FundingNotes: Further Developments Regarding Fannie Mae's ...

Description

Revised July 2001
Volume 6 • Issue 4
Fundingnotes is now available on Fannie Mae’s
website. Visit www.fanniemae.com, choosesm the “Debt Securities” option and select
“Fundingnotes Publications.” Fundingnotes is
also available at "FNM" on Bloomberg.undingnotesf
Monthly Report for Fannie Mae’s Investors and Dealers
Further Developments regarding Fannie Mae’s
®Subordinated Benchmark Notes
Fannie Mae has successfully issued two publicly traded and credit assessment institution (e.g. Standard & Poor’s or
externally rated Subordinated Benchmark Notes issues that Moody’s Investor Service); and (3) the credit quality of
have lead to the creation of a new, liquid class of fixed income Subordinated Benchmark Notes, as indicated by their credit
assets for investors. rating and the consequent low credit risk the debt presents to
investing banking organizations merit a 20 percent risk
The issuance of Subordinated Benchmark Notes is a result of weight.
one of the six voluntary initiatives made by Fannie Mae (in
conjunction with Freddie Mac) on October 19, 2000 to imple- Voluntary Initiatives
ment a series of financial operating and disclosure changes On October 19, 2000, Fannie Mae jointly announced with
designed to enhance capital adequacy, transparency and Freddie Mac and a bipartisan group of Members of Congress a
market discipline. As Franklin Raines, Fannie Mae’s Chair- set of six voluntary initiatives. Coupled with one of the
man, said in a speech at the Brookings ...

Sujets

• Federal National Mortgage Association
• Risky Business
• Investors Group Inc.
• Capital social
• Securities and Exchange Commission
• Moody's

Informations

• Publié par: Chuwyar
• Nombre de lectures: 869
• Langue: English

Extrait

Copyright ©2001 by Fannie Mae. No part of this document may be duplicated, reproduced, distributed or displayed in public in any manner or by any means

without the written permission of Fannie Mae. This document is for the private information of dealers in Fannie Mae securities (“Dealers”) and qualified sophisti-

cated institutional investors. Fannie Mae does not intend to solicit and is not soliciting any action with respect to any Fannie Mae security based upon this

document. This document does not constitute, and under no circumstances should it be used as, or considered to be, an offer to sell or a solicitation of an offer to

buy the securities or other instruments mentioned herein or derived from such securities or instruments. Fannie Mae expects Dealers to make every effort to assist

investors to consider and understand the risks of the securities or instruments mentioned herein. The securities or other instruments mentioned in this document

may not be eligible for sale in certain jurisdictions or to certain persons and may not be suitable for all types of investors. Opinions and estimates expressed herein

constitute our present judgment and are subject to change without notice. Such opinions or estimates should not be construed as either projections or predictions of

value, performance or results; nor as legal, tax, financial, or accounting advice. (See back cover.)

Revised July 2001

Volume 6 • Issue 4

Monthly Report for Fannie Mae’s Investors and Dealers

f

undingnotes

sm

continued

Further Developments regarding Fannie Mae’s

Subordinated Benchmark Notes

®

Fannie Mae has successfully issued two publicly traded and

externally rated Subordinated Benchmark Notes issues that

have lead to the creation of a new, liquid class of fixed income

assets for investors.

The issuance of Subordinated Benchmark Notes is a result of

one of the six voluntary initiatives made by Fannie Mae (in

conjunction with Freddie Mac) on October 19, 2000 to imple-

ment a series of financial operating and disclosure changes

designed to enhance capital adequacy, transparency and

market discipline. As Franklin Raines, Fannie Mae’s Chair-

man, said in a speech at the Brookings Institution in Decem-

ber 2000, “these commitments taken together put Fannie Mae

at the vanguard of safety and soundness protections, the kind

of advances that the G-7’s Basel Committee and others are

recommending for all major financial institutions.” Fannie

Mae now has perhaps the most comprehensive configuration

of protections against risk and loss of any financial institution

in the world. The concept of market discipline is a key

component in that configuration and Subordinated Bench-

mark Notes is the primary vehicle Fannie Mae is using to

enhance market discipline and serve as an independent

barometer of the company’s credit quality. When investors

evaluate Subordinated Benchmark Notes for investment

purposes it is important that they recognize that, just with

other securities issued by Fannie Mae, Subordinated Bench-

mark Notes are not guaranteed by the United States govern-

ment.

The U.S. banking regulatory agencies — the Office of the

Comptroller of the Currency, the Board of Governor’s of the

Federal Reserve System, the Federal Deposit Insurance

Corporation, and the Office of Thrift Supervision — have

assigned a 20 percent risk weighting to Fannie Mae’s Subordi-

nated Benchmark Notes. In a letter to Fannie Mae dated April

19, 2001, these agencies concluded that the Subordinated

Benchmark Notes warrant a 20 percent risk weight classifica-

tion for three reasons: (1) the agencies’ current risk-based

capital guidelines apply a 20 percent risk weight to the debt of

U.S. government-sponsored agencies, including Fannie Mae;

(2) a 20 percent risk weight is consistent with a proposed

revision to the Basel Capital Accord capital framework which

would assign a 20 percent risk weight to the securities of

commercial companies rated in one of the two highest invest-

ment-grade rating categories (e.g. AAA or AA) by an external

credit assessment institution (e.g. Standard & Poor’s or

Moody’s Investor Service); and (3) the credit quality of

Subordinated Benchmark Notes, as indicated by their credit

rating and the consequent low credit risk the debt presents to

investing banking organizations merit a 20 percent risk

weight.

Voluntary Initiatives

On October 19, 2000, Fannie Mae jointly announced with

Freddie Mac and a bipartisan group of Members of Congress a

set of six voluntary initiatives. Coupled with one of the

toughest capital and examination regimes of any financial

company in America (as a result of measures that Congress

enacted in 1992), the voluntary initiatives create an unparal-

leled, multi-layered approach to safeguarding its financial

strength. Fannie Mae implemented all of these voluntary

initiatives during the first quarter of this year and in several

cases has exceeded its commitments from October. The six

voluntary measures we have implemented place Fannie Mae

at the vanguard of risk management and disclosure practices

worldwide, with cutting-edge regulatory discipline bolstered

by cutting-edge market discipline. A review of those commit-

ments and the results of the implementation of each commit-

ment is described below (see

Figure 1

).

