. Capital
Markets will focus on the following areas in particular:
};>
•
Emphasize less liquid assets. We expect the greatest return to investment and the
greatest mission benefit by supporting less liquid securities and those investments
whose fundamental value is less recognized by the market. That includes multifamily loans and securities, commercial MBS backed by multifamily properties,
non-traditional single family products such as 40-year, reverse mortgages, interest- ·
first loans, "seconds," hybrid ARMs and specified pools of long-term fixed-rate·
mortgages.
};>
Supporting the liquidity of the TBA MBS. A major priority for our balance sheet is
to maintain equilibrium in TBA MBS trading in the market. To this end, we attempt
to maintain an active volume of securities in secondary hands. We believe the free
market is likely to operate effectively most of the time as the volume of lenders
contributing to the MBS market remains large and diverse. Simultaneously, we
expect REMIC and Mega production to remain healthy as it adds demand to MBS
without detracting from overall MBS liquidity. We expect to use our balance sheet
· from time to time to support the demand for, and liquidity of, our MBS when
market supply/demand conditions are unsettled for new or seasoned paper.
};>
Investments in more credit-sensitive products. We believe there will be more
opportunities for the portfolio to invest in credit~sensitive products, which would
yield a significant premium above any expected losses. We also have unused risktaking capacity relative to our required economic capital. In addition, we expect to
be able to select a subset of credit-sensitive investments that should perform
relatively well over their investment horizons. We believe this gradual shift
supports our mission to provide investment capital to housing challenges.
};>
Adoption of Fair Value Option. We cannot sell any significant volume of assets out
of our holdings because we have declared the intent and ability to hold these assets.
The adoption of the FAS 159 accounting standard in January .2008 will permit us to
sell or re-securitize from a large pool of assets that are not currently availabl~. to us.
This additional flexibility should enhance our profitability, our liquidity mission
and our .risk management to a modest extent.
};>
Emphasis on structured products for financing. The market for GSE debt is
increasingly moving toward a tailored model with frequent issuance of relatively
small-denomination securities being issued to meet specific demands by small
institutional investors. We expect this trend to continue over the next few years and
plan to streamline our operations in order to be increasingly responsive to our debt
investors.
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What changes if we succeed - Capital Markets Strategy
2007
201t
Size of Mortgage Portfolio
Determined by economics and
accounting constraints
FAS 159 will reduce current constraints
on sales
Unused capacity of economic capital
Considerable surplus economic
capital
Increased Use of economic capital
against credit sensitive assets
Funding source mix
Active funding tailored to investor
demand
Extended investment in permitting new
structures
Level of portfolio sales or resecuritizations
Highly limited currently due to
accounting constraints
We expect to open up 10-20% of
investment to possible sale
Balance Sheet asset mix
Largely concentrated in 30-year
FRM
More illiquid securities & loans
Risk Layering • Management and Distribution
Mostly AAA assets including
Fannie Mae MBS and private
label securities purchased from
the street
Greater use of subordinated !ranches I
RTF issued by Fannie Mae
Balance Sheet liability mix
Limited amount of structured
product
Greater ability to use structured
products
Strong returns with modest risk
over 3-5 year horizon
Incremental credit risk on balance
sheet with greater total returns
Support of price spread and
purchase of loans
Increased purchase of credit sensitive
loans and securities
Key Value proposition -to investors, lenders and
partners
Key Value proposition internally-- to SFB and HCD
Business Strategy Impact on Mission
•
•
•
•
•
We will "mainstream our mission" into our business and into the market with approaches
that we can replicate and carry out in large scale.
We will proudly re-enlarge our mission to include not only affordability, but middle
incomes, liquidity and impact.
As we focus on meeting tougher HUD goals, we also will target four key areasurban/worliforce housing; rural and Native American housing; rebuilding the Gulf Coast;
and housing the homeless.
We will integrate our mission-business strategies with our corporate giving.
An important goal as we determined our raison d'etre as a company and chose our
strategic path was to ensure our business would n.ot only achieve our mission, but also
transform how we achieve it. We want to "mainstream" our mission- that is, provide liquidity
to low- and moderate-income segments of the market every day as part of our normal course of
business. (Or, as I began stressing three years ago, "The mission is the business and the
business is the mission.")
Our strategic choice to emphasize credit risk management offers tremendous
opportunities to achieve our affordable housing mission because, quite simply, underserved
segments of the market would benefit as we bring our "fairest of them all" products, pricing
and standards deeper down the credit scale. Expanding our service to these markets also offers
tremendous business growth potential because these markets are both underserved (e.g., the
•
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20-point gap between the minority homeownership rate and the national average), and the
fastest -growing populations.
We are taking a more businesslike approach to our pursuing our mission in four ways:
1. Replicate, scale and grow. We will seek to replicate, expand in scale and grow one-off
affordable housing initiatives and boutique products into full-fledged lines of businesses
that serve communities and create value for shareholders. Our MyComrnunityMortgage
product is a gooci model. It began as a modest initiative to help our commercial bank
customers meet their Community Reinvestment Act requirements. It evolved into our
flagship affordable housing product now distributed nationally through .our Desktop
Underwriter (DU) system; in fact, in wake of the subprime market meltdown, demand has
surged and we recently raised the price to more accurately balance risk and return. We will
identity more places where Fannie Mae can mainstream mission activities into our business
with approaches that are scalable and replicable.
2. Build controls, processes, metrics. The mission-related business will be subject to the same
controls, processes and disciplines that we apply to our "normal" business. The work we
have done over the past two years to "operationalize" our acquisition, development and
construction lending program is a lesson learned for all our mission-related initiatives- do
it right the first time, then go. We also will carry out our mission activities in way that
provides measurable business value, and build mission-relevant metrics into our business
activities and judge these activities based on the numbers.
•
3. Innovate guickly, nimbly. We will move quickly to pursue innovative approaches to
affordable lending needs as they arise. For example, in response to the subprime market
meltdown, in early 2007 we launched our HomeStay initiative to help struggling
homeowners facing adjustable-rate payment shock refinance into safer products. Housing
market shifts tend to hit underserved populations the hardest, so we will emphasize moving
nimbly with our innovations.
4. Integrate business and mission. We will take steps to link and overlap the three business'
affordable housing initiatives with the company's mission support functions, including our
revamped Community Business Centers and Corporate Giving functions (described later in
this se~tion), and relationships with housing partners.
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Takingand managing more credit risk in our Single-Family, HCD, and Capital Markets
businesses will give the company access to a wider array of mortgage assets that help our
partners meet the needs of underserved populations - low- and moderate-income families,
borrowers with non-traditional financial and credit histories, and communities that need
investment capital for renewal. In particular:
•
•
•
•
Single-Family will be able to offer more "affordability" mortgage products for
borrowers with imperfect credit or non-standard employment and income records .
HCD will grow businesses such as small multifamily lending that provides rental
housing to lower income populations and its acquisition, development, and construction
lending that is critical for community revitalization. It will also continue to expand its
business with housing finance agencies to bring mortgage financing solutions to their ·
targeted populations.
Capital Markets' focus on purchasing less liquid mortgage assets and credit-sensitive
products will increase its contribution to our affordable housing business.
We plan to seek a reasonable rate of return on our "mission-rich" affordable housing
business. We will not in all cases seek the highest rate of return, but we also will not subsidize
our affordable housing business by accepting negative rates of return. In fact, because the
affordable housing business tends to serve credit-challenged markets, proper risk-based pricing
should provide a pricing premium and our effective credit risk management should reduce loss
and expense. We will continue to utilize our experience and understanding of the multifamily
housing market to serve the broadest possible spectrum of housing needs nationwide. Existing
proofs of this concept include:
•
•
Fannie Mae's Low Income Housing Tax Credit business provides equity capital for the
construction or rehabilitation of affordable housing targeted to households below 60
percent of area median income. Since 1987, this product has committed more
than $14.8 billion in capital serving more than 450,000 very low
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income households while achieving returns which meet or exceed corporate return on
equity targets.
