I

i

Message from the Acting Director

It is not the going out of port, but the coming in,

that determines the success of the voyage

 - - Henry Ward Beecher

The atmosphere around OFHEO is charged with excitement as we near the completion of our risk-based

capital regulation. To be a part of such unprecedented work, and to have the opportunity to work with

such a talented and dedicated staff, is professionally invigorating and rewarding. Chapter 1 of this report

outlines OFHEO’s work on the development of this next generation of capital regulation. We will be

establishing a risk-based standard that effectively captures both the credit risk and interest rate risk exposures to the Enterprises. By more closely aligning capital with risk, OFHEO’s standard will be well-designed to assure that Fannie Mae and Freddie Mac can continue to fulfill their public mission while maintaining their financial safety and soundness.

Early in 1998, OFHEO reached another important regulatory milestone as we moved to a comprehensive,

annual, risk-based examination program. Chapter 2 describes the details and fundamental principles of

our new examination program. Chapter 3 reports the results and conclusions of our information technology and internal audit examinations of the Enterprises. These examinations provided OFHEO with the

final building blocks to the essential foundation of information necessary for the evolution of our examination program.

One of OFHEO’s highest priorities is working closely with the Enterprises to ensure that they successfully

address their Year 2000 date change issues. Together with our partners in the federal financial regulatory

community, OFHEO is working to make sure that the secondary mortgage market’s transition into the

new millennium is technologically successful.

A strong economy and a strong housing market proved beneficial to the operations of the Enterprises this

past year. Chapter 4 analyzes developments in the primary and secondary mortgage markets as well as the

performance of the Enterprises in this favorable environment.

In this period of record rates of homeownership and favorable economic conditions, strong regulation and

the development of additional regulatory tools such as OFHEO’s risk-based capital standard may seem like

an enigma. After all, OFHEO is charged with regulating two companies that are currently healthy and

enjoying record profits. However, it is our mission and responsibility to assure the financial safety and

soundness of the secondary mortgage market at all times. OFHEO’s regulatory activities serve to protect

the American taxpayer and keep the housing finance industry safe and sound.

OFHEO’s ultimate goal is that every potential homebuyer achieves their dream of owning a home. Ensuring a strong secondary mortgage market through fair and effective regulation of these two important

companies can help make those dreams come true.

Mark Kinsey

June 15, 1998
iiii

Table of Contents

Message from the Acting Director ................................................. i

Chapter 1: Setting a New Standard in Capital Regulation

Risk-Based Capital Standards for Banks and Thrifts ...................................................... 2

Risk-Based Capital Standards for Fannie Mae and Freddie Mac .................................. 3

Stress Testing ..................................................................................................................... 3

Advantages of Using a Stress Test to Determine a Risk-Based Capital Standard ....... 4

The stress test will provide incentives to manage risk ........................................... 4

The stress test will provide the Enterprises with options to

meet regulatory capital requirement ...................................................................... 5

The stress test will be forward-looking ................................................................... 5

The stress test will be robust in measuring credit and interest rate risk................ 5

Using Minimum and Risk-Based Capital Standards to Ensure

 Effective Capital Regulation ............................................................................................ 6

Enhancing OFHEO’s Regulatory Oversight of the Enterprises .................................... 6

Chapter 2: OFHEO’s Comprehensive, Annual, Risk-Based

Examination Program

OFHEO’s Examination Program ...................................................................................... 10

OFHEO’s Examination Principles ........................................................................ 11

A Quality Examination Force ................................................................................ 11

The Examination Process................................................................................................ 11

Risk Profiles ........................................................................................................... 13

Examination Strategies ......................................................................................... 13

Program Areas for Risk-Based Examinations and

 Categories of Risk and Risk Management .......................................................... 13

Credit Risk .......................................................................................................... 13

Market Risk ........................................................................................................ 13

Operations Risk .................................................................................................. 14

Corporate Governance ....................................................................................... 14
iii

Examination Objectives, Assessment Factors, and Evaluation Criteria ......... 14

Communicating Examination Findings. . . . ......................................................... 15

Effect Changes and Follow-Up ............................................................................. 15

The End . . . or Starting Over? .............................................................................. 16

Chapter 3: OFHEO’s Regulatory Activities

Preparing for Transition ................................................................................................... 18

The Information Systems and Technology (IT) Examinations ...................................... 18

IT Exposure............................................................................................................ 18

Objective of the IT Examination ........................................................................... 19

Sources of IT Exposure ........................................................................................ 19

Examination Scope ............................................................................................... 19

Examination Results and Conclusions—Fannie Mae ........................................ 19

Examination Results and Conclusions—Freddie Mac........................................ 20

The Internal Audit/Operations Risk Examinations ........................................................ 20

The Role of Internal Audit ..................................................................................... 20

Objective of the Internal Audit/Operations Risk Examinations ......................... 20

Examination Scope ............................................................................................... 20

Examination Results and Conclusions—Fannie Mae ........................................ 21

Examination Results and Conclusions—Freddie Mac........................................ 22

The Year 2000 Challenge and Examination Activities ................................................... 22

What Is the Year 2000 Challenge? ........................................................................ 22

How Does OFHEO Evaluate the Enterprises’ Efforts to Achieve

 Year 2000 Compliance? ....................................................................................... 22

The Year 2000 Evaluative Framework ................................................................. 23

The Enterprises’ Year 2000 Efforts Are Appropriate .......................................... 23

Flood Insurance Compliance Activities ......................................................................... 24

Background ............................................................................................................ 24

Results of Flood Insurance Review ..................................................................... 24

Capital Classification and Minimum Capital .................................................................. 25

Executive Compensation Authority ................................................................................ 25
iviv

Chapter 4: Mortgage Markets And The Enterprises In 1997

and Early 1998

Housing and Primary Mortgage Market Developments ................................................ 28

Record Housing and Mortgage Market Activity .................................................. 28

Credit Risk Profile of 1997 Originations Appears Relatively Unchanged ......... 30

Subprime Originations Surge............................................................................... 31

Secondary Market Activities of the Enterprises............................................................. 32

Overall Secondary Mortgage Market Activity Declined in 1997 ......................... 32

Enterprise Purchases and Issuances Decline .................................................... 33

Fannie Mae and Freddie Mac Expand into Wider Range

 of Mortgage Products ........................................................................................ 33

Increased Use of Credit Enhancements Improves Credit

 Risk Profile of Enterprise Purchases and Guarantees.................................. 34

Financial Condition of the Enterprises ........................................................................... 35

Earnings Exceed $4 Billion in 1997, as Mortgage Investments Increase and

 Credit Losses Decline ....................................................................................... 35

Enterprise Credit Losses Decline, While Delinquencies Remain Low .............. 38

Year 2000 Costs Add to Administrative Expenses ............................................. 39

Refinance Activity Affects First Quarter 1998 Enterprise Earnings................... 39

The Enterprises’ Asset Growth Rate Continues to Decline................................ 39

As Debt Grows, Enterprises Expand Funding Sources and Seek New

 Types of Funding Vehicles ............................................................................... 40

Enterprises Meet Regulatory Minimum Capital Requirements,

 While Exercising Capital Management ........................................................... 41

Historical Data Tables ................................................................................. 45

Appendix ........................................................................................ 71

Federal Housing Enterprises Financial Safety and Soundness Act of 1992

 (Title XIII of Public Law 102-550)

Office of Federal Housing Enterprise Oversight

OFHEO Senior Officials
v

List of Boxes, Figures & Tables

Boxes

Box 1: OFHEO’s Financial Simulation Model ................................................................. 6

Box 2: OFHEO’s Comprehensive, Annual, Risk-Based Examination Program ......... 12

Box 3: Benchmark and Reference Notes ..................................................................... 43

Figures

Figure 1: Mortgage Interest Rates ............................................................................... 28

Figure 2: New and Existing Single-Family Home Sales ............................................. 29

Figure 3: Originations of Single-Family Mortgages ($ in Billions) ............................ 29

Figure 4: One-Year Change in House Prices U.S. Census Divisions

 Fourth Quarter 1996 to Fourth Quarter 1997 .......................................... 30

Figure 5: Refinance Share of Total Mortgage Originations vs. Commitment

 Rate on 30-Year FRMs............................................................................... 30

Figure 6: ARM Share of Conventional Single-Family Loans vs. Commitment

 Rate on 30-Year FRMs.............................................................................. 31

Figure 7: Enterprise Single-Family Mortgage Purchases ($ in Billions)................... 31

Figure 8: Enterprise Multifamily Mortgage Purchases............................................... 32

Figure 9: Enterprise Share of Conventional Single-Family Mortgage Market .......... 32

Figure 10: Enterprise Single-Class MBS Issuance ($ in Billions) ............................... 33

Figure 11: Enterprise REMIC Issuances ($ in Billions) ................................................ 33

Figure 12: Average LTV on Enterprise Purchases........................................................ 34

Figure 13: Enterprise Mortgage Investments ($ in Billions) ........................................ 34

Figure 14: Enterprise Primary Sources of Revenue ($ in Billions) ............................ 38

Figure 15: Single-Family Delinquency Rates ................................................................ 38

Figure 16: Combined Enterprise Assets and Growth Rate ($ in Billions) .................. 40

Figure 17: Enterprise Average Non-Mortgage Investments ($ in Billions) ................. 40

Figure 18: Effective Long-Term Debt as a Percent of Total Debt ($ in Billions) ......... 41

Figure 19: Enterprise Core Capital as a Percent of Minimum

 Capital Requirements ............................................................................... 41

Tables

Table A: Fannie Mae, Selected Financial Highlights .................................................... 36

Table B: Freddie Mac, Selected Financial Highlights ................................................... 37
1998 OFHEO REPORT TO CONGRESS

1

CHAPTER 1

SETTING A NEW STANDARD IN

CAPITAL REGULATION
1998 OFHEO REPORT TO CONGRESS

2

SETTING A NEW STANDARD IN

 CAPITAL REGULATION

The Office of Federal Housing Enterprise Oversight (OFHEO) is developing the next generation

of capital regulation for the two largest housing

government-sponsored enterprises - Fannie Mae

and Freddie Mac (the Enterprises). Through the

technique of stress testing, OFHEO will establish

a risk-based capital standard that effectively captures both the credit and interest rate risk exposures of the Enterprises.

OFHEO’s risk-based capital standard will represent a new standard in capital regulation because

it will more closely align capital with risk than current capital standards for other federally regulated

financial institutions. OFHEO’s standard will be

able to do this because it is being tailored to the

specific risks facing the Enterprises, namely the risks

associated with owning and guaranteeing conforming residential mortgages. In addition, OFHEO’s

risk-based capital standard will simulate the credit

risk associated with mortgages along multiple risk

dimensions. This allows distinctions to be made

among the risks associated with different types of

mortgages and mortgage products. By more closely

aligning capital with risk, OFHEO’s risk-based

capital standard will be well-suited to permitting

Fannie Mae and Freddie Mac to fulfill their public

mission while ensuring their financial safety and

soundness.

Risk-Based Capital Standards

for Banks and Thrifts

The current capital requirements for banks and

thrifts implement the principles articulated in the

1988 Basle Accord1

 and reflect an evolution in capital regulation that occurred during the 1980s. As

the capital position of significant numbers of

financial institutions deteriorated during this period, bank supervisory authorities adopted common standards for defining capital, and they formalized risk-based capital requirements and capital adequacy standards. The Basle Accord formalized several key ideas:

 Capital requirements must be tied to financial risk.

 Capital requirements should be tailored to

the magnitude and nature of the risks (that

is, the risk profile) of the individual financial institution.

• Off-balance-sheet contingent liabilities must

be included in computing capital levels.

The resulting bank and thrift risk-based capital requirements were regarded as a significant improvement in capital adequacy regulation at the time

that they were adopted. Previously, banks and

thrifts were assessed a flat capital charge for all assets. However, distortions could arise because there

was neither a penalty for risk-taking nor a benefit

for risk reduction. Risk-based capital standards

eliminated some of the distortions by establishing

four categories of risk. The new rules also required

the holding of capital against off-balance-sheet

obligations, which were growing in importance and

represented a potentially significant liability.

Yet the bank and thrift risk-based capital requirements are not entirely satisfactory. The implementation of the Basle Accord resulted in a risk-based

capital standard that was only loosely related to

the credit risks associated with a bank’s or thrift’s

assets. The problem was that the standards had

too few risk distinctions among types of assets, resulting in a failure to capture fully the risks associated with a bank’s or thrift’s assets.
1998 OFHEO REPORT TO CONGRESS

3

A common criticism of the bank and thrift riskbased capital standards is that the required capital

level for an institution is still more a function of

asset size than of risk. That is, a large institution

with very conservative investments may be required

to hold more capital than a smaller institution with

riskier investments. Also, as a financial institution’s

activities become more complex, bank and thrift

risk-based capital ratios can be misleading; the ratios can give the appearance of capital adequacy

because the limited number of risk categories are

not adequate to capture accurately the risk associated with new types of financial instruments.

Although the bank and thrift regulators also were

directed to create uniform rules that would take

account of interest rate risk, that task proved to be

very difficult to accomplish within the existing

capital framework. Instead, banks and thrifts are

currently required to determine the impact of significant shifts in interest rates, and there is no explicit link to required capital.

Risk-Based

Capital Standards for

Fannie Mae and Freddie Mac

The financial institution crises of the 1980s and

the early 1990s not only motivated new approaches

to bank and thrift supervision, they also focused

attention on the potential liability to the government posed by the government-sponsored enterprises, especially the two largest ones, Fannie Mae

and Freddie Mac. Though not explicitly guaranteed by the federal government, the Enterprises’

financial obligations are priced in the market virtually as if they have such a guarantee. Market

participants behave as though they are confident

the federal government would make good on any

financial obligation of an Enterprise that failed.

As the legislation that created safety and soundness oversight for Fannie Mae and Freddie Mac

was being written, Congress recognized that the

risk-based capital standards for banks and thrifts

would be inappropriate for the Enterprises. In particular, Congress was concerned about the need to

align capital closely with risk so that the taxpayers

would be protected and the ability of the Enterprises to achieve the public policy goal of fostering

homeownership would not be impaired. The single

risk category for mortgages under the bank and

thrift risk-based capital standards would not result

in an accurate alignment of risk with capital because it could not distinguish between the relative

risks associated with the specific types of mortgages

the Enterprises purchased. Congress also recognized the need for the capital standard to capture

interest rate risk associated with the Enterprises’

activities.

The risk-based capital standard that Congress has

mandated for the Enterprises adopts the key principles in the Basle Accord but implements them in

a way that is tailored to the specific activities of the

Enterprises. OFHEO is charged with developing

a risk-based capital standard using a stress test methodology that measures credit and interest rate risk

for the Enterprises more accurately than would a

direct application of the bank and thrift capital

standards.

Stress Testing

A stress test is a scenario of financial distress. It is

a vehicle for estimating the losses that might occur

under unforeseen circumstances. A computer

model is used to simulate the cash flows from financial instruments in hypothetical severe economic conditions. The effects of the risks embedded in those instruments and the way the risks are

managed are captured in the modeling of income

and expense cash flows.

Stress testing is a common tool many firms use to

quantify risk. Rating agencies use stress tests to

simulate future performance of mortgage- and asset-backed securities. Banks use stress tests to simulate trading portfolio performance. Mortgage insurance companies use stress tests to project capital needs. The Enterprises, as well, use stress tests

to simulate performance of their assets and obligations to project capital needs.
1998 OFHEO REPORT TO CONGRESS

4

As a regulatory tool, a stress test allows the

regulator to establish a capital requirement that is

tailored to the specific risk profile of a financial

institution. By simulating the performance of the

assets and obligations held by the institution each

time the stress test is conducted, the capital requirement will adjust appropriately as the institution’s

risk profile changes.

The basic parameters of the stress test that OFHEO

will propose for the risk-based capital standard for

the Enterprises are spelled out in the Federal Housing Enterprises Financial Safety and Soundness Act

of 1992 (the 1992 Act). The Enterprises will be

required to hold an amount of capital sufficient to

remain solvent during a 10-year period of severe

credit and interest rate stresses. The risk-based capital requirement will be equal to the amount of capital needed to survive the stress test, plus an additional 30 percent to cover unspecified management

and operations risks.

The 1992 Act requires OFHEO to project credit

losses on a national scale comparable to the worst

historical mortgage default and loss experience in

any region of the country.2

 Using historical Enterprise data, OFHEO found the worst regional

experience for 30-year, fixed-rate mortgages to be

the performance of loans originated in Arkansas,

Louisiana, Mississippi, and Oklahoma in 1983 and

1984.3 These mortgages were originated in the

eastern part of the Oil Belt just before oil prices

collapsed in the mid-1980s. OFHEO’s research

shows that 14.9 percent of these mortgages defaulted in their first 10 years, leading to dollar losses

equaling 63.3 percent of the original principal balance of the defaulting loans. (These losses do not

include the proceeds from mortgage insurance or

other credit enhancements.) The defaults and losses

associated with these mortgages serve as a benchmark for determining how all of the mortgages on

the Enterprises’ current books of business perform

during the stress test.

The 1992 Act defined the interest rate stress in

terms of sizable movements of the 10-year, constant maturity Treasury yield. The Treasury rate is

assumed to increase by as much as 75 percent or

decrease by as much as 50 percent during the first

year of the stress test, whichever results in the greatest losses, and to remain at that level for the remaining nine years of the test. Other interest rates

are assumed to move consistently with the Treasury rate and must be reasonably related to historical experience.

To subject the Enterprises to the types of credit

and interest rate stresses required by the 1992 Act,

OFHEO developed a sophisticated financial simulation model. The model is capable of simulating

each Enterprise’s financial performance for all assets, liabilities, and off-balance-sheet activities and

projecting pro forma financial statements (See Box

1).

Advantages of Using a

Stress Test to Determine a

Risk-Based Capital Standard

There are important advantages in using a stress

test to determine the risk-based capital requirements for government-sponsored enterprises like

Fannie Mae and Freddie Mac. These advantages

help strike a meaningful balance between the need

for ensuring financial safety and soundness and the

need for the Enterprises to fulfill their public mission.

The stress test will provide incentives

to manage risk

A risk-based capital standard that closely aligns

capital with risk provides market-like incentives to

manage risk. Because capital market investors treat

Enterprise debt as implicitly guaranteed by the federal government, the Enterprises’ borrowing costs

are little affected by changes in their leverage or

general financial conditions. Since the Enterprises

are not subject to the same type of market disci-
1998 OFHEO REPORT TO CONGRESS

5

pline as fully private firms, the market cannot be

relied upon to provide the Enterprises with the

proper signals to hold additional capital when the

Enterprises take on additional risk. OFHEO’s

stress test, however, will provide such signals. For

example, if the Enterprises begin to purchase higher

percentages of mortgages with higher risk characteristics, their overall risk will increase. The stress

test will then project higher credit losses, resulting

in a higher capital requirement.

The stress test will provide the Enterprises

with options to meet regulatory capital

requirements

Since the stress test closely aligns capital with risk,

an Enterprise will have the option of adjusting its

capital position to match its risk profile, or adjusting its risk profile to match its capital position.

