Fannie Mae Reports 2002 Financial Results
January 15, 2003
GAAP Net Income At $4,619 Million, Down 21.6 Percent
Operating net income at $6,394 million, up 19.1 percent; Operating net income per diluted common share at $6.31, up 21.3 percent Fannie Mae (FNM/NYSE), the nation's largest source of financing for home mortgages, today reported financial results for the year ended December 31, 2002.
|GAAP Earnings||Operating Earnings|
|EPS (in dollars)||$4.53||$5.72||(20.8)%||$6.31||$5.20||21.3%|
Fannie Mae's net income was $4,619 million in 2002 compared with $5,894 million in 2001, and earnings per diluted common share (EPS) were $4.53 in 2002 compared with $5.72. For 2002 strong growth in net interest income of 30.6 percent and guaranty fee income of 22.5 percent were more than offset by a $4,507 million increase in mark-to-market losses in the time value of purchased options used to hedge the company's interest rate risk. These unrealized mark-to-market losses were recorded in accordance with Financial Accounting Standard No. 133 (FAS 133), Accounting for Derivative Instruments and Hedging Activities. For the fourth quarter of 2002 Fannie Mae's net income was $952 million, or $0.94 per diluted common share, compared with $1,969 million, or $1.92 per diluted common share, for the fourth quarter of 2001. In the fourth quarter of 2002 $1,881 million of mark-to-market losses on purchased options were recorded compared with $578 million of mark-to-market gains in the fourth quarter of 2001.
Operating net income and operating EPS are non-GAAP (generally accepted accounting principles) measures that are the primary performance measures used by Fannie Mae's management. Operating net income and EPS provide consistent accounting treatment for purchased options and the options embedded in callable debt by allocating the cost of purchased options over their expected lives, comparable to the accounting used for these items prior to the adoption of FAS 133. Fannie Mae's operating net income measure may not be comparable to similarly titled measures used by other companies. Page one of the attachments to this release provides a reconciliation of GAAP to operating net income. Management believes that operating net income and operating EPS more accurately reflect the financial results of the company than GAAP measures which include the FAS 133 treatment of purchased options.
Operating net income was $6,394 million in 2002 compared with $5,367 million in 2001. Operating EPS in 2002 was $6.31, or 21.3 percent above 2001. Operating net income for the fourth quarter of 2002 was $1,672 million, a 16.3 percent increase compared with the fourth quarter of 2001. For the fourth quarter of 2002 operating EPS of $1.66 rose 18.6 percent above the same period in 2001.
During 2002, GAAP net income was $1,775 million less than operating net income because of $4,545 million (on a pre-tax basis) in mark-to-market losses in the time value of purchased options -- interest rate swaptions and interest rate caps. Mark-to-market losses on these options were the result of increased use of options and significant declines in interest rates during the year, mitigated by an increase in interest rate volatility. The unrealized mark-to-market losses in purchased option time value in 2002 were more than offset by increases in the intrinsic value of these options, which are not reflected in GAAP net income. Because Fannie Mae generally holds purchased options to maturity or exercise, quarterly fluctuations in time value will net to the initial option premium over the expected lives of these options, and total purchased options expense therefore will equal the purchased option amortization expense included in operating net income. In 2001 GAAP net income was $527 million more than operating net income.
2002 Financial Performance Summary
Highlights of Fannie Mae's 2002 financial performance include:
- Record total business volume of $848.9 billion, 38 percent higher than 2001;
- Growth in the total book of business of 16.4 percent, mortgage portfolio growth of 11.9 percent, and growth in outstanding MBS of 19.9 percent;
- Taxable-equivalent revenue of $11.9 billion, up 16.8 percent compared with 2001;
- An average net interest margin of 115 basis points compared with 111 basis points in 2001;
- Credit-related losses of $87.0 million compared with $81.3 million in 2001;
- and, Losses of $710.5 million from the call and repurchase of debt compared with $523.9 million in 2001.