•
Fannie Mae's Modernization Express product provides capital to public housing
authorities to renovate and recapitalize their public housing developments. Through
this product we have invested more than $143 million serving more than 13,400 very
low-income households in publicly subsidized housing. This product is directed at
families earning less than 30 percent of their area median income, and exceeds the
company's required rate of return.
HUD goals get tougher
The HUD affordable housing goals are one public manifestation of our mission. Our
strategy of expanding our credit risk appetite is critical in meeting these goals. For 2004-2008,
the goals require Fannie Mae's acquisitions to finance a greater percentage of low-and
moderate-income family mortgages than the proportion the market will produce. That is
especially true as housing affordability- the combination of home prices, mortgage costs and
incomes- has fallen. We had to absorb significant costs to meet the HUD purchase money
subgoals in 2006, and we are struggling to meet the goals and subgoals in 2007. We will
continue to pursue every reasonable opportunity to expand our purchases of goals-eligible
mortgages.
•
The current housing goals rule will expire at the end of 2008. The strategy over the
next year and a half is to work with our regulator to establish a more flexible goals regime that
reflects market realities while still ensuring our market leadership in supporting affordable
housing lending. We believe the new rule should set the housing goals levels based on the
most current, best available market data and guide the regulator to adjust the goals levels in
line with changing market conditions. Similarly, among the objectives for our engagement on
the legislation before Congress is to enact new housing goal authorities that are consistent with
the principle that the goals should reflect changing market opportunities for affordable housing
lending.
Beyond HUD goals: Focused Investments on Particular Needs
In addition to providing liquidity and access to the broad housing finance market,
Fannie Mae will seek to make investments in particular areas of housing need where the
Company's specific skills and commitment can make an impact.
•
Four target areas: Our strategic plan will focus on difficult and complex affordable
housing challenges in four targeted areas: l) Urban/workforce housing needs; 2) rural
and Native American communities; 3) Gulf Coast rebuilding; and, 4) permanent,
supportive housing for the homeless. This will require the company to invest in new
infrastructure and products, as well as reorganize our Community Business Centers to
focus on these areas (as described below).
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•
Above and beyond: Since the aftermath of Hurricane Katrina, we have invested over
$3.5 billion in thehard-hit Gulf Coast areas helping to restart lives, aiding evacuees,
financing rebuilding, and leveraging our employees. That is in addition to our $20
billion in normal business in that region to keep the market flowing. But in two years,
we- and the rebuilding- have barely begun. In this area we are especially willing to
take and manage additional credit risk, try new investment strategies and occasionally
accept lower returns.
.::~~. '-~Cr......:.t;.. u· ..:.:-~
Fannie lVbe Investing Billions
in Gulf Coast Recovery
:_~:..
:".
:::
.
I
•
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. .··::--fi:.~~~~.<:<
The company is refocusing the current 49 Community Business Centers from localized
community development efforts to a centralized, higher-impact national approach to the four
targeted mission activities (urban/workforce housing; rural and Native American communities;
Gulf Coast rebuilding; and homelessness).
The Centers will be responsible for finding business opportunities for Single-Family,
HCD and Capital Markets to address these four areas. The Centers will have a greater
engagement directly with community partners, gathering local market intelligence for the
company's competitive advantage and providing detailed analysis of potential opportunities
and risks. In realigning the Centers, Fannie Mae will still maintain national coverage through
49 offices, and also, link the Centers with the Office of Community and Charitable Giving to
provide more tools (e.g., investments and contributions). The goal is to have a more tangible
impact on communities and work with local housing leaders nationwide to address specific
community needs.
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Integration of Corporate Giving
Our new Office of Community and Charitable Giving will help to achieve our mission.
A major goal of bringing our philanthropic efforts into the company was to integrate them with
our community investment strategies to have a greater impact on a broader scale- and to
promote an even greater culture of service within the company. As we complete the transition
of our giving efforts from the Fannie Mae Foundation, the company plans to make $42 million
in contributions this year while the foundation plans to provide $28 million.
The community giving office will focus on 1) supporting housing and community
development initiatives nationwide; 2) helping to prevent and end homelessness; ·and 3)
helping to build thriving communities in Washington, D.C. The office·willleverage all of the
resources of Fannie Mae- financial capital; seed capital (grants); human capital
(volunteerism); and intellectual capital- and collaborate with the business units and support
functions of the company, such as Human Resources.
A recent example of this work can be found in our response to the subprime market
turmoil. As part of Fannie Mae's effort to assist, we provided $5 million in grants to
NeighborWorks America and the Homeownership Preservation Foundation to increase public
awareness of foreclosure challenges, expand counseling, build the capacity of local coalitions,
and enhance the use of technology in counseling. The goal of the grants is to provide
counseling to more than 90,000 homeowners at risk of foreclosure, with nearly 40,000
ultimately avoiding foreclosure.
•
Another important element of the Office of Community and Charitable Giving will be
targeting resources to build capacity among our housing development partners to both
strengthen their work and its impact on local communities. For instance, the Office of
Community and Charitable Giving is currently working with our Community Lending team to
develop a comprehensive strategy that presents one voice to the non-profit community. In
recent strategic discussions with the Local Initiatives Support Corporation (USC), we
presented an outline that includes:
•
•
•
•
•
a line of credit debt facility to help fund specific community development
projects through our Financial Intermediaries Channel;
training with our Public Entities Channel to address public ho~sing
rehabilitation strategies;
·
tax credit investments to spur supportive housing development for the homeless
in select markets;
sharing of intellectual capital to support Rural 515 manufactured housing
financing; and
grant money to support both forums convened by USC to address affordable
housing challenges and operating support to help USC scale its operations
behind these business opportunities.
Our new strategy ties our grant making activities to business opportunities wherever possible,
and in its early stages, has been well-received by the non-profit CillUIIlJJ.ll.it.¥..:
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Taking Action - Execution Drivers
Our business and mission will be powered by a corporate-wide strategy for execution.
Our strategic plan has a number of dependent variables in order to generate results. In some
cases, systems and processes need to be revamped. In others it is a simple matter of shoring up
talent, organizational structure, controls, or policies. In all cases, however, the businesses will
chart their path to execution so we can set our priorities across the company and make the
appropriate trade-offs in our resource allocation plan.
For example, take our strategy of adding credit-sensitive assets to the balance sheet.
We currently have capacity to grow in this direction, but our vision of becoming a nimble and
effective market player in this space will require us to cover many bases over a period of time
as you see in the exhibit on the next page.
Execution Strategy to be nimble and effective
Real-time execution adding
credit sensitive assets as
opportunities arise
•
Grow credit
sensitive
assets on
the balance
sheet
Our listening tour with customers pointed to the need to improve in how and when we
execute. Some said in substance "Stop listening and start delivering." Others said "Provide
solutions now ... It's nice that Fannie Mae is listening, but in this challenging market,
customers are looking to Fannie Mae for answers not questions."
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Over the next 90 days following Board input, this strategic plan will be joined by an
execution plan to deliver on approved priorities throughout all organizational functions
including:
•
•
•
•
•
•
•
Operations and Information
Human Resources
Risk
Financial Management
Legal and Compliance
Government and Industry Relations
Audit
All levels of the organization will align themselves with what those priorities are, what
resources will be deployed, what our timelines are, and where the accountability rests. We will
shift, adapt, and redirect our efforts as needed by unique windows of opportunity or challenges.
Our strategy and our execution plan will aim to be responsive to our customers, investors, and
partners in real time. The execution will need to be as good as our strategy- if not better.
