OFFERING CIRCULAR

6,000,000 Shares

5.125% Non-Cumulative Preferred Stock, Series L

(stated value $50 per share)

This OÅering Circular relates to the oÅer of 6,000,000 shares of the 5.125% Non-Cumulative Preferred

Stock, Series L (the ""Preferred Stock'') of the Federal National Mortgage Association (""Fannie Mae''). The

Preferred Stock has a stated value and liquidation preference of $50 per share. Dividends at the rate of 5.125%

per year will accrue from and including April 29, 2003. We will be required to pay dividends quarterly on

March 31, June 30, September 30 and December 31 of each year, commencing June 30, 2003. However, we will be

required to pay dividends only when, as and if declared by our Board of Directors, or a duly authorized committee

thereof, in its sole discretion out of funds legally available for such payment. The amount of dividends we will be

required to pay, if our Board declares them, may be increased if legislation is enacted that changes the Internal

Revenue Code of 1986, as amended, to reduce the dividends-received deduction applicable to dividends on the

Preferred Stock as set forth under ""Description of the Preferred StockÌDividendsÌChanges in the DividendsReceived Percentage.''

Dividends on the Preferred Stock will not be cumulative. Accordingly, if for any reason our Board of

Directors does not declare a dividend on the Preferred Stock for a dividend period, we will have no obligation to

pay a dividend for that period, whether or not our Board declares dividends on the Preferred Stock for any future

dividend period. If, however, we have not paid or set aside for payment dividends on the Preferred Stock for a

dividend period, we may not pay dividends on our common stock for that period.

On or after April 29, 2008, we may redeem the Preferred Stock, in whole or in part, at any time or from time

to time, at our option at the redemption price of $50 per share plus the dividend (whether or not declared) for

the then-current quarterly dividend period accrued to but excluding the date of redemption.

The Preferred Stock will not have any voting rights, except as set forth under ""Description of the Preferred

StockÌVoting Rights; Amendments.''

We will apply to list the Preferred Stock on the New York Stock Exchange (the ""NYSE'') under the symbol

""FNMprL.'' If approved for listing, we expect trading of the Preferred Stock on the NYSE to commence within a

thirty-day period after the initial delivery of the Preferred Stock.

Our obligations under the terms of the Preferred Stock are only our obligations and are not those

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

Initial Public Underwriting Proceeds to

OÅering Price(1) Discount Fannie Mae(1)(2)

Per Share ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $50.00 $0.4375 $49.5625

Total(3)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $300,000,000 $2,625,000 $297,375,000

(1) Plus accrued dividends, if any, from April 29, 2003.

(2) Before deducting estimated expenses of $300,000.

(3) Fannie Mae has granted the Underwriters an option to purchase up to an additional 900,000 shares of Preferred Stock to cover

overallotments, if any. If all such shares are purchased, the total Initial Public OÅering Price, Underwriting Discount and

Proceeds to Fannie Mae will be $345,000,000, $3,018,750 and $341,981,250, respectively. See ""Underwriting''.

Lehman Brothers Goldman, Sachs & Co.

Bear, Stearns & Co. Inc.

Deutsche Bank Securities

Utendahl Capital Partners, L.P.

The date of this OÅering Circular is April 24, 2003.
We are not required to register the Preferred Stock under the U.S. Securities Act of 1933, as amended.

Accordingly, we have not Ñled a registration statement for the Preferred Stock with the U.S. Securities and

Exchange Commission (the ""SEC''). The shares of Preferred Stock are ""exempted securities'' within the

meaning of the U.S. Securities Exchange Act of 1934, as amended (the ""Exchange Act''). Neither the SEC

nor any state securities commission has approved or disapproved the Preferred Stock or determined if this

OÅering Circular is truthful or complete. Any representation to the contrary is a criminal oÅense.

The distribution of this OÅering Circular and the oÅer, sale, and delivery of the Preferred Stock in certain

jurisdictions may be restricted by law. Persons who come into possession of this OÅering Circular must inform

themselves about and observe any applicable restrictions.

This OÅering Circular is not an oÅer to sell or a solicitation of an oÅer to buy any securities other than the

Preferred Stock or an oÅer to sell or a solicitation of an oÅer to buy the Preferred Stock in any jurisdiction or

in any other circumstance in which an oÅer or solicitation is unlawful or not authorized.

No person has been authorized to give any information or make any representations other than those

contained in this OÅering Circular and, if given or made, such information or representations must not be

relied upon as having been authorized. Neither the delivery of this OÅering Circular nor any sale made

hereunder shall, under any circumstances, create an implication that there has been no change in the aÅairs of

Fannie Mae since the date hereof, or in the case of facts set forth in the documents incorporated by reference

herein, since the respective dates thereof or that the information contained herein or therein is correct as to

any time subsequent thereto.

TABLE OF CONTENTS

Description Page

Summary of the OÅering ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 3

Fannie Mae ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 5

Recent Developments ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 5

Use of ProceedsÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 9

Capitalization ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 10

Selected Financial Information ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 11

Government Regulation and Charter ActÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 13

Description of the Preferred Stock ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 17

Legality of Investment ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 22

United States Taxation ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 23

Underwriting ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 26

Rating ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 27

Accountants ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 27

Validity of the Preferred Stock ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 27

Additional Information About Fannie Mae ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 27

Reconciliation of Core Business Earnings to GAAP Reported Results ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Appendix A

CertiÑcate of Designation ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Appendix B

Annual Report on Form 10-K for the Fiscal Year Ended December 31, 2002 ÏÏÏÏÏÏÏÏÏÏÏÏ Appendix C

2
SUMMARY OF THE OFFERING

This summary highlights information contained elsewhere in, or incorporated by reference in, this

OÅering Circular. It does not contain all of the information you should consider before investing in the

Preferred Stock. You also should read the more detailed information contained elsewhere in this OÅering

Circular and in the documents incorporated herein by reference.

Fannie Mae

Fannie Mae is a federally chartered and stockholder-owned corporation organized and existing under the

Federal National Mortgage Association Charter Act. We are the largest investor in home mortgage loans in

the United States. We were established in 1938 as a United States government agency to provide

supplemental liquidity to the mortgage market and were transformed into a stockholder-owned and privately

managed corporation by legislation enacted in 1968.

Description of the Preferred Stock

Issuer ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Fannie Mae

Securities OÅered ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 6,000,000 shares (assuming the Underwriters do not exercise their

overallotment option) of 5.125% Non-Cumulative Preferred Stock,

Series L, no par value, with a stated value and liquidation preference of $50 per share.

Dividends:

Dividend Rate ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 5.125% per annum. Non-cumulative quarterly cash dividends at

the rate of 5.125% per year will accrue from and including April 29,

2003.

Frequency of Payment ÏÏÏÏÏÏÏÏÏÏÏÏ Quarterly, when, as and if declared by the Board of Directors in its

sole discretion, but only out of funds legally available for the

payment of dividends.

Payment Dates ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ March 31, June 30, September 30, and December 31 of each year,

commencing June 30, 2003.

DRD Protection ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ If, prior to October 29, 2004, amendments to the Internal Revenue

Code of 1986, as amended, are enacted that eliminate or reduce

the percentage of the dividends-received deduction below 70%, the

amount of dividends payable in respect of the Preferred Stock will

be adjusted to oÅset the eÅect of such reduction. However, no

adjustment will be made to the extent that the percentage of the

dividends-received deduction is reduced below 50%.

Preferences ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ The Preferred Stock will be entitled to a preference, both as to

dividends and upon liquidation, over the common stock (and any

other junior stock) of Fannie Mae. The Preferred Stock will rank

equally, both as to dividends and upon liquidation, with all other

currently outstanding series of Fannie Mae preferred stock.

Optional Redemption ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ On or after April 29, 2008, we may redeem the Preferred Stock, in

whole or in part, at any time or from time to time, at our option at

the redemption price of $50 per share plus an amount equal to the

dividend for the then-current quarterly dividend period accrued to,

but excluding the date of redemption (whether or not declared, but

without accumulation of any dividends for prior dividend periods).

3
Holders of Preferred Stock will have no right to require the

redemption of the Preferred Stock.

Liquidation Rights ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ In the event of any dissolution or liquidation of Fannie Mae,

holders of the Preferred Stock will be entitled to receive, out of any

assets available for distribution to stockholders, $50 per share plus

the dividend for the then-current quarterly dividend period accrued

through the liquidation payment date.

Voting Rights ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ None, except with respect to certain changes in the terms of the

Preferred Stock

Preemptive and Conversion Rights ÏÏÏÏ None

RatingÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ The Preferred Stock has been rated ""AA¿'' by Standard & Poor's

Ratings Group, a Division of the McGraw-Hill Companies, ""Aa3''

by Moody's Investors Service, Inc. and AA by Fitch, Inc.

Use of Proceeds ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ To be added to the working capital of Fannie Mae and used for

general corporate purposes, including the repurchase of outstanding shares of our stock.

Transfer Agent, Dividend Disbursing

Agent and Registrar ÏÏÏÏÏÏÏÏÏÏÏÏÏÏ EquiServe Trust Company, N.A.

NYSE Listing ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ We will apply to list the Preferred Stock on the NYSE under the

symbol ""FNMprL''. If approved for listing, we expect trading on

the NYSE to commence within a thirty-day period after the initial

delivery of the Preferred Stock.

CUSIP Number ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 313586844

4
FANNIE MAE

Fannie Mae is a federally chartered and stockholder-owned corporation organized and existing under the

Federal National Mortgage Association Charter Act, 12 U.S.C. Û 1716 et seq. (the ""Charter Act''). See

""Government Regulation and Charter Act'' in this OÅering Circular and in our Annual Report on Form 10-K

for the Ñscal year ended December 31, 2002, Ñled with the SEC on March 31, 2003 (""Form 10-K'') and

""Additional Information About Fannie Mae'' in this OÅering Circular. We are the largest investor in home

mortgage loans in the United States. We were established in 1938 as a United States government agency to

provide supplemental liquidity to the mortgage market and were transformed into a stockholder-owned and

privately managed corporation by legislation enacted in 1968.

Fannie Mae provides funds to the mortgage market by purchasing mortgage loans and mortgage-related

securities from lenders, thereby replenishing their funds for additional lending. We acquire funds to purchase

these loans and mortgage-related securities by issuing debt securities to capital market investors, many of

whom ordinarily would not invest in mortgages. In this manner, we are able to expand the total amount of

funds available for housing.