Franklin D. Raines, Fannie Mae's Chairman and Chief Executive Officer, said, "In an extremely difficult business environment that affected virtually every company in America, Fannie Mae's operating results in 2002 were among the best in the company's history." Raines noted that in 2002 Fannie Mae reported a second consecutive year of growth in operating earnings per share in excess of 20 percent, and posted its 16th consecutive year of double-digit growth in operating earnings per share. Raines said credit-related losses remained at historically low levels in 2002, and that in spite of volatile interest rates the duration gap on the company's mortgage portfolio remained within its preferred range for all but three months of the year. Said Raines, "Fannie Mae's disciplined risk management in the fast-growing market of residential mortgage finance has enabled us to achieve a record of growth and consistency of earnings over the past decade and a half that is without equal in financial services."
Fannie Mae's Chief Financial Officer, Timothy Howard, said that the company's 21.3 percent growth in operating earnings per share in 2002 was paced by 16.8 percent growth in taxable equivalent revenues. Adjusted net interest income -- net interest income less purchased options amortization expense -- grew by 16.7 percent during the year, while guaranty fees grew by 22.5 percent. Paced by record transactions and technology fees, Fannie Mae's fee and other income rose by $81 million during the year.
Howard said that with interest rates falling to 40-year lows in 2002 and mortgage refinancings reaching unprecedented amounts, Fannie Mae's business volumes soared to record levels. The company's total 2002 business volume was $849 billion, 38 percent more than during 2001. Volume consisted of $371 billion in purchases for portfolio and $478 billion in mortgage-backed securities (MBS) issued to other investors. Howard noted that even with record liquidations of mortgages and MBS the company experienced strong growth in business outstandings during the year. Howard said that during the 12 months ended December 31, 2002 Fannie Mae's total book of business grew by 16.4 percent, with its mortgage portfolio growing by 11.9 percent and its outstanding MBS growing by 19.9 percent.
Howard said that the company's net interest margin averaged a higher-than-expected 115 basis points in 2002 as short-term interest rates continued to decline through much of the year. The 2002 net interest margin was 4 basis points above the 111 basis point average of 2001 and 14 basis points above the 101 basis point average of 2000. Howard added that the guaranty fee rate on outstanding MBS averaged 19.1 basis points in 2002 compared with an average fee rate of 19.0 basis points in 2001.
Finally, Howard said, Fannie Mae's credit-related losses increased only slightly to $87.0 million in 2002 from $81.3 million in 2001. Although the number of properties acquired through foreclosure in 2002 rose by 35 percent, continued declines in the loss per case on foreclosure kept total credit losses relatively level. For the full year 2002, Fannie Mae's credit loss ratio -- credit-related losses as a percent of mortgages and mortgage-backed securities outstanding -- was 0.5 basis points.
Howard reaffirmed that the company expected strong financial performance in 2003. Specifically, Howard said, "While there is a range of possible growth rates for our operating earnings per share in 2003, the current analyst consensus of between 12 and 13 percent appears to be a reasonable centering point for estimates at this time."
Howard said that the two factors that most would affect the growth in Fannie Mae's operating EPS in 2003 were a likely decline in the net interest margin and reduced amounts of losses on the repurchase of debt.
Howard noted that since early 2001, when large volumes of debt calls caused Fannie Mae's net interest margin to temporarily move higher, the company had been expecting the margin eventually to come back down again. Said Howard, "A normal level for Fannie Mae's net interest margin probably is in the area of 100 basis points, or perhaps a bit lower. It would not be surprising to see the margin return to these levels by the end of this year or the first half of 2004."
Howard said that the smaller losses on debt calls and repurchases, which totaled more than $700 million last year, would serve as a partial offset to the effect of a lower net interest margin in 2003.