The first of the initiatives to be completed was the issuance of

publicly traded and externally rated subordinated debt.

Fannie Mae priced its first issue of Subordinated Benchmark

Notes in late January and its second in early May. The first

issue was a $1.5 billion 10-year maturity and was priced at a

spread of 22 basis points over our on-the-run 10-year senior

Benchmark Notes. The second issue was a $1.5 billion 5-year

issue that came to market at a spread of 18 basis points over

our on-the-run 5-year senior Benchmark Notes. Both securi-

ties are rated Aa2 by Moody’s and AA minus(AA-) by Standard

& Poor’s. Moody’s and Standard and Poor’s will rate each

subsequent issue of Subordinated Benchmark Notes.

Fannie Mae has committed to issue subordinated debt on at

least a semi-annual basis irrespective of the prevailing

market environment. Subordinated debt will be issued in such

an amount that the sum of total capital, net of certain

adjustments described below, and outstanding subordinated

debt will equal or exceed 4 percent of on balance sheet assets

Fundingnotes

is now available on Fannie Mae’s

website. Visit www.fanniemae.com, choose

the “Debt Securities” option and select

“Fundingnotes

Publications.”

Fundingnotes

is

also available at "FNM" <GO> on Bloomberg.

2

continued

Figure 1

As of March 31, 2001, Fannie Mae has delivered

on the six Voluntary Initiatives announced

in October 2000 putting Fannie Mae’s safety

and soundness protections at the forefront of

evolving world practices.

1 Committed to Periodic Issuance of Subordinated Debt

—

Issuance of rated and publicly traded subordinated debt that,

together with core capital, equals or exceeds 4% of on-balance-sheet

assets, after adjusting for capital required to support the off-

balance-sheet mortgage securities business and adding back the

allowance for losses.

This level of outstanding subordinated debt is

to be achieved by the end of a three-year phase in period.

–

Resulted in

Fannie Mae pricing two transactions to date; $1.5

billion of 10-year Subordinated Benchmark Notes on January

25, 2001 and $1.5 billion of 5-year Subordinated Benchmark

Notes on May 2, 2001.

Both are rated Aa2/AA-.

We also

committed to issue such Notes quarterly during 2001 and on at

least a semi-annual basis thereafter.

2 Committed to Liquidity Management and Contingency

Planning

— Maintain more than three months’ worth of liquidity

needs under an assumption that Fannie Mae has no access to the

public debt markets.

–

Resulted in

Fannie Mae announcing on March 12, 2001 that

we had met this commitment.

As of June 30, 2001 Fannie Mae’s

ratio of liquid assets to total assets was 8.0%, well above the

stipulated 5%. Our liquidity plan meets the 14 principles for

sound liquidity management set forth by the Basel Committee.

3 Committed to an Annual Public Disclosure of a Rating

—

Obtain and publicly disclose an annual rating from a nationally

recognized statistical rating organization that will assess the risk

to the government, or the independent financial strength, of Fannie

Mae.

–

Resulted in

S&P assigning a AA- “risk to the government”

rating to Fannie Mae on February 27, 2001.

The rating will be

maintained on a surveillance basis.

This rating according to

S&P, “refers to the inherent default risk of a federally-related

entity operating under its authorizing legislation, but without

assuming an infusion of cash from the government.”

4 Committed to New Credit Risk Disclosures

— Quarterly

public disclosure of the impact of an immediate 5 percent decline in

U.S. home prices.

–

Resulted in

Fannie Mae announcing the first quarterly

disclosure on March 26, 2001 that as of December 31, 2000, the

company’s net sensitivity of future credit losses, taking into

account the effect of credit enhancements, was $295 million.

As

of March 31, 2001 this value was $307 million.

This low level of

sensitivity to credit losses reflects the quality of our existing

book of business, the impact of our loss mitigation techniques,

and the effectiveness of our credit enhancement and risk-

sharing strategies.

5 Committed to New Interest Rate Disclosures

— Monthly

public disclosure of the effects of 50 basis point parallel shift and 25

basis point change in slope in the yield curve.

–

Resulted in

Fannie Mae going beyond the commitment made

in October by releasing the two primary measures of interest

rate risk that the company uses: portfolio net interest income at

risk and effective asset/liability duration gap. As of June 30,

2001, the company’s net interest income at risk from a 50 basis

point change in interest rates was 1.7% over the next one year

and 4.4% over the next four years. The company’s net interest

income at risk from a 25 basis point change in the slope of the

yield curve was 0.9% over the next one year and 2.2% over the

next four years.

The effective duration gap of Fannie Mae’s

mortgage portfolio was a plus 5 months, within the targeted

range of plus or minus six months.

6 Committed to Interim Risk-Based Capital Stress Tests

—

Pending final promulgation of a risk based capital standard by

OFHEO, implement a risk-based capital test based on the

parameters set forth in the Federal Housing Enterprises Financial

Safety and Soundness Act of 1992, and publicly disclose the test

outcome on a quarterly basis.

–

Resulted in

Fannie Mae having sufficient capital to pass our

interim version of the OFHEO risk-based capital test as of

December 31, 2000, and our capital cushion on that date was

between 10 - 30% of total capital.

This cushion has since grown

to exceed 30% as of March 31, 2001.

at the end of a three year phase-in period. For this purpose,

total capital will be adjusted downwards by an amount equal

to 0.45% times the net Mortgage Backed Securities outstand-

ing that are guaranteed but not owned by Fannie Mae.