•
Summary: Section IV
• Maintain MBS positioning
)o> Liquidity and transparency
;.,. Portfolio support
)o> Best execution
• Expand credit securitization/investment capabilities
)o> New product segments plus Risk Transformation Facility
)o> Single-Family: front and back end capability
)o> HCD: extend beyond Low Income Housing Tax Credits and DUS multifamily
lender partners
)o> Capital Markets: broader asset mix
• Mainstream the mission
)o> Redefine and integrate
)o> Restructure Community Business Centers
)o> Office of Community and Charitable Giving in supportive role
• Drive execution
;.,. Affirm priorities
~ Human Resources and culture implications
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Section V: How We Will Measure Success- New Financial Measures and
Metrics
•
•
•
Disclosures and new financial measures will reflect the economic drivers of the
businesses and create a common language for both performance management and
performance measurement.
These measures, combined with a two-tiered capital distribution strategy, will provide
a clear picture of value creation over time.
The new performance measures focus on three key elements:
- Reporting segment results for Single-Family, HCD and Capital Markets
- Disclosing.a new non-GAAP measure called "Adjusted Net Income"
- Providing a suite offinancial disclosures for each segment
This plan introduces new measures of financial performance and more expansive
disclosures of business segment results. At their root, these new measures are designed to
provide a reasonable picture of how the Company is performing and highlight the key drivers
affecting the business. Also, these measures are aligned with the metrics we use to manage the
business- which links the numbers and management activities.
•
Fundamentally, two key numbers drive our value: The earnings multiple paid for
sustainable GAAP earnings from the guaranty fee business; and the book multiple attached to
the net balance sheet assets. Apple-to-apple, the guaranty fee multiple is likely to be higher
than that for Capital Markets .
Business Segment Results
The plan is focused on three business segments- Single-Family, HCD, and Capital
Markets - which is consistent with how we manage .the business. The numbers we use to
measure our own internal performance will be the same as those used to report the business;
key metrics that are important to the business are also reported as part of the plan. This
approach communicates information about the company in a consistent manner and it should
help us focus on and deliver shareholder value as we all begin to speak a common
measurement language.
Segment reporting also delineates the different businesses drivers that exist within the
company. In particular, the business drivers behind Single-Family and HCD businesses are
meaningfully different from the business drivers supporting the Capital Markets business.
Segment reporting allows an insightful view into the revenues, expenses, adjusted net income
and related metrics associated with each of our business segments.
A New Measure
There is not one standard measure that comprehensively and accurately captures the
operating results of Fannie Mae. GAAP does a good job at capturing the results in the SingleFamily and HCD businesses and, in our judgment, best reflects how successful (or not) we
have been at managing those businesses.
·
•
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However, GAAP does not produce a reasonable measure of Capital Markets'
performance, principally because it applies different accounting to assets, liabilities and
derivatives. In addition, GAAP recognizes net interest income of certain matched asset-andliability transactions in an uneven way, frequently accelerating net interest income into earlier
periods.
We believe changes in the fair value of net assets after an adjustment for changes in
spread are a good measure for Capital Markets' annual performance. Essentially, this adjusted
fair-value measure reflects a level net interest income (spread), which represents economic
earnings over the life of the portfolio. We believe it best reflects our strategy of being a longcycle investor in mortgages, and removes the impact of periodic and temporary changes in
market value. Importantly, this measure is used to manage the business and also is used to
describe the capital markets activity of our primary competitor, Freddie Mac.
Fair value does not do a good job reflecting the operating performance of SingleFamily and HCD, principally because the credit characteristics of our book of business are
hard to measure in a reliable manner. Fair value also is not reflective of the business practices
of our Single-Family and HCD businesses, as we are a "buy-and-hold" issuer of guarantees,
not a trader of guarantees.
•
For purposes of this plan, we propose a measure, Adjusted Net Income, which
combines GAAP results for the Single-Family and HCD businesses and fair value adjusted for
changes in spread for the Capital Markets business. We believe Adjusted Net Income is the
best measure for capturing the performance of the Company.
These non-GAAP metrics will supplement, not replace, GAAP. In all cases, non-GAAP
measures will be reconciled to GAAP. In the case of adjusted fair value, total fair value, which
includes the effect of spreads, will be provided as well. These disclosures will be completely
consistent with SEC rules that contemplate some companies do in fact manage their business
for results that differ from GAAP. Such is the case with Fannie Mae's Capital Markets
business.
Capital Markets
Single Family
Fair Value
Income
(ex spreads)
Suite of Financial Disclosures
In addition to this new measure, a suite of financial disclosures will be provided on our
three business segments. These disclosures will focus on the key drivers affecting the business
and are consistent with disclosures of our competitors in similar industries. These disclosures
can be summarized as follows:
•
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Single Family & HCD
Capital Markets
C,--------------------,--------------------,
~~~----G_AA
N_e_t_A_ss_e_ts--~
__P_N
__
et_l_n_co_m
__
e ____4 -_ _F_a_ir_v_a_l_ue__
~------------------------.---~-------------------,
~
•
~
•
•
Book of Business
- Size
- Growth
- Fees
- Liquidations
New Business
- Volume
·- Acquisition share
- Fees
Credit
- Loss and allowance to book
- Number of defaults
- Charge-offs
8 •
Book of Business
New Business
Credit
•
•
•
Portfolio
Fair Value (FV)
FV Changes Due to OAS
•
Portfolio
- Size
- Percent of new business
- Prepayment rate
Fair Value
- With spread
- Without spread
FV Changes Due to Option
Adjusted Spreads (OAS)
- Spread of book
- Roll off
- New business
oL-----------------------~----------------------~
~
.g
Gi
~ •
gj
-~
•
~
•
•
•
Combination of New Measures and Metrics. Taken together, the segment focus,
GAAP and non-GAAP measures, and supplemental financial disclosures of key business
drivers should provide a clear picture of economic results and help investors and other
stakeholders answer key questions about our operating performance and value.
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Financial Overview
•
•
•
Growth across all three business segments.
18% annual growth rate of quarterly cash dividends.
Mix of net income shifts to higher-multiple earnings from Single-Family and HCD.
This plan is the result of a bottom-up process involving the business segment and
finance organizations. The plan is focused around three key drivers that provide strong
financial results over the plan period- high single-digit revenue growth, aggressive cost
containment, and active distribution of excess capital. The plan assumes that OFHEO lifts the
portfolio cap after we are a current filer and have completed all outstanding remediation
requirements. We believe the plan is challenging, but achievable. The key elements of the plan
are as follows:
•
•
10 percent annual revenue growth through 2011, from $10.5 billion to $15.5 billion,
with growth across all of our business segments.
•
13 percent annual adjusted net income growth through 2011, from $4.5 billion to $7.3
billion, driven by revenue growth and cost containment.
•
14 percent annual adjusted EPS growth through 2011, from $4.39 to $7.49, driven by
adjusted net income growth and stock repurchases.
•
18 percent average quarterly cash dividend growth annually through 2011, from 47
cents to 93 cents, which should place Fannie Mae in the top quartile for dividend
returns.
•
Adjusted Return on Average Equity (ROE) in mid to high teens, growing from an
annual rate of 14 percent in 2008 to 17 percent in 2011.
•
$3 billion of shares repurchased through 2011.
In addition, over the plan period the mix of earnings shifts toward the higher-valued net
income generated from the Single-Family and HCD businesses. In particular, in 2007 about 60
percent of Fannie Mae's adjusted net income is from Single-Family and HCD, and 40 percent
is from Capital Markets. By the end of the plan, 70 percent of the adjusted net income is from
Single-Family and HCD, and 30 percent is from Capital Markets. Unless otherwise noted,
income numbers exclude non-recurring administrative expenses, catch-up/get current, and
restructuring costs.