Howard said that the company did not have a set target for 2003 portfolio growth. He added, however, that the company expected healthy growth in the overall mortgage market, and noted that if purchases of fixed-rate mortgages by banks and fixed-income investors eased from their torrid pace of 2002 a reasonable expectation for the company's 2003 portfolio growth might be somewhere in the mid teens.
Finally, Howard said, it was probable that Fannie Mae's 2003 credit losses would be somewhat higher this year than in 2002. Howard said that with single-family home prices likely to rise less rapidly in 2003 than in previous years, the company's loss per case on foreclosed properties likely would increase. But with Fannie Mae's credit losses totaling just $87 million in 2002, Howard added, any dollar increase in the company's 2003 credit losses should be relatively modest.
Details of Fannie Mae's 2002 financial performance follow.
Fannie Mae's business volume -- mortgages purchased for portfolio plus MBS issues acquired by other investors -- totaled $848.9 billion in 2002 compared with $615.3 billion in 2001. Business volume in 2002 consisted of $370.6 billion in portfolio purchases and $478.3 billion in MBS issues acquired by investors other than Fannie Mae's portfolio, compared with $270.6 billion and $344.7 billion, respectively, in 2001. Business volume in the fourth quarter of 2002 was $304.5 billion compared with $185.2 billion in the fourth quarter of 2001. Retained commitments to purchase mortgages surged to $388.1 billion in 2002 from $296.5 billion in 2001 as a result of lower interest rates and a related increase in mortgage refinancings. Outstanding portfolio commitments for mandatory delivery totaled $85.1 billion at December 31, 2002.
Fannie Mae's combined book of business -- the gross balance of mortgages held in portfolio and outstanding MBS held by other investors -- grew at a compound annual rate of 16.4 percent during 2002, ending the period at $1.820 trillion. This growth resulted from an 11.9 percent annualized growth rate in the gross mortgage portfolio and a 19.9 percent rate of growth in outstanding MBS. For the fourth quarter of 2002, the combined book of business grew at an annual rate of 19.3 percent compared with 17.1 percent in the comparable time period in 2001.
Portfolio investment business results
Fannie Mae's portfolio investment business manages the interest rate risk of the company's mortgage portfolio and other investments. The results of this business are largely reflected in net interest income. Net interest income for 2002 was $10,566 million, up 30.6 percent from $8,090 million in 2001. Adjusted net interest income, which is net interest income less the amortization expense of purchased options, was $8,752 million, up 16.7 percent from $7,500 million in 2001. This increase was driven by a 12.2 percent rise in the average net investment balance and a 4 basis point increase in the average net interest margin. Net interest income was $3,012 million in the fourth quarter of 2002 compared with $2,404 million during the comparable period in 2001. Adjusted net interest income was $2,238 million in the fourth quarter of 2002, up 3.4 percent from $2,165 million during the comparable period in 2001.
Fannie Mae's net investment balance -- consisting of the company's liquid investment portfolio together with its mortgage portfolio net of unrealized gains or losses on available for sale securities, deferred balances, and the allowance for losses -- averaged $805 billion during 2002 compared with $717 billion during 2001. The net investment balance was $859 billion at December 31, 2002.
The company's net interest margin averaged 115 basis points in 2002, up from 111 basis points in 2001. The company's net interest margin averaged 114 basis points in the fourth quarter of 2002 compared with 121 basis points in the fourth quarter of 2001 and 116 basis points in the third quarter of 2002. Fannie Mae's net interest margin continued to benefit from an unusually steep yield curve and low short-term interest rates.
For the full year 2002 the company realized losses from debt repurchases and debt calls of $710.5 million compared with losses of $523.9 million in 2001. During the year the company realized $586.7 million of losses on debt repurchases and $123.8 million of losses on debt calls. Debt repurchased and debt called during the year totaled $7.9 billion and $173.6 billion, respectively. Fannie Mae regularly calls or repurchases debt as part of its interest rate risk management program.