Fannie Mae’s subordinated debt acts as a risk-absorbing layer

to supplement capital for the benefit of senior debt holders,

and also serve as a consistent and early market signal of

credit risk for investors. Fannie Mae has designed Subordi-

nated Benchmark Notes, described below in more detail,

under which each issue will at all times be publicly rated by

Moody’s Investors Service and Standard & Poor’s. The Notes

have been designed to create maximum secondary liquidity

for the benefit of investors and to ensure the effectiveness of

the program as an early warning system about market

perceptions of Fannie Mae’s financial strength.

Fannie Mae currently expects to issue $12 - $15 billion of

Subordinated Benchmark Notes over the three year phase-in

period stipulated in the voluntary commitment. The weighted-

average maturity of outstanding subordinated debt issues will

be at least five years following the three-year phase-in period.

Fannie Mae has made a firm commitment to bring at least

one new issue or reopening of Subordinated Benchmark Notes

to market in each quarter during 2001. Subsequently, the

company will issue at least semi-annually and possibly more

frequently. Subordinated debt will not detract in any way

from our commitment to bring to market large, liquid senior

Benchmark Securities

SM

according to the issuance calendar

that the company published in September 2000 for the

calendar year 2001.

The second voluntary initiative was fulfilled in February

when Fannie Mae obtained and disclosed a standalone “risk

to the government rating” of AA- from Standard & Poor’s. This

rating measures our inherent credit quality. No U.S. commer-

cial bank holding company or thrift institution has an S&P

rating higher than AA-. Fannie Mae went beyond the October

19 commitment by seeking this rating on a surveillance basis,

which means that S&P will continually monitor its rating

during the year and may change it if our financial condition

changes. This “risk to the government” rating does not apply

to any security that Fannie Mae issues.

The third voluntary commitment Fannie Mae implemented

related to the company’s liquidity. Fannie Mae announced in

February that it met this commitment by putting in place a

contingency plan to ensure that the company could meet its

obligations for at least three months without access to the

new issue debt markets. Fannie Mae also announced that the

company is maintaining at least 5 percent of its on-balance

sheet assets in the form of high-quality, liquid, non-mortgage

securities. Fannie Mae exceeded the October commitment by

disclosing that its ratio of such assets to on-balance sheet

assets was 8.0 percent as of June 30, 2001. Fannie Mae

further announced that its liquidity management meets the

14 principles of sound liquidity management set forth by the

Basel Committee on Banking Supervision in February 2000.

Fourth, pending final promulgation of a risk-based capital

standard by the Office of Federal Housing Enterprise Over-

sight, our safety and soundness regulator, Fannie Mae

committed to implement an interim version of the risk-based

capital stress test detailed in the Federal Housing Enterprises

Financial Safety and Soundness Act of 1992. We also commit-

ted to publicly disclose the test outcome each quarter. As of

March 31, 2001, the company passed its internal interim risk-

based capital test with a capital cushion that exceeded 30

3

continued

percent of total capital. Fannie Mae intends to manage its

risk so that the cushion between total capital and calculated

risk-based capital is at least 10 percent of total capital.

Fifth, Fannie Mae has initiated public disclosure of credit risk

sensitivity analyses on a quarterly basis that will show the

expected financial impact of an immediate 5 percent decline

in the value of all single-family properties securing mortgages

owned or guaranteed by Fannie Mae. Following this decline,

home prices are assumed to increase at the same long-run

rate projected by the company’s credit pricing models. We are

showing our credit loss sensitivities both with and without the

effective credit enhancements. As of March 31, 2001, Fannie

Mae’s net sensitivity to future credit losses was $307 million

taking into account the effect of credit enhancements and

$1.061 billion without the effect of credit enhancements.

Fannie Mae’s low level of net credit loss sensitivity is due to a

combination of factors including the quality of the existing

book of business, the impact of loss mitigation techniques, and

the effectiveness of credit enhancement and risk-sharing

strategies.

Finally, Fannie Mae has initiated public disclosure of two

primary measures of interest rate risk the company uses in

managing its mortgage portfolio business. These are portfolio

net interest income at risk and the effective asset/liability

duration gap. The portfolio net interest income at risk

measure discloses the sensitivity of Fannie Mae’s net interest

income to an immediate 50 basis point shift in interest rates

and a 25 basis point change in the slope of the yield curve.

Fannie Mae generally expects its net income at risk to remain

within a range of 1 percent to 5 percent of baseline income. As

of June 30, 2001, the company’s net interest income at risk

from a 50 basis point change in interest rates was 1.7 percent

over the next year and 4.4 percent over each of the next four

years. The company’s net interest income at risk from a 25

basis point change in the slope of the yield curve was 0.9

percent over the next one-year and 2.0 percent over the next

four years.

Fannie Mae is supplementing its net interest income at risk

disclosure with monthly disclosure of the company’s effective

asset/liability duration gap. At the end of June, the effective

duration of our assets was 5 months longer than the effective

duration of our liabilities. Fannie Mae has a target range for

its effective duration gap of plus or minus six months. The

disclosure of effective asset/liability duration gap exceeds the

commitment the company announced last October.

The company’s interest rate risk disclosures follow the

recommendations of the new Basel Accord and the January

11, 2001 report of the Federal Reserve’s Working Group on

Public Disclosure, a private sector body established by the

Federal Reserve and chaired by Walter V. Shipley, former

chairman of Chase Manhattan Bank. Both recommend that

risk disclosures be consistent with internal risk management

practices. As noted above, net interest income at risk and

duration gap are the primary portfolio risk measures used at

Fannie Mae. Basel further proposes that disclosures incorpo-

rate expected future activity, and that sophisticated disclo-

sures use multiple simulations of interest rates. Fannie Mae’s

net interest income at risk measure incorporates future

activity in line with the company’s one- and four-year busi-

ness projections, and both net interest income at risk and

duration gap are calculated using at least three hundred

interest rate paths. Furthermore, both the credit risk and

interest rate risk disclosures meet or exceed the current best

practices of financial institutions.