Fannie Mae also issues mortgage-backed securities (""MBS''), receiving guaranty fees for our guarantee

of timely payment of principal and interest on MBS certiÑcates. We issue MBS primarily in exchange for

pools of mortgage loans from lenders. The issuance of MBS enables us to further our statutory purpose of

increasing the liquidity of residential mortgage loans.

In addition, Fannie Mae oÅers various services to lenders and others for a fee. These services include

issuing certain types of MBS and credit enhancements and providing technology services for originating and

underwriting loans. See ""Business'' in the Form 10-K and ""Additional Information About Fannie Mae'' in

this OÅering Circular.

Fannie Mae's principal oÇce is located at 3900 Wisconsin Avenue, N.W., Washington, D.C. 20016

(telephone: (202) 752-7000).

RECENT DEVELOPMENTS

Fannie Mae reported results for the Ñrst quarter of 2003 on April 14, 2003. These reported results are

based on generally accepted accounting principles (""GAAP''). Management also tracks and analyzes Fannie

Mae's Ñnancial results based on a supplemental non-GAAP measure called ""core business earnings''

(previously referred to as ""operating net income'' or ""operating earnings''). While core business earnings is

not a substitute for GAAP net income, management relies on core business earnings in operating our business

because management believes that core business earnings provides both management and investors with a

better measure of our Ñnancial results and better reÖects risk management strategies than GAAP net income.

Core business earnings was developed in conjunction with our January 1, 2001 adoption of Financial

Accounting Standard No. 133, Accounting for Derivative Instruments and Hedging Activities (""FAS 133''), to

adjust for accounting diÅerences between alternative transactions used to hedge interest rate risk that produce

similar economic results but require diÅerent accounting treatment under FAS 133.

The diÅerence in the values and percentage changes between net income and core business earnings, and

earnings per share (""EPS'') and core business EPS, are attributable to accounting diÅerences for interest rate

hedges. Refer to Appendix A of this OÅering Circular for a reconciliation of our non-GAAP Ñnancial

measures to GAAP results.

Reported Results

We reported net income of $1,941 million in the Ñrst quarter of 2003, up 60.5 percent from $1,209 million

in the Ñrst quarter of 2002. Diluted EPS was $1.93 in the Ñrst quarter of 2003, up 65.0 percent from $1.17 in

the Ñrst quarter of 2002.

Strong growth in net interest income contributed signiÑcantly to our reported results. Net interest income

for the Ñrst quarter of 2003 was $3,368 million, up 38.6 percent from the Ñrst quarter of 2002. This increase

5
was in part attributable to an 11.7 percent rise in the average net investment balance and a 29 basis point

increase in the net interest yield.

Our net interest yield averaged 160 basis points in the Ñrst quarter of 2003, compared with 131 basis

points in the Ñrst quarter of 2002. Our net interest yield beneÑted from an increase in the amount of purchased

options used as a substitute for callable debt, since the cost of these options is not included in our net interest

income or net interest yield. Prior to the adoption of FAS 133, we included the amortization of purchased

option premiums as a component of interest expense. This amortization expense is now included as a

component of purchased options expense on the income statement and excluded from interest expense. Net

interest margin, discussed below, is calculated consistently with our previous methodology.

In the Ñrst quarter of 2003 we recorded $625 million of mark-to-market losses on purchased options

compared with $787 million in the Ñrst quarter of 2002. These unrealized losses were recorded in accordance

with FAS 133. The reduction in the unrealized losses positively aÅected reported results.

Core Business Earnings

Our core business earnings for the Ñrst quarter of 2003 were $1,850 million, a 21.8 percent increase

compared with $1,519 million in the Ñrst quarter of 2002. Core business diluted EPS for the Ñrst quarter of

2003 was $1.84, or 24.3 percent above the Ñrst quarter of 2002. Growth in core business earnings and diluted

EPS was paced by a 10 basis point increase in the net interest margin, a 34.1 percent increase in guaranty fee

income, and a $110 million increase in fee and other income.

Business Volume

Our business volumeÌmortgages purchased for portfolio plus MBS issues acquired by other investorsÌtotaled $335.9 billion in the Ñrst quarter of 2003, compared with $197.8 billion in the Ñrst quarter of

2002 and $304.5 billion in the fourth quarter of 2002. Business volume in the Ñrst quarter of 2003 consisted of

$132.0 billion in portfolio purchases and $203.9 billion in MBS issues acquired by investors other than our

portfolio. This compares with $91.0 billion and $106.8 billion, respectively, in the Ñrst quarter of 2002.

Retained commitments to purchase mortgages were $115.9 billion in the Ñrst quarter of 2003 compared with

$50.8 billion in the Ñrst quarter of 2002. Outstanding portfolio commitments for mandatory delivery totaled

$73.4 billion at March 31, 2003.

Our combined book of businessÌthe gross balance of mortgages held in portfolio and outstanding MBS

and other mortgage-related securities guaranteed by us and held by other investorsÌgrew at a compound

annual rate of 24.7 percent during the Ñrst quarter of 2003, ending the period at $1.923 trillion. This growth

resulted from a 13.3 percent annualized growth rate in the gross mortgage portfolio and a 34.0 percent

annualized rate of growth in outstanding MBS.

Portfolio Investment Business Results

Our portfolio investment business manages the interest rate risk of our mortgage portfolio and other

investments. The results of this business are largely reÖected in core net interest income, which is net interest

income less the amortization expense of purchased options. Core net interest income for the Ñrst quarter of

2003 was $2,604 million, up 22.8 percent from $2,120 million in the Ñrst quarter of 2002. This increase was in

part attributable to a 11.7 percent rise in the average net investment balance and a 10 basis point increase in

the net interest margin.

Our net investment balanceÌconsisting of our liquid investment portfolio together with our mortgage

portfolio net of unrealized gains or losses on available for sale securities, deferred balances, and the allowance

for loan lossesÌaveraged $872 billion during the Ñrst quarter of 2003 compared with $781 billion during the

Ñrst quarter of 2002. The net investment balance was $885 billion at March 31, 2003. Our net interest margin

averaged 125 basis points in the Ñrst quarter of 2003 compared with 115 basis points in the Ñrst quarter of 2002

and 114 basis points in the fourth quarter of 2002. 

6
For the Ñrst quarter of 2003 we realized losses from debt repurchases and debt calls of $392.2 million

compared with losses of $171.7 million in the Ñrst quarter of 2002. During the quarter we realized

$377.8 million of losses on debt repurchases and $14.4 million of losses on debt calls. Debt repurchased and

debt called in the Ñrst quarter totaled $3.6 billion and $44.0 billion, respectively. We regularly call or

repurchase debt as part of our interest rate risk management program.

Credit Guaranty Business Results

Our credit guaranty business manages our credit risk. The results of this business are primarily reÖected

in guaranty fee income and credit-related losses. Guaranty fee income was $546.6 million in the Ñrst quarter of

2003, a 34.1 percent increase compared with the Ñrst quarter of 2002. The increase in guaranty fee income was

in part attributable to a 22.7 percent rise in average outstanding MBS and a 9.1 percent increase in the

eÅective guaranty fee rate on that business. The eÅective guaranty fee rate in the Ñrst quarter of 2003 was 20.3

basis points compared with 18.6 basis points in the Ñrst quarter of 2002 and 20.4 basis points in the fourth

quarter of 2002. The increase in the guaranty fee between the Ñrst quarters of 2003 and 2002 was a result of

higher fee rates on new business, together with the faster amortization of deferred fees due to accelerated

prepayments.

Credit-related lossesÌcharge-oÅs plus foreclosed property incomeÌremained very low in the Ñrst

quarter, in part attributable to a strong housing market and continued home price gains. Credit-related losses

totaled $20.4 million in the Ñrst quarter of 2003 compared with $21.5 million in the Ñrst quarter of 2002. Our

credit loss rateÌcredit-related losses as a percentage of the average combined book of businessÌwas 0.4 basis

points in the Ñrst quarter of 2003 compared with 0.5 basis points in the Ñrst quarter of 2002.

Credit-related expense, which includes the provision for losses and foreclosed property income and is the

amount recorded on our income statement, totaled $20.3 million in the Ñrst quarter of 2003, in line with

credit-related losses. Our loss provision was $23.0 million in the Ñrst quarter of 2003, compared with

$28.3 million in the Ñrst quarter of 2002. Foreclosed property income was $2.7 million in the Ñrst quarter of

2003 compared with income of $6.6 million in the Ñrst quarter of 2002, primarily due to gains on foreclosed

property dispositions. Our allowance for loan losses and guaranty liability for MBS totaled $808 million at

March 31, 2003, unchanged from December 31, 2002.

Our conventional single-family serious delinquency rate, an indicator of potential future loss activity, was

0.59 percent at February 28, 2003, compared with 0.57 percent at December 31, 2002. Our reporting of

delinquent loans has been expanded from ""at risk'' loans to include the performance of all seriously delinquent

conventional loans, whether or not they beneÑt from credit enhancement.

Fee and Other Income

Fee and other income in the Ñrst quarter of 2003 totaled $113.3 million compared with $3.6 million in the

Ñrst quarter of 2002. The increase in Ñrst quarter volume from a strong reÑnancing market was primarily

responsible for the increase of combined transaction, technology, and multifamily fees to $240.8 million,

$154.1 million higher than the previous year. Partially oÅsetting these increased fees were higher operating

losses from growth in tax-advantaged investments and lower other miscellaneous income.

Fee and other income includes technology fees, transaction fees, multifamily fees and other miscellaneous items, and is net of operating losses from certain tax-advantaged investmentsÌprimarily investments in

aÅordable housing which qualify for the low income housing tax credit. Tax credits associated with housing

tax credit investments are included in the provision for federal income taxes.

Income Taxes

Provision for federal income taxes on net income was $706.9 million in the Ñrst quarter of 2003 compared

with $362.3 million in the Ñrst quarter of 2002. The eÅective federal income tax rate on net income was

27 percent in the Ñrst quarter of 2003, compared with 23 percent for the same period last year. The increase in

the eÅective rate is attributable to an increase in taxable income.

7
Provision for federal income taxes on core business earnings was $658.0 million in the Ñrst quarter of

2003, compared with $529.2 million in the Ñrst quarter of 2002. The eÅective federal income tax rate on core

business earnings was 26 percent in the Ñrst quarter of 2003, unchanged from the same period last year.