Purchased option expense -- the mark-to-market of the time value of purchased options -- was a net mark-to-market loss of $4,545 million during 2002, compared with a net mark-to-market loss of $37.4 million during 2001. Purchased option expense totaled $1,881.1 million in the fourth quarter of 2002, compared with $577.9 million of income during the same period in 2001.
During the fourth quarter Fannie Mae prospectively adopted a preferred method for measuring the time value on interest rate caps at purchase. This change will not affect the total expense that will be recorded in the income statement over the life of the caps, and has no effect on operating earnings, but resulted in a pre-tax decline in purchased options expense of $282.3 million in the current quarter.
Credit guaranty business results
Fannie Mae's credit guaranty business manages the company's credit risk. The results of this business are primarily reflected in guaranty fee income and credit-related losses. Guaranty fee income was $1,816 million in 2002, a 22.5 percent increase compared with 2001. The increase in guaranty fee income was driven by a 21.9 percent rise in average outstanding MBS, while the effective guaranty fee rate on that business rose slightly to 19.1 basis points. Guaranty fee income for the fourth quarter of 2002 was $522.3 million compared with $398.3 million in the fourth quarter of 2001. The effective guaranty fee rate in the fourth quarter of 2002 was 20.4 basis points compared with 18.9 basis points in the fourth quarter of 2001. The effective guaranty fee rate rose in the last half of the year as a result of higher fee rates on new business and the faster amortization of deferred fees due to accelerated prepayments in the heavy refinance environment.
Credit-related losses -- foreclosed property expense plus charge-offs -- remained very low in 2002, driven by a strong housing market and continued home price gains. Credit-related losses totaled $87.0 million in 2002 compared with $81.3 million in 2001. Fannie Mae's credit loss rate -- credit-related losses as a percentage of the average combined book of business -- was 0.5 basis points in 2002 compared with 0.6 basis points in 2001. Credit-related losses were $34.3 million in the fourth quarter of 2002 compared with $17.5 million in the fourth quarter of 2001. Fannie Mae's fourth quarter 2002 credit losses included $17.0 million of losses on two multifamily properties in the Midwest. For the fourth quarter of 2002 the credit loss rate was 0.8 basis points compared with 0.5 basis points in the year-ago quarter. Fannie Mae's conventional at-risk single-family serious delinquency rate, an indicator of potential future loss activity, was 0.46 percent at November 30, 2002.
During the quarter the American Institute of Certified Public Accountants rescinded Statement of Position 92-3, Accounting for Foreclosed Assets. The rescission of this standard led Fannie Mae to reclassify on its income statement various items of foreclosed property expense or income related to the disposition of foreclosed properties. These changes were implemented in the fourth quarter of 2002, and historical charge-offs, provisions for loss, and foreclosed property expense have been reclassified for comparability. The changes do not affect total credit-related losses or total credit-related expenses for the year, or the balance of the company's allowance for loan losses.
Credit-related expense, which includes foreclosed property expense and the provision for losses and is the amount recorded on the company's income statement, totaled $91.7 million in 2002, in line with credit-related losses. Fannie Mae's loss provision was $128.1 million in 2002, compared with $93.4 million in 2001. Foreclosed property dispositions produced a net gain of $36.4 million in 2002 compared with a net gain of $15.7 million in 2001. In the fourth quarter of 2002, credit-related expense totaled $32.6 million compared with $15.8 million in the fourth quarter of 2001. Fannie Mae's loss provision was $40.9 million in the fourth quarter of 2002, compared with $20.8 million in the fourth quarter of 2001. Foreclosed property dispositions in the fourth quarter of 2002 produced a net gain of $8.3 million compared with a net gain of $5.0 million in the fourth quarter of 2001. The company's allowance for loan losses totaled $810 million at December 31, 2002 compared with $806 million at December 31, 2001.