For example, rather than hold a large amount of

capital against interest rate risk, an Enterprise might

choose to engage in more derivative transactions

that reduce risk. The stress test will incorporate

the beneficial effects of those derivatives. Similarly, instead of holding more capital against higher

risk mortgages, an Enterprise might utilize thirdparty credit enhancements that reduce the

Enterprise’s exposure to the risk associated with

these mortgages. OFHEO’s stress test will give

the Enterprises credit for high quality, third-party

credit enhancements such as private mortgage insurance. Thus, the stress test will provide each

Enterprise with the flexibility to pursue its own

business strategy in combination with its mortgage

purchase, funding, and risk management strategies,

while assuring that they are adequately capitalized.

The stress test will be forward-looking

Stress tests are by nature forward-looking. A stress

test approach to capital regulation allows OFHEO

to project how an Enterprise, with its current book

of business and management strategies, would perform in the future under stressful conditions. The

stress test requires the Enterprises to hold capital

today for losses that are projected to occur over

the next 10 years. In addition, the use of the stress

test will provide an early warning signal to OFHEO

of potential problems. The stress test will incorporate the changes to the risk profile of each Enterprise every time the test is run. In contrast, existing capital standards for other federally regulated

financial institutions are tied to backward-looking

book values. They have predetermined risk categories for broad classes of assets that are insensitive to changes in the underlying economic factors

that determine risk.

The stress test will be robust in measuring

credit and interest rate risk

OFHEO’s stress test captures the significant credit

and interest rate risk at the Enterprises. The performance of assets, liabilities, and off-balance-sheet

activities are modeled in some detail. The model

recognizes that, within one broad class of asset or

liability, risk varies. For example, credit risk associated with the Enterprises’ mortgage portfolios is

modeled along multiple risk dimensions, including borrower equity, property type, mortgage type,

and interest rates. This means that a high loan-tovalue (LTV) adjustable-rate mortgage will be simulated as more risky than a low LTV fixed-rate mortgage. By modeling both assets and liabilities, the

stress test will measure the interaction of risk factors, such as the mitigating effect that derivatives

and callable debt may have on interest rate risk. It

also will measure the interaction of the risk characteristics of the Enterprises’ financial instruments

and the external economic conditions. For example, changes in interest rates during the stress

period will have a direct effect on mortgage defaults and prepayments of the Enterprises’ mortgages.
1998 OFHEO REPORT TO CONGRESS

6

Using Minimum and

Risk-Based Capital Standards

to Ensure Effective Capital

Regulation

The minimum capital requirement for the Enterprises, which is based on simple ratios for on- and

off-balance-sheet items, represents the amount of

capital that the Enterprises must always hold. The

risk-based capital requirement hypothetically may

be equal to, higher than, or lower than the minimum capital requirement, depending on the risk

profile of each Enterprise. If the risk-based requirement is higher than the minimum, the Enterprises

must hold capital equal to the risk-based requirement. If the risk-based requirement is lower, the

Enterprises must hold the minimum capital requirement. There is no fixed relationship over time

between the minimum capital requirement and the

risk-based capital requirement, nor will the relationship between the two requirements be the same

for Fannie Mae and Freddie Mac.

Enhancing OFHEO’s

Regulatory Oversight of the

Enterprises

OFHEO’s risk-based capital standard combined

with our comprehensive, annual, risk-based examination program (discussed in Chapter 2) will

provide OFHEO with powerful tools to oversee

and promote the financial safety and soundness

of Fannie Mae and Freddie Mac. These regulatory tools are designed to hold the Enterprises to

a strong financial discipline. While the risk-based

capital standard will be based on a single set of

stressful conditions, the financial simulation model

used to run the stress test will provide OFHEO

with an unprecedented ability for a financial institution regulator to analyze the operations of the

Enterprises under a wide variety of economic conditions.

Box 1

OFHEO’s Financial Simulation Model

Translating the economic shocks produced by a stress test into projected company performance is no simple task. A financial simulation model was created to project the separate

financial performances of Fannie Mae and Freddie Mac under the stressful conditions outlined in the 1992 Act. The model consists of several components: statistical models that

project mortgage defaults, loss severities, and prepayment rates; computer programs that calculate the cash flows from assets, liabilities, and off-balance-sheet activities; and computer

programs that translate these cash flows into pro forma financial statements. The diagram on

the following page depicts the model and its components.
1998 OFHEO REPORT TO CONGRESS

7

Box 1 (Continued)

1. Database: OFHEO standardizes and enters

historical data obtained from the Enterprises into

models to determine the appropriate relationships

between mortgage risk factors and Enterprise performance. Data on the Enterprises’ current books

of business represent the starting positions for the

stress test.

2. Interest Rates: Interest rate models built by

OFHEO simulate future movements of Treasury

yields, related interest rates, and indexes that affect

Enterprise performance.

3. House Prices: OFHEO includes past house

prices and future house price projections as part of

the stress test because they directly affect the likelihood of mortgage default and prepayment, and the

magnitude of resulting losses. House prices are measured by indexes calculated from past house price

movements.

4. Benchmark Loss Experience: OFHEO

makes assumptions regarding default losses for the

stress test that are based, by law, on the country’s

worst regional default loss experience. Models of

mortgage performance must produce results that are

consistent with this benchmark loss experience.

5. Mortgage Performance: Models simulate

whether and when a mortgage is prepaid or defaults,

as well as any resulting default losses. These three

factors translate directly into Enterprise financial performance. OFHEO’s models replicate the benchmark loss experience based on mortgage risk factors

for both single-family and multifamily properties

taken from Enterprise databases, interest rates, and

house prices.

6. Other Credit Factors: Models simulate benefits of third-party credit enhancements, such as private mortgage insurance, as well as the creditworthiness of such third parties.

7. Cash Flows: Models project cash flows from

all Enterprise assets, liabilities, and off-balance-sheet

activities.

8. Operations: OFHEO assesses Enterprise performance, in part, by accounting for key aspects of

Enterprise operations, such as dividend payouts and

assumptions about operating costs, new financing,

and short-term investing.

9. Financial Reports: Accounting software generates pro forma financial statements showing resulting capital levels for each period during the 10-

year stress test. Results are based on cash flow model

outputs and certain assumptions about Enterprise

operations.

10. Capital Calculation: A computer program determines the additional amount of starting capital

that an Enterprise would need to pass the risk-based

capital requirement, given the results of the stress

test.

1 9 2

10

8

7

6

Other Credit Factors

(third parties, etc.)

5

4

3

Mortgage

Performance

Default/

Severity/

Payments

(SingleFamily/

Multifamily)

House

Prices

Database

GSE

Historical/

Current

Data

Cash

Flows

Mortgages

MBS

REMICs

Liabilities

Swaps

Guarantee Fee

Float

Benchmark

Loss

Experience

Interest

Rates

Operations

(dividends, etc.)

Capital

Calculation

Financial

Reports
1998 OFHEO REPORT TO CONGRESS

8

1 The Basle Accord was adopted by representatives of banking supervisory authorities and central banks from

the G-10 countries: Belgium, Canada, France, Germany, Italy, Japan, Netherlands, Sweden, United Kingdom, and the United States; plus Switzerland and Luxembourg. It was designed to diminish competitive

inequality among international banks and to strengthen the soundness and stability of the international

banking system.

2 The 1992 Act defines the worst regional mortgage default and loss experience to have occurred in a contiguous area of the United States containing an aggregate of not less than 5 percent of the total population of the

United States that, for a period of not less than 2 years, experienced the highest rates of default and severity

of loss in comparison to the rates of default and severity of loss in other such areas for any period of such

duration.

3 In June 1996, OFHEO published a notice of proposed rulemaking on risk-based capital addressing the

methodology for establishing the worst regional mortgage default and loss experience of the Enterprises.
9

1998 OFHEO REPORT TO CONGRESS

CHAPTER 2

OFHEO’S COMPREHENSIVE, ANNUAL,

RISK-BASED EXAMINATION PROGRAM
1998 OFHEO REPORT TO CONGRESS

10

OFHEO reached a new milestone for its safety and

soundness examinations of the Enterprises in January 1998. Beginning in January, OFHEO

transitioned from its initial cycle of core examinations covering discrete areas of risk at the Enterprises to its comprehensive, annual, risk-based examination program.

This chapter first describes in detail OFHEO’s comprehensive, annual, and risk-based examination program. The chapter then describes the process

OFHEO examiners use to conduct examinations

in this program.

OFHEO’s Examination

Program

OFHEO’s approach to examinations recognizes

that the Enterprises must accept risks in order to

meet their public purposes of providing a secondary mortgage market for conforming mortgages.1

OFHEO determines whether the risks assumed by

the Enterprises are warranted. As a key part of

making this judgment, examiners evaluate whether

the Enterprises knowingly accept risks and have

the capacity to identify, measure, monitor, and

control or alter risks on an ongoing basis. An Enterprise that, in OFHEO’s opinion, appropriately

identifies, measures, monitors, and controls or alters its risks and effectively prices those risks would

be considered to operate in a safe and sound manner. If OFHEO were to conclude that an Enterprise was not operating in a safe and sound manner, OFHEO would take appropriate action to

ensure the Enterprise’s continued operation was not

jeopardized.

Comprehensive

OFHEO’s comprehensive, annual, risk-based examination program is designed to capture all areas of

risk and risk management in the Enterprises. As

described in detail later in this chapter, OFHEO

has segmented the sources of risk into 10 program

areas that roll up into four categories of risk and

risk management. OFHEO will render the following judgments on each of the 10 program areas:

 The appropriateness of the levels of risk;

• The appropriateness of Board of Directors

and Executive Management governance;

• The adequacy of the policies, procedures,

and limits intended to mitigate risk;

• The appropriateness of the risk selection,

measurement, and reporting mechanisms;

• The adequacy of the framework for internal

controls;

• The quality of issue resolution; and

• The effectiveness of risk-taking and risk management initiatives.

Annual

OFHEO’s comprehensive, annual, risk-based examination program is designed so that an examination cycle corresponds to one calendar year.

Between January 1 and December 31, OFHEO

will assess risk and risk management of both Enterprises in the 10 program areas covering all areas

of risk. This will enable OFHEO to assess, every

year, all areas of risk on a timely basis and communicate its findings to each Enterprise.

OFHEO’S COMPREHENSIVE, ANNUAL,

RISK-BASED EXAMINATION PROGRAM
11

1998 OFHEO REPORT TO CONGRESS

Risk-Based

OFHEO’s examination program has always been

risk-based and will continue to be so. Largely

through its initial set of core risk examinations,

OFHEO gained a thorough understanding of the

risks, business strategies, organizational structures,

and cultures at the two Enterprises. A risk-based

examination approach promotes the effective use

of OFHEO resources by focusing on areas of relatively high risk in each Enterprise. Examiners pay

particular attention to those risks that represent a

current or potential threat to the stable operations

of an Enterprise.

As described below, OFHEO’s examiners assess all

areas of risk in the Enterprises. The risk-based focus allocates more OFHEO resources to the highest areas of risk in each Enterprise. This facilitates

OFHEO’s ability to take corrective action before

issues pose a financial threat to an Enterprise, thus

furthering the goal of protecting the United States

taxpayer.

OFHEO’s risk-based examination approach is flexible and allows OFHEO to adjust its oversight focus as conditions change in the Enterprise, industry, or economy. Finally, this approach allows examiners to evaluate Enterprise actions and initiatives against established standards and to determine

whether an Enterprise engages in an activity in a

safe and sound manner.

OFHEO’s Examination Principles

OFHEO has adopted six examination principles

to implement its comprehensive, annual, risk-based

examination program. These principles add transparency to the examination process. The six principles, which are set out below, guide the implementation of OFHEO’s examination program and

its assessment of risk and risk management at the

Enterprises.

1. Effective examination (which incorporates

all examination-related activities) evaluates

the existing financial condition and state of

risk management and attempts to anticipate

the onset of potential issues or problems that

have the capacity to adversely impact the financial health of an Enterprise.

2. Effective examination requires each

Enterprise’s management to exercise a degree

of oversight and control that is commensurate with the risks at that Enterprise.

3. Effective examination focuses examination

resources on those areas where errors are pervasive, result from intentional disregard, or

could impair the financial health of an Enterprise.

4. Effective examination incorporates the opportunity to share with each Enterprise the

regulator’s unique perspective on best practices and emerging issues, promoting operations and performance enhancements

through sharing knowledge.

5. Effective examination is goal- and resultsoriented and does not rigidly prescribe the

means by which an Enterprise achieves the

desired goals or results.

6. Effective examination uses the regulator’s resources efficiently and does not impose unwarranted costs on an Enterprise.

A Quality Examination Force

Achieving OFHEO’s examination program goals

critically depends on OFHEO’s continued ability

to be staffed by talented individuals who have the

ability to render judgments on complex safety and

soundness issues. OFHEO is committed to maintaining a high quality examination force that has

the capacity to assess risks and risk management in

the increasingly sophisticated Enterprises.

The Examination Process

The manner in which OFHEO conducts its comprehensive, annual, risk-based examinations is depicted on the chart on the next page and in the

discussion that follows. The description starts with

the bottom of the chart and concludes with the

arrow at the top.
1998 OFHEO REPORT TO CONGRESS

12

Box 2

ASSESSMENT FACTORS

EXAMINATION OBJECTIVES

EVALUATION CRITERIA

L

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it

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M

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t

FREDDIE MAC

Risk Profile

 On- and Off-Balance-Sheet Items

 Strategy

 Business Initiatives

 Management of Risks

 On- and Off-Balance-Sheet Items

 Strategy

 Business Initiatives

 Management of Risks

FANNIE MAE

Risk Profile

 Strategy Tailored for Fannie Mae

 Strategy Tailored for Freddie Mac

OFHEOS COMPREHENSIVE,

ANNUAL, RISK-BASED

EXAMINATION PROGRAM

Basis for evaluating the

quantitative and qualitative

features of risk and risk

management

 remain constant

Categories of risk and

risk management

 remain constant

Program areas for riskbased examinations

 remain constant

Annual risk-based

examination plan

 review and update quarterly

OFHEOs risk profile for

each Enterprise

 review and update quarterly

 change routinely

Continuous communications

and follow-up

MARKET

4

3

2

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EXAMINATION STRATEGIES

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CREDIT OPERATIONS CORPORATE GOVERNANCE

Communicate

Examination

Findings;

Effect Changes

and Follow-Up
13

1998 OFHEO REPORT TO CONGRESS

Risk Profiles

OFHEO begins the examination process by assessing the quantity of risk and quality of risk management at each Enterprise. OFHEO reviews each

Enterprise’s risk profile at least quarterly, and revises its views if, for example, the Enterprise has

planned or undertaken significant new business initiatives or the Enterprise has substantially changed

the manner in which it manages risks.

Examination Strategies

In the next step of the examination process,

OFHEO develops detailed examination strategies

to provide effective, efficient oversight of each Enterprise. Written examination strategies are dynamic; they are reviewed and updated quarterly

based on Enterprise, industry, and economic developments. Each strategy is tailored to the Enterprise and is based on OFHEO’s knowledge of a

variety of factors: the Enterprise’s management,

strengths, weaknesses, past performance, and markets; the applicable economic conditions and their

actual or potential impact on the Enterprise;

OFHEO’s guidelines, standards, and priorities; and

examination requirements. Each strategy is designed to evaluate the continued effectiveness of

the Enterprise’s risk management processes, enhancements management has made, and, if applicable, actions management has taken in response

to previously identified issues. Examination activities identified in the strategy correlate to the level

of risk in the Enterprise or in a particular current

or proposed activity. Part of the oversight activity

detailed in the strategy is the communication plan,

including the means and frequency of communication with the Enterprises.

In conjunction with the strategies, OFHEO creates work plans that describe how the strategies

will be achieved. The work plans outline the scope,

timing, and resources needed to meet the objectives and examination activities set forth in the

strategies.

Program Areas for Risk-Based

Examinations and Categories of

Risk and Risk Management

Once OFHEO has strategies and work plans in

place, examiners implement strategies by completing examination work in each of the 10 program

areas for risk-based examinations. These 10 program areas capture all areas of risk and risk management in the Enterprises, and each program area

focuses on specific sources of risk or risk management. In order to complete examinations and allocate resources efficiently, OFHEO has grouped

the 10 program areas into four categories of risk

and risk management and aligned its examiner

force into four teams that correspond to the categories of risk and risk management.

The 10 program areas, grouped by risk category,

are:

Credit

1. Credit Risk - the risk that borrowers and

counterparties will fail to meet their contractual or other obligations to an Enterprise.

Market

2. Interest Rate Risk - the risk to earnings and

capital from movements in interest rates,

including changes in the level of interest

rates, the shape of the yield curve, the level

of volatility, and the relationships or spreads

among various yield curves or indices.

3. Liquidity Management - the risk to earnings and capital arising from an Enterprise’s

inability to meet its obligations as they come

due and to transact the next incremental

dollar of business cost-effectively.






1998 OFHEO REPORT TO CONGRESS

14

Operations

4. Information Technology - the infrastructure, or the general controls, needed to safeguard data, protect computer application

programs, prevent system software from

unauthorized access, and ensure continued

computer operations in case of unexpected

interruptions.

5. Business Process Controls - the controls related to the data inputs, files, programs, and

outputs of a specific computer application

that ensure transactions are valid, properly

authorized, and completely and accurately

processed and reported.

6. Internal Controls - the plan of organization,

methods, and procedures adopted by management to ensure that goals and objectives

are met; resource use is consistent with laws,

regulations, and policies; resources are safeguarded against waste, loss, and misuse; and

reliable data are obtained, maintained, and

fairly disclosed in reports.

Corporate Governance

7. Board Governance - the manner in which

the board of an Enterprise discharges its

duties and responsibilities.

8. Management Processes - the processes used

to drive behaviors to support an Enterprise’s

defined corporate goals, standards, and risk

tolerances.

9. Audits - the possibility that a board’s or

management’s reliance on internal or external audits is misplaced.

10. Management Information - the possibility

that management will make decisions based

on ineffective, inaccurate, or incomplete information or reports.

Examination Objectives,

Assessment Factors, and

Evaluation Criteria

OFHEO conducts examination work in each of

the 10 program areas by using examination objectives, assessment factors, and evaluation criteria.

The examination objectives are broad in scope, the

assessment factors are more narrowly focused, and

the evaluation criteria are narrower still.

For each program area, there are four or five examination objectives. These are broad statements of

what OFHEO’s examiners will determine through

their work in each of the 10 program areas. For

example, one of the examination objectives for the

credit risk program area is to identify and evaluate

the change in the level of credit risk and the potential

impact on the Enterprise.

The assessment factors, in conjunction with the

examination objectives, form the basis for

OFHEO’s evaluating the qualitative and quantitative features of risk and risk management in the

Enterprises. The assessment factors link directly

to one or more of the examination objectives for

each of the 10 program areas. There are between

10 and 15 assessment factors for each program area.

Sources for the assessment factors include industry standards and benchmarks, best practices, and

examiner expertise. In order to make a determination on an examination objective, OFHEO’s

examiners are required to opine on each of the supporting assessment factors. An example of one of

the assessment factors that supports the credit risk

examination objective set forth above is to determine the degree and trend of diversification in the

credit portfolio.