Administrative Expenses

Administrative expenses totaled $343.8 million in the Ñrst quarter of 2003, up 18.5 percent from the Ñrst

quarter of 2002. On January 1, 2003, we adopted the fair value method for accounting for stock-based

compensation and began expensing all new stock-based compensation. The above-average growth in expenses

is related primarily to our reengineering of our core technology infrastructure to enhance our ability to process

and manage the risk on mortgage assets and the expensing of all new stock-based compensation.

The growth rate of administrative expenses in 2003 is expected to decline compared with 2002, but

remain above historical levels as we complete our core infrastructure project.

Our ratio of administrative expense to the average combined book of business in the Ñrst quarter of 2003

was .073 percent, unchanged from the Ñrst quarter of 2002. Our eÇciency ratioÌadministrative expense

divided by core taxable-equivalent revenueÌwas 9.5 percent in the Ñrst quarter of 2003 compared with

10.2 percent in the Ñrst quarter of 2002.

Capital

Our core capital, which is the basis for our statutory minimum capital requirement, was $29.5 billion at

March 31, 2003 compared with $28.1 billion at December 31, 2002 and $25.5 billion at March 31, 2002. Core

capital was an estimated $1,291 million above the statutory minimum at March 31, 2003. At December 31,

2002, core capital was $877 million above the statutory minimum.

Total capital includes core capital and the total allowance for loan losses and guaranty liabilities for MBS,

less any speciÑc loss allowances, and is the basis for the risk-based capital standard. Total capital was $30.3

billion at March 31, 2003 compared with $28.9 billion at December 31, 2002 and $26.3 billion at March 31,

2002. Our total capital exceeded the risk-based requirement by $11.4 billion as of December 31, 2002, the

latest period for which a risk-based capital requirement has been determined. The risk-based standard uses a

stress test to determine the amount of total capital we need to hold in order to protect against credit and

interest rate risk, and requires an additional 30 percent capital for management and operations risk. The higher

of our risk-based or minimum capital standard is binding.

We repurchased 8.6 million shares of common stock during the Ñrst quarter of 2003, compared with

7.5 million shares in the Ñrst quarter of 2002. At March 31, 2003 we had 981.0 million shares of common

stock outstanding compared with 988.8 million shares at December 31, 2002.

We had $8.5 billion of subordinated debt outstanding at March 31, 2003. Subordinated debt serves as an

important risk-bearing supplement to our equity capital, although it is not a component of core capital. After

providing for capital to support our oÅ-balance sheet MBS, our total capital and outstanding subordinated

debt as a percent of on-balance sheet assets was 3.7 percent at March 31, 2003. We issued $400 million of

preferred stock during the Ñrst quarter of 2003. At March 31, 2003, preferred stock made up 10.4 percent of

our core capital.

Voluntary Disclosures

At March 31, 2003, our ratio of liquid assets to total assets was 6.7 percent compared with 6.9 percent at

December 31, 2002. We have committed to maintain a portfolio of high-quality, liquid, non-mortgage

securities equal to at least 5 percent of total assets.

At December 31, 2002, the present value of our net sensitivity of future credit losses to an immediate

5 percent decline in home prices was $596 million, taking into account the beneÑcial eÅect of third-party

credit enhancements. This compares with $501 million at September 2002. The December 31 Ñgure reÖects a

8
gross credit loss sensitivity of $1,838 million before the eÅect of credit enhancements, and is net of projected

credit risk sharing proceeds of $1,242 million.

Derivatives and FAS 133

We primarily use derivative instruments as substitutes for noncallable and callable debt issued in the cash

markets to help match the cash Öow characteristics of our debt with those of our mortgages and reduce the

interest rate risk in our portfolio. We account for our derivatives under FAS 133.

FAS 133 requires that we mark to market on our income statement the changes in the time value, but not

the total value, of our purchased optionsÌinterest rate swaptions and interest rate caps. The marking to

market of the time value of our purchased options during the Ñrst quarter of 2003 resulted in a net mark-tomarket loss of $624.6 million compared with a net mark-to-market loss of $787.2 million in the Ñrst quarter of

2002, which is reported on the purchased option expense line of the income statement. Purchased option

expense in the Ñrst quarter of 2003 includes $764.3 million in amortization expense, which was included in net

interest income prior to FAS 133 and currently is included in core net interest income and in core business

earnings. This amortization expense represents the straight-line amortization of the up-front premium paid to

purchase the options over the expected life of the options.

FAS 133 also requires that we record any change in the fair values of certain derivatives, primarily

interest rate swaps we use as substitutes for noncallable debt, on our balance sheet in accumulated other

comprehensive income (""AOCI''), which is a separate component of stockholders' equity. For these types of

transactions FAS 133 does not require or permit noncallable debt to be marked to market. At March 31, 2003,

the AOCI component of stockholders' equity included a reduction of $15.8 billion, or 1.9 percent of the net

mortgage balance, from the marking to market of these derivatives. Accumulated other comprehensive

income is not a component of core capital.

Our primary credit exposure on derivatives is that a counterparty might default on payments due, which

could result in our having to replace the derivative with a diÅerent counterparty at a higher cost. Our exposure

on derivative contracts (taking into account master settlement agreements that allow for netting of payments

and excluding collateral received) was $3.256 billion at March 31, 2003. All of this exposure was to

counterparties rated A-/A3 or higher. We held $3.0 billion of collateral through custodians to oÅset the risk of

the exposure for these instruments. Our exposure, net of collateral, was $256 million at March 31, 2003 versus

$197 million at December 31, 2002.

USE OF PROCEEDS

We will add the net proceeds from the sale of the Preferred Stock to our working capital and use them for

general corporate purposes, including the repurchase of shares of our stock. We anticipate the need for

additional Ñnancing from time to time, including Ñnancing through various types of equity and debt securities.

The amount and nature of such Ñnancings will depend upon a number of factors, including the volume of our

maturing debt obligations, the volume of mortgage loan prepayments, the volume and type of mortgage loans

we purchase, and general market conditions.

9
CAPITALIZATION

The following table sets forth our capitalization as of December 31, 2002, and it is adjusted to give eÅect

to the issuance of the Preferred Stock (before giving eÅect to the payment of estimated oÅering expenses and

underwriting discount, and assuming that the Underwriters' overallotment option is not exercised), and the

issuance of the Variable Rate Non-Cumulative Preferred Stock, Series K, on March 18, 2003.

Actual

Average Average Outstanding at

Maturity Cost(1) December 31, 2002 Adjusted

(Dollars in millions)

Debentures, notes, and bonds, net:

Due within one year:

Short-term notes ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 3 mos. 1.55% $290,091 $290,091

Universal Benchmark ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 5 mos. 4.89 37,376 37,376

Universal Retail ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 0 mos. 9.52 73 73

Universal Short-term ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 7 mos. 1.48 3,440 3,440

Universal StandardÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 5 mos. 2.25 41,681 41,681

Other(2) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 0.27 9,751 9,751

Total due within one year ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 382,412 382,412

Due after one year:

Universal Benchmark ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 5 yrs. 9 mos. 5.49% 291,429 291,429

Universal Retail ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 10 yrs. 5 mos. 6.10 10,556 10,556

Universal StandardÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 4 yrs. 7 mos. 4.32 152,900 152,900

Other ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 13 yrs. 10 mos. 8.30 13,685 13,685

Total due after one year ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 468,570 468,570

Total debentures, notes, and bonds ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $850,982 $850,982

Stockholders' equity:

Preferred stock, $50 stated value;

100,000,000 shares authorizedÌ

53,550,000 shares issued

at December 31, 2002;

67,550,000 shares issued as adjusted ÏÏÏÏÏÏÏÏÏÏÏÏÏ

Series D, 3,000,000 shares issuedÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 150 $ 150

Series E, 3,000,000 shares issued ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 150 150

Series F, 13,800,000 shares issued ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 690 690

Series G, 5,750,000 shares issuedÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 288 288

Series H, 8,000,000 shares issued ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 400 400

Series I, 6,000,000 shares issued ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 300 300

Series J, 14,000,000 shares issued ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 700 700

Series K, 8,000,000 shares issuedÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Ì 400

Series L, 6,000,000 shares issued ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Ì 300

Common stock, $.525 stated value, no maximum

authorizationÌ1,129,090,420 shares outstanding ÏÏÏÏÏÏÏ 593 593

Additional paid-in capital ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 1,839 1,839

Retained earningsÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 29,385 29,385

Accumulated other comprehensive lossÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (11,792) (11,792)

22,703 23,403

Less treasury stock, at costÌ140,245,667 shares(3) 6,415 6,415

Total stockholders' equity ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 16,288 $ 16,988

(1) Represents weighted-average cost, which includes the amortization of discounts, premiums, issuance costs, hedging

results, and the eÅects of currency and debt swaps.

(2) Average maturity is indeterminate because the outstanding amount includes investment agreements that have varying

maturities.

(3) Does not reÖect any repurchases of our stock that may be made using proceeds from the sale of the Preferred Stock.

See ""Use of Proceeds.''

We frequently issue debentures, notes, and other debt obligations, and from time to time we redeem such

debt obligations. The amount of debentures, notes, other debt obligations outstanding, and stockholders'

equity on any date subsequent to December 31, 2002 may diÅer from that shown in the table above.

10
SELECTED FINANCIAL INFORMATION

The following selected Ñnancial data has been summarized or derived from our audited Ñnancial

statements. This data should be read in conjunction with ""Item 7ÌManagement's Discussion and Analysis of

Financial Condition and Results of Operations,'' ""Item 1ÌBusiness,'' and our Ñnancial statements and related

notes contained in the Form 10-K incorporated herein by reference and attached hereto as Appendix C.