No financial company in the world will tell investors and

policymakers more about its financial condition than Fannie

Mae does. Our new disclosures reinforce the fact that Fannie

Mae is one of the safest, soundest financial institutions in the

world. If there is any question or concern about how Fannie

Mae is doing, there are now several ways to find out. Inves-

tors can look at our supervision exams, our capital levels, our

regular stress test results, our external rating reports, our

monthly and quarterly reports on how the economy is affect-

ing our business, or changes in the value of our subordinated

debt.

Subordinated debt as a barometer of safety and

soundness and a tool promoting market discipline

Direct “market discipline” is exerted when an issuer’s cost of

issuing a debt instrument increases with its risk profile. The

issuer is dissuaded from taking excessive risks because it will

have to pay higher funding costs. Fannie Mae and Freddie

Mac found in discussions last year that policymakers view the

issuance of subordinated debt as a valuable tool to promote

market discipline. Issuance of subordinated debt promotes

market discipline because investors must conduct indepen-

dent reviews and consistently monitor Fannie Mae’s risk

profile, capital positions, creditworthiness and financial

health. Unlike equity holders who may have a prospect of

higher returns from greater risk, the subordinated debt

holders will not gain anything and could suffer losses if

Fannie Mae were to take excessive risks. The issuance of

subordinated debt strengthens the position of senior debt-

holders relative to equity holders. Fannie Mae’s issuance of

subordinated debt creates a powerful tool that investors may

use to monitor risk management and capital adequacy, in

conjunction with regular disclosures of interest rate and credit

risk exposures and the stringent stress test based capital

standard to which the company adheres.

Many financial regulators support subordinated debt as an

important way to crystallize the views of thousands of market

participants into a clear descriptor - the yield or spread of a

company’s subordinated debt over risk-free yields - of the

market’s view of a company’s risk position and potential for

loss. Some proponents of subordinated debt have suggested

that financial institutions should be required to issue a

certain amount of it and the Financial Laws Modernization

Act mandates a study of such a requirement. Under the

proposal made by the Bank for International Settlements for

a new capital adequacy framework for financial institutions,

market discipline is one of the “three pillars” set forth as

promoting better financial risk management, along with

improved capital standards and enhanced risk–based supervi-

sion. The Federal Reserve also has endorsed the concept of

increased market discipline as a means to ensure stringent

risk management by financial institutions. Federal Reserve

Chairman Alan Greenspan has noted that:

“The great advantage of…subordinated debentures is that it

[has] something of the nature…of a canary in a mine, that

if…the credit capacity of these institutions seems to be eroding

at the edges, it is very much more likely to show up in the

prices of liabilities which are not insured and have no collat-

eral behind them.”

Testimony before the Senate Banking Committee,

January 26, 2000.

Investors must gather information about Fannie Mae’s risks

and then incorporate that information into their decisions to

buy subordinated debt. Fannie Mae is relying on investors to

4

continued

analyze their risks on Subordinated Benchmark Notes based

on the components making up the financial safety and

soundness of Fannie Mae. Investors who purchase our

subordinated debt should pay close attention to our financial,

credit and capital positions.

One feature of Fannie Mae’s Subordinated Benchmark Notes

that promotes market discipline and distinguishes it from

other types of subordinated debt is the introduction of triggers

to defer interest payments. The terms of Fannie Mae’s

Subordinated Benchmark Notes, as stipulated in the volun-

tary commitments, call for interest deferral under the follow-

ing defined conditions of financial stress:

1) Fannie Mae’s core capital falls below 125% of critical

capital levels; or

2) (a) Fannie Mae’s core capital falls below minimum capital

levels,

and,

(b) pursuant to the company’s request, the

Secretary of the Treasury exercises his or her discretionary

authority to purchase the company’s obligations under

Section 304(c) of the company’s Charter Act.

A more detailed discussion of the capital definitions and

related issues is provided in a later section of this publication.

Unlike other subordinated debt issues, neither of the two

triggers can be set in motion arbitrarily by Fannie Mae or a

regulator, nor can the interest deferral be delayed by Fannie

Mae or by any other party if the defined conditions occur.

Required and regular issuance of subordinated debt further

promotes market discipline. Regular issuance provides

potential investors with ongoing information about safety and

soundness and alerts them to any excessive risk taking

because they continually get fresh updates on the health of

the issuer. Fannie Mae Subordinated Benchmark Notes will

be issued quarterly in 2001 and at least semi-annually in

successive years. This regular issuance pattern encourages

Fannie Mae to maintain a relatively stable risk profile on a

consistent basis. Another component of market discipline that

has been incorporated into the program is that the subordi-

nated debt securities are issued in a competitive, public

market in large size to investors representing a variety of

investor segments. Minimum initial new issue size is $1

billion, and through reopenings it is possible that Fannie Mae

will grow outstanding issues to $1.5 billion or larger. Most

dealers have been trading Subordinated Benchmark Notes on

their agency trading desks. Fannie Mae also has encouraged

dealers to take additional steps to promote liquidity in the

subordinated debt market. These features taken together –

the interest deferral trigger, regular issuance in large sizes,

and an actively traded and liquid secondary market – enhance

the role of Fannie Mae Subordinated Benchmark Notes as an

appropriate and effective barometer of Fannie Mae’s success

at risk management.

Investors should be aware that subordinated debt is treated

strictly as debt on Fannie Mae’s balance sheet. The subordi-

nated debt is not equity nor is it convertible to equity. It is

also not regulatory core capital. Due to its subordinate

position, this debt will serve as a risk-absorbing supplement

to core capital. Fannie Mae’s core capital requirement will

remain unchanged. Fannie Mae Subordinated Benchmark

Notes may be thought of as “economic” capital rather than

regulatory capital.

Although there are other instruments that Fannie Mae could

issue to enhance its capital position, subordinated debt was

selected as the best alternative to assure investors, regulators

and other outside parties that the company is fully committed

to the principle of market discipline by frequently issuing and

repricing supplemental capital. Two other alternative instru-

ments are preferred stock and convertible debt. In our

opinion, both of these instruments are less appropriate than

subordinated debt for the purpose of promoting market

discipline. The market for preferred stock is not as liquid or

homogeneous as the market for non-callable subordinated

debt that is investment grade.