The evaluation criteria detail items that examiners

routinely consider when making decisions about

the assessment factors. The evaluation criteria are

designed to assist the examiners by ensuring that

the examination work performed throughout the

Enterprises is consistent. For example, when

„
15

1998 OFHEO REPORT TO CONGRESS

making a decision about the assessment factor on

diversification in the credit portfolio, examiners

would refer to evaluative criteria that directed them

to consider, among other things, the following

methods of diversifying a portfolio: by product, by

origination channel, by geography, and by

counterparty.

The work performed in an examination cycle that

results in decisions on all assessment factors and

renders judgments on the examination objectives

constitutes a comprehensive examination.

Consistent with the examination cycle,

comprehensive examinations will be completed

annually.

Communicate Examination

Findings. . .

Throughout the course of an examination,

OFHEO communicates with Enterprise personnel

not only to gather information, but also to share

findings and discuss observations. The types of

communication run the gamut from a hallway

discussion with a technical expert to clarify a point,

to a letter addressed to executive management or

the board. Regardless of the format, OFHEO has

the same goal for all communications: that the

free flow of information furthers the objective of

ensuring the safe and sound operations of the

Enterprises. OFHEO is committed to continuous,

effective communication with the Enterprises.

Communications are tailored to the individual

structure and dynamics of the Enterprise, and the

timing of the communication depends on the

situation being addressed. OFHEO keeps

executive management and the board appropriately

informed and communicates with them as often

as required by the Enterprise’s condition and the

findings from examination activities. OFHEO

brings those issues to the immediate attention of

the board and executive management that either:

introduce an exposure to the stable operation of

the Enterprise, fall under the normal duties and

responsibilities of the board, or otherwise warrant

immediate attention. Technical issues and matters

relating to a single line of business or activity will

generally be brought to the attention of the

technical and operating managers, with the board

and executive management kept appropriately

informed. This communication plan reinforces the

risk-based examination concept and permits timely

corrective action to be effected at the appropriate

level.

One special form of communication that will be

delivered annually to each Enterprise is the written Report of Examination (ROE). The ROEs will

have an open date of January 1 and a close date of

December 31. The ROEs will be delivered to the

Enterprises no later than 60 days after the close

date.

The ROE will describe the focus of the examination activities at each Enterprise, reflect the cumulative conclusions made throughout the yearlong

examination process, and address each Enterprise’s

safety and soundness on an ongoing basis. Thus,

while the same examination standards are applied

at both Enterprises, the same issues may not be

addressed in both ROEs. While all 10 program

areas will be addressed, the emphasis and level of

detail in the ROE will vary between Enterprises

and from year to year.

. . .Effect Changes

and Follow-Up

A primary goal of the examination process is to

effect needed changes in the Enterprises to enhance

their financial safety and soundness. Both the degree of specificity OFHEO provides to the Enterprises about items to be changed and the level of

OFHEO follow-up with the Enterprises relate directly to the risk presented by an issue. If, for

example, in the course of an examination, OFHEO

identifies a significant issue in risk management

systems or an undesirable risk level, OFHEO will

...
1998 OFHEO REPORT TO CONGRESS

16

require management to develop and execute a corrective action plan and will ensure that the board

holds management accountable for executing the

action plan. OFHEO will review the action plan

to ensure that it identifies the steps or methods

management expects will cure the root causes of

significant deficiencies and to determine whether

the plan is likely to resolve the significant issues

within an appropriate timeframe. As part of the

follow-up, OFHEO will verify that the action plan

has been executed and evaluate its success.

OFHEO will consider the responsiveness of the

Enterprise in recognizing the issue and formulating an effective solution when determining if

OFHEO needs to take further action. If an Enterprise is unresponsive or unable to effect resolution of significant issues, OFHEO will take more

formal steps to ensure deficiencies are corrected.

The End . . . or Starting Over?

While “effect changes and follow-up” is designated

as the final step in OFHEO’s comprehensive,

annual, risk-based examination process, that is not

really the case. In practice, the final steps start the

entire examination cycle anew. The examination

findings, including items for follow-up, affect

OFHEO’s assessment of the Enterprise’s risk

profile. That, in turn, drives the examination

strategy and begins the examination cycle once

again.

1 The sizes of mortgage loans that the Enterprises are permitted to buy are limited by their Charter Acts.

These limits are usually referred to as “conforming loan limits.” For example, the maximum original principal amount of a single-family mortgage that the Enterprises can currently buy is $227,150. In addition to

loan size, conforming loans must also meet the Enterprises’ underwriting guidelines. Non-conforming

loans are loans that either exceed the conforming loan limits or do not meet the Enterprises’ underwriting

guidelines. Non-conforming loans that exceed the current limit of $227,150 are often called “jumbo” loans.
17

1998 OFHEO REPORT TO CONGRESS

CHAPTER 3

 OFHEO’S REGULATORY ACTIVITIES
1998 OFHEO REPORT TO CONGRESS

18

OFHEO’s Office of Examination and Oversight

(OEO) conducts a comprehensive, annual, riskbased program of examination activities to determine the condition of Fannie Mae and Freddie Mac

for the purpose of ensuring their financial safety

and soundness. These activities include on-site examinations and off-site financial analysis and supervisory monitoring, as well as ongoing communication with the Board of Directors and

management of each Enterprise. OEO’s examination program complements OFHEO’s quarterly

capital classification of the Enterprises and provides

comprehensive oversight of the financial safety and

soundness of each Enterprise.

Preparing for Transition

OFHEO completed its initial cycle of core examinations, which focused on corporate governance,

credit risk, interest rate risk, business risk, information systems and technology risk, and internal

audit/operations risk. OFHEO’s 1997 Annual

Report explained OFHEO’s strategy to complete

these core examinations and proceed into a continuous examination program. Chapter 2 of this

report describes OFHEO’s transition into the comprehensive, annual, risk-based examination program that began in January 1998. This chapter

describes the activities, which focused on information technology and internal audit/operations risk,

that completed the initial cycle of examinations.

In addition, this chapter describes OFHEO’s ongoing examination of the Year 2000 “challenge,”

the Enterprises’ compliance with applicable flood

insurance requirements, OFHEO’s capital classifications of the Enterprises and minimum capital,

and OFHEO’s executive compensation authority.

Through the initial cycle of examinations, OFHEO

developed a knowledge base of the Enterprises’ respective organizational structures, programs, processes, tools, policies, practices, and business strategies. From this knowledge base, OFHEO

formulated a business and risk profile for each Enterprise, and refined examination objectives and

assessment factors to be used in examining the Enterprises. As explained in the preceding chapter,

the risk profiles are given form in the examination

strategies OFHEO prepares each year, and on

which OFHEO bases its annual examination activities. The knowledge gained during the course

of the initial examinations is crucial to OFHEO’s

effective oversight and positions OFHEO to effectively deploy its risk-based examination program.

The Information Systems and

Technology (IT) Examinations

IT Exposure

The secondary mortgage market increasingly relies on information technology. The Enterprises

have been among the leaders in the development

and implementation of technological innovations.

In recognition of this increased reliance, OFHEO

conducted examinations to assess each Enterprise’s

exposures to risks presented by the management

and use of information technology. For purposes

of the IT examinations, OFHEO defined IT risk

to mean the potential that an event or action may

impair an Enterprise’s ability to process transactions and information in a timely and accurate

manner.

OFHEO’S REGULATORY

ACTIVITIES
19

1998 OFHEO REPORT TO CONGRESS

Objective of the IT Examination

The primary objective of the IT examination was

to assess whether management at each Enterprise

effectively governs its proprietary risk management

framework and tools. This included assessing

management’s ability to identify and resolve IT issues. Based upon these examinations, OFHEO

reached a conclusion on whether management effectively oversees the IT area and the risks associated with the use of technology.

Sources of IT Exposure

When evaluating the quality of IT management

and the risks associated with technology use,

OFHEO must consider the numerous paths by

which risk can be introduced. For example,

OFHEO must consider such aspects as

management’s degree of reliance on IT to meet the

needs of the business; management’s success in integrating the IT strategies with the organization’s

business needs; and management’s success in obtaining and retaining the expertise and staffing to

implement and maintain the technology to effectively operate the business. Additional considerations include the dependence placed on external

resources; the quality and reliability of vendors and

service providers; the reliability and effectiveness

of the Enterprise’s existing technology platforms;

and the quality of change management to ensure

there is the capacity to evolve with the technological environment.

Examination Scope

OFHEO considered the sources of IT risk when

developing the examination plan, and structured

its work to assess seven control areas: (1) program

management, (2) systems development, (3) program monitoring, (4) change management, (5) data

security, (6) business continuity planning, and (7)

facilities management. OFHEO’s IT examination

scope was to:

 Determine the extent of IT usage in the business processes;

 Identify the existing IT controls;

 Assess IT strengths and weaknesses;

 Evaluate the strategic thinking associated

with IT;

 Evaluate the adequacy of the risk management framework as it relates to IT; and

 Conclude on the effectiveness of the overall

management of IT.

Examination Results and Conclusions—

Fannie Mae

Based upon our review, OFHEO concluded that

Fannie Mae’s risk management of the IT area is

satisfactory.1 This designation signifies that the

risk management of Fannie Mae’s automated environment adheres to appropriate safety and soundness standards. While some issues OFHEO identified warrant the attention of the Board of

Directors and senior management, none pose safety

and soundness concerns.

OFHEO identified various strengths in Fannie

Mae’s IT risk management framework and concluded that the use of this framework provides effective management of the risks associated with

using IT. The key strengths of IT risk management include:

1. Direct, quality involvement by the Board

of Directors and senior management in IT

risk management;

2. Effective utilization of information

technology to address the Enterprise’s

business needs;

3. Timely and sound IT-related decisions;

and

4. Competent and capable IT staff.

There were no findings which presented OFHEO

with safety and soundness concerns; however,

OFHEO directed the attention of the Board of

Directors and senior management to certain areas

of the IT management framework. OFHEO also

brought a number of other observations and suggestions to the attention of the appropriate level

of operating management. OFHEO’s recommendations and suggestions to the board and senior
1998 OFHEO REPORT TO CONGRESS

20

management pertained primarily to documentation enhancements for certain aspects of the risk

management framework, especially end-user computing policies and procedures. Fannie Mae has

addressed, or is addressing, OFHEO’s recommendations, and examiners are monitoring the

Enterprise’s progress.

Examination Results and Conclusions—

Freddie Mac

Based upon its review, OFHEO concluded that

Freddie Mac’s risk management of the IT area is

satisfactory.2 This designation signifies that the risk

management of Freddie Mac’s automated environment adheres to appropriate safety and soundness

standards. While some issues warrant the attention of the Board of Directors and senior management, none pose safety and soundness concerns.

OFHEO identified various strengths in Freddie

Mac’s IT risk management framework and concluded that the use of this framework provides effective management of the risks associated with

using IT. The key strengths of IT risk management include:

1. A comprehensive risk assessment framework;

 2. Comprehensive management reporting;

 3. Effective monitoring for resolution of

 significant issues and concerns; and

 4. Competent and capable IT staff.

While there were no findings that presented safety

and soundness concerns, OFHEO directed the attention of the Board of Directors and senior management to certain aspects of the IT management

framework. OFHEO also brought a number of

other observations and suggestions to the attention of the appropriate level of operating management. OFHEO’s recommendations and suggestions to the board and senior management

pertained primarily to enhancing the formal oversight of cross-cutting IT-related issues; continuing

management’s efforts to strengthen the control environment for data security; enhancing end-user

computing standards and procedures; and enhancing business recovery testing. Freddie Mac has

addressed, or is addressing, OFHEO’s recommendations, and examiners are monitoring the

Enterprise’s progress.

The Internal Audit/Operations

Risk Examinations

The Role of Internal Audit

Internal audit is a fundamental instrument for the

discharge of corporate governance to ensure that

operating controls are effective and appropriate to

minimize risks. The primary objective of the internal audit function is to serve the Board of Directors in the effective discharge of its responsibilities. The work performed by internal auditors

plays a vital role in evaluating the effectiveness of

the risk management program, the sound operation of internal controls, and the reliability of

records and data. A flawed internal audit program

might not detect breaches in controls which are

intended to mitigate financial exposure and maintain or improve an Enterprise’s quality standards.

Objective of the Internal Audit/

Operations Risk Examinations

The primary objective of the examinations was to

evaluate the structure, scope of authority, activities, policies, and procedures for the internal audit

programs. By evaluating the work of each

Enterprise’s internal audit department, which focuses on, among other things, the development of

and adherence to an effective internal control program, OFHEO was able to assess the degree to

which the Enterprises manage their exposure to

operations risk.

Examination Scope

OFHEO considers the work performed by the internal auditing departments at each Enterprise

when discharging its examination authority. Leveraging off the work of internal audit contributes

to OFHEO’s effective use of its examination re-
21

1998 OFHEO REPORT TO CONGRESS

sources. OFHEO’s ability to rely upon internal

audit requires routine testing and evaluation of the

audit programs to ensure that the work within each

department meets OFHEO’s standards and the

appropriate professional standards. The examination activities evaluated aspects of the auditing

function to re-validate the reliability of internal

audit’s work. Under OFHEO’s risk-based examination program, OFHEO will assess more comprehensively the quality of the internal audit program on an annual basis.

OFHEO structured its work to:

1. Test a sample of audit workpapers to

determine whether the work supported the

department’s conclusions and whether the

workpapers were consistent with internal

standards and applicable professional

standards;

2. Review adherence to the policies and

procedures;

3. Review the role of audits in management’s

internal control risk assessment programs;

4. Review the department’s risk assessment

activities; and

5. Review the tracking and reporting of

control issues.

Examination Results and Conclusions—

Fannie Mae

OFHEO concluded that Fannie Mae’s internal

audit work products are high quality and that audit activities and results generally are well documented. Particular attention was given during the

examination to the Office of Auditing’s transition

to a continuous-presence audit approach. The

continuous audit approach allows the department

to maintain ongoing contact with business activities and personnel, and to rapidly adjust audit activities to address issues and concerns as they

emerge.

OFHEO identified various strengths in Fannie

Mae’s internal audit program. These strengths include:

1. A written charter that establishes, among

other things, the department’s scope of authority;

2. Comprehensive written policies and procedures to guide audit personnel;

3. An internal quality control program;

4. A formal tracking and reporting system to

communicate weaknesses to management

and the Audit Committee of the Board of

Directors;

5. A formal risk assessment process to analyze

business developments and allocate resources

appropriately; and

6. An active role in management’s internal control self-assessment program.

OFHEO did not identify any safety and soundness concerns; however, it suggested a number of

enhancements to the internal audit program. These

recommendations relate to the auditing

department’s implementation of its quality assurance program and to documentation in certain areas impacted by the department’s shift to a continuous-presence audit program. With respect to

documentation, OFHEO recommended that management update internal policies and consolidate

guidance related to the department’s risk assessment activities, and also that it review its process

for ensuring that internal control verifications are

documented in a manner that complies with Enterprise policy. In addition, OFHEO encouraged

the Enterprise to adopt written guidance with respect to management’s internal control self-assessment program.

OFHEO has shared with senior management its

suggestions and recommendations on areas which

would benefit from enhancement. Fannie Mae has

addressed, or is addressing, those recommendations, and examiners are monitoring the

Enterprise’s progress. As part of OFHEO’s riskbased examination program, examiners will continue monitoring the internal audit program

throughout the year, and OFHEO will produce

annual conclusions on the quality of the internal

audit program.
1998 OFHEO REPORT TO CONGRESS

22

Examination Results and Conclusions—

Freddie Mac

OFHEO concluded that Freddie Mac’s internal

audit work products are high quality and that audit activities and results are well documented. The

audit program was found to meet the prescribed

professional standards, and various aspects were

found to substantially exceed those standards.

OFHEO identified various strengths in Freddie

Mac’s internal audit function. These strengths include:

1. A written charter that establishes, among

other things, the department’s scope of authority;

2. A key role in management’s risk assessment

process;

3. Sophisticated risk assessment tools to identify and prioritize risks and allocate resources;

4. A quality assurance program which exceeds

prescriptive professional standards; and

5. An automated audit program which enhances management’s capability to actively

oversee audit scheduling, findings, status,

and follow-up.

OFHEO did not identify any safety and soundness concerns, nor did it identify aspects of the

internal audit program that require the board’s or

senior management’s involvement or follow-up. As

part of OFHEO’s risk-based examination program,

examiners will continue monitoring the internal

audit program throughout the year, and OFHEO

will produce annual conclusions on the quality of

the internal audit program.

The Year 2000 Challenge

and Examination Activities

What Is the Year 2000 Challenge?

The Year 2000 “challenge” arises because computer

systems have typically used two digits, rather than

four, to represent the year—for example, “98” represents the year 1998. The problem with a twodigit date field is that computer systems may identify “00” as the year 1900, rather than 2000. This

error would lead to errors in performing date-sensitive tasks, including calculations to determine

payment amounts, payment dates, payoff balances,

interest payments, investor payouts, and other

mortgage-related payment information. Failure to

address this problem also may lead to errors in annual financial reporting to investors, shareholders,

and federal regulatory agencies; reporting related

to mortgage-backed and debt securities and derivative financial instruments; portfolio rebalancing;

mortgage commitments and purchases; and the issuance of securities.

OFHEO’s role as the Enterprises’ financial safety

and soundness regulator requires it to evaluate

management’s efforts to resolve the problem as it

may impact the Enterprises’ internal systems.

OFHEO also is evaluating management’s efforts

to safeguard against circumstances where an

Enterprise’s key business partners (such as sellers,

servicers, vendors, and service providers) have not

corrected the problem in their own systems.

How Does OFHEO Evaluate the

Enterprises’ Efforts to Achieve

Year 2000 Compliance?

Year 2000 compliance efforts were an important

focus of OFHEO’s examination effort during 1997

and will remain an examination priority into the

new millennium. OFHEO follows the principles

and framework laid out in the General Accounting Office’s guide entitled Year 2000 Computing

Crisis: An Assessment Guide to evaluate the Enterprises’ efforts to address the problem. Additionally, OFHEO has been participating in the Federal Financial Institutions Examination Council’s

Year 2000 efforts and the Working Group on Year

2000 to ensure consistent standards and treatment

with the other financial regulators.

The complexity of the effort to achieve Year 2000

compliance is not in the solution to the actual problem, but in the size and scope of the project itself.

Given that this is essentially a project management
23

1998 OFHEO REPORT TO CONGRESS

issue, OFHEO has examined, and will continue

to examine, the Enterprises’ timely and successful

management of this critical project.

The Year 2000

Evaluative Framework

The framework used to achieve Year 2000 compliance follows a five-phase approach. This five-phase

approach progresses in the following sequence:

1. Awareness Phase - define the Year 2000

problem, make personnel aware of the issue,

establish a Year 2000 program team, and

develop an overall compliance strategy.

2. Assessment Phase - assess the Year 2000 impact on the organization, identify core business areas and processes, analyze the systems

supporting the core business areas, and prioritize conversion and/or replacement of

those critical systems.

3. Renovation Phase - perform the conversions,

replacement, or elimination of critical platforms, applications, databases, and utilities,

and modify interfaces.