Year Ended December 31,

2002 2001 2000 1999 1998

(Dollars and Shares in millions, except per common share amounts)

Income Statement Data:

Interest incomeÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 50,853 $ 49,170 $ 42,781 $ 35,495 $ 29,995

Interest expense ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (40,287) (41,080) (37,107) (30,601) (25,885)

Net interest income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 10,566 8,090 5,674 4,894 4,110

Guaranty fee income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 1,816 1,482 1,351 1,282 1,229

Fee and other income (expense), net ÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 232 151 (44) 191 275

Provision for losses ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (128) (94) (122) (151) (245)

Foreclosed property income (expense) ÏÏÏÏÏÏÏÏÏÏÏÏÏ 36 16 28 24 (16)

Administrative expenses ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (1,219) (1,017) (905) (800) (708)

Special contribution ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Ì (300) Ì Ì Ì

Purchased options expense(1) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (4,545) (37) Ì Ì Ì

Debt extinguishments, netÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (710) (524) 49 (14) (40)

Income before federal income taxes and cumulative

eÅect of change in accounting principle ÏÏÏÏÏÏÏÏÏÏ 6,048 7,767 6,031 5,426 4,605

Provision for federal income taxes ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (1,429) (2,041) (1,583) (1,514) (1,187)

Income before cumulative eÅect of change in

accounting principle ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 4,619 5,726 4,448 3,912 3,418

Cumulative eÅect of change in accounting principle,

net of tax eÅect(2) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Ì 168ÌÌÌ

Net income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 4,619 $ 5,894 $ 4,448 $ 3,912 $ 3,418

Preferred stock dividendsÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (99) (138) (121) (78) (66)

Net income available to common stockholdersÏÏÏÏÏÏÏ $ 4,520 $ 5,756 $ 4,327 $ 3,834 $ 3,352

Basic earnings per common share:

Earnings before cumulative eÅect of change in

accounting principle ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 4.56 $ 5.58 $ 4.31 $ 3.75 $ 3.26

Cumulative eÅect of change in accounting principle Ì .17 Ì Ì Ì

Net earnings ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 4.56 $ 5.75 $ 4.31 $ 3.75 $ 3.26

Diluted earnings per common share:

Earnings before cumulative eÅect of change in

accounting principle ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 4.53 $ 5.55 $ 4.29 $ 3.72 $ 3.23

Cumulative eÅect of change in accounting principle Ì .17 Ì Ì Ì

Net earnings ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 4.53 $ 5.72 $ 4.29 $ 3.72 $ 3.23

Cash dividends per common shareÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 1.32 $ 1.20 $ 1.12 $ 1.08 $ .96

Balance Sheet Data:

Mortgage portfolio, net ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 797,693 $705,324 $607,551 $522,921 $415,355

Liquid assets ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 61,554 76,072 55,585 41,850 59,258

Total assets ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 887,515 799,948 675,224 575,308 485,146

Borrowings:

Due within one yearÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 382,412 343,492 280,322 226,582 205,413

Due after one year ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 468,570 419,975 362,360 321,037 254,878

Total liabilities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 871,227 781,830 654,386 557,679 469,693

Preferred stock ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2,678 2,303 2,278 1,300 1,150

Stockholders' equity ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 16,288 18,118 20,838 17,629 15,453

11
Year ended December 31,

Core Business Earnings Data(3): 2002 2001 2000 1999 1998

(Dollars and Shares in millions, except per common share amounts)

Core business earnings(4) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 6,394 $ 5,367 $ 4,448 $ 3,912 $ 3,418

Total taxable-equivalent revenues(5)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 11,896 10,187 7,825 6,975 6,272

Net interest margin ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 1.15% 1.11% 1.01% 1.01% 1.03%

Return on average assets(6) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ .76 .71 .71 .73 .78

Return on average realized common equity(7) ÏÏÏÏÏÏÏÏÏ 26.1 25.4 25.2 25.0 25.2

December 31,

Other Data: 2002 2001 2000 1999 1998

Average eÅective guaranty fee rate ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ .191% .190% .195% .193% .202%

Credit loss ratio(8) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ .005 .006 .007 .011 .027

Administrative expense ratio(9) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ .072 .071 .072 .071 .074

EÇciency ratio(10) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 10.2 10.0 11.6 11.5 11.3

Dividend payout ratio ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 29.0 20.9 26.0 28.8 29.5

Ratio of earnings to combined Ñxed charges and

preferred stock dividends(11) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 1.15:1 1.19:1 1.16:1 1.17:1 1.17:1

Mortgage purchases ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 370,641 $270,584 $154,231 $195,210 $188,448

MBS issues acquired by others(12) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 478,260 344,739 105,407 174,850 220,723

Outstanding MBS(13) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 1,029,456 858,867 706,684 679,169 637,143

Weighted-average diluted common shares outstanding ÏÏ 997 1,006 1,009 1,031 1,037

Return on average assets ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ .55% .78% .71% .73% .78%

Average equity to average assets ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2.1 2.3 3.1 3.1 3.3

Return on common equityÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 30.2 39.8 25.6 25.2 25.2

Core capital(14) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 28,079 $ 25,182 $ 20,827 $ 17,876 $ 15,465

Total capital(15)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 28,871 25,976 21,634 18,677 16,257

(1) Represents the change in the fair value of the time value of purchased options under FAS 133, ""Accounting for Derivative

Instruments and Hedging Activities''.

(2) Represents the after-tax eÅect on income of the adoption of FAS 133 on January 1, 2001.

(3) Core business earnings data are non-GAAP measures management uses to track and analyze our Ñnancial performance.

See ""Management's Discussion and Analysis of Financial Condition and Results of OperationsÌCore Business Earnings

and Business Segment Results'' in the Form 10-K for additional discussion of these measures.

(4) Core business earnings is a non-GAAP measure developed by management, in conjunction with the adoption of FAS 133,

to evaluate and assess the quality of Fannie Mae's earnings from its principal business activities on a consistent basis. Core

business earnings is presented on a net of tax basis and excludes the transition adjustment from the adoption of FAS 133

and unrealized gains and losses on purchased options recorded under FAS 133, and includes purchased options premiums

amortized on a straight-line basis over the original estimated life of the option.

(5) Includes revenues net of operating losses on low-income housing tax credit limited partnerships (accounted for using the

equity method of accounting) and amortization expense of purchased options premiums, plus taxable-equivalent adjustments for tax-exempt income and investment tax credits using the applicable federal income tax rate. This is a non-GAAP

measure.

(6) Core business earnings less preferred stock dividends divided by average assets. This is a non-GAAP measure.

(7) Core business earnings less preferred stock dividends divided by average realized common stockholders' equity (common

stockholders' equity excluding accumulated other comprehensive income). This is a non-GAAP measure.

(8) Charge-oÅs, net of recoveries, and foreclosed property income (expense) as a percentage of average mortgage portfolio (on

an amortized cost basis) and average outstanding MBS.

(9) Administrative expenses as a percentage of average net mortgage portfolio and average outstanding MBS.

(10) Administrative expenses as a percentage of taxable-equivalent revenues.

(11) ""Earnings'' consists of (a) income before federal income taxes and cumulative eÅect of accounting changes and (b) Ñxed

charges. Fixed charges represent interest expense.

(12) Includes MBS and other mortgage-related securities guaranteed by Fannie Mae.

(13) Includes MBS and other mortgage-related securities guaranteed by Fannie Mae and held by investors other than Fannie

Mae.

(14) The sum of (a) the stated value of common stock, (b) the stated value of outstanding noncumulative perpetual preferred

stock, (c) paid-in capital, and (d) retained earnings, less treasury stock. Core capital represents a regulatory measure of

capital. Refer to Note 11 of the Ñnancial statements, ""Dividend Restrictions and Regulatory Capital Ratios,'' in the

Form 10-K for a discussion of core capital.

(15) The sum of (a) core capital and (b) the total allowance for loan losses and guaranty liability for MBS, less (c) the speciÑc

loss allowance. Total capital represents a regulatory measure of capital. SpeciÑc loss allowances totaled $19 million,

$13 million, $2 million, $3 million, and $10 million for the years ended December 31, 2002, 2001, 2000, 1999, and 1998,

respectively. Refer to Note 11 of the Ñnancial statements, ""Dividend Restrictions and Regulatory Capital Ratios,'' in the

Form 10-K for a discussion of total capital.

12
GOVERNMENT REGULATION AND CHARTER ACT

Charter Act

We were established in 1938 under Title III of the National Housing Act as a government owned entity.

In 1954, under the Federal National Mortgage Association Charter Act, the entity became a mixed-ownership

corporate instrumentality of the United States. Under the Housing and Urban Development Act of 1968, the

entity was divided into two separate institutions, the present Fannie Mae and Ginnie Mae. Fannie Mae

became an entirely stockholder-owned corporation, organized and existing under the Charter Act. The

Charter Act provides that the corporation will continue until dissolved by an act of Congress. The Charter Act

was further amended by the Federal Housing Enterprises Financial Safety and Soundness Act of 1992 (the

""1992 Act'').

Under the Charter Act, our purpose is:

""to (1) provide stability in the secondary market for residential mortgages, (2) respond appropriately to

the private capital market, (3) provide ongoing assistance to the secondary market for residential

mortgages (including activities relating to mortgages on housing for low- and moderate-income families

involving a reasonable economic return that may be less than the return earned on other activities) by

increasing the liquidity of mortgage investments and improving the distribution of investment capital

available for residential mortgage Ñnancing, ®and© (4) promote access to mortgage credit throughout the

nation (including central cities, rural areas and underserved areas) by increasing the liquidity of mortgage

investments and improving the distribution of investment capital available for residential mortgage

Ñnancing.''

The Charter Act authorizes us to ""deal in'' conventional mortgage loans, and ""purchase,'' ""sell,''

""service,'' and ""lend on the security of'' such mortgages, subject to limitations on the quality of mortgages

purchased and credit enhancement requirements. Fannie Mae can act as a depositary, custodian, or Ñscal

agent ""for its own account or as Ñduciary, and for the account of others.'' The Charter Act expressly enables

Fannie Mae ""to lease, purchase, or acquire any property, real, personal, or mixed, or any interest therein, to

hold, rent, maintain, modernize, renovate, improve, use, and operate such property, and to sell, for cash or

credit, lease, or otherwise dispose of the same, at such time and in such manner as and to the extent that it

may deem necessary or appropriate.'' The Charter Act also permits Fannie Mae to ""purchase,'' ""service,''

""sell,'' ""lend on the security of'' and otherwise deal in loans or advances of credit for the purchase and

installation of home improvements (so long as the loans are secured by a lien against the property to be

improved).

Under the Charter Act, we may not originate mortgage loans or advance funds on an interim basis

pending the sale of a mortgage in the secondary market. We may not purchase loans in excess of the amount

of the current loan limits. (See ""BusinessÌFannie Mae Business StandardsÌPrincipal Balance Limits'' in

the Form 10-K). We may conduct business only in the United States, its territories and possessions, the

District of Columbia and the Commonwealth of Puerto Rico. Our activities must relate to housing, mortgages

and related Ñnancial products.