Fee and other income
Fee and other income in 2002 totaled $232.2 million compared with $151.0 million in 2001. Fee and other income includes technology fees, transaction fees, multifamily fees and other miscellaneous items, and is net of operating losses from certain tax-advantaged investments -- primarily investments in affordable housing which qualify for the low income housing tax credit. Tax credits associated with housing tax credit investments are included in federal income tax expense.
The change in fee income between 2002 and 2001 was primarily due to higher transaction and technology fees, partially offset by an increase in premiums paid to purchase third-party credit enhancement on certain loans. Fee and other income for the fourth quarter of 2002 was $95.4 million compared with $50.2 million in the same period last year.
Federal income tax expense on operating net income was $2,385.1 million in 2002, compared with $1,847.3 million in 2001. The effective federal income tax rate on operating net income was 27 percent in 2002 compared with 26 percent for the same period last year. The increase in the effective rate is attributable to an increase in taxable income. Federal income tax expense on operating net income for the fourth quarter of 2002 was $662.3 million compared with $517.7 million for the fourth quarter of 2001. The effective federal income tax rate on operating net income was 28 percent for the fourth quarter of 2002 compared with 26 percent for the same period last year.
Administrative expenses totaled $1,219.2 million in 2002, up 19.8 percent from $1,017.6 million in 2001. The above-average growth in expenses is related to Fannie Mae's reengineering of its core technology infrastructure to enhance its ability to process and manage the risk on mortgage assets. The growth rate of administrative expenses should decline in 2003 but remain above historical levels, as the company completes its core infrastructure project and begins to expense the cost of stock-based compensation.
The company's ratio of administrative expense to the average combined book of business in 2002 was .072 percent compared with .071 percent in 2001. Fannie Mae's efficiency ratio -- administrative expense divided by taxable-equivalent revenue -- was 10.2 percent in 2002 compared with 10.0 percent in 2001. Administrative expenses totaled $313.2 million in the fourth quarter of 2002, up 24.6 percent from the fourth quarter of 2001.
Fannie Mae's core capital, which is the basis for the company's statutory minimum capital requirement, was $28.1 billion at December 31, 2002 compared with $25.2 billion at December 31, 2001 and $26.5 billion at September 30, 2002. Core capital was an estimated $877 million above the statutory minimum at December 31, 2002. At September 30, 2002, core capital was $729 million above the statutory minimum.
Total capital, which includes core capital and the general allowance for losses and is the basis for the risk-based capital stress test, was $28.9 billion at December 31, 2002 compared with $26.0 billion at December 31, 2001 and $27.3 billion at September 30, 2002. The risk-based capital standard developed by Fannie Mae's regulator, the Office of Federal Housing Enterprise Oversight (OFHEO), became binding during the third quarter. This standard utilizes a stress test to determine the amount of total capital the company needs to hold to protect against credit and interest rate risk, and requires an additional 30 percent capital for management and operations risk. At September 30, 2002, Fannie Mae's total capital exceeded the OFHEO risk-based capital requirement by $5.8 billion. The higher of Fannie Mae's risk-based or minimum capital standard is binding.
Fannie Mae repurchased 15.4 million shares of common stock during 2002 compared with 6.0 million shares in 2001. The company repurchased 0.3 million shares in the fourth quarter of 2002. Repurchases for 2002 include shares used to fund the company's $300 million commitment to the Fannie Mae Foundation made in the fourth quarter of 2001. At December 31, 2002 Fannie Mae had 988.8 million shares of common stock outstanding compared with 997.2 million shares at December 31, 2001. The company issued $1.0 billion of preferred stock and called $625 million of preferred stock in 2002. At December 31, 2002 preferred stock made up 9.5 percent of Fannie Mae's core capital.
The company issued $1.0 billion of subordinated debentures in the fourth quarter of 2002 and $3.5 billion for the full year. Subordinated debt outstanding totaled $8.5 billion at December 31, 2002. Subordinated debt serves as an important supplement to Fannie Mae's equity capital, although it is not a component of core capital. After providing for capital to support its off-balance sheet MBS, Fannie Mae's capital and outstanding subordinated debt as a percent of on-balance sheet assets was 3.7 percent at December 31, 2002, compared with 3.4 percent at December 31, 2001.