4. Validation Phase - test, verify, and validate

the converted or replacement platforms, applications, databases, and utilities to ensure

that they meet the organization’s needs.

5. Implementation Phase - implement the converted and replacement platforms, applications, databases, utilities, and interfaces while

maintaining appropriate back-up.

The Enterprises’ Year 2000

Efforts Are Appropriate

In addition to examining the Enterprises’ efforts

to achieve Year 2000 compliance with their systems, OFHEO also assesses the Enterprises’ efforts

to ensure that their critical business partners achieve

timely Year 2000 compliance. Because technology is a cornerstone of the Enterprises’ business,

Year 2000 compliance is critical for business continuity.

OFHEO’s Year 2000 priority with respect to the

Enterprises is to safeguard the orderly operation of

the secondary mortgage market by ensuring that

the Enterprises are able to process transactions and

information at the new millennium. OFHEO will

continue to treat the Year 2000 challenge as a priority during 1998 and 1999 (and thereafter as appropriate) and will monitor the Enterprises’ efforts

to lead, and ultimately require, their business partners to be Year 2000 compliant.

OFHEO is able to report that each Enterprise is

proceeding with an acceptable plan, and the implementation of these plans is on schedule. Year 2000

ranks among the top priorities at each Enterprise

and receives the attention of senior management

and substantial resource investment (both human

and financial). The Enterprises recognize the significance of the Year 2000 challenge, and each organization has designated working groups to address the numerous business and technology issues.

The implementation plans for correcting the problem are comprehensive, and these plans are also

being enhanced as the body of knowledge for Year

2000 issues evolves. Each Enterprise has begun

internal testing and is following a schedule that

will allow comprehensive testing (including testing with business partners) to begin early in 1999.

Overall, OFHEO continues to view each

Enterprise’s Year 2000 compliance plans and related timetables as reasonable.

Because OFHEO believes the Year 2000 challenge

is a crucial operating issue for the Enterprises, it

believes that the Board of Directors and senior

management of each company should be actively

involved. OFHEO has determined that the Boards

of Directors are being appropriately and routinely

briefed on the progress toward Year 2000 compliance, including the meeting of pertinent timetables. Senior executives at both Enterprises are

actively engaged and routinely receive status updates. In addition to frequent dialogue with appropriate Enterprise representatives, OFHEO has

been testing, and will continue to test and verify,

each Enterprise’s performance against its respective plan and evaluate its contingency plans. In
1998 OFHEO REPORT TO CONGRESS

24

the event there are adverse deviations from the plans

or timetables, OFHEO will immediately determine

the appropriate regulatory response.

Flood Insurance

Compliance Activities

Background

Federal legislation requires the Enterprises to implement procedures designed to ensure that adequate

flood insurance is in place over the term of loans

that the Enterprises purchased after September 28,

1995, and that are secured by properties located in

certain designated flood hazard areas. OFHEO is

responsible for assessing whether the Enterprises

have adopted, and are adhering to, such procedures

and is also responsible for including that assessment in our annual reports to Congress for 1996,

1998, and 2000.

In its 1996 Annual Report, OFHEO reported that

Freddie Mac had established adequate flood insurance policies and procedures and was complying

with them. OFHEO further reported that Freddie

Mac had established appropriate internal controls

to provide reasonable assurance of compliance with

applicable flood insurance requirements and had

adopted quality control procedures that would allow the Enterprise to verify sufficient flood insurance coverage on applicable loans.

OFHEO’s 1996 Annual Report also reported that

Fannie Mae had established an appropriate flood

insurance compliance framework and adequate

procedures to ensure the Enterprise’s compliance

with the applicable flood insurance requirements.

OFHEO further reported that the Enterprise was

developing internal controls to ensure adequate

flood insurance is in place on applicable loans, and

that OFHEO would monitor the Enterprise’s

implementation of the compliance program.

Results of Flood Insurance

Review

In 1997, OFHEO again reviewed the flood insurance procedures and controls at each Enterprise.

These reviews included on-site evaluations of applicable procedures and meetings with responsible

management. The reviews also included the evaluation of each Enterprise’s efforts to test and validate the internal controls established to ensure

compliance with applicable statutory requirements.

Based on these reviews, OFHEO concluded that

each Enterprise has implemented, and is adhering

to, adequate flood insurance procedures.

Capital Classification and

Minimum Capital

The 1992 Act requires OFHEO to determine the

capital classifications of Fannie Mae and Freddie

Mac for purposes of financial safety and soundness. The Act requires that these determinations

be made “not less than quarterly.” The classifications are “adequately capitalized,” “undercapitalized,” “significantly undercapitalized,” and “critically undercapitalized.” The Act gives the

OFHEO Director “prompt corrective action” enforcement authorities if an Enterprise is classified

other than adequately capitalized.

To qualify as adequately capitalized, an Enterprise

must meet both minimum and risk-based capital

standards. However, only the minimum capital

standard applies currently. During this period, an

Enterprise is considered adequately capitalized if

its core capital - common stock, preferred stock,

paid-in capital and retained earnings - equals or

exceeds its minimum capital requirement.

The minimum capital requirement is designed to

establish an essential amount of capital that an Enterprise must hold as a cushion against losses from

broad business categories. It is computed on the

basis of leverage ratios applied to all assets (2.50

percent) and off-balance sheet obligations (0.45

percent), with more complex rules applied to in-
25

1998 OFHEO REPORT TO CONGRESS

terest rate and foreign exchange contracts.

OFHEO implemented the minimum capital provision of the 1992 Act by publishing a proposed

minimum capital regulation for public notice and

comment on June 8, 1995. After considering the

comments received, OFHEO published the final

regulation on July 8, 1996. Based on the minimum capital requirement, OFHEO has classified

Fannie Mae and Freddie Mac adequately capitalized in each quarter since June 30, 1993.

Executive Compensation

Authority

OFHEO’s enabling statute and the Enterprises’

Charter Acts give the Director of OFHEO oversight responsibility in the area of executive compensation. OFHEO’s statute requires the Director

to prohibit the Enterprises from providing excessive compensation to any executive officer. Specifically, the statute provides that compensation

must be reasonable and comparable with compensation paid by other similar businesses to executives having similar duties and responsibilities.

“Similar businesses” include publicly held financial institutions or major financial services companies. Additionally, the Enterprises’ Charter Acts

require the Enterprises to obtain the prior approval

of OFHEO’s Director before entering into or

changing termination agreements with their executive officers. The Charter Acts provide that the

Director of OFHEO may not approve any such

agreement unless the Director determines that the

benefits provided under the agreement are comparable to benefits provided under such agreements

for officers of other public and private entities involved in financial services and housing interests

who have comparable duties and responsibilities.

1 OFHEO has substituted the term “satisfactory” for the term “adequate” to characterize practices that

adhere to safety and soundness standards. OFHEO uses the term “strong” to characterize practices that

substantially exceed safety and soundness standards.

2 Ibid.

During the past 12 months, OFHEO has approved

two termination agreements submitted by the Enterprises: one termination agreement for an executive officer and one amendment for another executive officer.
27

1998 OFHEO REPORT TO CONGRESS

CHAPTER 4

MORTGAGE MARKETS AND THE

ENTERPRISES IN 1997 AND EARLY 1998
1998 OFHEO REPORT TO CONGRESS

28

Fannie Mae and Freddie Mac continued to prosper in 1997 and early 1998 as a strong housing

market and reduced credit losses resulted in record

profits. The record profits were driven by net interest income from growing mortgage investments.

The Enterprises also experienced declining credit

losses during 1997, reflecting an improving housing market, particularly in California. In addition,

the credit risk profiles of the Enterprises’ 1997 and

early 1998 mortgage purchases benefited from a

significant increase in the use of credit enhancements, principally pool insurance, to reduce the

costs of future mortgage defaults.

While the Enterprises’ market share benefited from

a surge in refinance volumes early this year, increased competitive pressures from private security issuers and increased holdings of mortgages

by depository institutions held down Enterprise

market share during 1997. In an effort to maintain business growth, the Enterprises expanded the

range of their activities. In addition, the Enterprises

continued to repurchase common stock shares last

year rather than investing surplus funds at lower

than target rates of return. Both Enterprises maintained sufficient capital to meet minimum regulatory requirements.

Housing and Primary

Mortgage Market

Developments

Record Housing and

Mortgage Market Activity

Continued rapid growth in the economy coupled

with low interest rates contributed to a banner year

for housing and mortgage origination markets.

Growth in gross domestic product was 3.6 percent in 1997, even stronger than the 3.3 percent pace in 1996. Unemployment remained

low, while tame inflation and low interest rates

kept consumer confidence high. Rising real

wages, a strong stock market, and increases in

house prices contributed to an estimated

$4 trillion rise in net household wealth during 1997.

As a result of the favorable interest rate environment and unusually warm weather in

many parts of the country, the primary housing activity indicators - housing starts and

home sales - posted record performances in

1997. After peaking at just over 8 percent in

April, the 30-year fixed mortgage rate declined

to end 1997 with an average of 7.6 percent -

its lowest annual level since 1993. The downward trend continued into 1998, with the 30-

MORTGAGE MARKETS AND THE

ENTERPRISES IN 1997 AND EARLY 1998

Figure 1

Mortgage Interest Rates

Source: Freddie Mac Primary Mortgage Market Survey

4%

6%

8%

10%

30-Year FRM Rate

1-Year ARM Rate
29

1998 OFHEO REPORT TO CONGRESS

year rate at 7.1 percent by the end of the

first quarter (See Figure 1). Housing starts

maintained the 1996 rate of 1.5 million units

in 1997, and then rose to an annual rate of

1.6 million units in the first quarter of this

year.

The pace of single-family home sales tracked

mortgage interest rates, declining briefly in

the second quarter of last year as mortgage

rates peaked, and then increasing through

the first quarter of 1998 (See Figure 2). New

single-family home sales increased 6 percent

to 0.8 million units—the highest level since

1978—while existing single-family home

sales reached a record 4.2 million sold during the year.

Single-family mortgage originations increased to an estimated $834 billion in 1997

(See Figure 3), with the majority of the increase in conventional originations, while FHA and

VA originations were relatively unchanged. Originations increased 6 percent from 1996 to the highest level since the refinance boom years of 1992

and 1993. Benefiting from a further decline in

rates, origination volume in the first quarter of this

year surged to an estimated $300 billion. This

first quarter estimate exceeds the previous

high of $289 billion in the fourth quarter of

1993.

Record housing activity was accompanied by

an increasing homeownership rate, rising

from 65.4 percent of all households at yearend 1996 to a record rate of 65.7 percent by

the end of 1997. Subsequently, the surge in

home sales and originations in the first quarter of 1998 pushed the rate of homeownership

to a new high of 65.9 percent of total households.

Single-family house prices, as measured by

OFHEO’s House Price Index (See Figure 4),

increased an average of 4.7 percent in 1997,

with the West Coast posting the highest gains.

Figure 3

Originations of Single-Family Mortgages

($ in Billions)

Source: HUD

$0

$200

$400

$600

$800

$1,000

$1,200

198619881990199219941996

FHA/VA Conventional Total

0

200

400

600

800

1,000

Jan-92Jan-93Jan-94Jan-95Jan-96Jan-97Jan-98

0

1,000

2,000

3,000

4,000

5,000

New Home Sales

Existing Home Sales

New Home Sales

(Thousands of Units)

Existing Home Sales

(Thousands of Units)

Figure 2

New and Existing Single-Family Home Sales

Source: HUD
1998 OFHEO REPORT TO CONGRESS

30

The 5.6 percent increase in the California market is

especially notable after a series of declines dating

back to 1995.

Credit Risk Profile

of 1997 Originations

Appears Relatively

Unchanged

The relative shares of purchase money mortgages and refinanced mortgages, as well as the

mix of mortgage product type, affect the credit

risk profile of mortgage loans. (A purchase

money mortgage is a loan for the purchase of

a single-family home. A refinance mortgage

is a loan that refinances an existing mortgage.)

Refinance mortgage loans represented 31 percent of total single-family originations last

year, down just one percentage point from

1996, although refinancing soared in early

1998 in response to lower interest rates (See

Figure 5). Refinance mortgages typically

have lower loan-to-value (LTV) ratios than purchase

money mortgages because borrowers who refinance

typically have more equity in the underlying property from principal repayments and house price appreciation. The level of borrower equity has proven

Source: Freddie Mac Primary Mortgage Market Survey

Refinance Share of Total Mortgage Originations

vs. Commitment Rate on 30-Year FRMs

6%

7%

8%

9%

10%

0%

20%

40%

60%

80%

30-Year FRM Rate

Refinance Share

30-Year 

FRM Rate

Refinance 

Share

Figure 4

One-Year Change in House Prices

U.S. Census Divisions

Fourth Quarter 1996 to Fourth Quarter 1997

CA

WA

NV

OR

ID

AZ

UT CO

NM

AR

TN

NJ

 CT

DE

RI

DC

 

HI TX 

LA 

ND

SD 

NE 

KS

OK 

 MO 

IA 

 MN 

 WI 

IN 

 PA 

 NY 

 ME 

IL

MS

AK

MT VT

 NH

WY 

AL

 MD

East

South

Central

Pacific

New England

East MA

North

Central

West North

Central

Mountain

West South Central

MS

TN

KY

PA

ME

OH

IL IN

WI MI

NY

PA

South Atlantic

 FL

GA

SC

NC

VA

WV

NY

CA

Middle Atlantic

5.4% 4.5%

5.2%

3.1%

5.2%

5.7%

3.6%

4.7%

4.8%

Figure 5
31

1998 OFHEO REPORT TO CONGRESS

to be a key determinant in the incidence and severity of mortgage loan defaults. The average LTV

ratio on conventional purchase money mortgages

increased only slightly to 79.4 percent from 79.0

percent in 1996. The proportion of those loans

originated with LTVs greater than 90 percent was

unchanged from the prior year at 25 percent.

As mortgage rates declined throughout the

second half of last year and the spread between

fixed and adjustable mortgage interest rates

narrowed, an increasing proportion of borrowers

chose fixed-rate mortgage (FRM) loans. The

adjustable-rate mortgage (ARM) share of

conventional originations averaged 25 percent

in the first half of the year -- slightly below the

1996 average -- then declined to a low of 13

percent early this year (See Figure 6). The

decrease in the proportion of adjustable-rate loans

has positive implications for the credit profile of

1997 and early 1998 originations. ARM loans

typically have a higher risk of default due to

potential increases in borrower payment

obligations when rates increase.

Subprime Originations Surge

A surge in originations of subprime mortgage

loans in 1997 was driven by a combination

of easy access to capital markets for many

subprime lenders and low interest rates that

made debt consolidation refinancing

attractive to borrowers. According to Inside

Mortgage Finance, originations of these loans

jumped to $125 billion in 1997, an increase

of 39 percent from 1996, outpacing the

growth in overall originations. (Inside

Mortgage Finance defines subprime

originations as mortgage loans to borrowers

with credit weaknesses. These loans include

A-minus through D-rated borrowers.)

Subprime loans represented 15 percent of total

mortgage originations, up from 12 percent in 1996

and just 5 percent of all originations in 1994.

Figure 6

ARM Share of Conventional Single-Family Loans vs.

Commitment Rate on 30-Year FRMs

Source: Freddie Mac and Federal Housing Finance Board

6%

7%

8%

9%

10%

0%

20%

40%

60%

80%

30-Year FRM Rate

ARM Share

30-Year

FRM Rate

ARM 

Share

Figure 7

Enterprise Single-Family Mortgage Purchases

($ in Billions)

Source: Fannie Mae and Freddie Mac

$289 $277

$217

$283

$519

$440

$233

$185

$0

$100

$200

$300

$400

$500

$600

Freddie Mac Fannie Mae Combined
1998 OFHEO REPORT TO CONGRESS

32

Secondary Market

Activities of the

Enterprises

Overall Secondary Mortgage

Market Activity Declined

in 1997

Despite robust origination activity during

1997, increased holdings of mortgage debt

by depository institutions contributed to a

decline in overall secondary market activity.

The drop in sales of mortgages to the secondary market combined with increased

competition from private label issuers posed

challenges for the volume of secondary market activities for Fannie Mae and Freddie Mac.

Overall secondary mortgage market activity, as

measured by the total rate of mortgage

securitizations, declined slightly to an estimated

50 percent in 1997, and was well below the record

65 percent securitization rate for 1993. This decline occurred despite the increase in fixed-rate loans

(and, conversely, the decrease in adjustable-rate

loans) as a proportion of total originations. Typically, depository lending institutions prefer to

securitize fixed-rate mortgage loans and hold adjustable-rate loans in their mortgage portfolios, because adjustable-rate loans better match the repricing characteristics of depository institution liabilities. However, as a result of strong capital positions and a decline in mortgage prepayment concerns, mortgage debt holdings of financial institutions increased at an annualized rate of 6

percent for the first three quarters of 1997 compared to 5 percent for 1996.

The favorable credit environment that prevailed during 1997 reduced the credit risk premium for many private label issuers. Private

label mortgage-backed security (MBS) issuance was $64 billion in 1997 compared to

$39 billion the prior year. Private label issuance comprised 15 percent of all MBS issuances during the year, up from just 10 percent

in 1996.

Figure 8

Enterprise Multifamily Mortgage Purchases

($ in Billions)

Source: Fannie Mae and Freddie Mac

$9 $9

$7

$4 $5

$3 $3

$5

$0

$1

$2

$3

$4

$5

$6

$7

$8

$9

19901991199219931994199519961997

F reddie Mac F annie Mae Combined

Figure 9

Enterprise Share of Conventional Single-Family

Mortgage Market

Source: Fannie Mae, Freddie Mac and Federal Reserve Board

0%

10%

20%

30%

40%

50%

60%

1990 1991 1992 1993 1994 1995 1996 1997

Purchases/Originations

Share of Outstandings
33

1998 OFHEO REPORT TO CONGRESS

Enterprise Purchases and

Issuances Decline

As a result of the increased competition for mortgage loans, Enterprise purchases and MBS issuances

of single-family mortgage loans declined in 1997,

while purchases of multifamily loans remained flat

(See Figures 7 & 8). Single-family purchases comprised 37 percent of total single-family conventional originations, down from their 42 percent market share of single-family conventional

originations in 1996, and well below their 58

percent share in 1993 (See Figure 9). To

maintain growth in business volumes in the

face of declining market share, both Fannie

Mae and Freddie Mac augmented their activities with purchases of non-current coupon, seasoned MBS.

Enterprise issuances of MBS also declined

slightly last year (See Figure 10).

Resecuritization activity, however, driven by

increased investor demand, was more than

twice that of Real Estate Mortgage Investment

Conduit (REMIC) issuances during 1996 (See

Figure 11). In comparison, this represents a

little more than half the REMIC volume

posted in 1993.

Fannie Mae and Freddie Mac

Expand into Wider Range of

Mortgage Products

Driven by competitive pressures for attractive mortgage investment opportunities coupled with their

own double-digit growth targets, Freddie Mac

and Fannie Mae have begun to expand into a

wider range of mortgage products. Freddie

Mac announced its intention to use its automated underwriting system, Loan Prospector,

and risk-based pricing (the practice of pricing

loans on the basis of projected costs) to expand into two markets: alternative-A mortgages, which are typically loans to low-risk borrowers with either reduced documentation or

relaxed LTV requirements, and A-minus mortgages, which are loans with slightly more risk

than traditional Enterprise mortgages.