The market for convertible debt is also more limited than the

market for highly rated subordinated debt. Limited liquidity

in this market makes it less likely that convertible debt would

be effective as an early warning signal of financial weakness

or distress. If Fannie Mae’s Subordinated Benchmark Notes

were convertible into equity after a trigger event, Fannie

Mae’s ability to raise additional capital by issuing stock would

be compromised. In addition, the pricing of convertible debt is

often affected by factors relating to the stock market, and

these factors may at times cause convertible debt prices to

behave quite differently than prices or spreads of the

company’s straight debt securities. Should this happen, the

market signal given by convertible debt prices will most likely

not be conveying a useful indication about the market percep-

tions of Fannie Mae’s safety and soundness.

Fannie Mae Subordinated Benchmark Notes

Fannie Mae’s Subordinated Benchmark Notes incorporate

some of the hallmark features of Benchmark Notes

®

and

Benchmark Bonds

SM

, which are consistency, liquidity, and

transparency. As our experience over the last three years has

taught us, our investors greatly benefit from these features.

Subordinated Benchmark Notes are brought to market

consistently through a traditional syndicate underwriting

structure similar to that of Benchmark Notes and Bonds. For

each transaction, Fannie Mae will appoint two or three lead

managers, several more co-managers and a selling group of

dealers.

New issues of Subordinated Benchmark Notes are typically

announced a few days before pricing. Cashflow, date conven-

tion, settlement and other aspects of Subordinated Bench-

mark Notes are consistent with those of Fannie Mae’s senior

Benchmark Notes and Bonds. Subordinated Benchmark Notes

settle through the Federal Reserve’s book-entry system.

Fannie Mae lists Subordinated Benchmark Notes on the

Luxembourg Stock Exchange.

Fannie Mae expects to issue quarterly during 2001, the first

year of the initiative, and at least semi-annually thereafter,

with a minimum issue size of $1 billion. From time to time in

order to enhance liquidity, Fannie Mae may also reopen an

existing Subordinated Benchmark Notes issue. Fannie Mae

currently expects that individual issues size could ultimately

be $1.5 billion or larger. Subordinated Benchmark Notes will

be issued over a three-year phase-in period in such a manner

that the weighted-average maturity of outstanding Subordi-

nated Benchmark Notes will be at least five years.

It is Fannie Mae’s intention to fashion some form of yield

curve in these securities. Our intent is to facilitate as much

liquidity in Subordinated Benchmark Notes as possible, given

the parameters of the program. Fannie Mae expects to issue

$12 to $15 billion in Subordinated Benchmark Notes over the

first three years, and that the weighted average maturity of

outstanding Subordinated Benchmark notes will be at least

five years at the end of the three-year phase-in period. We

may issue Subordinated Benchmark Notes in maturities from

5

continued

3- to 30-years to achieve these goals, with the maturity of

each issue being decided as we bring it to market. Given our

volume and average maturity objectives, we expect that there

will be a liquid secondary market at several points on the

yield curve, although we may not be able to issue enough

Subordinated Benchmark Notes for there to be liquidity at all

points on the curve.

Subordinated Benchmark Notes are independently rated and

are included in major dealer fixed-income indices. Our web-

based Benchmark Automated Syndication System (BASS),

which captures distribution information directly from under-

writers during the book-building process is used in the

distribution process of Subordinated Benchmark Notes. The

latest announcements, pricing information and other informa-

tion releases about upcoming and past Subordinated Bench-

mark Notes issues is available from the Debt Securities

section of Fannie Mae’s web-site

www.fanniemae.com

.

Unlike senior Benchmark Notes and Bonds, Subordinated

Benchmark Notes are not strip eligible, and so cannot be

stripped into single payment securities by investors.

Review of Fannie Mae’s First Two Subordinated

Benchmark Notes Issues

Fannie Mae’s first Subordinated Benchmark Notes transac-

tion was priced on January 25, 2001. The issue is $1.5 billion

of a 10-year maturity with a coupon of 6.25%. It was priced at

a spread of 22 basis points over our on-the-run, senior 10-year

Benchmark Notes. The initial issue was placed with over 175

investors at the time of pricing. Participating institutions

included fund managers, insurance companies, pension funds,

commercial banks, corporations and state and local govern-

ments. With respect to geographical distribution, 88% was

placed in the United States, 9% in Europe, 1% in Asia and 2%

in other areas.

Figure 2

provides a break down of the new

issue distribution on both a geographic and investor segment

basis.

Fannie Mae’s second Subordinated Benchmark Notes transac-

tion was priced on May 2, 2001. The issue is $1.5 billion of a

5-year maturity with a coupon of 5.50%. It was priced at a

spread of 18 basis points over our on-the-run, senior 5-year

Benchmark Notes. The second issue was placed with over 140

investors at the time of pricing. Participating institutions

included fund managers, insurance companies, pension funds,

commercial banks, corporations and state and local govern-

ments. With respect to geographical distribution, 83% was

placed in the United States, 15% in Europe and 2% in other

areas.

Figure 3

provides a break down of the second issue

distribution on both a geographic and investor segment basis.

Since pricing, 10-year Subordinated Benchmark Notes have

traded at a spread of between 18 and 29 basis points over

their relevant Benchmark security and 5-year Subordinated

Benchmark Notes have traded at a spread of between 17 and

22 basis points over their relevant Benchmark security. That

is a higher spread to senior debt than the subordinated debt of

many high-quality commercial banks, and it demonstrates

that investors do believe that subordinated debt is in a

different risk category from our senior debt. Our dealers have

reported trading in the secondary market, and that the bid/

offer spread has typically been between 1 and 2 basis points.

Trigger mechanism and various capital levels

As mentioned earlier, the critical feature distinguishing

Fannie Mae’s new Subordinated Benchmark Notes from other

more traditional bank-issued subordinated debt is the use of

two interest deferral triggers. These triggers (defined earlier)

result in interest deferral under defined conditions for up to

five years, though not exceeding the maturity of the issue.