As part of Fannie Mae's voluntary market discipline, liquidity, safety and soundness initiatives of October 2000, the company discloses on a quarterly basis its liquid assets as a percent of total assets along with the sensitivity of its future credit losses to an immediate 5 percent decline in home prices.
At December 31, 2002 Fannie Mae's ratio of liquid assets to total assets was 6.9 percent, compared with 6.4 percent at September 30, 2002. Fannie Mae has committed to maintain a portfolio of high-quality, liquid, non-mortgage securities equal to at least 5 percent of total assets.
At September 30, 2002 the present value of Fannie Mae's net sensitivity of future credit losses to an immediate 5 percent decline in home prices was $501 million, taking into account the beneficial effect of third-party credit enhancements. This compares with $465 million at June 30, 2002. The September 30 figure reflects a gross credit loss sensitivity of $1,738 million before the effect of credit enhancements, and is net of projected credit risk sharing proceeds of $1,237 million.
Fannie Mae's quarterly disclosures, together with the monthly interest-rate-risk disclosures, are included in the attachments to this release.
Derivatives and FAS 133
Fannie Mae primarily uses derivative instruments as substitutes for noncallable and callable debt issued in the cash markets to help match the cash flow characteristics of its debt with those of its mortgages and reduce the interest rate risk in its portfolio. Fannie Mae accounts for its derivatives under FAS 133, which was adopted on January 1, 2001. The implementation of this standard resulted in significant accounting presentation changes to both the company's income statement and balance sheet.
FAS 133 requires that Fannie Mae mark to market on its income statement the changes in the time value, but not the total value, of its purchased options -- interest rate swaptions and interest rate caps. The mark-to-market of the time value of Fannie Mae's purchased options during 2002 resulted in a net mark-to-market loss of $4.545 billion, which is reported on the purchased option expense line of the income statement. Purchased option expense in 2002 includes $1.814 billion in amortization expense, which was included in net interest income prior to the adoption of FAS 133 and currently is included in adjusted net interest income and in operating net income. This amortization expense represents the straight-line amortization of the up-front premium paid to purchase the options over the expected life of the options.
FAS 133 also requires that the company record any change in the fair values of certain derivatives, primarily interest rate swaps it uses as substitutes for noncallable debt, on the balance sheet in accumulated other comprehensive income (AOCI), which is a separate component of stockholders' equity. For these types of transactions FAS 133 does not require or permit noncallable debt to be marked to market. At December 31, 2002, the AOCI component of stockholders' equity included a reduction of $16.3 billion, or 2.0 percent of the net mortgage balance, from the marking to market of these derivatives. The comparable reductions to AOCI were $16.5 billion at September 30, 2002 and $9.5 billion at June 30, 2002. Partially offsetting the reduction in AOCI from the mark to market of derivatives was a $4.5 billion mark-to-market gain on the available-for-sale securities portfolio. Accumulated other comprehensive income is not a component of core capital.
Fannie Mae's primary credit exposure on derivatives is that a counterparty might default on payments due, which could result in Fannie Mae having to replace the derivative with a different counterparty at a higher cost. Fannie Mae's exposure on derivative contracts (taking into account master settlement agreements that allow for netting of payments and excluding collateral received) was $3.301 billion at December 31, 2002. All of this exposure was to counterparties rated A-/A3 or higher. Fannie Mae held $3.104 billion of collateral through custodians to offset the risk of the exposure for these instruments. Fannie Mae's exposure, net of collateral, was $197 million at December 31, 2002 versus $401 million at September 30, 2002. The replacement cost at December 31, 2002 represents about one week of annualized pre-tax operating net income.
Source: Fannie Mae