In addition, Freddie Mac has participated in a

small number of highly credit-enhanced structured transactions involving still higher risk

mortgages - so called “B” and “C” credit grades.

Freddie Mac has indicated that participation

in these transactions might lead to improveFigure 10

Enterprise Single-Class MBS Issuance

($ in Billions)

Source: Fannie Mae and Freddie Mac

$264

$171

$205

$373

$430

$248

$270

$196

$0

$50

$100

$150

$200

$250

$300

$350

$400

$450

$500

19901991199219931994199519961997

Freddie Mac Fannie Mae Combined

Figure 11

Enterprise REMIC Issuances

($ in Billions)

Source: Fannie Mae and Freddie Mac

$159

$61

$24

$129

$311

$286

$174

$101

$0

$50

$100

$150

$200

$250

$300

$350

Freddie Mac Fannie Mae Combined
1998 OFHEO REPORT TO CONGRESS

34

ments in underwriting and risk management systems for these types of loans. Other Freddie Mac

initiatives in 1997 include pilot programs for assisted living rental housing loans, and single source

loans for construction and permanent financing of

selected new multifamily projects.

During the fourth quarter of 1997, Fannie Mae announced changes to its automated underwriting

software, Desktop Underwriter, that will allow the

Enterprise to become more competitive in the

alternative-A mortgage market. In addition, the

Enterprise initiated a pilot program that will

allow purchases of higher risk loans through

Desktop Underwriter with the placement of

deeper private mortgage insurance. These loans

would generally be classified as A-minus. Fannie

Mae also is developing new product initiatives

in the areas of manufactured housing, home improvement loans, low down payment mortgages, energy loans, and reverse mortgages.

Increased Use of Credit

Enhancements Improves

Credit Risk Profile of

Enterprise Purchases and

Guarantees

The composition of purchases and guarantees

by Fannie Mae and Freddie Mac reflected, in

general, the composition of primary market

originations during 1997. However, while 30-

year fixed-rate loans continued to account for

approximately 70 percent of total Enterprise

purchases and guarantees, ARM product comprised an increased proportion of purchases

and guarantees from 1996. ARMs accounted

for approximately 11 percent of new volumes

at Fannie Mae compared to 8 percent the prior

year, and 8 percent at Freddie Mac compared

to 7 percent in 1996. Despite the increase in

ARMs as a proportion of new volume, heavy liquidations of this product during 1997 resulted in relatively little change in ARMs as a proportion of the

Enterprises’ total outstanding portfolios. Consistent with activity in the primary market, the proportion of 15-year loans purchased declined at both

Enterprises and represented a decreasing percentage

of their outstanding portfolios.

Figure 12

Average LTV on Enterprise Purchases

Source: Fannie Mae and Freddie Mac

66%

68%

70%

72%

74%

76%

78%

Freddie Mac Fannie Mae

Figure 13

Enterprise Mortgage Investments

($ in Billions)

Source: Fannie Mae and Freddie Mac

$0

$500

$1,000

$1,500

$2,000

199219931994199519961997

1Q98

1.0

1.1

1.2

1.3

1.4

Net Interest Margin

Enterprise Investments

Fannie Mae's Net Interest Margin

Freddie Mac's Net Interest Margin
35

1998 OFHEO REPORT TO CONGRESS

The average LTV ratio on Enterprise single-family

purchases and guarantees was unchanged in 1997

at 76 percent for Fannie Mae and Freddie Mac.

The average LTV on new business has increased

since 1993 due to the shift towards purchase money

mortgages with higher LTVs relative to the heavy

refinance environment in 1992 and 1993 (See Figure 12), but has also been higher than the average

LTV prior to the refinance years. As a result of the

increase in refinancings in the first quarter of 1998,

the average LTV ratio on new purchases and guarantees declined for both Enterprises.

While the average LTV on Enterprise purchases and

guarantees was unchanged in 1997, the significant

increase in the use of credit enhancements (which

shifts the primary default risk of the mortgages to

the lender or a third party) improved the credit risk

profile of these mortgages. The growth in credit

enhancements was driven by the favorable economic environment and increased competition

among mortgage insurers, making the acquisition

of pool insurance against credit losses attractive for

lenders, who received lower guarantee fee rates from

the Enterprises in return. Pool insurance covers a

large group of loans and augments the protection

provided by primary mortgage insurance on individual loans.

A significant 40 percent of Freddie Mac’s 1997 purchases and guarantees were credit-enhanced, compared to 11 percent in 1996. As a result, the proportion of Freddie Mac’s total outstanding portfolio that is supported by credit enhancements other

than primary mortgage insurance increased to 16

percent from 10 percent in 1996. At Fannie Mae,

24 percent of guarantees were credit-enhanced compared to 9 percent in 1996. Similarly, the percentage of Fannie Mae’s total portfolio outstanding that

is credit-enhanced increased to 13 percent from 10

percent a year ago. While pool insurance transactions reduce the Enterprises’ exposure to default

losses, they do not eliminate their exposure. Pool

insurance provides coverage for expected losses, but

not for extraordinary losses.

Financial Condition of the

Enterprises

Earnings Exceed $4 Billion in

1997, as Mortgage Investments

Increase

Combined earnings for the Enterprises grew 13

percent to $4.5 billion in 1997 (See Tables A &

B). Net interest income for both Enterprises rose

to $5.9 billion in 1997, from $5.3 billion in 1996.

Net interest income was impacted mainly by higher

levels of mortgage investments, as the net interest

margin of each Enterprise fell (See Figure 13).

 1

The Enterprises increased their purchases of

seasoned MBS, REMICs, and other non-current

coupon MBS during most of 1997, as the spreads

on current coupon mortgages (recent production

mortgages) remained tight. Enterprise earnings

growth has become heavily dependent on volume

as competition and other factors have put pressure

on their net interest margins.

A comparison of the Enterprises’ two principal

lines of business - portfolio investments and

mortgage guarantees - indicates that net interest

income continues to be the primary source of

income for the Enterprises (See Figure 14).

The combined mortgage guarantee fee income for

the Enterprises rose slightly by 3.6 percent during

1997. Fannie Mae drove the increase in guarantee

fee income, as Freddie Mac’s guarantee fee income

did not change from its 1996 level of

approximately $1.1 billion. Fannie Mae’s guarantee

fee income increased to approximately $1.3 billion

in 1997, compared with $1.2 billion in 1996. The

increase in guarantee fee income resulted from a

$27 billion increase in average net Fannie Mae

MBS outstanding and an increase of 0.3 basis

points in the average guarantee fee rate. Higher

guarantee fee mortgages rolled off Freddie Mac’s

books through liquidations and were replaced by

lower guarantee fee mortgages. These lower
1998 OFHEO REPORT TO CONGRESS

36

Table A

FANNIE MAE

SELECTED FINANCIAL HIGHLIGHTS

(Dollars in Billions)

1998Q1

Annualized 1997 1996 1995 1994

EARNINGS PERFORMANCE:

 Earnings ($) 3.30 3.06 2.72 2.14 2.13

 Net Interest Income ($) 4.14 3.95 3.59 3.05 2.82

 Guarantee Fees ($) 1.28 1.27 1.20 1.09 1.08

 Net Interest Margin (%)11.14 1.17 1.18 1.16 1.24

 Average Guarantee Fee (bp)221.9 22.7 22.4 22.0 22.5

 Return on Common Equity (%) 25.0 24.6 24.1 20.9 24.3

 Dividend Payout Ratio (%)332.2 30.9 31.5 34.6 30.8

BALANCE SHEET POSITION:

 Total Assets ($) 404.0 391.7 351.0 316.5 272.5

 Outstanding Debt ($) 381.1 369.8 331.3 299.2 257.2

Mortgages:

 Retained Mtge. Portfolio ($) 327.2 316.6 286.5 252.9 220.8

 MBS (excl. MBS in Portfolio) ($) 593.3 579.1 548.2 513.2 486.3

 Retained as % of Total Mtgs.

 in Portfolio and MBS (%) 35.5 35.3 34.3 33.0 31.2

Capital:

 Equity/Assets & MBS (%) 1.41 1.42 1.42 1.32 1.26

 Equity & Reserves/

 Assets & MBS (%)41.49 1.50 1.50 1.41 1.37

Source: Fannie Mae

 1. Taxable equivalent net interest income divided by average earning assets.

 2. Guarantee fees divided by average MBS outstanding net of MBS held in portfolio.

 3. Common and preferred dividends divided by net income.

 4. Effective 1/1/95, reserves exclude valuation allowance related to impaired loans pursuant to SFAS 114.
37

1998 OFHEO REPORT TO CONGRESS

Table B

FREDDIE MAC

SELECTED FINANCIAL HIGHLIGHTS

(Dollars in Billions)

1998Q1

Annualized 1997 1996 1995 1994

EARNINGS PERFORMANCE:

 Earnings ($) 1.57 1.40 1.24 1.09 0.98

 Net Interest Income ($)1,6 2.18 1.99 1.71 1.40 1.11

 Guarantee Fees ($)1 1.06 1.08 1.08 1.09 1.11

 Net Interest Margin (%)1,2,6 1.05 1.07 1.15 1.23 1.25

 Average Guarantee Fee (bp)3 22.4 22.9 23.4 23.8 24.4

 Return on Common Equity (%) 22.7 23.1 22.6 22.1 23.3

 Dividend Payout Ratio (%)4 27.0 26.4 26.0 25.8 25.7

BALANCE SHEET POSITION:

 Total Assets ($) 226.6 194.6 173.9 137.2 106.2

 Outstanding Debt ($) 192.9 168.6 156.5 119.3 92.1

Mortgages:

 Retained Mtge. Portfolio ($) 186.0 164.5 137.8 107.7 73.2

 MBS(excl. MBS in Portfolio) ($) 462.8 476.0 473.1 459.0 460.7

 Retained as % of Total Mtgs.

 in Portfolio and MBS (%) 28.7 25.7 22.6 19.0 13.7

Capital:

 Equity/Assets & MBS (%) 1.19 1.12 1.04 0.98 0.91

 Equity & Reserves/

 Assets & MBS(%)5 1.29 1.21 1.14 1.09 1.04

Source: Freddie Mac

1. Effective 1/1/96, Freddie Mac reports guarantee fees on retained Freddie Mac MBS as guarantee fee income. Previously

estimated and included in net interest income rather than fee income.

2. Taxable equivalent net interest income divided by average earning assets.

3. Guarantee fees divided by average MBS outstanding net of MBS held in portfolio.

4. Common and preferred dividends divided by net income.

5. Effective 1/1/95, reserves exclude valuation allowance related to impaired loans pursuant to SFAS 114.

6. Adjusted to exclude the formation of REIT subsidiaries during 1Q97, issuances of step-down preferred stock, and 

associated investment activities. Dividends paid by REIT subsidiaries are reported on Freddie Mac’s Consolidated 

Statements of Income as Minority interest in earnings of real estate investment trusts.”
1998 OFHEO REPORT TO CONGRESS

38

guarantee fee mortgages were the result of increased

purchases of credit-enhanced mortgages by Freddie

Mac.

Enterprise Credit Losses Decline,

while Delinquencies Remain Low

Credit losses for the Enterprises (charge-offs plus

foreclosure expenses) fell approximately 17 percent

in 1997. The drop in credit losses was primarily

due to an improving housing market (especially

in California) that reduced foreclosure expenses

for the Enterprises.

Freddie Mac’s single-family delinquency rate

fell to 0.55 percent during the year, while

Fannie Mae’s rose to 0.62 percent (See Figure

15). While this was the third consecutive

annual increase for Fannie Mae, the rate was

still less than half as large as it was in the mid1980s.

Losses in future years may benefit from actions

taken by the Enterprises in recent years. Three

years ago, both Fannie Mae and Freddie Mac

raised private mortgage insurance requirements

on high LTV loans. Some of those loans will

soon begin to enter their peak default years.

Also, the Enterprises continue to implement

new loss mitigation initiatives that appear to

have worked well in the current favorable

housing market. Last year, Freddie Mac

introduced a new delinquency management

tool called Early Indicator, created through a

strategic alliance with Mortgage Guaranty

Insurance Corp. Early Indicator is designed

to determine the probability of delinquent

loans continuing through to foreclosure.

Fannie Mae introduced its own delinquency

management tool, Risk Profiler, in 1997. Risk

Profiler provides servicers with monthly data

on both performing and nonperforming loans

to assist them in identifying and focusing on

loans which have the greatest foreclosure

potential.

Multifamily delinquency rates fell for both

Enterprises in 1997. Freddie Mac’s multifamily

delinquency rate dropped to 0.96 percent in 1997,

from 1.96 percent in 1996. Fannie Mae’s

multifamily delinquency rate declined to a very low

of 0.37 percent in 1997, down from 0.68 percent

in 1996. Freddie Mac continues to benefit from

the reduction of poor credit quality multifamily

loans purchased prior to 1991. Fannie Mae and

Freddie Mac’s decline in multifamily delinquency

Figure 15

Single-Family Delinquency Rates

(Loans Delinquent 90 Days or More

or in Foreclosure)

Source: Fannie Mae and Freddie Mac

0.4%

0.5%

0.6%

0.7%

0.8%

199219931994199519961997

Freddie Mac Fannie Mae

Figure 14

Enterprise Primary Sources of Revenue

($ in Billions)

Source: Fannie Mae and Freddie Mac

$0

$1

$2

$3

$4

$5

$6

$7

199219931994199519961997

1Q98*

Net Interest Inc. Guarantee Fees

* Annualized
39

1998 OFHEO REPORT TO CONGRESS

rates also can be attributed to lower vacancy rates

and increasing market rents in various parts of the

country.

Year 2000 Costs Add to

Administrative Expenses

Administrative expenses increased more rapidly

than the combined Enterprises’ revenue growth rate

of 10 percent in 1997. Administrative expenses

increased 14 percent at Fannie Mae and 13 percent

at Freddie Mac. Higher administrative expenses

were partly driven by increased costs associated with

the Year 2000 date change issue. In particular, the

Enterprises had to pay a premium to retain systems

professionals due to the industry-wide shortage of

skillful systems professionals to effect the Year 2000

date change.

Fannie Mae is planning to have all of its major

systems Year 2000 compliant by December 31,

1998. In addition, Fannie Mae expects that all of

the systems of its lenders (sellers and servicers) will

be Year 2000 compliant by March 31, 1999.

Freddie Mac also plans to have all of its systems

ready for the Year 2000 date change by the end of

1998. Freddie Mac is requiring its seller servicers

to be Year 2000 compliant by December 31, 1998.

Both Enterprises are participating in the Mortgage

Bankers Association Year 2000 Inter-Industry Work

Group. The group collects general Year 2000

information, identifies risks specific to the industry,

shares ideas on topics such as effective testing plans

and contingencies, and serves as an industry

resource on Year 2000 planning.

Refinance Activity Affects First

Quarter 1998 Enterprise Earnings

The Enterprises experienced double-digit earnings

growth during the first quarter of 1998; Fannie

Mae’s earnings were $824 million, and Freddie Mac

earned $393 million. Although mortgage

investments increased during the quarter, growth

in earnings was mainly attributable to continued

declines in credit losses and gains in other income.

The decline in interest rates from September 1997

through January 1998 raised MBS investor

prepayment fears during first quarter 1998. As

investors began to sell their MBS, prices became

more attractive to the Enterprises because they are

able to hedge prepayment risks more cheaply than

most other investors. Fannie Mae experienced

growth in its mortgage investment portfolio at an

annualized rate of 13.3 percent during the first

quarter of 1998. Freddie Mac increased its retained

portfolio by a record $22 billion during the quarter.

Although mortgage investments rose at the

Enterprises during the quarter, net interest income

increased only marginally as both Enterprises

experienced compression in their net interest

margins. Fannie Mae’s net interest margin fell 3

basis points to 1.14 percent from fourth quarter

1997, while Freddie Mac’s net interest margin

dropped 5 basis points to 1.05 percent. The

Enterprises’ decline in net interest margins was due

to incomplete hedging of prepayment risk for

previously acquired mortgages and narrower

spreads on new mortgage assets acquired during

the first quarter of 1998.

Fannie Mae’s credit losses dropped approximately

8 percent from fourth quarter 1997, while Freddie

Mac’s credit losses fell 15 percent. Both Enterprises

experienced gains in other income (resecuritization

fees, MBS-related fees, and gains or losses on the

sale of securities). Fannie Mae’s other income rose

$26 million, while Freddie Mac’s increased $8

million.

The Enterprises’ Asset Growth

Rate Continues to Decline

Total assets for the Enterprises increased 12 percent

to $586 billion during 1997, in spite of a generally

lower supply of attractive mortgage investment
1998 OFHEO REPORT TO CONGRESS

40

opportunities. The decline in supply of attractive

mortgage investments was due to tight mortgageto-debt spreads throughout the year.

Although total Enterprise assets grew 12 percent

in 1997, the rate of asset growth declined for the

third consecutive year (See Figure 16). As the

Enterprises continue to grow, it has become more

difficult to increase asset size at previous growth

rates. Asset growth has become more important

for the Enterprises as they continue to

experience declining margins. In an effort to

address asset growth and margin pressures, the

Enterprises are increasing their purchases in a

wider range of mortgage products.

The average balance of non-mortgage

investments increased steadily at Fannie Mae

to $68 billion during fourth quarter 1997, up

from $60 billion during the first quarter of 1997

(See Figure 17). Freddie Mac’s non-mortgage

investments fell $1 billion over the same period

to an average balance of $34 billion during

fourth quarter 1997. However, Freddie Mac’s

non-mortgage investment activity was more

volatile than Fannie Mae’s during 1997.

Examples of non-mortgage investments for the

Enterprises include U.S. Treasury and agency

securities, federal funds, repurchase agreements,

commercial paper, municipal bonds, corporate

and Eurodollar securities, and asset-backed

securities.2

As Debt Grows, Enterprises

Expand Funding Sources

and Seek New Types

of Funding Vehicles

The Enterprises’ total combined debt

outstanding reached $538 billion in 1997, an

increase of 10 percent from 1996. While most

of the Enterprises’ debt outstanding is long-term

(See Figure 18), Freddie Mac’s long-term debt

was callable or had downward rate adjustment

features in 1997. Forty-six percent of Fannie

Mae’s long-term debt outstanding in 1997 was

callable. Callable debt is attractive to the

Enterprises because it reduces the risk associated

with the prepayment uncertainty of their

mortgage-related assets.

Debt issuance also increased for the Enterprises in

1997. Debt issuance increased by 43 percent at

Freddie Mac and 18 percent at Fannie Mae. Heavy

debt issuance continued in first quarter 1998

following the exercise of call options on highFigure 16

Combined Enterprise Assets and Growth Rate

($ in Billions)

Source: Fannie Mae and Freddie Mac

$0

$100

$200

$300

$400

$500

$600

$700

199219931994199519961997

0%

5%

10%

15%

20%

25%

30%

Enterprise Assets Growth Rate

Figure 17

Enterprise Average Non-Mortgage Investments

($ in Billions)

Source: Fannie Mae and Freddie Mac

$0

$20

$40

$60

$80

1Q97 2Q97 3Q97 4Q97

Fannie Mae Freddie Mac
41

1998 OFHEO REPORT TO CONGRESS

coupon debt. Fannie Mae called $20 billion

during first quarter 1998, compared with $9

billion in fourth quarter 1997. Freddie Mac

called $14 billion during first quarter 1998, up

from the fourth quarter 1997 call amount of

approximately $6 billion.