•
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Comorate Financial Outlook 2007-2011
2007
$8, unless noted
2009
2008
07-11
CAGR
2011
2010
Adjusted Revenue
7.0
$
Single Family
$
7.8
$
8.8
$
9.6
$
10.7
11.1%
Housing & Community Development
1.2
1.4
1.6
1.8
2.0
12.6%
Capital Markets
3.1
3.1
3.2
3.5
3.8
5.7%
Elimination
(0.8)
. (0.9)
(1.0)
(1.0)
(1.0)
$ 10.5·
$ 11.5
$ 12.6
$ 13.9
$
$
$
$
$
$
Total Company
15.5
10.1%/
Adjusted Net Income (1}
4.2
17.3%
Housing & Community Development
0.4
0.6
0.7
0.8
0.9
18.8%
Capital Markets
1.9
1.8
1.9
2.0
2.2
4.9%
Total Company
4.5
12.9o/~
Single Family
2.2
$
$
2.8
5.2
3.4
$
3.7
5.9
$
6.5
$
7.3
Financial Metrics
Adjusted EPS
. Quarterly Cash Dividends
$ 4.39
$ 5.18
$ 6.01
$
6.66
$
7.49
14.3%
$ 0.47
$ 0.55
$ 0.73
$ 0.81
$
0.93
18.2%
$1.0
$0.4
$0.6
$1.1
Share Repurchases ($8)
•
Adjusted ROE
12.2%
14.1%
15.5%
16.2%
17.2%
GAAP ROE
12.6%
13.2%
13.9%
14.8%
15.2%
( 1) Excluding non-recurring admin expense I Catch-Up I Get Current and restructuring costs
2007
$8
Adjusted Nl to Common
Single Family
HCD
Capital Markets
2008
2009
2010
07-11
CAGR
2011
$
2.0
0.4
1.9
$
2.6
0.5
1.8
$
3.2
0.7
1.9
$
3.5
0.8
2.0
$
3.9
0.9
2.2
18.4%
19.0%
4.8%
$
4.3
$
5.0
$
5.7
$
6.3
$
7.0
13.1%1
Allocated Common Ca~ital (excluding OCI}
Single Family
12.3
$
$
HCD
0.8
Capital Markets
20.8
Cushions I Excess*
1.7
13.0
0.9
19.9
2.0
$
13.9
1.0
20.9
2.0
$
14.7
1.1
22.0
2.0
$
15.1
1.2
23.1
2.0
5.2%
10.3%
2.7%
35.8
$
37.8
$
39.9
$
41.5
3.9%1
ITotal Adjusted Nl
ITotal Allocated Capital
Returns on Allocated
Single Family
HCD
Capital Markets
jAdjusted ROC
• Excludes
Derivati~.e
•
Confidential Proprietary Business Information
Produced Pursuant to House Rules
$
35.7
$
Ca~ital
16.1%
52.7%
9.6%
20.6%
62.1%
9.2%
23.5%
68.3%
9.2%
24.4%
70.3%
9.5%
26.2%
71.5%
9.9%
12.2%
14.1%
15.5%
16.2%
17.2%
VAR, which is attributed to Capital Markets
PROPRIETARY AND CONFIDENTIAL. ~ONFIDENTIAL TREATMENT REQ~¥STED
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•
Single-Family Earnings Outlook and Key Metrics
•
•
•
•
•
•
•
•
The Single-Family business outlook is for 17 percent annual adjusted net income growth,
from $2.2 billion in 2007 to $4.2 billion in 2011, driven by double-digit revenue growth
and controlled administrative costs and credit expenses.
Revenue grows 11 percent annually, from $7.0 billion in 2007 to $10.7 billion in 2011,
. because of increases in guaranty fee (G-Fee) income. G-Fee income growth is driven by
increased volume and changes in mix: our book grows at rates that exceed mortgage debt
outstanding (MOO) growth while the G-Fee rate increases as our mix of business includes
higher..;yielding Alt-A and subprime product.
.
New business volumes are expected to track the market:.__ shrinking in 2008 and 2009 as
refinancing activity slows, but rising thereafter. ·our share, about 30 percent of total
origination volume, is expected to remain stable.
Day One Losses - the accounting treatment on assets for which we pay a premium over
market price- reach their highest levels in 2007 at $1 billion, reflecting declining home
prices and competitive pricing pressures. After 2008, those losses level off at
approximately $0.5 billion, as home prices increase and pricing returns to normal levels.
Credit and credit-enhancement expenses increase because of higher-risk products in our
book, partially offset by reduced credit costs related to our traditional products as home
prices rebound at the levels assumed in our outlook: As indicated in the summary part of
this plan, it is likely we will assume more credit risk. This would result in lower credit
enhancement expense than indicated in the chart below, which in turn would lead to higher
credit expenses.
Administrative costs decline in 2008, reflecting improved operating efficiencies and the
effect of actions undertaken in 2007.
Returns on equity grow from 16 percent in 2007 to 26 percent by 2011, driving significant
value creation over the plan period. The returns highlight the benefits of scale.
Single-Family Earnings Outlook 2007-2011
$8
j
2007
Net interest income
Guaranty fees (ind. notional)
Fee and other income
$
1.2
5.6
0.3
$
1.1
6.5
0.3
Revenue
$
7.0
$
7.8
Investment Gain/(Loss)
2009
2008
2010
1.2
7.4
0.3
$
8.8
$
07-11
CAGR
2011
1.2
8.1
0.3
$
1.3
9.1
0.3
3.0%
13.1%
-1.7%
9.6
$
10.7
11.1°/ol
0.2
0.2
0.2
0.2
0.2
Day 1 Losses
(1.0)
(0.7)
(0.5)
(0.5)
(0.5)
N/A
Credit Expenses
(1.3)
(1.4)
(1.5)
(1.6)
(1.7)
7.6%
Credit enhancement/Other Expenses
(0.4)
(0.5)
(0.7)
(0.8)
(0.9)
25.0%
Operating Admin Expenses
(1.2)
(1.1)
(1.1)
(1.1)
(1.2)
0.3%
(4.2}
3.2°/o)
I Total Expenses
$
Pre-tax income
Taxes
I NI Exd. Non-Recurring Admin Expenses
$
(3.7}
$
(3.5}
$
(3.6}
$
(3.9}
$
0.0%
3.3
4.3
5.2
5.7
6.5
18.3%
(1.1)
(1.5)
(1.8)
(2.0)
(2.3)
20.2%
4.2
17.3°/o)
2.2
$
2.8
$
3.4
$
3.7
$
(1) Excluding non-recurring admin expense I Catch-Up I Get Current and restructurin~ cos~
•
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Key Single-Family Metrics
SF Credit Expenses ($B) and Cr Exp to Avg Book Ratio (bps)
SF Book of Business ($T) and Guaranty Fee (bps)
$4.0
Book 07-11 CAGR
= 5.5%
G-Fee rate 07-11 CAGR 5.6%
=
$3.5
50
$2.0
45
$1.8
'$3.0
40
35
·$2.5
30
!$2.0 :
25
20
15
10
:$1.5 .
i$1.0
:$0.5 '
5
:so.o
10.0
9.0
8.0
7.0
6.0
5.0
4.0
3.0
2.0
1.0
$1.5
$1.3.
.$1.0
$0.8
$0.5
$0.3
$0.0
2007 .
2008
-= Book of Business
2009
-
2010
2007
2011
11!15!
Avg G-Fee of Book (bps)
2010
Book of Business growth higher than MOO
' 12.0%·
New Business Volume stays at 30%
Market Share
$700
10.0%!
$600
8.0%;
•. 50.0%
. 40.0%
$500
1
6.0%
$400
'30.0%
4.0%
$300
. 20.0%
$200'
2.0%'
10.0%
$100
0.0%
2007
2008
2009
._ Book of Business Growth (%)
2010
-
2011
MJO Growth(%)
. 0.0%
$0
2007
2008
2009
Acquisition Volume ($8)
"MOO., Single Family Fintlien
•
2011
-Credit Expense I Book
New Business Volume {$B)
Book of Business Growth
12.0%;
2009
2008
Credit Expense
llli!il
- ------··------·- -. ·---- ·----------
2010
2011
-Acquisition Share (%)
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HCD Earnings Outlook and Key Metrics
•
•
•
•
•
HCD's adjusted net income grows almost 19 percent annually, from $0.4 billion in
2007 to $0.9 billion in 2011, driven by annual revenue growth of 13 percent and costs
containment.