Thirteen members of our eighteen-member Board of Directors are elected by the holders of our common

stock. The President of the United States appoints the remaining Ñve members. The appointed directors must

include one person from the home building industry, one person from the mortgage lending industry, one

person from the real estate industry, and one person from a consumer or community interest organization or

who has demonstrated a career commitment to providing low-income housing. Any member of the Board of

Directors that is appointed by the President of the United States may be removed by the President for good

cause. All members of the Board of Directors are elected or appointed annually.

In general, the U.S. Department of Housing and Urban Development (""HUD'') and the OÇce of

Federal Housing Enterprise Oversight (""OFHEO'') oversee the activities of Fannie Mae. HUD has ""general

regulatory power'' over Fannie Mae. The 1992 Act established OFHEO to ensure that Fannie Mae is

adequately capitalized and is operating safely.

13
The Secretary of the Treasury has the authority to approve Fannie Mae's issuance of debt obligations and

mortgage-related securities. At the discretion of the Secretary of the Treasury of the United States, the U.S.

Treasury may purchase obligations of Fannie Mae up to a maximum of $2.25 billion outstanding at any one

time. This facility has not been used since our transition from government ownership in 1968. Neither the

United States nor any agency thereof is obligated to Ñnance our operations or to assist us in any other manner.

The Federal Reserve Banks are authorized to act as depositories, custodians, and Ñscal agents for Fannie Mae,

for the Bank's own account, or as Ñduciary.

Securities we issue are ""exempt securities'' under laws administered by the SEC to the same extent as

securities that are obligations of, or guaranteed as to principal and interest by, the United States. Registration

statements with respect to oÅerings of our securities are not required to be Ñled with the SEC. In July 2002,

we announced our voluntary initiative to register our common stock with the SEC under Section 12(g) of the

Exchange Act. The registration of our common stock became eÅective on March 31, 2003. As a result, we will

Ñle periodic reports with the SEC, including annual reports on Form 10-K, quarterly reports on Form 10-Q,

and current reports on Form 8-K, together with any required exhibits. These Ñlings will be available on the

SEC's Electronic Data Gathering, Analysis, and Retrieval (""EDGAR'') system at www.sec.gov. Registration

of our common stock with the SEC will not impact the status of our securities (including equity, debt and

MBS) as ""exempt securities'' within the meaning of the laws administered by the SEC.

We are exempt from taxation by states, counties, municipalities, or local taxing authorities, except for

taxation by those authorities on our real property. We are not exempt from payment of federal corporate

income taxes. We also may conduct our business without regard to any qualiÑcation or similar statute in any

state of the United States, including the District of Columbia, the Commonwealth of Puerto Rico, and the

territories and possessions of the United States.

Regulatory Approval and Oversight

As a federally chartered corporation, Fannie Mae is subject to Congressional legislation and oversight and

is regulated for various purposes by HUD, OFHEO and the U.S. Department of the Treasury, to the extent

authorized by statute. In addition, the Ñnancial institutions with whom we do business are subject to extensive

federal and state law and regulation. Changes to legislation, regulations or policy that impact us or our

business partners could adversely or favorably aÅect the performance, development, or results of our business.

OFHEO, an independent oÇce within HUD, is responsible for ensuring that we are adequately

capitalized and operating safely in accordance with the 1992 Act. OFHEO conducts on-site examinations of

Fannie Mae for purposes of ensuring our Ñnancial safety and soundness. We are required to submit annual and

quarterly reports of our Ñnancial condition and operations to OFHEO. OFHEO is authorized to levy annual

assessments on Fannie Mae and the Federal Home Loan Mortgage Corporation (""Freddie Mac''), pursuant

to annual Congressional appropriations, to cover OFHEO's reasonable expenses. OFHEO's formal enforcement powers include the power to impose temporary and Ñnal cease-and-desist orders and civil monetary

penalties on us and on our directors and executive oÇcers, provided certain conditions are met. OFHEO may

use other informal supervisory tools of the type that are generally used by agencies with authority to regulate

other Ñnancial institutions. In accordance with OFHEO regulation, Fannie Mae has elected to follow the

applicable corporate governance practices and procedures of the Delaware General Corporation Law, as it

may be amended from time to time. On January 21, 2003, OFHEO proposed regulations that would require

Fannie Mae to Ñle with the SEC all reports, statements and forms relating to our common stock that are

required to be Ñled under Sections 14(a) and (c) of the Exchange Act and the rules and regulations under

those sections and require Fannie Mae's directors and oÇcers to Ñle all reports and forms relating to our

common stock that are required to be Ñled under Section 16 of the Exchange Act and the rules and

regulations under that section.

The Secretary of the Treasury has the authority to approve Fannie Mae's issuance of debt obligations and

mortgage-related securities. The General Accounting OÇce is authorized to audit the programs, activities,

receipts, expenditures, and Ñnancial transactions of Fannie Mae. The Secretary of HUD has general

regulatory authority to promulgate rules and regulations to carry out the purposes of the Charter Act,

14
excluding authority over matters granted exclusively to OFHEO. The Secretary of HUD has authority to

approve any new conventional mortgage program that is signiÑcantly diÅerent from those approved or engaged

in prior to the 1992 Act. The Secretary must approve any new program unless it is not authorized by the

Charter Act or the Secretary Ñnds that it is not in the public interest. The Secretary has adopted regulations

related to the program approval requirement. We are also required to meet certain goals established by the

Secretary of HUD to promote aÅordable housing and to serve the housing needs of those in underserved areas.

See ""BusinessÌHousing Goals'' in the Form 10-K.

Capital Requirements

The 1992 Act established minimum capital, risk-based capital, and critical capital requirements for

Fannie Mae. See also ""Item 7ÌManagement's Discussion and Analysis of Financial Condition and Results of

OperationsÌLiquidity and Capital ResourcesÌCapital ResourcesÌRegulatory Environment'' in the

Form 10-K. OFHEO issued a Ñnal rule in 1996 that sets forth the minimum capital requirements for Fannie

Mae and Freddie Mac, which are to be calculated, reported, and classiÑed on a quarterly basis. We were in

compliance with the minimum capital rule as of December 31, 2002, and have been in compliance for every

reporting period since the rule became eÅective. OFHEO issued regulations in September 2001, as

subsequently amended, to establish a risk-based capital test to be used to determine the amount of total capital

Fannie Mae must hold to meet the risk-based capital standard. Fannie Mae and Freddie Mac are required to

hold enough capital to withstand a severe 10-year stress period, characterized by extreme interest-rate

movements and credit losses occurring simultaneously, plus 30 percent of that amount for management and

operations risk. The risk-based capital test evaluates combined interest-rate and credit stress for both rising

and declining interest-rate scenarios. The more stringent of these two scenarios determines the required riskbased capital. The test assumes that (1) interest rates increase or decrease by up to 600 basis points over the

Ñrst year, and remain constant at this new level for the remaining 9 years of the test; (2) severe credit

conditions apply nationwide; and (3) we acquire no new business during this period except to meet

outstanding mortgage commitments. The regulations specify that ""benchmark loss experience'' will be

combined with other assumptions and applied each quarter to our book of business to establish expected credit

losses based on the stress assumptions under the risk-based capital standard. The regulations also specify the

housing price index that OFHEO will use in connection with the standard and how the test will be used to

determine Fannie Mae's risk-based capital requirements. On March 31, 2003, OFHEO announced that

Fannie Mae complied with the risk-based capital rule as of December 31, 2002. See ""Item 7ÌManagement's

Discussion and Analysis of Financial Condition and Results of OperationsÌLiquidity and Capital ResourcesÌCapital ResourcesÌRegulatory Environment'' in the Form 10-K.

If we fail to meet the capital standards, OFHEO is permitted or required to take remedial measures,

depending on the standards we fail to meet. Compliance with the capital standards could limit operations that

require intensive use of capital and restrict our ability to repay debt or pay dividends on our common stock.

We are required to submit a capital restoration plan if we fail to meet any of the capital standards. If OFHEO

determines that we are engaging in conduct not approved by the Director of OFHEO (the ""Director'') that

could result in a rapid depletion of core capital or that the value of the property subject to mortgages we hold

or have securitized has decreased signiÑcantly, or if OFHEO does not approve the capital restoration plan or

determines that we have failed to make reasonable eÅorts to comply with the plan, OFHEO may take

remedial measures as if we were not meeting the capital standards we otherwise meet. The 1992 Act gives

OFHEO authority, after following prescribed procedures, to appoint a conservator if we do not meet the

critical capital level.

Dividend Restrictions

The Charter Act as amended by the 1992 Act restricts the ability of our Board of Directors to make

capital distributions, including any dividends, in the following circumstances:

‚ Fannie Mae may not pay any dividend, without the approval of OFHEO, if the dividend payment

would decrease our total capital below the risk-based capital level or our core capital below the

minimum capital level.

15
‚ If we do not meet the risk-based capital standard but do meet the minimum capital standard, we may

not make any dividend payment that would cause us to fail to meet the minimum capital standard.

‚ If we meet neither the risk-based capital standard nor the minimum capital standard but do meet the

critical capital standard established under the 1992 Act, we may make a dividend payment only if we

would not fail to meet the critical capital standard as a result of the payment and the Director approves

the payment after Ñnding that the payment satisÑes certain statutory conditions.

The Director has the authority to require us to submit a report to the Director regarding any capital

distribution we declare before we make the distribution.