The Enterprises’ increasing demands for debt

have caused Freddie Mac and Fannie Mae to

expand their funding sources and seek new

types of funding vehicles. The primary funding

source for the Enterprises continues to be

institutional investors. Fannie Mae’s global debt

outstanding increased 53 percent to $21.8

billion, while Freddie Mac issued $3.5 billion

of debt in the international markets, including

$700 million of debt securities denominated

in foreign currencies. The expansion of funding

sources improves the Enterprises’ potential for

lower cost funding.

In addition to expanding their sources of funds,

the Enterprises are also exploring new debt

programs. Fannie Mae and Freddie Mac both

introduced new debt programs during first quarter

1998 (See Box 3). Fannie Mae’s new debt program

is called Benchmark Notes and Freddie Mac’s is

called Reference Notes. Both programs will be used

by the Enterprises respectively to potentially reduce

their funding costs by taking advantage of market

opportunities created by the decline in Treasury

funding demand. Treasury funding needs have

tapered off due to the shift from a federal budget

deficit to a surplus. The reduction in supply of

new Treasury securities has opened a window of

opportunity for other instruments with Treasurylike qualities such as liquidity and agency status.

Enterprises Meet Regulatory

Minimum Capital

Requirements, while

Exercising Capital

Management

The Enterprises exceeded their regulatory

minimum capital requirements by

approximately $1.5 billion in 1997. Fannie

Mae’s minimum capital requirement was $12.7

billion at year-end 1997. The Enterprise held

surplus capital of approximately $1.1 billion

(See Figure 19). Freddie Mac held $440

million above its minimum capital

requirement of nearly $7.1 billion. The

Enterprises were required to hold $1.8 billion

Figure 18

Effective Long-Term Debt as a Percent of Total Debt

Source: Fannie Mae and Freddie Mac

0%

20%

40%

60%

80%

100%

120%

199219931994199519961997

Fannie Mae Freddie Mac

Figure 19

Enterprise Core Capital as a Percent of Minimum

Capital Requirements

Source: OFHEO

0%

20%

40%

60%

80%

100%

120%

4Q90*4Q91*4Q92*

4Q934Q944Q954Q964Q97

Freddie Mac Fannie Mae

*Estimated
1998 OFHEO REPORT TO CONGRESS

42

more in regulatory capital at year-end 1997

compared with 1996, due to higher levels of assets.

The Enterprises were engaged in active capital

management during 1997, as attractive mortgage

investment opportunities were limited. In

particular, the Enterprises repurchased shares of

their common stock to reduce their levels of capital

in excess of internal and regulatory requirements.

Freddie Mac repurchased $557 million in common

stock, while Fannie Mae repurchased $1.3 million

in common stock. The board of directors at each

Enterprise authorized the return of capital to

shareholders as an alternative to deploying capital

in assets at lower than target rates of return.

The repurchasing of common stock shares has a

positive impact on earnings per share (net earnings

divided by average shares of common stock

outstanding) because it lowers the number of shares

outstanding. Both Enterprises experienced doubledigit increases in their earnings per share during

1997.

During 1997, Freddie Mac redeemed a $563

million preferred stock issue and replaced it with

$600 million of lower cost preferred stock. Freddie

Mac’s refinancing of capital at a lower dividend

rate is expected to generate annual savings of $10

million. The Enterprise also issued an additional

$150 million of preferred stock in 1997.

1 Freddie Mac’s figures on net interest income, guarantee fees, and net interest margin are adjusted to shift

guarantee fees on portfolio holdings of its MBS from guarantee fee income as reported to net interest

income. This adjustment makes the data comparable to Fannie Mae’s. In addition, Freddie Mac’s figures

have been adjusted to exclude the formation of REIT subsidiaries established during first quarter 1997.

2 The Department of Housing and Urban Development (HUD) published an advanced notice of proposed

rulemaking in December 1997 to seek comments regarding possible regulations concerning non-mortgage

investments by the Enterprises. HUD seeks to make certain that in carrying out its regulatory responsibilities with respect to the Enterprises, the Department has the necessary tools to ascertain and ensure that

these non-mortgage investments are consistent with the Enterprises’ charter purposes.
43

1998 OFHEO REPORT TO CONGRESS

Benchmark and Reference Notes

In December 1997, Fannie Mae announced a new issuance initiative called Benchmark Notes. The

notes, issued through the Enterprise’s global debt facility, are bullet instruments designed to serve as a

liquidity alternative for investors at a time of reduced government borrowing.

Fannie Mae announced that as much as $40 billion of Benchmark Notes could be issued in 1998, which

would account for approximately half of its long-term debt issuance this year. Through May, the

Enterprise had issued $19.75 billion. There have been four issues of $4 billion each, one of which was

reopened for an additional $750 million, and one $3 billion issue.

Fannie Mae states that the minimum new issue size for the Benchmark Notes is $2 billion, and the

minimum size for a reopening is $500 million. The average par amount of Fannie Mae’s bullet issues

in 1997 was only $166.5 million. Thus, there is

substantially more liquidity in the Benchmark Notes than

in previous bullet issues.

On April 9, 1998, Freddie Mac issued its first Reference

Notes, issued under terms of its global bond program, with

proceeds of $5 billion. The 10-year Reference Note have

traded within two basis points in yield to the 10-year

Benchmark Notes. Subsequent offerings will have a

minimum size of $4 billion. Freddie Mac sold

approximately $15 billion of bullet debt in 1997 with

maturities in the 5- to 10-year range.

For the Benchmark and Reference Notes, spreads over U.S. Treasury issues have been considerably tighter

than for the Enterprises’ other bullet issues. Total funding costs are also reduced by the fact that

underwriting fees, as a percentage of the amount of debt issued, have been less than the fees for issuing

smaller bullet bonds.

In addition to the mere size of the Benchmark and Reference Notes, liquidity for these bonds has been

enhanced by the visibility of pricing. This enhanced liquidity has enabled traders to use Benchmark

and Reference Notes as hedge vehicles, since these bonds can be borrowed in the security repurchase

market.

Reference Notes

Size

Interest Rate

Issue Date

Price at Issue

Maturity Date

 10-year

$5 billion

5.75%

Apr 9, 1998

99.256

Apr 15, 2008

Box 3

Benchmark Notes 3-year 5-year 5-year 10-year

(Reopened by

$750 million on

March 3)

10-year

Size $4 billion $4 billion $4 billion $4.75 billion $3 Billion

Interest Rate 5.625% 5.25% 5.75% 5.75% 6.00%

Issue Date Mar 6, 1998 Jan 15, 1998 Apr 6, 1998 Feb 5, 1998 May 11, 1998

Price at Issue 99.779 99.662 99.723 99.659 99.954

Maturity Date Mar 15, 2001 Jan 15, 2003 Apr 15, 2003 Feb 15, 2008 May 15, 2008
1998 OFHEO REPORT TO CONGRESS

45

HISTORICAL DATA TABLES
1998 OFHEO REPORT TO CONGRESS

46
1998 OFHEO REPORT TO CONGRESS

47

Table Source Content Period

1 Fannie Mae Balance Sheet / MBS 1971-1997

2 Fannie Mae Capital / Earnings 1971-1997

3 Fannie Mae Mortgage Asset Quality 1971-1997

4 Fannie Mae Business Activity: Purchases / MBS 1971-1997

5 Fannie Mae Non-Mortgage Investments 1991-1997

6 Fannie Mae Debt / Market Share 1989-1997

7 Fannie Mae Derivative Financial Instruments 1991-1997

8 Freddie Mac Balance Sheet / MBS 1971-1997

9 Freddie Mac Capital / Earnings 1971-1997

10 Freddie Mac Mortgage Asset Quality 1971-1997

11 Freddie Mac Business Activity: Purchases / MBS 1971-1997

12 Freddie Mac Non-Mortgage Investments 1994-1997

13 Freddie Mac Debt / Market share 1995-1997

14 Freddie Mac Derivative Financial Instruments 1995-1997

15 Aggregate Balance Sheet / MBS 1971-1997

16 Aggregate Capital / Earnings 1971-1997

17 Aggregate Business Activity: Purchases / MBS 1971-1997

18 Aggregate Non-Mortgage Investments 1995-1997

19 Aggregate Debt 1995-1997

20 Aggregate Rates on Loans 1972-1997

21 Mortgage Interest Rates 1972-1997

22 Housing Market Activity 1971-1997

23 Weighted Repeated Sales House Price Index 1976-1997
1998 OFHEO REPORT TO CONGRESS

48

Fannie Mae Financial Data

Table 1

Balance Sheet/ MBS

($ in millions)

Total Assets Retained Mortgage

Portfolio Outstanding

1/

Debt

Outstanding

Total MBS

Outstanding

2/

Multiclass MBS

Outstanding

3/

1Q98 403,993 327,171 381,093 593,303 397,116

4Q97 391,673 316,592 369,774 579,138 388,360

3Q97 379,225 307,037 358,003 565,697 378,476

2Q97 365,997 297,073 345,462 558,081 363,500

1Q97 357,010 291,713 336,174 554,109 351,791

Annual Data

1997 391,673 316,592 369,774 579,138 388,360

1996 351,041 286,527 331,270 548,173 339,798

1995 316,550 252,868 299,174 513,230 353,528

1994 272,508 220,815 257,230 486,345 378,733

1993 216,979 190,169 201,112 471,306 381,865

1992 180,978 156,260 166,300 424,444 312,369

1991 147,072 126,679 133,937 355,284 224,806

1990 133,113 114,066 123,403 288,075 127,278

1989 124,315 107,981 116,064 216,512 64,826

1988 112,258 100,099 105,459 170,097 26,660

1987 103,459 93,665 97,057 135,734 11,359

1986 99,621 94,123 93,563 95,568 Not Applicable

Before 1987

1985 99,076 94,609 93,985 54,552

1984 87,798 84,135 83,719 35,738

1983 78,383 75,247 74,594 25,121

1982 72,981 69,356 69,614 14,450

1981 61,578 59,629 58,551 717

1980 57,879 55,589 54,880 Not Applicable

Before 1981

1979* 51,300 49,777 48,424

1978* 43,506 42,103 40,985

1977* 33,980 33,252 31,890

1976* 32,393 31,775 30,565

1975* 31,596 30,820 29,963

1974* 29,671 28,666 28,168

1973* 24,318 23,589 23,003

1972* 20,346 19,652 19,239

1971* 18,591 17,886 17,672

Source: Fannie Mae

 *Note: Figures are not restated for 12/87 FAS 91 change.

 1/ Gross Retained Portfolio net of unamortized purchase premiums, discounts, and fees.

 2/ Excludes MBS held in portfolio.

 3/ Includes Multiclass MBS held in portfolio.
1998 OFHEO REPORT TO CONGRESS

49

Fannie Mae Financial Data

Table 2

Capital Earnings

Stockholders'

Equity

($ in millions)

Equity / (Assets

+ MBS) (%)

(Equity + Loss

Reserves) /

(Assets + MBS)

(%)

1/

Net Income

($ in millions)

Net Interest

Margin (%)

2/

Average

Guarantee Fee

Rate (%)

Return on

Average

Common

Equity (%)

1Q98 14,071 1.41 1.49 824 1.14 0.219 25.0

4Q97 13,793 1.42 1.50 794 1.17 0.227 24.8

3Q97 13,358 1.41 1.50 775 1.17 0.228 24.8

2Q97 13,264 1.36 1.52 753 1.17 0.227 24.4

1Q97 13,178 1.34 1.53 734 1.17 0.227 24.0

Annual Data

1997 13,793 1.42 1.50 3,056 1.17 0.227 24.6

1996 12,773 1.42 1.50 2,725 1.18 0.224 24.1

1995 10,959 1.32 1.41 2,144 1.16 0.220 20.9

1994 9,541 1.26 1.37 2,132 1.24 0.225 24.3

1993 8,052 1.17 1.29 1,873 1.38 0.213 25.3

1992 6,774 1.12 1.25 1,623 1.37 0.212 26.5

1991 5,547 1.10 1.24 1,363 1.42 0.210 27.7

1990 3,941 0.94 1.06 1,173 1.39 0.211 33.7

1989 2,991 0.88 1.01 807 1.16 0.213 31.1

1988 2,260 0.80 0.94 507 0.89 0.216 25.2

1987 1,811 0.76 0.90 376 1.00 0.224 23.5

1986 1,182 0.61 0.74 105 0.40 0.238 9.5

1985 1,009 0.66 0.76 (7) 0.15 0.256 (0.7)

1984 918 0.74 0.85 (71) (0.11) 0.262 (7.4)

1983 1,000 0.97 1.10 49 (0.01) 0.263 5.1

1982 953 1.09 1.25 (192) (0.72) 0.272 (18.9)

1981 1,080 1.73 1.90 (206) (0.74) 0.250 (17.2)

1980* 1,457 2.49 2.73 14 0.04 Not Applicable

Before 1981

0.9

1979* 1,501 2.93 3.17 162 0.70 11.3

1978* 1,362 3.13 3.36 209 0.98 16.5

1977* 1,173 3.45 3.66 165 0.95 15.3

1976* 983 3.03 3.19 127 0.82 13.8

1975* 861 2.73 2.84 115 0.73 14.1

1974* 772 2.60 2.69 107 0.70 14.7

1973* 680 2.80 2.87 126 0.98 20.3

1972* 559 2.75 2.78 96 0.84 18.8

1971* 460 2.47 2.49 61 0.40 14.4

Source: Fannie Mae

 *Note: Figures are not restated for 12/87 FAS 91 change.

 1/ Effective 1/1/95 reserves exclude valuation allowance related to impaired loans pursuant to SFAS 114.

 2/ Taxable equivalent net interest income divided by average earning assets.
1998 OFHEO REPORT TO CONGRESS

50

Fannie Mae Financial Data

Table 3

Mortgage Asset Quality

Single-Family

Delinquency Rate

(%) 1/

Multifamily

Delinquency Rate

(%)

Charge-Offs /

(Portfolio + MBS)

 (%) 2/

REO / (Portfolio +

MBS)

(%) 3/

1Q98 0.61 0.36 0.03 0.10

4Q97 0.62 0.37 0.04 0.10

3Q97 0.59 0.43 0.04 0.11

2Q97 0.58 0.47 0.05 0.11

1Q97 0.59 0.58 0.05 0.11

Annual Data

1997 0.62 0.37 0.04 0.10

1996 0.58 0.68 0.05 0.11

1995 0.56 0.81 0.05 0.08

1994 0.47 1.21 0.06 0.10

1993 0.48 2.34 0.04 0.10

1992 0.53 2.65 0.04 0.09

1991 0.64 3.62 0.04 0.07

1990 0.58 1.70 0.06 0.09

1989 0.69 3.20 0.07 0.14

1988 0.88 6.60 0.11 0.15

1987 1.12 Not Available

Before 1988 0.11 0.18

1986# 1.38 0.12 0.22

1985# 1.48 0.13 0.32

1984# 1.65 0.09 0.33

1983# 1.49 0.05 0.35

1982# 1.41 0.01 0.20

1981# 0.96 0.01 0.13

1980# 0.90 0.01 0.09

1979* 0.56 0.02 0.11

1978* 0.55 0.02 0.18

1977* 0.46 0.02 0.26

1976* 1.58 0.03 0.27

1975* 0.56 0.03 0.51

1974* 0.51 0.02 0.52

1973* Not Available

Before 1988 0.00 0.61

1972* 0.02 0.98

1971* 0.01 0.59

Source: Fannie Mae

 *Note: Asset Quality figures are not restated for 12/87 FAS 91 change.

 #Note: Charge-off ratio has not been restated for change in Loss Accounting

 methodology for the years 1971 through 1986

 1/ Single-family delinquency rate has been restated for periods prior to

 12/31/95, to include loans three or more months delinquent or in

 foreclosure.

 2/ Average Balances for Portfolio and MBS used to calculate ratios

 subsequent to 1994; includes REO expenses.