Revenue growth is fueled by our book of business rising at 8 percent annually, from
$141 billion in 2007 to $195 billion in 2011. Growth is attributable to the multifamily
business growing in excess of MOO, and from new HCD initiatives such as small loans
and acquisition, development and construction (AD&C) lending in Community
Lending.
The tax -advantaged LIHTC business increases from $1.5 billion in volume in 2007 to
generating $2 billion or more of volume annually from 2008 through 2011, which
benefits Fannie Mae's effective tax rate.
Credit and operating expenses remain essentially flat over the plan period.
Return on equity is extraordinarily high, growing to over 70 percent as the Company
scales up its investment in the highly capital-efficient business of multi-family lending
combined with a high degree of tax benefits.
HCD Earnings Outlook 2007-2011
07-11
•
2007
$8
Debt Revenue
$
Equity Revenue
I Revenue
$
0.6
0.7
0.6
0.7
1.2
Credit expenses
(0.0)
Credit enhancement
·ongoing Administrative Expenses
(0.1)
(0.5)
I Total Expenses
$
Pre-tax income
Taxes
I Nl Exd. Non-Recurring Admin Expenses $
2008
(0.6)
$
$
1.4
(0.6)
CAGR
1.0
0.9
10.8%
0.8
0.9
1.1
14.4%
2.0
12.6%1
(0.1)
(0.1)
18.7%
(0.1)
(0.5)
(0.1)
(0.5)
0.0%
0.90fo
(0.7)
2.4%1
$
(0.1)
(0.1)
(0.5)
$
2011
0.8
1.6
$
(0.1)
{0.1)
(0.5)
$
2010
2009
(0.6)
$
1.8
(0.6)
$
$
0.6
0.9
1.0
1.2
1.3
20.0%
(0.2)
(0.3)
(0.4)
(0.4)
(0.5)
22.5%
0.9
18.8%1
0.4
$
0.6
$
0.7
$
0.8
$
( 1) Excluding non-recurring admin expense I Catch-Up I Get Current and restructuring costs
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Key HCD Metrics
HCD Book of Business ($B) & MF Guaranty Fees (bps)
Book 07·11 GAGA
= 8.1%
$195
$200
LIHTC Volumes per Year ($B)
50
40
$150
30
$100
20
$2.5
New LIHTC oroduction continues to be strona
$2.0
$1.5
$1.0
$0.5
$50 :
10
$0.0
$0
2007
2007
2008
2009
2010
2008
2009
2010
2011
2011
liUHTC
III!!E
MF- Other HCD -HCD Guaranty Fees (Bps)
MF Book of Business Growth vs. MOO Growth
9.0%
MF Debt Book grows faster than MOO
. 7.5%
. 6.0%
. 4.5%
1.5%
. 0.0%
2007
2008
2009
2010
2011
l&!lll!ll fiiF Book.Growth-MJO Growth
•
•
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Capital Market Fair Value Earnings Outlook and Key Metrics
•
•
•
•
•
Capital Markets fair value net income grows almost 5 percent annually, from $1.9
billion in 2007 to $2.2 billion in 2011, driven by increases in average option-adjusted
spreads and modest portfolio growth.
Fair value revenue grows almost 6 percent annually, from $3.1 billion in 2007 to $3.8
billion in 2011, as option-adjusted spreads grow from over 25 bps to 28 bps over the
plan period. Portfolio grows from about $700 billion in 2007 to more than $800 billion
in 2011. We are assuming the current cap on the portfolio is lifted or revised to allow
for this growth.
Costs remain relatively flat over the plan period.
Return on equity will be in the 9 percent range per year throughout the plan period.
We have not assumed any "opportunity" events, though historically these events have
occurred.
Capital Markets Earnings Outlook 2007-2011
07-11
2007
$B
Portfolio and LIP Fair Value Income
Market Risk Fair Value Return
Less Capital Charge
•
I Total Fair Value Net Interest Income
_1Q!Q_ _1Q!!_
CAGR
3.2
0.1
(0.5)
$
3.2
0.1
(0.5)
$
3.4
0.1
(0.5)
$
3.7
0.1
(0.6)
$
4.0
0.1
(0.6)
6.3%
3.7%
5.8%
~
2.8
0.3
~
2.8
0.2
~
3.0
0.2
~
3.2
0.2
~
3.6
0.2
6.3%1
6.3%
3.1
~
3.1
~
3.2
~
3.5
~
3.8
5.7%1
(0.5)
1.1%
~
(0.5)
Operating Administrative Expenses
Pre-Tax Income
Taxes
I FV NI Exd. Non-Recurring Admin. Expenses
2009
$
Fee & Other Income
I Total Fair Value Revenue
2008
$
(0.4)
(0.4)
(0.5)
2.6
2.6
2.7
3.0
3.3
6.5%
(0.7)
(0.8)
(0.8)
(0.9)
(1.1)
10.4%
2.2
4.9%1
1.9
$
1.8
$
1.9
$
2.0
$
{1) Excluding non-recurring admin expense I Catch-Up I Get Current and restructuring costs
Key Capital Markets Metrics
CM Portfolio Size ($B) and Annual Growth (%)
Option Adjusted Spread (bps)
35.0::-- - - - - - - - - - - - - - - - - - · · - - - - - - - - - -
·$1,000
Assume Portfolio grows at MOO
Overall OAS increases due to Higher
Spreads on New Business
starting in 2009
30.0
25.0
20.0
2007
2008
2009
Blilil Portfolio Size (Average)
•
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2010
2007
2011
am New Business
-Growth
2008
2009
-
Run Off
2010
2011
-Weighted OAS
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Administrative Expenses
•
•
Costs before non-recurring expenses reduced to $2 billion in 2008, remain flat in 2009,
and then grow slightly in 2010-2011.
Expenses will be actively managed with a focus on headcount, our professional
services and more modest employee benefits.
2007
$6, unless noted
$
Single Family
$
1.1
$
1.1
2010
$
1.1
2011
$
1.2
HCD
0.5
0.5
0.5
0.5
0.5
Capital Markets
0.5
0.4
0.4
0.5
0.5
$
!Total Before Non-Recurring Admin Expense
2.1
$
2.0
$
2.0
$
2.1
$
Catch-Up I Get Current (CU/GC)
0.7
0.2
$
$
$
Restructuring
0.1
0.1
$
$
$
2.3
$
$
!Total
Growth Before Non-Recurring Admin Expense
Efficiency Ratio Before Non-Recurring Admin Expense
•
1.2
2009
2008
2.9
$
2.0
$
2.1
$
2.21
2.21
3%
-5%
0%
4%
4%
20%
17%
16%
15%
14%
Sensitivities
2008 EPS Impact
Corporate
($0.07)
Admin Expense Reductions Miss Target by $100m
Single Family
Subprime Volume 30% lower than expected
($0.02)
Credit loss severity per loan increases 10%
($0.13)
Elimination of Non-charter CE for 2008 Acquisitions
$0.10
HCD
Delayed ramp-up of Community Lending initiatives (2008 ~.s 2007)
($0.01)
($0.02)
New Dil.1sional lni!iatives 50% lower than expected
Capita! Markets
OAS on New Business Reduced Sbps to -25bps
($0.06)
Portfolio Growth at MOO in 2008
$0.04
!Total Company Impact
($0.31}
$0.14
$5.18
$5.18
Total Company Adjusted EPS
3%
!sensitivity as %of Total
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•
This plan has three key assumptions, any of which could change projections if
circumstances change. However, we believe, overall, that the risks and sensitivities are
relatively balanced. The three assumptions are:
• The company is able to grow its credit risk prudently, that it can hire and retain the
expertise necessary to assess the credit risk, and be adequately compensated for taking
the risk.