16
DESCRIPTION OF THE PREFERRED STOCK

We are authorized by the Charter Act to have preferred stock on such terms and conditions as our Board

of Directors may prescribe. On December 27, 1995, our Board of Directors amended our bylaws to authorize

us to issue up to 100,000,000 shares of preferred stock. To date, we have issued the following:

‚ on March 1, 1996, 7,500,000 shares of 6.41% Non-Cumulative Preferred Stock, Series A (stated value

$50 per share) (the ""Series A Preferred Stock'');

‚ on April 12, 1996, 7,500,000 shares of 6.50% Non-Cumulative Preferred Stock, Series B (stated value

$50 per share) (the ""Series B Preferred Stock'');

‚ on September 20, 1996, 5,000,000 shares of 6.45% Non-Cumulative Preferred Stock, Series C (stated

value $50 per share) (the ""Series C Preferred Stock'');

‚ on September 30, 1998, 3,000,000 shares of 5.25% Non-Cumulative Preferred Stock, Series D (stated

value $50 per share) (the ""Series D Preferred Stock'');

‚ on April 15, 1999, 3,000,000 shares of 5.10% Non-Cumulative Preferred Stock, Series E (stated value

$50 per share) (the ""Series E Preferred Stock'');

‚ on March 20, 2000, 13,800,000 shares of Variable Rate Non-Cumulative Preferred Stock, Series F

(stated value $50 per share) (the ""Series F Preferred Stock'');

‚ on August 8, 2000, 5,750,000 shares of Variable Rate Non-Cumulative Preferred Stock, Series G

(stated value $50 per share) (the ""Series G Preferred Stock'');

‚ on April 6, 2001, 8,000,000 shares of 5.81% Non-Cumulative Preferred Stock, Series H (stated value

$50 per share) (the ""Series H Preferred Stock'');

‚ on October 28, 2002, 6,000,000 shares of 5.375% Non-Cumulative Preferred Stock, Series I (stated

value $50 per share (the ""Series I Preferred Stock'');

‚ on November 26, 2002, 14,000,000 shares of Variable Rate Non-Cumulative Preferred Stock, Series J

(stated value $50 per share (the ""Series J Preferred Stock''); and

‚ on March 18, 2003, 8,000,000 shares of Variable Rate Non-Cumulative Preferred Stock, Series K

(stated value $50 per share (the ""Series K Preferred Stock'').

We redeemed all of our outstanding Series A Preferred Stock on March 1, 2001, all of our outstanding

Series B Preferred Stock on February 28, 2002, and all of our outstanding Series C Preferred Stock on July 31,

2002. In this OÅering Circular, we refer to the Series D Preferred Stock through the Series K Preferred Stock

as the ""Outstanding Preferred Stock.''

The terms of the Preferred Stock will be established by a CertiÑcate of Designation of Terms of 5.125%

Non-Cumulative Preferred Stock, Series L (the ""CertiÑcate of Designation''), adopted by a duly authorized

committee of our Board of Directors, which will be substantially in the form attached as Appendix B to this

OÅering Circular. The following is a brief description of the terms of the Preferred Stock; you also should read

the CertiÑcate of Designation for a full description of the Preferred Stock.

General

We have the right to create and issue additional shares of Preferred Stock and additional classes or series

of stock that rank, as to dividends, liquidation or otherwise, prior to, on parity with or junior to the Preferred

Stock, without the consent of holders of the Preferred Stock. As of the date hereof, the shares of Outstanding

Preferred Stock are the only shares of our preferred stock outstanding. The Preferred Stock will rank equally

as to the payment of dividends and the distribution of assets upon our dissolution, liquidation or winding up

with the Outstanding Preferred Stock.

The Preferred Stock has no par value, has a stated value and liquidation preference of $50 per share, and,

upon issuance against full payment of the purchase price therefor, will be fully paid and nonassessable.

17
The Preferred Stock will not be subject to any mandatory redemption, sinking fund, or other similar

provisions. In addition, holders of Preferred Stock will have no right to require redemption of any shares of

Preferred Stock.

The Preferred Stock will not be convertible into or exchangeable for any of our other stock or obligations

and will have no preemptive rights.

EquiServe Trust Company, N.A., will be the transfer agent, dividend disbursing agent, and registrar for

the shares of Preferred Stock.

The obligations of Fannie Mae under the terms of the Preferred Stock are obligations of Fannie Mae

only and are not those of the United States or of any instrumentality thereof other than Fannie Mae.

Dividends

Dividends on shares of the Preferred Stock will not be mandatory. Holders of record of Preferred Stock as

they appear on our books and records (the ""Holders'') will be entitled to receive, when, as and if declared by

our Board of Directors, or a duly authorized committee thereof, in its sole discretion out of funds legally

available for dividend payments, non-cumulative, quarterly cash dividends that will accrue from and including

April 29, 2003 and will be payable on March 31, June 30, September 30, and December 31 of each year (each

a ""Dividend Payment Date''), commencing June 30, 2003, at the annual rate of $2.5625 per share (without

taking into account any adjustments as described below under ""Changes in the Dividends-Received

Percentage''). We will pay dividends on the Preferred Stock to the Holders on the relevant record date Ñxed

by the Board of Directors, or a duly authorized committee thereof, which may not be earlier than 45 days or

later than 10 days prior to the applicable Dividend Payment Date. If declared, the initial dividend, which will

be for the period from and including April 29, 2003 to but excluding June 30, 2003, will be $0.4342 per share

and, thereafter, if declared, quarterly dividends will be $0.6406 per share. After the initial dividend, the

dividend period relating to a Dividend Payment Date will be the period from and including the preceding

Dividend Payment Date to but excluding the Dividend Payment Date. If a Dividend Payment Date is not a

Business Day, we will pay dividends (if declared) on the Preferred Stock on the succeeding Business Day,

without interest from that Dividend Payment Date to the date of actual payment. A ""Business Day'' is any day

other than a Saturday, Sunday, or other day on which banking institutions in New York, New York are

authorized or required by law to close. We will compute dividends payable on the Preferred Stock for any

period greater or less than a full dividend period on the basis of a 360-day year consisting of twelve 30-day

months. The amount of dividends per share payable at redemption will be rounded to the fourth digit after the

decimal point. (If the Ñfth digit to the right of the decimal point is Ñve or greater, the fourth digit will be

rounded up by one.)

The Preferred Stock will rank prior to our common stock with respect to the payment of dividends to the

extent provided in the CertiÑcate of Designation. As a result, unless dividends have been declared and paid or

set apart (or ordered to be set apart) on the Preferred Stock for the then current quarterly dividend period, no

dividend may be declared or paid or set apart for payment on our common stock (or on any of our other stock

ranking, as to the payment of dividends, junior to the Preferred Stock), other than dividends or distributions

paid in shares of, or options, warrants or rights to subscribe for or purchase shares of, our common stock or any

of our other stock ranking junior to the Preferred Stock as to the payment of dividends and the distribution of

assets upon our dissolution, liquidation or winding up. When dividends are not paid in full upon the Preferred

Stock and all of our other classes or series of stock, if any, ranking on a parity as to the payment of dividends

with the Preferred Stock, all dividends declared upon shares of Preferred Stock and all of our other such stock

will be declared pro rata so that the amount of dividends declared per share on the Preferred Stock and all

such other stock will in all cases bear to each other the same ratio that accrued dividends per share on the

shares of Preferred Stock (including any adjustment in the amount of dividends payable due to changes in the

Dividends-Received Percentage (as deÑned below) but without, in the case of any non-cumulative preferred

stock, accumulation of unpaid dividends for prior dividend periods) and each other stock bear to each other.

Dividends on the Preferred Stock will not be cumulative. If we do not pay a dividend on the Preferred

Stock, the Holders of Preferred Stock will have no claim in respect of such non-payment so long as no

18
dividend (other than those referred to in the preceding paragraph) is paid on our common stock (or any of our

other stock ranking, as to the payment of dividends, junior to the Preferred Stock) for the then-current

quarterly dividend period.

The Board of Directors, or a duly authorized committee thereof, may, in its discretion, choose to pay

dividends on the Preferred Stock without the payment of any dividends on our common stock (or any of our

other stock ranking, as to the payment of dividends, junior to the Preferred Stock).

No dividends may be declared or paid or set apart for payment on any shares of the Preferred Stock if at

the same time any arrears exist or default exists in the payment of dividends on any outstanding class or series

of our stock ranking prior to the Preferred Stock with respect to the payment of dividends. At the time of

issuance of the Preferred Stock, there will be no class or series of our stock which ranks prior to the Preferred

Stock with respect to the payment of dividends.

Holders of Preferred Stock will not be entitled to any dividends, whether payable in cash or property,

other than as described above and will not be entitled to interest, or any sum in lieu of interest, in respect of

any dividend payment.

See also ""Regulatory Matters'' for a description of certain regulatory restrictions on our payment of

dividends.

Changes in the Dividends-Received Percentage. If, prior to October 29, 2004, one or more amendments

to the Internal Revenue Code of 1986, as amended (the ""Code''), are enacted that eliminate or reduce the

percentage of the dividends-received deduction applicable to the Preferred Stock (currently 70 percent) as

speciÑed in section 243(a)(1) of the Code or any successor provision (the ""Dividends-Received Percentage''), certain adjustments may be made in respect of the dividends payable by us, and Post Declaration Date

Dividends and Retroactive Dividends (as such terms are deÑned below) may become payable, as described

below.

The amount of each dividend payable (if declared) per share of Preferred Stock for dividend payments

made on or after the eÅective date of such change in the Code will be adjusted by multiplying the amount of

the dividend that would otherwise be payable (before adjustment) by a factor, which will be the number

determined in accordance with the following formula (the ""DRD Formula''), and rounding the result to the

nearest cent (with one-half cent rounded up):

1 ¿.35(1¿.70)

1¿.35(1¿DRP)

For purposes of the DRD Formula, ""DRP'' means the Dividends-Received Percentage (expressed as a

decimal) applicable to the dividend in question; provided, however, that if the Dividends-Received Percentage

applicable to the dividend in question shall be less than 50%, then the DRP shall equal .50. No amendment to

the Code, other than a change in the percentage of the dividends-received deduction applicable to the

Preferred Stock as set forth in section 243(a)(1) of the Code or any successor provision, will give rise to an

adjustment. Notwithstanding the foregoing provisions, if, with respect to any such amendment, we receive

either an unqualiÑed opinion of nationally recognized independent tax counsel selected by us or a private letter

ruling or similar form of assurance from the Internal Revenue Service (the ""IRS'') to the eÅect that such an

amendment does not apply to a dividend payable on the Preferred Stock, then such amendment will not result

in the adjustment provided for pursuant to the DRD Formula with respect to such dividend. The opinion

referenced in the previous sentence shall be based upon the legislation amending or establishing the DRP or

upon a published pronouncement of the IRS addressing such legislation. Unless the context otherwise

requires, references to dividends in this OÅering Circular will mean dividends as adjusted by the DRD

Formula. Our calculation of the dividends payable as so adjusted shall be Ñnal and not subject to review.

Notwithstanding the foregoing, if any such amendment to the Code is enacted after the dividend payable

on a Dividend Payment Date has been declared but before such dividend is paid, the amount of the dividend

payable on such Dividend Payment Date will not be increased; instead, additional dividends (the ""Post

Declaration Date Dividends''), equal to the excess, if any, of (1) the product of the dividend paid by us on

19
such Dividend Payment Date and the DRD Formula (where the DRP used in the DRD Formula would be

equal to the greater of the Dividends-Received Percentage applicable to the dividend in question and .50) over

(2) the dividend paid by us on such Dividend Payment Date, will be payable (if declared) to Holders of

Preferred Stock on the record date applicable to the next succeeding Dividend Payment Date.