 3/ REO balances reflect end-of-period amounts. Begnning 1Q95, data

includes adoption of SFAS 114.
1998 OFHEO REPORT TO CONGRESS

51

Fannie Mae Financial Data

Table 4

Business Activity

($ in millions)

Purchases MBS

Single-Family

Mortgage

Purchases

Multifamily

Mortgage

Purchases

Total

Mortgage

Purchases

Mortgage

Securities

Purchased 1/

Single-Family

MBS Issued

Multifamily

MBS Issued

Total MBS

Issued

Multiclass

MBS Issued

1Q98 66,070 1,711 67,781 18,850 56,784 1,475 58,259 22,382

4Q97 52,374 2,171 54,545 15,332 45,539 1,861 47,400 26,025

3Q97 44,065 1,788 45,853 15,416 39,058 1,644 40,702 19,462

2Q97 33,765 1,367 35,132 9,739 29,264 1,182 30,446 20,369

1Q97 34,230 1,286 35,516 8,361 29,754 1,127 30,881 19,559

Annual Data

1997 164,434 6,612 171,046 48,848 143,615 5,814 149,429 85,415

1996 166,965 6,942 173,907 45,016 144,201 5,668 149,869 30,780

1995 127,988 5,030 133,018 34,036 106,269 4,187 110,456 9,681

1994 164,619 3,840 168,459 24,552 128,385 2,237 130,622 73,365

1993 303,071 4,135 307,206 6,275 220,485 959 221,444 210,630

1992 262,055 2,956 265,011 4,930 193,187 850 194,037 170,205

1991 144,517 3,204 147,721 2,384 111,488 1,415 112,903 112,808

1990 116,496 3,181 119,677 977 96,006 689 96,695 68,291

1989 87,446 4,836 92,282 Not Applicable

Before 1990 66,489 3,275 69,764 41,715

1988 73,808 4,180 77,988 51,120 3,758 54,878 17,005

1987 82,277 1,483 83,760 62,067 1,162 63,229 9,917

1986 89,515 1,877 91,392 60,017 549 60,566 2,400

1985 43,959 1,200 45,159 23,142 507 23,649 Not Applicable

Before 1986

1984 29,161 1,106 30,267 13,087 459 13,546

1983 30,757 140 30,897 13,214 126 13,340

1982 29,077 9 29,086 13,970 Not Applicable

Before 1983 13,970

1981 6,828 2 6,830 717 717

1980 8,074 27 8,101 Not Applicable

Before 1981

Not Applicable

Before 1981

1979 10,798 9 10,807

1978 12,302 3 12,305

1977 4,650 134 4,784

1976 3,337 295 3,632

1975 3,646 674 4,320

1974 4,746 2,273 7,019

1973 4,170 2,082 6,252

1972 2,596 1,268 3,864

1971 2,742 1,298 4,040

Source: Fannie Mae

 1/ Not included in mortgage purchases.
1998 OFHEO REPORT TO CONGRESS

52

Fannie Mae Financial Data

Table 5

Non-Mortgage Investments

($ in millions)

Federal

Funds &

Eurodollars

Asset-Backed

Securities

Repurchase

Agreements

Commercial

Paper &

Corporate

Debt

Other Total

1Q98 16,939 16,832 6,503 11,888 15,045 67,207

4Q97 19,212 16,639 6,715 11,745 10,285 64,596

3Q97 20,906 11,835 6,611 7,857 16,144 63,353

2Q97 23,171 12,207 5,214 6,619 12,072 59,283

1Q97 21,534 12,168 3,869 6,241 13,305 57,117

Annual Data

1997 19,212 16,639 6,715 11,745 10,285 64,596

1996 21,734 14,635 4,667 6,191 9,379 56,606

1995 19,775 9,905 10,175 8,629 8,789 57,273

1994 17,593 3,796 9,006 7,719 8,221 46,335

1993 4,496 3,557 4,684 0 8,659 21,396

1992 6,587 4,124 3,189 0 5,674 19,574

1991 2,954 2,416 2,195 0 2,271 9,836

1990 Not Available

Before 1991

Not Available

Before 1991

Not Available

Before 1991

Not Available

Before 1991

Not Available

Before 1991

Not Available

Before 1991

1989

Source: Fannie Mae
1998 OFHEO REPORT TO CONGRESS

53

Fannie Mae Financial Data

Table 6

Debt

$ in millions

Market

share /1

Callable Effective

Long-Term

/2

Callable % Overall %

1Q98 139,948 304,066 46% 58%

4Q97 136,276 293,636 46% 57%

3Q97 133,882 284,040 47% 61%

2Q97 131,329 273,105 48% 57%

1Q97 130,218 271,092 48% 58%

Annual Data

1997 136,276 293,636 46% 58%

1996 126,818 266,816 48% 57%

1995 106,079 221,176 48% 58%

1994 101,873 186,687 47% 57%

1993 93,533 160,848 58% 56%

1992 63,237 129,523 49% Not Available

Before 1993

1991 41,196 114,545 36%

1990 22,301 101,896 22%

1989 9,428 92,977 10%

1988 Not Available

Before 1989

Not Available

Before 1989

Not Available

Before 1989

1987

Source: Fannie Mae

1/ Fannie Mae share of combined enterprise purchases

2/ Included the effect of off-balance sheet transactions that convert

short funding to long-term.
1998 OFHEO REPORT TO CONGRESS

54

Fannie Mae Financial Data

Table 7

Derivative Financial Instruments 1/

($ in millions)

Interest Rate Debt-linked Asset-linked Other 2/ Total

Outstandings

1Q98 89,200 53,900 1,000 13,100 157,200

4Q97 96,100 52,700 1,000 11,500 161,300

3Q97 95,200 50,900 1,900 10,100 158,100

2Q97 96,100 57,000 2,000 9,800 164,900

1Q97 98,500 59,700 2,300 8,300 168,800

Annual Data

1997 96,100 52,700 1,000 11,500 161,300

1996 97,900 57,900 2,600 8,300 166,700

1995 74,800 48,400 2,800 5,900 131,900

1994 54,300 32,100 1,500 3,800 91,700

1993 31,600 17,200 1,000 3,200 53,000

1992 14,300 9,300 600 2,700 26,900

1991 4,700 4,300 1,000 1,100 11,100

1990 Not Available

Before 1990

Not Available

Before 1990

Not Available

Before 1990

Not Available

Before 1990

Not Available

Before 1990

1989

Source: Fannie Mae

 1/ notional balances or contract amounts

 2/ Includes short-sales of Treasury securities
1998 OFHEO REPORT TO CONGRESS

55

Freddie Mac Financial Data

Table 8

Balance Sheet / MBS

($ in millions)

Total Assets Retained Mortgage

Portfolio Outstanding

1/

Debt

Outstanding

2/

Total MBS

Outstanding

3/

Multiclass MBS

Outstanding

1Q98 226,571 185,928 192,868 462,765 214,330

4Q97 194,597 164,543 168,574 475,985 233,591

3Q97 184,275 157,263 159,538 470,015 236,517

2Q97 184,003 149,397 161,396 474,195 236,517

1Q97 174,442 144,672 153,124 473,405 246,723

Annual Data

1997 194,597 164,543 168,574 475,985 233,591

1996 173,866 137,826 156,491 473,065 231,539

1995 137,181 107,706 119,328 459,045 246,969

1994 106,199 73,171 92,053 460,656 263,662

1993 83,880 55,938 48,510 439,029 264,122

1992 59,502 33,629 28,173 407,514 217,030

1991 46,860 26,667 28,300 359,163 142,960

1990 40,579 21,520 28,375 316,359 83,437

1989 35,462 21,448 24,102 272,870 47,573

1988 34,352 16,918 24,846 226,406 10,877

1987 25,674 12,354 17,461 212,635 Not Applicable

Before 1988

1986 23,229 13,093 13,378 169,186

1985 16,299 13,547 11,754 99,908

1984 13,175 10,018 10,186 70,025

1983 8,954 7,485 6,782 57,720

1982 6,029 4,679 4,521 42,952

1981 6,326 5,178 5,480 19,897

1980 5,478 5,006 4,686 16,962

1979 4,648 4,003 3,981 15,316

1978 3,697 3,038 3,066 12,017

1977 3,501 3,204 3,110 6,765

1976 4,832 4,175 3,351 2,765

1975 5,899 4,878 4,050 1,643

1974 4,901 4,469 3,989 780

1973 2,873 2,521 2,696 791

1972 1,778 1,726 1,639 444

1971 1,038 935 915 64

Source: Freddie Mac

 1/ Gross Retained Portfolio net of unamortized purchase premiums, discounts, and fees.

 Beginning 1/1/95, the data reflects adoption of SFAS 114. Data for prior periods have not been

 restated.

 2/ Does not include subordinated borrowings.

 3/ Excludes MBS held in portfolio.
1998 OFHEO REPORT TO CONGRESS

56

Freddie Mac Financial Data

Table 9

Capital Earnings

Stockholders'

Equity

($ in millions)

Equity / (Assets

+ MBS) (%)

(Equity + Loss

Reserves) /

(Assets + MBS)

(%)

1/

Net Income

2/

($ in millions)

Net Interest

Margin (%)

2/ 3/ 4/ 5/

Average

Guarantee Fee

Rate (%)

3/

Return on

Average

Common

Equity (%)

1Q98 8,204 1.19 1.29 393 1.05 0.224 24.2

4Q97 7,521 1.12 1.21 372 1.09 0.228 23.9

3Q97 7,148 1.09 1.19 354 1.08 0.229 23.7

2Q97 7,507 1.14 1.23 340 1.04 0.230 23.0

1Q97 6,811 1.05 1.15 329 1.08 0.230 22.7

Annual Data

1997 7,521 1.12 1.21 1,395 1.07 0.229 23.1

1996 6,731 1.04 1.15 1,243 1.15 0.234 22.6

1995 5,863 0.98 1.10 1,091 1.23 0.238 22.1

1994 5,162 0.91 1.04 983 1.25 0.244 23.3

1993 4,437 0.85 0.99 786 1.02 0.238 22.3

1992 3,570 0.76 0.93 622 1.17 0.241 21.2

1991 2,566 0.63 0.81 555 1.66 0.237 23.6

1990 2,136 0.60 0.77 414 1.76 0.224 20.4

1989 1,916 0.62 0.77 437 1.62 0.234 25.0

1988 1,584 0.61 0.76 381 1.95 0.215 27.5

1987 1,182 0.50 0.64 301 1.50 0.242 28.2

1986 953 0.50 0.64 247 1.66 0.224 28.5

1985 779 0.67 0.86 208 2.31 0.221 30.0

1984 606 0.73 0.95 144 2.08 0.247 52.0

1983 421 0.63 0.85 160 1.83 0.262 44.5

1982 296 0.60 0.84 60 0.53 0.245 21.9

1981 250 0.95 1.30 31 0.63 0.195 13.1

1980 221 0.98 1.31 34 1.17 0.143 14.7

1979 238 1.19 1.49 36 1.45 0.132 16.2

1978 202 1.29 1.56 25 1.11 0.149 13.4

1977 177 1.72 2.02 21 0.77 0.189 12.4

1976 156 2.05 2.34 14 0.34 0.136 9.5

1975 142 1.88 2.24 16 0.58 0.248 11.6

1974 126 2.22 2.52 5 1.09 0.255 4.0

1973 121 3.30 3.71 12 1.35 0.324 9.9

1972 110 4.95 5.18 4 Not Available

Before 1973 0.394 3.5

1971 107 9.71 Not Available

Before 1972 6 Not AvailableBefore 1972 5.5

Source: Freddie Mac

 1/ Effective 1/1/95 reserves exclude valuation allowance related to impaired loans pursuant to SFAS 114.

 2/ Effective 1/1/96 Freddie Mac reports guarantee fees on retained MBS as guarantee fee income. Previously these

 fees were included in net interest income.

 However, for comparability with Fannie Mae, guarantee fee income on retained MBS has been estimated and

 included in the net interest income.

 3/ 1993 and 1992 pro forma, to reflect reporting change of uncollectible interest on Single Family mortgages

 implemented in 1 94.

 4/ Average balances used in pre-1987 calculations based on the simple average of the year-end balance of the

 reported period and the prior year-end balance.

 Subsequent calculations use average daily balances.

 5/ Beginning with 1993 data, net interest margin is calculated on a taxable equivalent basis, excludes the effects of

 a REIT formed in
1998 OFHEO REPORT TO CONGRESS

57

Freddie Mac Financial Data

Table 10

Mortgage Asset Quality

Single-Family

Delinquency Rate

(%)

Multifamily

Delinquency Rate

(%) 1/

Charge-Offs /

(Portfolio + MBS)

(%) 2/

REO / (Portfolio +

MBS) (%) 3/

1Q98 0.55 0.96 0.06 0.11

4Q97 0.55 0.96 0.07 0.11

3Q97 0.55 1.33 0.08 0.12

2Q97 0.55 1.71 0.09 0.12

1Q97 0.59 2.00 0.09 0.13

Annual Data

1997 0.55 0.96 0.08 0.11

1996 0.58 1.96 0.10 0.13

1995 0.60 2.88 0.11 0.14

1994 0.55 3.79 0.08 0.18

1993 0.61 3.45 0.05 0.20

1992 0.64 4.45 0.06 0.17

1991 0.61 3.40 0.08 0.14

1990 0.45 2.63 0.08 0.12

1989 0.38 2.53 0.06 0.09

1988 0.36 2.24 0.06 0.09

1987 0.36 1.49 0.06 0.08

1986 0.42 1.07 0.04 0.07

1985 0.42 0.63 0.04 0.10

1984 0.46 0.42 0.02 0.15

1983 0.47 0.58 0.02 0.13

1982 0.54 1.04 0.01 0.12

1981 0.61 Not Available

Before 1982

0.07

1980 0.44 0.04 0.04

1979 0.31 0.02 0.02

1978 0.21 0.02

1977 Not Available

Before 1978

0.03

1976 0.03 0.04

1975 0.05 0.03

1974 0.70 0.02

1973 0.36

1972 Not Available

Before 1973

Not Available

Before 1973

1971

Source: Freddie Mac

 1/ 1982-1987 Multifamily delinquencies were based on the number of loans delinquent 60 days or more.

 1988-1994 Multifamily delinquencies based upon unpaid principal balances.

 2/ Average balances for Portfolio and MBS used to calculate ratios subsequent to 1994; includes REO

 Expenses.

 3/ REO balances reflect end-of-period amounts. Beginning 1Q95, data includes adoption of SFAS 114.
1998 OFHEO REPORT TO CONGRESS

58

Freddie Mac Financial Data

Table 11

Business Activity

($ in millions)

Purchases MBS

Single-Family

Mortgage

Purchases

Multifamily

Mortgage

Purchases

Total

Mortgage

Purchases 1/

Mortgage

Securities

Purchased

Single-Family

MBS Issued

Multifamily

MBS Issued

Total MBS

Issued

Multiclass

MBS Issued

1Q98 47,445 296 47,741 30,229 44,268 0 44,268 26,559

4Q97 38,451 855 39,306 10,081 36,991 140 37,131 22,258

3Q97 28,000 435 28,435 10,363 26,670 0 26,670 22,290

2Q97 24,585 578 25,163 6,641 23,826 360 24,186 17,637

1Q97 24,124 373 24,497 8,300 26,271 0 26,271 22,181

Annual Data

1997 115,160 2,241 117,401 35,385 113,758 500 114,258 84,366

1996 122,850 2,229 125,079 36,824 118,932 770 119,702 34,145

1995 89,971 1,565 91,536 39,384 85,522 355 85,877 15,372

1994 122,563 847 123,410 19,866 116,901 209 117,110 73,131

1993 229,051 191 229,242 Not Available

Before 1994 208,724 0 208,724 143,336

1992 191,099 27 191,126 179,202 5 179,207 131,284

1991 99,729 236 99,965 92,479 0 92,479 72,032

1990 74,180 1,338 75,518 71,998 1,817 73,815 40,479

1989 76,765 1,824 78,589 72,931 587 73,518 39,754

1988 42,884 1,191 44,075 39,490 287 39,777 12,985

1987 74,824 2,016 76,840 72,866 2,152 75,018 Not Available

Before 1988

1986 99,936 3,538 103,474 96,798 3,400 100,198

1985 42,110 1,902 44,012 37,583 1,245 38,828

1984 Not Available

Before 1985

Not Available

Before 1985 21,885 Not AvailableBefore 1985

Not Available

Before 1985 18,684

1983 22,952 19,691

1982 23,671 24,169

1981 3,744 3,529

1980 3,690 2,526

1979 5,716 4,546

1978 6,524 6,412

1977 4,124 4,657

1976 1,129 1,360

1975 1,716 950

1974 2,185 46

1973 1,334 323

1972 1,265 494

1971 778 65

Source: Freddie Mac
1998 OFHEO REPORT TO CONGRESS

59

Freddie Mac Financial Data

Table 12

Non-Mortgage Investments 1/

($ in millions)

Federal

Funds and

Eurodollars

Asset-backed

Securities

Repurchase

Agreements

Commercial

Paper and

Corporate

Debt

Other Total NonMortgage

Investments

1Q98 8,549 2,424 4,997 8,825 1,591 26,386

4Q97 3,003 2,199 6,982 3,160 1,523 16,867

3Q97 3,414 1,536 5,874 839 1,085 12,748

2Q97 9,584 1,810 7,848 1,133 2,041 22,416

1Q97 8,571 1,981 5,534 796 2,024 18,906

Annual Data

1997 3,003 2,199 6,982 3,160 1,523 16,867

1996 10,183 2,084 6,440 1,077 2,740 22,524

1995 Not Available

Before 1996

Not Available

Before 1996

Not Available

Before 1996

Not Available

Before 1996

Not Available

Before 1996 10,977

1994 23,264

1993 Not Available

Before 1994

1992

1991

1990

Source: Freddie Mac

 1/ Excludes mortgage-related securities held for trading purposes
1998 OFHEO REPORT TO CONGRESS

60

Freddie Mac Financial Data

Table 13

Debt

Callable

($ in millions)

Effective

Long-Term

($ in millions)

2/

Callable

%

Market share

1/ %

1Q98 102,587 125,002 82% 42%

4Q97 96,414 118,293 82% 43%

3Q97 95,329 120,414 79% 39%

2Q97 88,057 114,352 77% 43%

1Q97 89,868 120,079 75% 42%

Annual Data

1997 96,414 118,293 82% 42%

1996 83,640 113,376 74% 43%

1995 60,671 83,735 72% 42%

1994 Not Available

Before 1995

Not Available

Before 1995

Not Available

Before 1995

43%

1993 44%

1992 Not Available

Before 1993

1991

1990

Source: Fannie Mae

 1/ Fannie Mae share of combined enterprise purchases.

 2/ Included the effect of off-balance transactions that convert short funding to

 long-term.

Source: Freddie Mac

1/ Freddie Mac share of combined enterprise purchases

2/ Included the effect of off-balance sheet transactions that convert

short funding to long-term.
1998 OFHEO REPORT TO CONGRESS

61

Freddie Mac Financial Data

Table 14

Derivative Financial Instruments1/

($ in millions)

Interest-Rate

Swaps

Interest-Rate

caps, floors,

corridors

Spread-lock

Agreements

2/

Options Foreign

Currency

Futures Total

Outstandings

1Q98 50,867 24,510 4,071 17,400 1,112 30,000 127,960

4Q97 54,172 21,995 12,228 6,000 1,152 0 95,547

3Q97 53,381 19,773 12,625 0 1,424 0 87,203

2Q97 51,909 15,285 11,590 0 1,281 0 80,065

1Q97 48,883 14,283 6,445 0 807 0 70,418

Annual Data

1997 54,172 21,995 12,228 6,000 1,152 0 95,547

1996 46,646 14,095 651 0 544 0 61,936

1995 45,384 13,055 24 0 0 0 58,463

1994 Not Available

Before 1995

Not Available

Before 1995

Not Available

Before 1995

Not Available

Before 1995

Not Available

Before 1995

Not Available

Before 1995

Not Available

Before 1995

1993

1992

1991

Source: Freddie Mac

 1/ Notional balances or contractual amounts at period end

 2/ Included options prior to 4Q97
1998 OFHEO REPORT TO CONGRESS

62

Aggregate Financial Data

Table 15

Balance Sheet/ MBS

($ in millions)

Total Assets Retained Mortgage

Portfolio Outstanding

Debt

Outstanding

Total MBS

Outstanding

Multiclass MBS

Outstanding

1Q98 630,564 513,099 573,961 1,056,068 611,446

4Q97 586,270 481,135 538,348 1,055,123 621,951

3Q97 563,500 464,300 517,541 1,035,712 614,993

2Q97 550,000 446,470 506,858 1,032,276 600,017

1Q97 531,452 436,385 489,298 1,027,514 598,514

Annual Data

1997 586,270 481,135 538,348 1,055,123 621,951

1996 524,907 424,353 487,761 1,021,238 571,337

1995 453,731 360,574 418,502 972,275 600,497

1994 378,707 293,986 349,283 947,001 642,395

1993 300,859 246,107 249,622 910,335 645,987

1992 240,480 189,889 194,473 831,958 529,399

1991 193,932 153,346 162,237 714,447 367,766

1990 173,692 135,586 151,778 604,434 210,715

1989 159,777 129,429 140,166 489,382 112,399

1988 146,610 117,017 130,305 396,503 37,537

1987 129,133 106,019 114,518 348,369 11,359

1986 122,850 107,216 106,941 264,754 Not Applicable

Before 1987

1985 115,375 108,156 105,739 154,460

1984 100,973 94,153 93,905 105,763

1983 87,337 82,732 81,376 82,841

1982 79,010 74,035 74,135 57,402

1981 67,904 64,807 64,031 20,614

1980 63,357 60,595 59,566 16,962

1979 55,948 53,780 52,405 15,316

1978 47,203 45,141 44,051 12,017

1977 37,481 36,456 35,000 6,765

1976 37,225 35,950 33,916 2,765

1975 37,495 35,698 34,013 1,643

1974 34,572 33,135 32,157 780

1973 27,191 26,110 25,699 791

1972 22,124 21,378 20,878 444

1971 19,629 18,821 18,587 64
1998 OFHEO REPORT TO CONGRESS

63

Aggregate Financial Data

Table 16

Capital

Stockholders'