• Supervisory and legislative bodies will accept the notion of additional credit risk at
current capital levels - and not change the rules of the road.
• The market will remain broad enough to support significant investment from Capital
Markets at acceptable spreads .
•
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Capital Distribution Strategy
Our capital distribution strategy results in significant increases in our cash dividend, as
well as the initiation of a multi-billion-dollar share repurchase program. The two tiers of the
strategy are related, with the intent to secure a steady stream of income for cash dividends
while using excess capital from Capital Markets opportunistically in the form of share
repurchases or, when necessary, to support the dividend.
Cash Dividend
We believe the steady and relatively predictable earnings of the Single-Family and
HCD businesses should be used as a guide to help determine the level of cash dividends paid
by the Company. This plan assumes 65 to 81 percent of Single-Family and HCD earnings will
be paid out in cash, ~hich results in average quarterly cash dividends growing from 47 cents in
2007 to 93 cents in 2011. We anticipate that our dividend payout ratio and dividend yield will
be competitive w_ith other select financial institutions.
Dividends as% of Guaranty Earnings ($8)
I
j$10
•••..
81.3%
~-s._o%____•_•-_o%____•_•._~_.____
68.0%
: $8 '
' $6 .
a~
.$1.5
$1.3
:
' 60%
~
•
Average Quarterly Dividends
:Jill._... ,.·....
2007
-
2006
Guaranty Earnings
2009
-Dividends
:$1.0
$0.8 .
·__ ...·:·
()",(,
2010
lOll
•$0.5
$0.3
$0.0
-Divas%ofG-Fee
2007
lnclNon·AIIcurring~min&;p
2008
2009
B Av Otrl Dividends
2010
2011
Share Repurchase
The capital needs of the Capital Markets business are more difficult to predict as the
portfolio could grow or contract depending on market conditions. Separately, we look to lower
our marginal cost of equity capital by approximately 4 percent by replacing common equity
with preferred stock to a practical limit of 20 to 25 percent of preferred stock outstanding to
total core capital. The plan assumes excess capital, including excess capital generated by the
Capital Markets business and through incremental preferred stock issuance, is distributed in the
form of a flexible share repurchase program. Over the plan period, we have assumed about $3
billion of share repurchases as follows:
Repurchase as% of FM Adjusted Income to Common ($8)
Total Payout as% of FM FV Adjusted Nl to Common ($8)
$10
30"!.
'$4
19.9%
2Qo;.
12
100%
$8
80%
$6
60%
$4
40%
1QOJ.
$2
. 0"!.
2007
2008
2009
2010
Confidential Proprietary Business Information
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$0
0%
20.07
2011
smm Repurchase -%of FNM FV Adj Nl to Common
•
20%
Emiii
Dividends
2008
-
2009
Repurchase
2010
2011
-%of FV Adj Nl
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•
Summary: Section V
• Lead with GAAP
• Adjusted Net Income combines guaranty fee GAAP with portfolio change in fair value as
key measure
• Plan outlook:
) Revenues: IO.I percent CAGR, reaching $I5.5 billion in 20/l
) Adjusted Net Income: 12.9 percent CAGR, reaching $7.3 billion in 2011
) Earnings Per Share: 14.3 percent CAGR, reaching $7.49 in 2011
) Return on Equity: Growing from 12.2 percent in 2007 to 17.2 percent in 201I
• Capital distribution competitive
) Dividend to 93 cents
) Share repurchased from Capital Markets
•
•
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•
•
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•
Section VI: The Reintroduction of Fannie Mae
•
•
•
•
Fannie Mae will begin this Fall to reemerge and reintroduce ourselves as a company.
We will reflect our new management, new approach to the market, new value
proposition and new "look,Jeel, tone and manner" consistent with our role in the
market.
We recognize and embrace our role as a B2B business- we are here to serve our
customers and partners who serve homeowners.
We will let our achievements- not hype- speak for us.
The final step in our business strategy is to "reintroduce" the company as we complete
the remediation phase at Fannie Mae, become a current financial filer and pursue our new
business strategy. The guiding principle of this "reintroduction" of Fannie Mae is alignment:
aligning the strategy, the mission and the metrics with one single, consistent message. As
Fannie Mae returns to the marketplace with current numbers, new management and a new
strategy, new impressions of the company will be formed that will last for years to come. I
believe we will get only one chance to make that first impression. This is our chance, and it is
crucial that we get it right- critical, because the tone and manner of our message has for many
years been an outsized part of the story of Fannie Mae.
•
It is vital, as we reintroduce the company, to recognize that not only will what we say
be scrutinized, but how we say it. Tone and manner matter, because they reinforce message
and numbers.
·
Since 2005, our actions, tone and manner have been closely aligned with our core
message: "Change, Progress, More to Do." The message reflected a set of values that people
could understand -- values such as humility, hard work, and forthrightness. The message
reflected a reality, a set of facts- intense regulatory and legal scrutiny combined with an
extensive and costly accounting restatement- that the company was grappling with on a daily
basis. Inherent in the message was an acknowledgement that the way Fannie Mae conducted
itself in the past had to change, that it was committed to making progress on the many issues
confronting it, and that it was forthright enough to admit it had more to do.
.. Maintaining this balanced posture will be critical to our introduction.
So, as we answer these questions:
•
•
•
•
What is our strategy for growth?
What is our investor/shareholder value proposition?
How will our performance be measured?
How is our mission fulfilled through our business strategy?
•
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The tone and manner will be:
•
•
•
•
Understate, over deliver
Continual striving for excellence (not just congratulating ourselves on achieving it)
Well-grounded, focused
Accepting of skepticism and listening to criticism
And the impression we leave:
•
•
•
•
Focused intent!~ on doirig the job, meeting our goals, fulfilling our mission
Business-to-business focused- not business-to-consumer focused
Nimble, market driven
Reliable, service-oriented, and value-producing
As this list implies, at the core of our message going forward is an understanding of
what Fannie Mae can deliver to its many diverse stakeholders. This is the essence of classical
"brand positioning." Over the last year-and-a-half, beyond the listening tours, we have
conducted formal research on the expectations of our stakeholders, especially our customers.
What we learned is that their expectations did not always align with our message.
•
For much of the last 15 years, our positioning conflicted with our activities. Through
annual reports, our charitable activities, television advertising, our speeches, and our relations
with policy makers and the media, we positioned Fannie Mae as a consumer company. We
sought to convey an impression that we served the American Homeowner, a consumer. While
the romance implicit in that message is potent and should remain implicit in our mission, the
fact is we are not a consumer company. While our mission is to bring global capital to address
the housing needs of America, we do it by being a business-to-business provider offinancial
services. We serve other businesses. When we go after their customers, they cease to be our
business partners, and become suspicious, hostile and un-partner-like.
Repositioning ourselves as a business-to-business company is part of our strategic plan,
and our message should closely align with this strategy, both internally and externally.
Operationally, the reintroduction will take place in two phases. In the first phase~ taking
place over 200 days beginning this fall, investors, employees and the media will be the focus
audience.
fROPRlE'fARY AND CO
,
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Reintroduction Timeline
Q4 '07
Oct
Nov
Q1 '08
Dec
Jan
Feb
Mar
Kickoff
Shareholder
Letter
New York,
New Jersey,
Boston,
Chicago,
Los Angeles
San
Pennsylvania
Ohio,
Texas,
Canada
Europe,
Asia
Positioning from Inside Out
(deep dives into businesses,
employee education, marketingadvertising, the anniversary)
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Phase One
Phase One of the reintroduction entails three aspects: A CEO letter to shareholders, a
200-day investor/media road show, and a employee engagement and education program.