Other financial institutions who have issued securities with a

deferral provision typically do not specify exactly what has to

happen for the deferral to be triggered, whereas investors in

Subordinated Debt Notes can evaluate how likely a deferral is

by monitoring Fannie Mae’s capital levels. For these reasons,

Subordinated Benchmark Notes will result in clearer market

discipline.

Figure 4

provides definitions of the different measures of

regulatory capital that are relevant to the new issues of

subordinated debt. Recent capital levels for the company are

also provided in Figure 4.

Fannie Mae’s core capital stood at $21.482 billion on March

31, 2001. With regard to the first trigger, since Fannie Mae’s

critical capital requirement was $10.712 billion on March 31,

core capital exceeded critical capital by $10.770 billion, and

was equivalent to 200% of the critical capital level. Further,

Figure 2

Distribution of Fannie Mae’s

10-Year Subordinated Benchmark Notes

®

.

Other

2%

Europe

9

%

Asia

1

%

U.S.

88%

Comm.

Banks

7%

Found./

Non-profits

1%

Insurance

Cos. 19%

Corp./

Pensions

5

%

State &

Local

Govt's

4%

Retail

1%

Fund

Managers

63%

Subordinated

Benchmark

Notes

Size/Cusip

Lead-Managers

Co-Managers

Pricing Date &

Spread

10-year

6.250%

2/1/11

$1.5 billion

31359MGT4

Goldman Sachs

Morgan Stanley

Salomon Smith

Barney

Bear Stearns

Blaylock

CSFB

JP Morgan

Lehman Brothers

Merrill Lynch

January 25, 2001

+22 bp vs.

Benchmark Notes

6.625% due

11/15/10

By Region

By Investor Type

O ther

2%

Europe

15%

U.S.

83%

By Region

By Investor Type

Comm.

Banks

7%

Found./

Non-profits

1%

Insurance

Cos. 19%

Corp./

Pensions

5%

State &

Local

Govt's

4%

Retail

3%

Fund

Managers

61%

Subordinated

Benchmark

Notes

Size/Cusip

Lead-Managers

Co-Managers

Pricing Date &

Spread

5-year

5.500%

5/2/06

$1.5 billion

31359MHX4

Lehman Brothers

Morgan Stanley

Salomon Smith

Barney

Bear Stearns

CSFB

Goldman Sachs

JP Morgan

Merrill Lynch

Utendahl

May 2, 2001

+18 bp vs.

Benchmark Notes

5.500% due

2/15/06

Figure 3

Distribution of Fannie Mae’s

5-Year Subordinated Benchmark Notes

®

.

6

continued

deferral ceasing, or (ii) the given issue maturing, or (iii) the

maximum five year period of deferral for the given issue

having elapsed, all missed interest will be due and payable

along with interest on the missed payments compounded at

the coupon rate of the particular issue.

Interest deferral would cease if none of the conditions that

trigger interest deferral continue to hold. Therefore, as soon as

Fannie Mae is no longer required to defer interest under the

terms described above and has repaid all obligations, if any,

purchased by the Secretary of the Treasury as described

above, Fannie Mae will be required to pay all deferred interest

on outstanding Subordinated Benchmark Notes and interest

thereon. If interest ceases to be deferred on any one issue of

Subordinated Benchmark Notes in this way, interest will also

cease to be deferred on all other outstanding issues of Subordi-

nated Benchmark Notes.

The securities will not contain any provision to allow holders

to accelerate the maturity of the securities if Fannie Mae does

not pay after a five year deferral. Therefore, holders will have

the right only to institute a judicial proceeding to collect

amounts then due and unpaid – i.e., the accrued interest and

compounded interest thereon. Holders would then need to

institute additional judicial proceedings for future payments

of interest and principal that become due and unpaid. This is

consistent with the structure of Fannie Mae’s senior debt

securities.

Since Fannie Mae will pay the deferred interest, if any, along

with compounded interest, the duration of the security will be

lengthened as a result of the interest deferral.

Priority of Payment

Subordinated Benchmark Notes are unsecured and subordi-

nated and rank junior in priority of payment to all of our

“Senior Liabilities.” “Senior Liabilities” means all existing and

future liabilities of Fannie Mae, other than liabilities that by

their terms expressly rank equal with or junior to Subordi-

nated Benchmark Notes. Senior Liabilities include, but are

not limited to, senior debt obligations issued under section

304(b) of the Charter Act, liabilities in respect of our guaran-

tees on mortgage-backed securities and our outstanding 9%

Capital Debentures due 2019 and our Zero Coupon Capital

Debentures due 2019. Senior Liabilities also include any

liabilities related to the $773.836 billion of outstanding

mortgage-backed securities at that date on which Fannie Mae

Figure 4

Definitions of various types of capital relating to

interest deferral feature of Subordinated

Benchmark Notes

®

• Issuance will be in an amount such that, following the three-year

phase-in period, the sum of core capital, loss allowances, and

outstanding subordinated debt will equal or exceed 4 percent of on-

balance sheet assets, after setting aside capital sufficient to support

off-balance sheet mortgage backed securities.

• At March 31, 2001, Fannie Mae’s core capital was $21.482 billion,

our minimum capital was $21.033 billion and our critical capital was

$10.712 billion.

• “Core capital” is the sum of:

- the stated value of our outstanding common stock,

- the stated value of our non-cumulative perpetual preferred stock,

- paid-in capital, and

- retained earnings.

• “Minimum capital” is the sum of:

- 2.50% of on-balance sheet assets,

- 0.45% of net mortgage-backed securities outstanding, and

- 0.45% of other outstanding balance sheet items, which may be

adjusted by OFHEO in certain circumstances.

• “Critical Capital” is the sum of:

- 1.25% of on-balance sheet assets,

- 0.25% of net mortgage-backed securities outstanding, and

- 0.25% of other off-balance sheet obligations, which may be adjusted

by OFHEO under certain circumstances.

core capital was $8.092 billion higher than the trigger level of

125% of critical capital.