Equity

($ in millions)

Equity / (Assets

+ MBS)

(%)

(Equity + Loss

Reserves) /

(Assets + MBS)

(%)

Net Earnings

($ in millions)

1Q98 22,275 1.32 1.41 1,217

4Q97 21,314 1.30 1.39 1,166

3Q97 20,506 1.28 1.38 1,129

2Q97 20,771 1.31 1.41 1,093

1Q97 19,989 1.28 1.37 1,063

Annual Data

1997 21,314 1.30 1.39 4,451

1996 19,504 1.26 1.36 3,968

1995 16,822 1.18 1.28 3,235

1994 14,703 1.11 1.23 3,115

1993 12,489 1.03 1.16 2,659

1992 10,344 0.96 1.11 2,245

1991 8,113 0.89 1.05 1,918

1990 6,077 0.78 0.93 1,587

1989 4,907 0.76 0.90 1,244

1988 3,844 0.71 0.85 888

1987 2,993 0.63 0.77 677

1986 2,135 0.55 0.69 352

1985 1,788 0.66 0.80 201

1984 1,524 0.74 0.89 73

1983 1,421 0.84 1.00 209

1982 1,249 0.92 1.10 (132)

1981 1,330 1.50 1.72 (175)

1980 1,678 2.09 2.33 48

1979 1,739 2.44 2.70 198

1978 1,564 2.64 2.88 234

1977 1,350 3.05 3.28 186

1976 1,139 2.85 3.03 141

1975 1,003 2.56 2.72 131

1974 898 2.54 2.66 112

1973 801 2.86 2.98 138

1972 669 2.96 3.02 100

1971 567 2.88 Not Available 67
1998 OFHEO REPORT TO CONGRESS

64

Aggregate Financial Data

Table 17

Business Activity

($ in millions)

Purchases MBS

Single-Family

Mortgage

Purchases

Multifamily

Mortgage

Purchases

Total

Mortgage

Purchases

Mortgage

Securities

Purchased

Single-Family

MBS Issued

Multifamily

MBS Issued

Total MBS

Issued

Multiclass

MBS Issued

1Q98 113,515 2,007 115,522 49,079 101,052 1,475 102,527 48,941

4Q97 90,825 3,026 93,851 25,413 82,530 2,001 84,531 48,283

3Q97 72,065 2,223 74,288 25,779 65,728 1,644 67,372 41,752

2Q97 58,350 1,945 60,295 16,380 53,090 1,542 54,632 38,006

1Q97 58,354 1,659 60,013 16,661 56,025 1,127 57,152 41,740

Annual Data

1997 279,594 8,853 288,447 84,233 257,373 6,314 263,687 169,781

1996 289,815 9,171 298,986 81,840 263,133 6,438 269,571 64,925

1995 217,959 6,595 224,554 73,420 191,791 4,542 196,333 25,053

1994 287,182 4,687 291,869 44,418 245,286 2,446 247,732 146,496

1993 532,122 4,326 536,448 Not Available

Before 1994 429,209 959 430,168 353,966

1992 453,154 2,983 456,137 372,389 855 373,244 301,489

1991 244,246 3,440 247,686 203,967 1,415 205,382 184,840

1990 190,676 4,519 195,195 168,004 2,506 170,510 108,770

1989 164,211 6,660 170,871 139,420 3,862 143,282 81,469

1988 116,692 5,371 122,063 90,610 4,045 94,655 29,990

1987 157,101 3,499 160,600 134,933 3,314 138,247 Not Available

Before 1988

1986 189,451 5,415 194,866 156,815 3,949 160,764

1985 86,069 3,102 89,171 60,725 1,752 62,477

1984 Not Available

Before 1985

Not Available

Before 1985 52,152 Not AvailableBefore 1985

Not Available

Before 1985 32,230

1983 53,849 33,031

1982 52,757 38,139

1981 10,574 4,246

1980 11,791 2,526

1979 16,523 4,546

1978 18,829 6,412

1977 8,908 4,657

1976 4,761 1,360

1975 6,036 950

1974 9,204 46

1973 7,586 323

1972 5,129 494
1998 OFHEO REPORT TO CONGRESS

65

Aggregate Financial Data

Table 18

Non-Mortgage Investments

($ in millions)

Federal

Funds and

Eurodollars

Asset-backed

Securities

Repurchase

Agreements

Commercial

Paper and

Corporate

Debt

Other Total NonMortgage

Investments

1Q98 25,488 19,256 11,500 20,713 16,636 93,593

4Q97 22,215 18,838 13,697 14,905 11,808 81,463

3Q97 24,320 13,371 12,485 8,696 17,229 76,101

2Q97 32,755 14,017 13,062 7,752 14,113 81,699

1Q97 30,105 14,149 9,403 7,037 15,329 76,023

Annual Data

1997 22,215 18,838 13,697 14,905 11,808 81,463

1996 31,917 16,719 11,107 7,268 12,119 79,130

1995 Not Available

Before 1996

Not Available

Before 1996

Not Available

Before 1996

Not Available

Before 1996

Not Available

Before 1996

Not Available

Before 1996

1994

1993

1992
1998 OFHEO REPORT TO CONGRESS

66

Aggregate Financial Data

Table 19

Debt

Callable

($ in millions)

Effective LongTerm

($ in millions)

Callable

%

1Q98 242,535 429,068 57%

4Q97 232,690 411,929 56%

3Q97 229,211 404,454 57%

2Q97 219,386 387,457 57%

1Q97 220,086 391,171 56%

Annual Data

1997 232,690 411,929 56%

1996 210,458 380,192 55%

1995 166,750 304,911 55%

1994 Not Available

Before 1995

Not Available

Before 1995

Not Available

Before 1995

1993
1998 OFHEO REPORT TO CONGRESS

67

Mortgage Interest Rates

Table 20

Average Commitment Rates on

Loans

Effective Rates on Closed

Loans

Conventional Conventional

30 Year Fixed

Rate (%)

One Year

ARMs (%)

Fixed Rate (%) Adjustable

Rate (%)

IQ98 7.1 5.6 7.3 6.6

4Q97 7.2 5.5 7.6 6.7

3Q97 7.5 5.6 7.9 6.8

2Q97 7.9 5.8 8.2 7.1

1Q97 7.8 5.6 8.0 7.0

Annual Data

1997 7.6 5.6 7.9 6.9

1996 7.8 5.7 8.0 7.0

1995 7.9 6.1 8.2 7.1

1994 8.4 5.3 8.2 6.4

1993 7.3 4.6 7.5 5.7

1992 8.4 5.6 8.5 6.6

1991 9.2 7.1 9.7 8.3

1990 10.1 8.4 10.4 9.2

1989 10.3 8.8 10.5 9.4

1988 10.3 7.9 10.4 8.5

1987 10.2 7.8 9.9 8.5

1986 10.2 8.4 10.5 9.4

1985 12.4 10.0 12.4 10.9

1984 13.9 11.5 13.2 12.1

1983 13.2 Not Available

Before 1984

13.0 12.3

1982 16.1 15.2 15.4

1981 16.6 Not Available

Before 1982

Not Available

Before 1982

1980 13.8

1979 11.2

1978 9.6

1977 8.8

1976 8.9

1975 9.0

1974 9.2

1973 8.0

1972 7.4

Average Commitment Rate Source: Freddie Mac

Effective Rates Source: Federal Housing Finance Board
1998 OFHEO REPORT TO CONGRESS

68

Housing Market Activity

Table 21

Housing Starts

(units in thousands)

Home Sales

(units in thousands)

Single-Family

Housing

Starts

Multifamily

Housing

Starts

Total Housing

Starts

New SingleFamily Home

Sales

Existing

Single-Family

Homes Sales

IQ98 1298 292 1590 849 4687

4Q97 1197 329 1526 828 4380

3Q97 1182 274 1456 809 4267

2Q97 1147 293 1440 777 4153

1Q97 1211 258 1469 824 4013

Annual Data

1997 1179 296 1474 803 4215

1996 1206 271 1477 757 4087

1995 1110 244 1354 667 3802

1994 1234 224 1457 670 3946

1993 1155 133 1288 666 3802

1992 1061 139 1200 610 3520

1991 876 138 1014 509 3220

1990 932 260 1193 534 3211

1989 1059 318 1376 650 3346

1988 1140 348 1488 676 3594

1987 1212 409 1621 671 3526

1986 1263 542 1805 750 3565

1985 1166 576 1742 688 3214

1984 1206 544 1750 639 2868

1983 1181 522 1703 623 2719

1982 743 320 1062 412 1990

1981 796 288 1084 436 2419

1980 962 331 1292 545 2973

1979 1316 429 1745 709 3827

1978 1558 462 2020 817 3986

1977 1573 414 1987 819 3650

1976 1248 289 1538 646 3064

1975 956 204 1160 549 2476

1974 956 382 1338 519 2272

1973 1250 795 2045 634 2334

1972 1451 906 2357 718 2252

1971 1271 781 2052 656 2019

Components may not add to totals due to rounding.

Housing Starts Source: Bureau of the Census.

New Single-Family Home Sales Source: Bureau of the Census

Existing Single-Family Home Sales Source: National Association of Realtors
1998 OFHEO REPORT TO CONGRESS

69

Weighted Repeat Sales House Price Index

(Annual Data)

Table 22

%

Change

USA New

England

MidAtlanticSouth

Atlantic

East

North

Central

West

North

Central

East

South

Central

West

South

Central

Mountain Pacific

1Q98 4.8 5.5 3.9 4.9 4.2 4.4 4.5 4.8 4.6 6.9

4Q97 5.0 5.6 3.3 4.9 5.5 5.0 5.4 3.8 5.6 6.1

3Q97 4.9 5.3 3.1 4.6 5.6 5.2 5.3 3.8 6.1 5.8

2Q97 3.6 3.6 1.2 3.3 5.6 4.5 4.2 2.4 5.0 3.4

1Q97 3.2 1.8 0.4 3.0 6.2 4.7 4.6 2.2 5.0 1.7

1996 3.3 1.9 0.8 2.9 6.0 4.8 4.8 2.8 5.5 1.7

1995 5.1 4.8 3.7 5.1 6.1 5.4 6.0 4.8 8.1 3.8

1994 1.3 -2.8 -2.8 0.6 6.0 6.2 5.2 1.6 9.9 -3.3

1993 2.3 0.7 1.6 2.2 3.7 4.0 4.2 4.2 8.5 -1.6

1992 1.9 -1.0 1.7 2.2 3.9 3.0 3.5 3.5 5.4 -1.1

1991 2.7 -1.9 1.6 3.2 4.5 3.8 4.1 3.7 4.8 1.6

1990 0.4 -7.3 -2.3 0.4 3.8 0.7 0.7 0.7 2.0 2.9

1989 6.2 1.1 2.6 5.3 6.1 3.3 3.4 2.9 2.6 19.5

1988 6.4 4.2 6.3 7.2 6.7 2.7 2.8 -2.0 0.7 17.1

1987 7.8 12.9 17.5 7.9 8.7 4.1 5.4 -8.0 -0.8 10.0

1986 9.9 20.9 19.9 8.9 8.4 6.0 9.0 0.9 4.5 7.5

1985 6.5 24.1 12.6 6.0 4.4 3.2 11.7 -2.4 0.5 4.6

1984 4.0 18.2 12.4 0.6 2.7 4.9 -3.4 -0.9 1.1 4.5

1983 3.9 15.3 10.4 4.3 3.0 3.7 4.6 -0.1 -2.8 0.9

1982 2.6 5.6 3.9 4.6 -3.0 -0.3 5.1 6.0 6.8 0.8

1981 3.8 4.4 0.2 4.3 0.6 0.0 -0.5 11.6 6.2 6.5

1980 5.7 5.8 7.1 6.9 0.9 3.0 1.7 7.0 6.2 11.5

1979 12.2 9.4 14.1 13.2 9.8 9.1 6.9 12.8 15.6 16.8

1978 12.7 13.5 8.1 8.8 14.3 13.2 9.0 17.4 15.8 16.5

1977 12.6 9.2 9.3 9.3 12.9 12.1 9.3 10.1 18.8 25.5

1976 8.2 3.1 6.4 3.8 7.7 6.1 9.7 9.5 10.8 20.4

All data is measured based on percentage change over the previous 4 quarters. Data from 1976-1996 is measured based on fourth quarter to fourth

quarter percentage change.

Regional Divisions: New England: CT, MA, ME, NH, RI, VT

Mid-Atlantic: NJ, NY, PA

South Atlantic: DC, DE, FL, GA, MD, NC, SC, VA, WV

East North Central: IL, IN, MI, OH, WI

West North Central: IA, KS, MN, MO, ND, SD, NE

East South Central: AL, KY, MS, TN

West South Central: AR, LA, OK, TX

Mountain: AZ, CO, ID, MT, NM, NV, UT, WY

Pacific: AK, CA, HI, OR, WA
71

1998 OFHEO REPORT TO CONGRESS

Federal Housing Enterprises Financial Safety and Soundness Act of 1992

(Title XIII of Public Law 102-550)

Office of Federal Housing Enterprise Oversight

OFHEO Senior Officials

APPENDIX
1998 OFHEO REPORT TO CONGRESS

72

Federal Housing Enterprises Financial Safety

and Soundness Act of 1992

(Title 13 of Public Law 102-550)

Section 1313. DUTY AND AUTHORITY OF DIRECTOR.

(a) DUTY.- The duty of the Director shall be to ensure that the enterprises are adequately capitalized and operating safely, in accordance with this title.

(b) AUTHORITY EXCLUSIVE OF SECRETARY.- The Director is authorized, without the review or approval of the Secretary, to make such determinations, take such actions, and perform such functions as the Director determines necessary regarding -

(1) the issuance of regulations to carry out this part, subtitle B, and subtitle C (including the establishment of capital standards pursuant to subtitle B);

(2) examinations of the enterprises under section 1317;

(3) determining the capital levels of the enterprises and classification of the enterprises

within capital classifications established under subtitle B;

(4) decisions to appoint conservators for the enterprises;

(5) administrative and enforcement actions under subtitle B, actions taken under subtitle C with respect to enforcement of subtitle B, and other matters relating to safety and soundness;

(6) approval of payments of capital distributions by the enterprises under section

303(c)(2) of the Federal National Mortgage Association Charter Act and section 303(b)(2) of

the Federal Home Loan Mortgage Corporation Act;

(7) requiring the enterprises to submit reports under section 1314 of this title, section

309(k) of the Federal National Mortgage Association Charter Act, and section 307(c) of the

Federal Home Loan Mortgage Corporation Act;

(8) prohibiting the payment of excessive compensation by the enterprises to any executive officer of the enterprises under section 1318;

(9) the management of the Office, including the establishment and implementation

of annual budgets, the hiring of, and compensation levels for, personnel of the Office, and

annual assessments for the costs of the Office;

(10) conducting research and financial analysis;

(11) the submission of reports required by the Director under this title.

(c) AUTHORITY SUBJECT TO APPROVAL OF SECRETARY.- Any determinations, actions,

and functions of the Director not referred to in subsection (b) shall be subject to the review and approval of

the Secretary.

(d) DELEGATION OF AUTHORITY.- The Director may delegate to officers and employees of

the Office any of the functions, powers, and duties of the Director, as the Director considers appropriate.

(e) INDEPENDENCE IN PROVIDING INFORMATION TO CONGRESS.- The Director

shall not be required to obtain the prior approval, comment, or review of any officer or agency of the United

States before submitting to the Congress, or any committee or subcommittee thereof, any reports, recommendations, testimony, or comments if such submissions include a statement indicating that the views

expressed therein are those of the Director and do not necessarily represent the views of the Secretary or the

President.
73

1998 OFHEO REPORT TO CONGRESS

OFFICE OF FEDERAL HOUSING ENTERPRISE OVERSIGHT

The Office of Federal Housing Enterprise Oversight (OFHEO) was established as an independent entity

within the Department of Housing and Urban Development by the Federal Housing Enterprises Financial

Safety and Soundness Act of 1992 (Title XIII of P.L. 102-550). The Office is headed by a Director appointed by

the President for a five-year term.

OFHEO’s primary mission is ensuring the capital adequacy and financial safety and soundness of two government-sponsored enterprises (GSEs) — the Federal National Mortgage Association (Fannie Mae) and the

Federal Home Loan Mortgage Corporation (Freddie Mac).

Fannie Mae and Freddie Mac are the nation’s largest housing finance institutions. They buy mortgages from

commercial banks, thrift institutions, mortgage banks, and other primary lenders, and either hold these mortgages in their own portfolios or package them into mortgage-backed securities for resale to investors. These

secondary mortgage market operations play a major role in creating a ready supply of mortgage funds for

American homebuyers. Combined assets and off-balance sheet obligations of Fannie Mae and Freddie Mac

were $1.6 trillion at the end of 1997.

Fannie Mae and Freddie Mac are Congressionally-chartered, publicly-owned corporations whose shares are

listed on the New York Stock Exchange. Under terms of their GSE charters, they are exempt from state and local

taxation and from registration requirements of the Securities and Exchange Commission. Each firm has a backup credit line with the U.S. Treasury.

OFHEO’s oversight responsibility includes:

· Conducting broad-based examinations of Fannie Mae and Freddie Mac;

· Developing risk-based capital standards using a “stress test” that simulates stressful interest rate and

credit risk scenarios;

· Making quarterly findings of capital adequacy based on minimum capital standards until a riskbased standard is completed;

· Prohibiting excessive executive compensation;

· Issuing regulations concerning capital and enforcement standards; and

· Taking necessary enforcement actions.

OFHEO is funded through assessments of Fannie Mae and Freddie Mac. OFHEO’s operations represent no

direct cost to the taxpayer. OFHEO’s 1998 budget of $16 million supports a full time staff of 72.

In its safety and soundness mission, OFHEO has regulatory authority similar to such other federal financial

regulators as the Federal Deposit Insurance Corporation, the Office of the Comptroller of the Currency, the

Office of Thrift Supervision and the Federal Reserve System.

(The legislation that established OFHEO also requires Fannie Mae and Freddie Mac to meet certain affordable

housing goals set annually by the Secretary of Housing and Urban Development. These goals specify the share of

mortgages that the two GSEs are required to purchase annually from low-income, moderate-income and central-city

homebuyers.)
1998 OFHEO REPORT TO CONGRESS

74

OFFICE OF FEDERAL HOUSING

ENTERPRISE OVERSIGHT

SENIOR OFFICIALS

G. Scott Calhoun

Director

Office of Examination and Oversight

Anne Dewey

General Counsel

Office of General Counsel

Joanne Hanley

Director

Office of Congressional Affairs

Susan Jacobs

Director

Office of Finance and Administration

Patrick Lawler

Chief Economist and

Director, Office of Policy Analysis

David Pearl

Director

Office of Research, Analysis

and Capital Standards

Jill Weide

Acting Director

Office of Public Affairs

Mark Kinsey

Acting Director