The CEO shareholder letter will be posted electronically in October, and will be sent to
all shareholders as part of the materials for the 2006 annual meeting. In addition, another
10;000 copies will be sent to a variety of other stakeholders. The letter will in a real sense kick
off the 200-day campaign, framing the basic answers to these questions: Who are we? Where
are we? How are our mission and our business linked? Where are we going?
Over the 200 days, senior management will conduct 100 meetings in· 25 cities. The
meetings will be formal investor conferences, one-on-one meetings with significant
shareholders and partners, as well as editorial-board meetings with media organizations. The
message and the presentation will be similar, no matter the venue or audience: our basic value
proposition, our business and strategic goals, and how we are going to accomplish those goals.
For investors, the objectives are to appeal to a broader base, ramp up our outreach, expand our
disclosures, and articulate the strategy. For the media, the objective is to move beyond the "no
comment" position we've often been forced to offer since 2004. The objective will be to return
to orderly, deliberate and routine interactions with the press- including forms of "new" media
as well as national, regional and local outlets.
•
The third part of Phase One will be the all-important campaign on the home front, a
company-wide effort to infuse business-to-business positioning and values throughout Fannie
Mae's employee base. We will do this by undertaking regular and measurable projects to
increase employee education about the business as well as encouraging specific behaviors that
build the brand proposition. The effort, parts of which have already been implemented, will
involve everything from new-employee orientation to online training modules for existing
employees.
Next year is Fannie Mae's 401h anniversary as a private company, and its 701h birthday.
We will use the occasion not only to recognize the accomplishments of the past, but to set the
stage for a new future for our organization.
Phase Two
The second phase is more wholesale in scope, involving broad initiatives to position the
company with our customers and in the market place as nimble, responsive and businessoriented. Again, some of the initiatives are well underway. Single-Family has been the focus of
our brand-building efforts so far, and is undertaking major initiatives in its customerrelationship-management, sales and marketing efforts.
Finally, Phase Two will include rollouts of new print advertising, and possibly a new
logo and a new mission statement. Again, these efforts will adhere closely to our business-tobusiness positioning, focusing on one basic premise: We serve our partners in the housing
finance system, and by doing so we create lasting value for shareholders and expand housing
opportunities for all Americans.
.
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Possible new logo ...
~ FannieJ\!Iae
P.4 Fannie Mae
Our Business is the American Dream
The Power of Partnership
New Advertising with
Business-to-Business Message ...
And a Possible New Mission
Statement
Fannie Mae's Current Mission
Statement ...
•
;
At Fannie Mae, we are in the American
Dream business. Our Mission is to tear
down barriers, lower costs, and increase
the opportunities for homeownership
and affordable rental housing for all
Americans. Because having a safe place
to call home strengthens families,
communities, and our nation as a whole.
<•"JUI>O\JOO!!);•NC'I<'=>'
• ~ '"''~· ~n~~~·;ll":t·
And A Draft Mission Statement ...
Fannie Mae exists to serve those who
house America. Our job is to provide
our customer:s and partners with the
services, solutions and access to global
capital they need to meet the everchanging housing needs of our nation's
communities. We strive to create lasting
value for our shareholders and expand
housing opportunities for all Americans.
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Section VI Summary Points
•
•
•
Position as business-to-business
Reintroduce consistent tone and manner
Two-phased plan
~ 200-day "blitz"
~ Ongoing return to normal
~ Examine re-branding
Consistent alignment of strategy, metrics, message
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Summary and Conclusion
We developed this strategic business plan in a spirit of optimism. After spending the
past two years rebuilding the company, we are on a sounder footing for the future.
Meanwhile, our businesses, in fact, have performed solidly. Fannie Mae continued to play a
key role in the U.S. housing finance system, raising and supplying billions of dollars in capital,
helping lenders and housing partners serve the nation's housing needs, and providing value to
shareholders.
But while our e·nterprise is in good shape, and still one of the most profitable companies
in the world, we begin the next chapter of Fannie Mae with a new challenge- to seize new
opportunities to compete, win, grow, thrive and serve our shareholders and housing in
America. That is the goal of this Strategic Business Plan.
We started with the givens- a charter with great value, a growing but competitive
market, some competitive advantages in our market, and aclear mission, purpose and vision.
Accepting these givens, we then made considered choices about our strategy,
recognizing that having a charter is just the framework for our strategic options. But we began
by imagining we were starting from scratch, and asking what direction we would take and what
choices we would make.
•
We are making here a strategic choice to grow organically- doing the most with the
market, businesses and competitive advantages we have to grow and add value. We believe of
all the options, this is the most attractive to proposition to shareholders. Choosing this option
also means deciding to stop and/or shed activities that have low value to shareholders and our
mission. If there is something we're doing internally that we should stop or sell, we should do
so. Accordingly, some of the choices- Community Business Centers, the Fannie Mae
Foundation, the primacy of the MBS, and cost-cutting, to name a few- have been painful or
contentious.
We have a distinct and important raison d'etre- to he the most effective mover of
global capital to U.S. housing.
We have a strategic path- to maximize the value of our three business segments within
the framework of the charter, with the first priority being to protect the value of the MBS, our
flagship, while serving the mission.
We have opportunities to broaden and deepen our reach within our market. Nearer
term, we have a growth opportunity by taking more-credit risk on balance sheet. Longer term,
we have a growth opportunity by leveraging the brand and scale of Fannie Mae securitization
business. Our mortgage portfolio continues to have strong value for the enterprise not just
through fair value growth, but also as a support function to our other businesses. The
portfolio's central strategy is to have the economics- not a pre-determined absolute numberdrive the size. Costs also matter- we will drive a wedge between revenue growth and
expenses; next year will start "the new normal" for Fannie Mae. Expenses will be down,
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permanently; efficiencies will be up and increase year over year; and the numbers to measure
performance will be clear internally and externally.
We will align our financial measures and metrics with how we mariage the business,
with three progressive drivers: Revenue growth; cost containment; and capital management.
We will measure our credit guaranty businesses and report them on a GAAP basis; Capital
Markets on a fair value basis; and any non-GAAP measures will be reconciled to GAAP,
consistent with SEC rules for companies that run their business on something other than
GAAP.
We start with the right attitude- we are not going back to the "velvet fist" of the past.
make no judgment about what may have been right at the time. But it is not what I feel is right
going forward. We learned our lessons about hubris and humility; we embrace our position in
the secondary mortgage market; and we recognize that in order to grow and thrive we must
focus on service - and providing better service than our competitors in the secondary market.
For us, humility is not just the right attitude; it is a strategic business imperative.
So, as we reintroduce the next Fannie Mae, expectations are high but our voice will be
measured. You will see a tone shift from the past, from superlatives to facts; explicit mention
of customers and partners; and letting our actions - and successes - speak for themselves.
•
We have many reasons to feel positive about the future. We are near closing a difficult
chapter in our history, successfully and in better shape. Our business is growing, putting
people into housing and making money for shareholders. We have over 2,000 customers
nationwide that choose to do business with us every day. Our stock price is recovering. Our
MBS is the most liquid in.the market. Our debt securities are valued the world over. We are
focused more on deeds than words, and delivering the numbers. We are clearing the
legislative/legal/regulatory overhangs. Relationships with customers, partners, shareholders,
stakeholders, regulators and Congress are as normal as they have ever been. And I believe we
have one of the best sets of Directors, Managers and Associates not only in Fannie Mae's
history, but in Corporate America today.
Finally, we are optimistic and we are committed because we have chosen to affiliate
ourselves with a business that has a soul ... our Mission. This is a blessing that is different
from other companies that make loans, or manufacture equipment or sell soft drinks. We have
all seen what Fannie Mae can do when we get it right: families realize their dreams,
communities are transformed, and economies are boosted. We have seen Fannie Mae get it
right in Los Angeles, in LeDroit Park in Washington, DC, on the Texas border, on the Gulf
Coast, and most likely in the towns where we all grew up. We all share a common wave of
pride, solidarity and hope when someone, learning of our role at this company, says, "Fannie
Mae made it possible for me to own my home."