At $21.482 billion, Fannie Mae’s core capital exceeded

minimum capital by $448 million as of March 31, 2001. Two

factors should be noted here. First, Fannie Mae manages the

difference between the core and minimum capital levels by

increasing and decreasing investments in its Liquid Invest-

ment Portfolio (high quality short term investments typically

of less than one year to maturity) to utilize or release core

capital as needed, and by share repurchases in case of excess

core capital. Also, the second trigger is activated only if core

capital is less than minimum capital

and

the Secretary of

Treasury purchases Fannie Mae’s debt at the company’s

request. Fannie Mae has never requested such purchases and

the Treasury has never undertaken such purchases at its own

discretion.

Figure 5

illustrates the margins by which Fannie

Mae’s core capital has exceeded minimum and critical capital

requirements over the last several years. Core capital has

been close to double the value or more than critical capital

and has exceeded minimum capital at all times.

Fannie Mae, like any other financial institution, has some

ability to manage its capital levels in times of financial stress,

particularly in terms of utilizing or reducing excess capital.

However, the trigger for Fannie Mae Subordinated Bench-

mark Notes relies much less on management discretion than

does the trigger of interest deferral for typical bank capital

securities.

In the event of interest deferral being triggered, it would

simultaneously be triggered for all outstanding Subordinated

Benchmark Notes. In addition, dividend payments on out-

standing equity and preferred stock would be suspended.

Interest deferral for an issue will occur for a maximum of five

years, but will not extend beyond the stated maturity of the

issue. Once interest deferral is triggered, no interest pay-

ments will be made until the requirement for interest deferral

ceases. Upon the earliest of (i) the requirement for interest

Differences between Core and Critical Capital levels

211.29%

203.96%

200.34%

200.54%

196.68%

216.86%

195.86%

$5,586

$6,883

$7,265

$7,602

$10,490

$10,770

$8,749

185.00%

190.00%

195.00%

200.00%

205.00%

210.00%

215.00%

220.00%

1995

1996

1997

1998

1999

2000

1Q2001

% Difference

$0

$2,000

$4,000

$6,000

$8,000

$10,000

$12,000

$ Difference

$0

$2,000

$4,000

$6,000

$8,000

$10,000

$12,000

$14,000

$16,000

$18,000

$20,000

$22,000

1 9 9 5

1996

1 9 9 7

1998

1999

2000

2001

Core over Minimum

Minimum over Critical

Critical Capital

Figure 5

Subordinated Benchmark Notes

®

provide an added

layer of protection to senior debt holders.

As of March 31, 2001

7

continued

guarantees timely payment of principal and interest (which

excludes mortgage-backed securities held by us in portfolio at

that date). Fannie Mae cannot make any payments of princi-

pal or interest on the Subordinated Benchmark Notes if the

company defaults on any Senior Liabilities. On June 30, 2001

Fannie Mae had outstanding total liabilities of $717.720

billion, $714.720 billion of which constitute Senior Liabilities.

The two outstanding subordinated debt securities referred to

above are a $6.75 billion (book value $1.093 billion as of June

30, 2001) zero coupon issue maturing on October 9, 2019 and

a $250 million 9.00% coupon issue maturing on February 1,

2019. The zero coupon was issued in 1984 and the 9.00%

coupon was issued in 1989.

Investors will have four public credit rating

viewpoints for Fannie Mae

Each issue of Subordinated Benchmark Notes will at all times

be publicly rated by Moody’s Investor Service and Standard &

Poor’s. With the annual publication of the new risk to the

government or independent financial strength ratings of

Fannie Mae mentioned earlier as one of our voluntary

commitments, investors will have available to them four

published ratings of our credit standing, each from a different

angle:

• First, our senior unsecured debt is currently rated Aaa by

Moody’s and AAA by Standard & Poor’s. This debt has

always been rated at these levels at all times that a rating

has actually been assigned to it.

• Second, our preferred stock is currently rated “aa3” by

Moody’s.

• Third, each issue of subordinated debt will be rated by

both Moody’s and Standard & Poor’s. The first two transac-

tions were rated Aa2 by Moody’s, and AA- by Standard &

Poor’s.

• Finally, Fannie Mae has obtained and disclosed a “risk to

the government” of AA- by Standard & Poor’s.

Inclusion in Major Fixed-Income Indices

Fannie Mae’s Subordinated Benchmark Notes are included in

many of the major dealer international and domestic fixed-

income indices. Lehman Brothers includes outstanding

Subordinated Benchmark Notes in the agency component of

their Global Aggregate Bond Index and their U.S. Aggregate

Bond Index. Merrill Lynch includes Subordinated Benchmark

Notes in the agency component of their Global Broad Market

Index and their U.S. Broad Market Index. Salomon Smith

Barney also includes the Subordinated Benchmark Notes in

the agency component of their World Broad Investment-Grade

Bond Index and their U.S. Broad Investment-Grade Bond

Index.

As of June 30, 2001 the market value of the agency sector in

Lehman Brothers’ Global Aggregate Bond Market Index stood

at 11.03%, with Fannie Mae comprising 41.28% of the agency

sector. The outstanding par amount of all Fannie Mae’s senior

bullet Benchmark Notes was $224 billion. Very little subordi-

nated agency debt exists apart from Fannie Mae’s and Freddie

Mac’s issuances in 2001. As noted above, Fannie Mae’s

projected issuance over the next three years will be in the

range of $12 to $15 billion. Therefore, the vast majority of

agency debt in the agency indexes will continue to be the

senior unsecured debt of Fannie Mae and other agency

issuers.

Unchanged status for senior unsecured debt

Fannie Mae’s senior unsecured debt is currently rated Aaa by

Moody’s and AAA by Standard & Poor’s. In addition, Fannie

Mae’s commitments with respect to issuing Subordinated

Benchmark Notes will not in any way affect the previously

stated commitments to issue senior Benchmark Securities

according to the calendar for 2001 that was published in

September 2000. As detailed in the calendar release, Fannie

Mae will issue Benchmark Notes and Bonds in maturities of

two-, three-, five-, ten- and thirty-years, and Benchmark Bills

in maturities of three- and six-months and one-year.

