Fannie Mae: 6 Months Into Conservatorship

Jim Vogel, CFAExecutive Vice PresidentFixed Income Research

March, 2009

2

GSEs Upside Down but Still Spinning Clockwise

Conservatorship is working for debt holders

Underlying financials still important

The next six months

Brave New World

3

1) From Botched Creation to Lower Spreads

Treasury over sold strength of support

Clarification for market: Seeing support in action

Transition from overseas investors to domestic

Renewed spread appetite in 2009

Fannie’s term market more than recovered from fall issuance drought.

4

U.S. Investors Perk Up as Yields and Equities FallAttractive pricing brings attention

2005-2007

2009

5

Rebuilding Fannie’s Liability BaseDiscount Note Maturities Lengthen, Too

Monthly Issuance Longer than 18 Months

Term bullets outstanding now exceed summer ‘08 by more than $15bb.

Callables still lag.

6

Spreads Improve Across the Curve As a Result

LIBOR Basis of the GSE On-the-run Bullet Curve: 2-30 Years

• Fed kickstarted the process, but influence on new issues has been limited.

• Bullet spreads have done better than current coupon mortgages (adjusted for volatility).

7

Fannie’s Retained Portfolio Holds Back

Monthly Retained Portfolio

• New Cap of $900 billion awaits clarity on debt limit.

• All growth since summer of 2008 has been in mortgage loans, mostly repurchased from pools for modification.

• 5 years ago portfolio was at $925 billion.

8

GSEs in the Mortgage WorldVital to credit, not to funding

Credit Risk Share = 49% Banks Dominate Funding

GSEs

Market Share as of March 31, 2009

9

2) Fannie’s Course Found in its Financials

GSEs are free to US policy makers after equity holders demolished.

Accumulated value accrual/destruction establishes resource pool to support housing.

Cash flow from portfolio offsets credit losses.

Analyzing reserve for future cash losses.

Speed and length of housing credit losses

10

GAAP Losses Dwarf Cash Losses

Non-Cash items include

• Mark to market charges on derivatives due to lower rates.

• Additions to reserves for future losses.

• Elimination of deferred tax calculation.

Note: 2007-08, Fannie paid $2.7 billion in federal taxes.

11

Net Interest Income Soars as Curve SteepensFannie producing cash flow to absorb credit hits

• Net interest yield of .89% in 2008 vs .39% in 2007.

• Total growth of 90% in annual net interest income.

• Typical increase for large banks was 25% to 40%.

• Built-in increases (GAAP) for 2009 based on asset write-downs in 2H 08.

Quarterly Net Interest Income

12

Credit Losses Still in Infancy Stage

• Reserve for losses now at $25 billion.

• Projected cash losses for 2009 are $25 billion, but Fannie will keep adding to reserves from cash flow and Treasury injections.

Quarterly Provision for Loan Losses and Actual Losses

13

Delinquencies are Still Accelerating

Rate of Change of Quarterly Delinquencies

• Alt-A still driving the bulk of delinquencies and losses.

• Fannie’s prime delinquencies of 1.40% at year-end still compare favorably with 3.75% for national figures.

• Florida is hands down the worst single state.

• Pre-2005 vintages remain intact for now.

14

Projecting Cash Accumulation Run RateFannie has a ‘future’ when it turns positive

Critical Components

• Net interest income growth despite refinancing role.

• Slowing additions to reserves once they are ‘ample.’

• Eliminate losses on securities holdings (nearer than expected).

• Avoid new mistakes.

15

3) Looking Ahead Six Months

Funding modified loans

Creating value in portfolio away from Fed purchase profile

Staying out of headlines. Capping preferred injections.

Regaining some dignity

16

4) Beyond Conservatorship is Congress

Overseas investors on sidelines until Treasury is no longer sole authority

Preferred stock purchase agreement very hard to reverse.

Status depends on relative success

Re-formation of housing finance system.

17

5) Brave New World

Demise of the rating agencies

Counterparty contraction

Really private equity

Sovereign wealth policy initiatives