Desiree George of New Orleans was visiting her sisters in Texas when Hurricane
Katrina destroyed her home. She decided to stay in Texas, and learned that Fannie Mae was
offering homes from our inventory for people in her situation. She's been in one of those
•
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homes since December 2005, and now hopes to buy it. She said, simply, "Fannie Mae came
through at the worst time of my life."
We have work to do .
•
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•
Appendix: Where We Have Been- A Brief History
For those not familiar with Fannie Mae's history (and/or mythology!), the following is
a brief rundown of our 70 years since our founding to put our current strategic plan in a
broader context. Another way of putting that: To understand where we need to go, we have to
understand how we got here. Looking back, our history unfolds as an ongoing story of change
and progress, each chapter driven by pivotal events and strategic choices.
~
Chapter 1: The Birth. As part of the New
Deal, President Franklin Roosevelt
established the Federal National Mortgage .
Association in 1938 to buy and hold FHA
(and then Veterans Administration)
government-backed mortgages to boost
homeownership among middle-class
Americans. In 1954, under a new charter,
FNMA became a "mixed-ownership"
corporation owned partly by private
shareholders. When the Department of
Housing and Urban Development (HUD)
was created in 1965, it assumed supervision
ofFNMA.
~
Chapter 2: The Rebirth. In 1968, President Lyndon Johnson signed legislation chartering
FNMA as a private, shareholder-owned company to move the agency off the government
books and help balance the federal budget.
In 1970, as we completed our transition to a private company, President Richard Nixon
signed legislation authorizing us to purchase conventional mortgages, and our common
stock began trading on the New York Stock Exchange (NYSE). Also in 1970, Congress
chartered Freddie Mac. Fannie Mae changed its loan purchase method from posting
predetermined prices to the Free Market System commitment auctions.
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~
Chapter 3: Back from the Brink. In 1981, a surge in interest rates sent Fannie Mae's
mortgage portfolio- primarily long-term, fixed-rate mortgages funded by short-term paper
-dangerously out of balance, causing the
... , ..,,.,.,., ......, ...,.,.... ...
company at one point to lose over a million
dollars a day, and to post its first annual loss.
$250,000,000 ''""'
.We made strategic decisions to launch a
mortgage-backed securities (MBS) business,
l Pass-T!'lrcugh Rate
·m
and began purchasing adjustable-rate
mortgages, second mortgages and
conventional multifamily· loans. We entered
the foreign capital markets - broadening our
source of funding - closing the chapter with
turnaround and growth for the company.
-
3~
o>..•c·;o;<.·.(l:·:,Ti::J•J:.• ""·.-.,;:::-.
~·~
~~
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Chapter 4: Rise to Dominance. As Fannie
Mae stock joined the S&P 500 and our MBS
became the market leader, we came under a
~J!<!!~""•b:on~......
--~·-~-·y
new regulator- the Office of Federal Housing
·· "'".
Enterprise Oversight (OFHEO) -- new capital
.
rules and new affordable housing goals. We made strategic decisions to launch automated
underwriting technology and establish local partnership offices nationwide. We set up a
separate foundation for the purpose of "consumer education," and in l994launched a
Trillion Dollar Commitment to affordable housing. Our book of business reached $1
trillion and stock price reached $80; we reported double-digit "core" earnings growth for
14 consecutive years. In 1999, management established a goal to double earnings per share
from $3.23 to $6.46 in five years. Commercial banks, large financial institutions, mortgage
insurers (and a few customers) contributed millions of dollars to fund a Washington-based,
bipartisan lobbying and public relations organization called "FM Watch" to raise questions
about our size and practices. In 2000, after achieving our $1 trillion affordable housing
commitment almost a year ahead of schedule, we launched a ten-year, $2 trillion American
Dream Commitment,
including a "Mortgage
Fannie Mae to Fund$2 Trillion of New Mortgages ·
Consumers Bill of Rights."
Jctt'Pi
trr.«u
Ttwo ··.,mmcan O;t3tR t'ommiCmer.r
rtlf.ise Its nnollngs I.J.Itr
)'tar.
We relinquished our charter
a
flnar.ct
than
F3Mit
It
un<krn:;. mllhoo In .J!:Of\111)1\• rtnU.I
Jince I!'H In otdtr II)
exemption to the 1934
in
rnl"$
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our common stock with the
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~
Chapter 5: Fall to Earth. In 2001, Fannie Mae was cited among 11 companies in a best.selling business book by Jim Collins, Good to Great. In 2004, having reached our ten-year
American Dream Commitment in four years following record growth in the mortgage
.
market, we launched our American Dream Commitment 3.0 with over 60 specific housing
initiatives. Later that year, OFHEO commenced a special review of our accounting
policies in response to accounting issues at Freddie Mac.
In September, OFHEO issued an interim report finding that
our accounting policies, controls, corporate governance and
a range of other company practices and operations wen:;
seriously deficient. We disagreed and appealed to the
SEC. Media reports began using the term "scandal" and
comparing Fannie Mae to Enron, WorldCom and Tyco. In
December 2004, the SEC ruled that we violated generally
accepted accounting principles, notably in our treatment of
hedge accounting, requiring one of the largest financial
restatements in U.S. corporate history. We were found
severely undercapitalized. Senior management- including
the CEO, CFO and internal auditor- departed and the
company terminated its longtime independent audit firm.
Report of tbe Spcciill [nnli.a:ation of
Fannie :\file
:\h.y200Ci
~
•
Chapter 6: Dark Days and Recovery. The company began 2005 with the task of rebuilding
from the ground up: regulatory capital, including a 30 percent surplus; the executive team;
financial, accounting and audit organizations; accounting policies, practices, systems and
controls; relationships with regulators, Congress, customers, shareholders and stakeholders;
compliance and other major policies; technology infrastructure; company culture and
external tone and manner. We were under investigation by the SEC and the Justice
Department; and being sued by shareholders. In 2006 the Board issued its Paul, Weiss
internal investigation report finding that our accounting practices were not consistent with
GAAP, accounting systems were "grossly inadequate," and the "corporate culture suffered
from an attitude of arrogance (both internally and externally) and an absence of crossenterprise teamwork (with a 'siloing' of information), and discouraged dissenting views,
criticism, and bad news." OFHEO issued its final special examination report of the period
1998-2004 firiding that the image the company had promoted as one of the lowest-risk
financial institutions in the world and as best in class in terms of risk management,
financial reporting, internal controls and corporate governance was "false," and that we had
overstated reported income and capital by over $10 billion. We reached settlements with
the SEC and OFHEO, including an agreement to cap the portfolio, and paid $400 million in
fines. The Justice Department discontinued its investigation into our accounting practices
and policies.
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We testified before Congress several times. Fannie Mae survived the threat of NYSE
delisting. Since 2005, 80 percent of senior management changed- half are new to the
company, and half are in materially new roles. The company also established compliance,
ethics, risk and various oversight functions, and continued to be the subject of various legal
matters. The corporation announced the closing of the Fannie Mae Foundation, and the
end of former lobbying practices.
•
Business-wise, we stepped back from the surge in "layered-risk" subprime mortgages
flooding the market, and gave up market share to private label competitors, but kept the
businesses operating as we began restructuring and realigning them to be a more cohesive,
efficient and market-responsive One Fannie Mae. Finally, in November 2006 we filed our
2004 10-K with our completed restatement and absorbed a $6.3 billion hit to previous
retained earnings, filed our 2005 10-K in May 2007, and set a new timeline to file our 2006
10-K (3Q/07), hold our first shareholder meeting in three years (12/07), and return to
timely filing (2/08).
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