As discussed earlier, the new Subordinated Benchmark Notes

will support the existing senior unsecured debt (in addition to

the Capital Debenture issues maturing 2019). As a result of

the issuance of the new subordinated debt, the level of support

enjoyed by senior debt-holders will increase substantially

from the current level of $21.482 billion of regulatory core

capital and the book value (as June 30, 2001) of $4.343 billion

of existing subordinated debt.

Potential investors in Fannie Mae Subordinated

Benchmark Notes

Subordinated Benchmark Notes have been distributed to

many traditional as well as non-traditional investors in the

company’s senior Benchmark Notes and Bonds. Many high-

grade corporate bond investors such as insurance companies,

money managers, and pension funds have been attracted to

the Fannie Mae Subordinated Benchmark Notes. In particu-

lar, corporate bond investors who fear under-performance of

certain credit sectors, due to a slowing economy and the

possibility of declining earnings, may choose to move assets

into Fannie Mae Subordinated Benchmark Notes as an

alternative strategy. In addition, those investors that desire

exposure to credit with solely U.S. domestic operations may

find the Subordinated Benchmark Notes an attractive

investment vehicle. Fannie Mae encourages the maintenance

of a liquid secondary market in these securities, so that total

rate of return oriented investors can easily trade them with a

number of dealer counterparties when they see opportunities

to buy or sell these securities.

Commercial banks are also participants in the Subordinated

Benchmark Notes program since they can hold the subordi-

nated debt without regard to limitations generally applicable

to investment securities. Additionally, Fannie Mae Subordi-

nated Benchmark Notes are eligible as collateral for borrow-

ing from the Federal Reserve Discount Window.

Pension funds and fund managers that manage pension

assets have also expressed interest in the Subordinated

Benchmark Notes since they are ERISA eligible.

Life insurance companies have also been attracted to the

Subordinated Benchmark Notes since the National Associa-

tion of Insurance Commissioners (NAIC) has provided

guidance that Subordinated Benchmark Notes should receive

a preliminary NAIC-1 designation.

Traditional agency debt investors are also thought to be active

participants in Subordinated Benchmark Notes since many of

the leading index providers have included our subordinated

debt in the agency component of their widely followed fixed-

income indices.

Information Sources

The Universal Debt Facility Offering Circular has been

amended to incorporate Subordinated Benchmark Notes.

Appendix C of the Offering Circular contains a summary

description of our Subordinated Benchmark Notes. We will

offer any issue of Subordinated Benchmark Notes through the

Offering Circular and a supplement that will contain detailed

information about the issue.

8

First Class

U.S. Postage

PAID

Washington, DC

Permit No. 8560

Treasurer

’

s Office

3900 Wisconsin Avenue, NW

Washington, DC 20016-2892

Fundingnotes

is published Monthly by

Fannie Mae’s Debt Marketing Group

Editors:

Hasan Latif

(202) 752-5659

Michael Kenney

(202) 752-2859

Toll-free Help line:

(888) BONDHLP

Website:

http://www.fanniemae.com

E-mail:

[e-mail]

f

undingnotes

sm

This document is based upon information and assumptions (including financial, statistical or historical data and computations based upon such data) that we

consider reliable and reasonable, but we do not represent that such information, assumptions, data or computations are accurate or complete, or appropriate or

useful in any particular context, including the context of any investment decision, and it should not be relied upon as such. In addition, we do not undertake to

update any information, data, or computations contained herein, or to communicate any change in the opinions and estimates expressed herein. No representation

is made that any strategy, performance or result illustrated herein can or will be achieved or duplicated. The effect of factors other than those assumed, including

factors not mentioned, considered or foreseen, by themselves or in conjunction with other factors, could produce dramatically different performance or results.

Fannie Mae is the issuer of certain securities and instruments mentioned herein and Fannie Mae or its employees may from time to time have long or short

positions in, and buy or sell or engage in other transactions, as principal, with respect to or relating to such securities or instruments. Fannie Mae securities are

more fully described in applicable offering circulars, prospectuses, or supplements thereto (such applicable offering circulars, prospectuses and supplements, the

“Offering Documentation”), which discuss certain investment risks and contain a more complete description of such securities. All statements made herein are

qualified in their entirety by reference to the Offering Documentation. An offering only may be made through delivery of the Offering Documentation. Investors

considering purchasing a Fannie Mae security should consult their own financial and legal advisors for information about such security, the risks and investment

considerations arising from an investment in such security, the appropriate tools to analyze such investment, and the suitability of such investment in each

investor’s particular circumstances. The Debt Securities, together with interest thereon, are not guaranteed by the United States and do not constitute a debt or

obligation of the United States or of any agency or instrumentality thereof other than Fannie Mae.

A key information resource pertaining to Fannie Mae Subordi-

nated Benchmark Notes is our web site,

http://

www.fanniemae.com/markets/debt/subordinated_debt/

index.html

.

Visit the Subordinated Benchmark Notes Web Site

for the most current information on Fannie Mae

Subordinated Benchmark Notes®

At this site, you will find the most recent developments,

offering circulars, press releases and other related informa-

tion on the Subordinated Benchmark Notes as well as on

specific transactions.

New issue pricing and distribution information on past issues

of Subordinated Benchmark Notes is also available on Fannie

Mae’s BASS web-page which is accessible from Fannie Mae’s

Debt Securities web-site,

http://www.fanniemae.com/markets/

debt/index.html

.

Conclusion

Fannie Mae is committed to being a leader among the premier

financial institutions in the world in terms of risk manage-

ment practices that adhere to an extremely high level of

safety and soundness. With the company’s implementation of

six voluntary safety and soundness commitments, Fannie

Mae now perhaps has the most comprehensive configuration

of protections against risk and loss of any financial institution

in the world. The concept of market discipline is a key

component in that configuration and Subordinated Bench-

mark Notes are the primary vehicle Fannie Mae is using to

enhance market discipline.

www.fanniemae.com/markets/debt/subordinated_debt/current_events.html