If any such amendment to the Code is enacted and the reduction in the Dividends-Received Percentage

retroactively applies to a Dividend Payment Date as to which we previously paid dividends on the Preferred

Stock (each, an ""AÅected Dividend Payment Date''), we will pay (if declared) additional dividends (the

""Retroactive Dividends'') to Holders of Preferred Stock on the record date applicable to the next succeeding

Dividend Payment Date (or, if such amendment is enacted after the dividend payable on such Dividend

Payment Date has been declared, to Holders of Preferred Stock on the record date applicable to the second

succeeding Dividend Payment Date following the date of enactment), in an amount equal to the excess of

(1) the product of the dividend paid by us on each AÅected Dividend Payment Date and the DRD Formula

(where the DRP used in the DRD Formula would be equal to the greater of the Dividends-Received

Percentage and .50 applied to each AÅected Dividend Payment Date) over (2) the sum of the dividend paid

by us on each AÅected Dividend Payment Date. We will only make one payment of Retroactive Dividends for

any such amendment. Notwithstanding the foregoing provisions, if, with respect to any such amendment, we

receive either an unqualiÑed opinion of nationally recognized independent tax counsel selected by us or a

private letter ruling or similar form of assurance from the IRS to the eÅect that such amendment does not

apply to a dividend payable on an AÅected Dividend Payment Date for the Preferred Stock, then such

amendment will not result in the payment of Retroactive Dividends with respect to such AÅected Dividend

Payment Date. The opinion referenced in the previous sentence shall be based upon the legislation amending

or establishing the DRP or upon a published pronouncement of the IRS addressing such legislation.

Notwithstanding the foregoing, we will not make any adjustment in our dividends payable, and we will

not be required to pay Post Declaration Date Dividends or Retroactive Dividends, in respect of the enactment

on or after October 29, 2004 of any amendment to the Code that eliminates or reduces the DividendsReceived Percentage.

In the event that the amount of dividends payable per share of the Preferred Stock is adjusted pursuant to

the DRD Formula and/or Post Declaration Date Dividends or Retroactive Dividends are to be paid, we will

give notice of each such adjustment and, if applicable, any Post Declaration Date Dividends and Retroactive

Dividends to the Holders of Preferred Stock.

Optional Redemption

The Preferred Stock will not be redeemable prior to April 29, 2008. On or after that date, subject to the

notice provisions set forth below and subject to any further limitations which may be imposed by law, we, at

our option, may redeem the Preferred Stock, in whole or in part, at any time or from time to time, out of funds

legally available therefor, at the redemption price of $50 per share plus an amount equal to the dividend

(whether or not declared) for the then-current quarterly dividend period accrued to but excluding the date of

redemption, including any adjustments in dividends payable due to changes in the Dividends-Received

Percentage but without accumulation of unpaid dividends on the Preferred Stock for prior dividend periods. If

less than all of the outstanding shares of the Preferred Stock are to be redeemed, we will select shares to be

redeemed from the outstanding shares not previously called for redemption by lot or pro rata (as nearly as

possible) or by any other method that the Board of Directors, or a duly authorized committee thereof, in its

sole discretion deems equitable.

We will give notice of any such redemption by mail to Holders of Preferred Stock not less than 30 days

prior to the date Ñxed by the Board of Directors, or duly authorized committee thereof, for such redemption.

Each notice will state the number of shares of Preferred Stock to be redeemed and, if fewer than all of the

shares of Preferred Stock held by the applicable Holder are to be redeemed, the number of shares to be

redeemed from such Holder, the redemption price, the redemption date and the place at which such Holder's

certiÑcate(s) representing shares of the Preferred Stock must be presented upon such redemption.

20
Under certain circumstances, we may need the approval of the Director prior to exercising our right to

redeem shares of Preferred Stock. See ""Regulatory Matters.''

Once proper notice has been given, from and after the redemption date, dividends on the Preferred Stock

called for redemption will cease to accrue and such Preferred Stock called for redemption will no longer be

deemed outstanding, and all rights of the Holders thereof as registered holders of the Preferred Stock will

cease.

Liquidation Rights

Upon any voluntary or involuntary dissolution, liquidation or winding up of Fannie Mae, after payment or

provision for our liabilities and the expenses of such dissolution, liquidation or winding up, the Holders of the

outstanding shares of the Preferred Stock will be entitled to receive the amount of $50 per share plus an

amount equal to the dividend (whether or not declared) for the then-current quarterly dividend period

accrued to but excluding the date of such liquidation payment, including any adjustments in dividends payable

due to changes in the Dividends-Received Percentage but without accumulation of unpaid dividends on the

Preferred Stock for prior dividend periods, out of our assets or proceeds thereof available for distribution to

stockholders, before any payment or distribution of assets is made to holders of our common stock (or any of

our other stock ranking, as to the distribution of assets upon our dissolution, liquidation or winding up, junior

to the Preferred Stock). If our assets available for distribution in such event are insuÇcient to pay in full the

aggregate amount payable to Holders of the Preferred Stock and holders of all other classes or series of our

stock, if any, ranking, as to the distribution of assets upon our dissolution, liquidation or winding up, equally

with the Preferred Stock, the assets will be distributed to the Holders of Preferred Stock and holders of such

other stock pro rata, based on the full respective preferential amounts to which they are entitled (including any

adjustments in dividends payable due to changes in the Dividends-Received Percentage but without, in the

case of any noncumulative preferred stock, accumulation of unpaid dividends for prior dividend periods).

After payment of the full amount of the distribution of assets upon our dissolution, liquidation or winding up to

which they are entitled, the Holders of Preferred Stock will not be entitled to any further participation in any

of our distributions of assets.

Notwithstanding the foregoing, Holders of Preferred Stock will not be entitled to be paid any amount in

respect of our dissolution, liquidation or winding up until holders of any class or series of our stock ranking, as

to the distribution of our assets upon dissolution, liquidation or winding up, prior to the Preferred Stock have

been paid all amounts to which such classes or series are entitled. At the time of issuance of the Preferred

Stock, there will be no class or series of our stock ranking prior to the Preferred Stock with respect to the

distribution of assets upon our dissolution, liquidation or winding up.

Neither the sale, lease or exchange (for cash, shares of stock, securities or other consideration) of all or

substantially all of our property and assets, nor our merger, consolidation or combination into or with any other

corporation, nor the merger, consolidation or combination of any other corporation or entity into or with us,

shall be deemed to be a dissolution, liquidation or winding up, voluntary or involuntary, for the purposes of

these provisions on liquidation rights.

Regulatory Matters

Holders of Preferred Stock are entitled to receive cash dividends if, as and when declared by the Board of

Directors. However, certain provisions of the 1992 Act may operate to restrict the ability of the Board of

Directors to declare dividends in certain circumstances. The 1992 Act established our risk-based capital,

minimum capital and critical capital requirements. OFHEO released risk-based capital regulations for us and

Freddie Mac on September 13, 2001. Until one year after the Ñnal regulations establishing the risk-based

capital test are in eÅect, a dividend may be paid without the prior approval of the Director if we meet the

minimum capital level and the dividend payment would not decrease our core capital below such level. See

""Government Regulation and Charter Act.''

One year after Ñnal regulations establishing the risk-based capital test take eÅect, a dividend may be paid

without the prior approval of the Director if we meet both the risk-based capital and minimum capital levels

21
and the dividend payment would not decrease our total capital below the risk-based capital level or our core

capital below the minimum capital level. If we meet either the risk-based capital standard or the minimum

capital standard, we may make a dividend payment without obtaining the approval of the Director only if the

dividend payment would not cause us to fail to meet another capital standard. At any time when we do not

meet the risk-based capital standard but meet the minimum capital standard, we are prohibited from making a

dividend payment that would cause us to fail to meet the minimum capital standard. If we meet neither the

risk-based capital standard nor the minimum capital standard but do meet the critical capital standard

established under the 1992 Act, we may make a dividend payment only if we would not fail to meet the critical

capital standard as a result of such payment and the Director approves the payment after Ñnding that it

satisÑes certain statutory conditions. The Director has the authority to require us to submit a report to the

Director regarding any capital distribution (including any dividend) declared by us before we make the

distribution. See ""Government Regulation and Charter Act'' and ""Management's Discussion and Analysis of

Financial Condition and Results of OperationsÌLiquidity and Capital ResourcesÌRegulatory Environment''

in the Form 10-K regarding our applicable capital standards.

Voting Rights; Amendments

Except as provided below, the Holders of Preferred Stock will not be entitled to any voting rights.

Without the consent of the Holders of Preferred Stock, we may amend, alter, supplement, or repeal any

terms of the Preferred Stock:

‚ to cure any ambiguity, or to cure, correct or supplement any provision contained in the CertiÑcate of

Designation that may be defective or inconsistent; or

‚ to make any other provision with respect to matters or questions arising with respect to the Preferred

Stock that is not inconsistent with the provisions of the CertiÑcate of Designation, so long as such

action does not materially and adversely aÅect the interests of the Holders of Preferred Stock.

The following are deemed not to materially and adversely aÅect the interests of the Holders of Preferred

Stock:

‚ any increase in the amount of authorized or issued Preferred Stock; or

‚ the creation and issuance, or an increase in the authorized or issued amount, of any other class or series

of our stock, whether ranking prior to, on a parity with or junior to the Preferred Stock as to dividends

or liquidation or otherwise.

Otherwise, the terms of the Preferred Stock may be amended, altered, supplemented, or repealed only

with the consent of the Holders of at least two-thirds of the outstanding shares of Preferred Stock. On matters

requiring their consent, Holders of Preferred Stock will be entitled to one vote per share.

New York Stock Exchange Listing

We will apply to list the Preferred Stock on the NYSE under the symbol ""FNMprL''. If approved for

listing, we expect trading of the Preferred Stock on the NYSE to commence within a thirty-day period after

the initial delivery of the Preferred Stock.

LEGALITY OF INVESTMENT

National banks may purchase, hold, and invest in for their own accounts the shares of Preferred Stock

without regard to limitations generally applicable to investment securities. The Preferred Stock would be

subject to a 100% risk weighting for capital adequacy purposes.

Federal savings associations and federal savings banks may invest in the shares of Preferred Stock without

regard to limitations generally applicable to investments. Preferred Stock held by a federal savings association

or federal savings bank would be subject to a 100% risk weighting for capital adequacy purposes.

22
Federally insured state-chartered banks, state-chartered savings banks, and state-chartered savings and

loan associations may invest in the shares of Preferred Stock to the extent permitted by the Secondary

Mortgage Market Enhancement Act of 1984 (""SMMEA'') and by applicable state law, after complying with

any procedures imposed by the state. Preferred Stock held by such an institution would be subject to a 100%

risk weighting for federal capital adequacy purposes.

Federal credit unions may purchase the shares of Preferred Stock without regard to limitations generally

applicable to investments.

The shares of Preferred Stock are ""stock . . . of a corporation which is an instrumentality of the United

States'' within the meaning of Û 7701(a)(19)(C)(ii) of the Code for purposes of the 60 percent of assets

limitation applicable to domestic building and loan associations 

In addition to the speciÑc authorizations discussed above, Û 106(a)(1) of SMMEA provides that any

person, trust, corporation, partnership, association, business trust or business entity created pursuant to or

existing under the laws of the United States or any state (including the District of Columbia and Puerto Rico)

(an ""investor'') is authorized to purchase, hold and invest in securities issued or guaranteed by us (including

the shares of Preferred Stock) to the same extent that such investor is authorized to purchase, hold or invest in

obligations issued or guaranteed as to principal and interest by the United States or any agency or

instrumentality thereof. Prior to October 4, 1991, states were authorized by SMMEA to enact legislation that

either prohibited or limited an investor's authority to purchase, hold or invest in securities issued or guaranteed

by us. To the best of our knowledge, 18 states currently have legislation limiting to varying extents the ability

of certain entities (in most cases, insurance companies) to invest in securities issued or guaranteed by us,

including the shares of Preferred Stock.

Notwithstanding the above, investors should consult their legal advisors to determine whether and to

what extent the shares of Preferred Stock constitute legal investments for such investors or are eligible to be

used as security for borrowings. The foregoing does not take into consideration the application of statutes,

regulations, orders, guidelines or agreements generally governing investments made by a particular investor,

including but not limited to ""prudent investor'' provisions, safety and soundness conditions and percentage-ofassets limits. The regulatory authorities that administer the legal provisions referred to above generally reserve

discretion whether securities, such as the Preferred Stock, that are otherwise acceptable for investment may be

purchased or pledged by the institutions subject to their jurisdiction. An institution under the jurisdiction of

the Comptroller of the Currency, the Board of Governors of the Federal Reserve System, the Federal Deposit

Insurance Corporation, the OÇce of Thrift Supervision, the National Credit Union Administration, or any

other federal or state agency with similar authority should review any applicable regulations, policy statements

and guidelines before purchasing the Preferred Stock.

UNITED STATES TAXATION

The Preferred Stock and payments thereon generally are subject to taxation. Therefore, you should

consider the tax consequences of owning Preferred Stock before acquiring it.

In the opinion of Dewey Ballantine LLP, our special tax counsel, the following discussion correctly

describes the principal aspects of the U.S. federal income tax treatment of U.S. Persons (as deÑned below)

that are beneÑcial holders of the Preferred Stock (""Shareholders''). This discussion does not address the U.S.

federal income tax treatment of Shareholders that are not U.S. Persons. This discussion is based on the Code,

its legislative history, existing and proposed Treasury regulations, revenue rulings and judicial decisions,

changes to any of which subsequent to the date of this OÅering Circular may aÅect, possibly on a retroactive

basis, the tax consequences described herein.

This summary discusses only the Preferred Stock purchased in this oÅering and held as a capital asset

(within the meaning of federal tax law). This discussion does not purport to address all of the U.S. federal

income tax consequences that may be applicable to particular investors in light of their individual circumstances or to Shareholders subject to special rules, such as dealers in securities, tax-exempt organizations, life

insurance companies, persons liable for alternative minimum tax, persons that hold the Preferred Stock as part

23
of a straddle or a hedging or conversion transaction, certain Ñnancial institutions and certain securities traders.

In addition, this discussion does not address taxes imposed by any state, local or foreign taxing jurisdiction. In

all cases, investors are advised to consult their own tax advisors regarding the U.S. federal tax consequences to

them of holding, owning and disposing of Preferred Stock, as well as any tax consequences arising under the

laws of any state or other taxing jurisdiction.

For purposes of this discussion, ""U.S. Person'' generally means (1) a citizen or individual resident of the

United States, (2) a corporation or partnership created or organized in or under the laws of the United States

or any political subdivision thereof, (3) an estate the income of which is includible in its gross income for U.S.

federal income tax purposes without regard to its source, or (4) a trust if a court within the United States is

able to exercise primary supervision over its administration and at least one U.S. Person has the authority to

control all substantial decisions of the trust.

Dividends

Dividends declared and paid on the Preferred Stock will be dividends for U.S. federal income tax

purposes to the extent paid out of our current or accumulated earnings and proÑts, as determined for federal

income tax purposes, and will be taxable as ordinary income. Although we expect that our current and

accumulated earnings and proÑts will be such that all dividends paid with respect to the Preferred Stock will

qualify as dividends for federal income tax purposes, we cannot guarantee that result. Our accumulated

earnings and proÑts and our current earnings and proÑts in future years will depend in signiÑcant part on our

future proÑts or losses, which we cannot accurately predict. To the extent that the amount of any dividend paid

on a share of Preferred Stock exceeds our current or accumulated earnings and proÑts for federal income tax

purposes attributable to that share, the dividend will be treated Ñrst as a return of capital (rather than as

ordinary income) and will be applied against and reduce the Shareholder's adjusted tax basis in that share of

Preferred Stock. The amount of any such dividend in excess of the Shareholder's adjusted tax basis will then

be taxed as capital gain. For purposes of the remainder of this discussion, it is assumed that dividends paid

with respect to the Preferred Stock will constitute dividends for U.S. federal income tax purposes.

Dividends received by Shareholders that are corporations generally will be eligible for the 70-percent

dividends-received deduction under section 243 of the Code. The 70-percent dividends-received deduction will

not be available with respect to a dividend received on Preferred Stock that a Shareholder has held for 45 days

or less (including the day of disposition, but excluding the day of acquisition) during the 90-day period

beginning on the day which is 45 days before the date on which the Preferred Stock becomes ex-dividend. If

the dividend is attributable to a period or periods aggregating more than 366 days, the dividends-received

deduction will be available only if the Shareholder has held the Preferred Stock for more than 90 days

(including the day of disposition, but excluding the day of acquisition) during the 180-day period beginning

90 days before the date on which the Preferred Stock becomes ex-dividend. The length of time that a

corporate shareholder is deemed to have held stock for these purposes is reduced by periods during which the

shareholder's risk of loss with respect to the stock is diminished by reason of the existence of certain options,

contracts to sell, short sales or other similar transactions. The aggregate dividends-received deduction allowed

a corporate shareholder cannot exceed 70 percent of its taxable income (with certain adjustments). Moreover,

the dividends-received deduction may be reduced if the stock is ""debt Ñnanced.'' Stock is ""debt Ñnanced'' if a

corporate shareholder incurs indebtedness ""directly attributable'' to a ""portfolio stock'' investment in another

company, which would include an investment in the Preferred Stock.

The Bush Administration has released a legislative proposal regarding dividends that is targeted at

eliminating double corporate taxation. The proposal would permit corporations to distribute nontaxable

dividends, but only to the extent that those dividends are paid out of income taxed at the corporate level. As of

the date of this OÅering Circular, it is impossible to predict whether Congress will enact the Administration's

proposal into law and, if so, the form or eÅective date of that legislation.

24
Dispositions, Including Redemptions

Any sale, exchange, redemption (except as discussed below) or other disposition of the Preferred Stock

generally will result in taxable gain or loss equal to the diÅerence between the amount realized upon the

disposition and the Shareholder's adjusted tax basis in the Preferred Stock. Such gain or loss will be capital

gain or loss and will be long-term capital gain or loss if the holding period for the Preferred Stock exceeds one

year. Tax rates on capital gain for individual Shareholders vary depending on each Shareholder's income and

holding period for the Preferred Stock. Shareholders that are individuals should contact their own tax advisors

for more information or for the capital gains tax rate applicable to speciÑc shares of Preferred Stock. The

deduction of capital losses is subject to certain limitations.

A redemption of Preferred Stock may be treated as a dividend, rather than as payment in exchange for

the Preferred Stock, unless the redemption is ""not essentially equivalent to a dividend'' with respect to the

Shareholder within the meaning of section 302(b)(1) of the Code, ""is in complete redemption of all of the

stock'' of Fannie Mae held by the Shareholder as described in section 302(b)(3) of the Code or otherwise

meets the requirements of one of the other exceptions from dividend treatment provided in section 302(b) of

the Code. In applying these rules, the Shareholder must take into account not only the Preferred Stock and

our other stock that it owns directly, but also the Preferred Stock and our other stock that it constructively

owns within the meaning of section 318 of the Code. Because of the complex nature of these rules, each

Shareholder should consult its tax advisor to determine whether a redemption of Preferred Stock will be

treated as a dividend or as payment in exchange for the Preferred Stock. If the redemption payment is treated

as a dividend, the rules discussed above under ""Dividends'' apply.

Information Reporting and Backup Withholding

Payments of dividends on shares of Preferred Stock and payments of proceeds upon the sale or

redemption of Preferred Stock generally are required to be reported to the IRS except in the case of a

beneÑcial holder that is an ""exempt recipient.'' Individuals generally are not exempt recipients, whereas

corporations and certain other entities generally are exempt recipients.

Backup withholding of U.S. federal income tax may apply to payments made with respect to shares of

Preferred Stock, as well as to payments of proceeds from the sale of shares of Preferred Stock, to Shareholders

that are not exempt recipients and that fail to provide certain identifying information (such as the taxpayer

identiÑcation number of the Shareholder) in the manner required.

The U.S. federal income tax discussion set forth above is included for general information only and may

not be applicable depending upon a Shareholder's particular situation. Each Shareholder should consult its

own tax advisor with respect to the tax consequences to it of the ownership and disposition of the Preferred

Stock, including the tax consequences under the tax laws of the United States, states, localities, countries

other than the United States and any other taxing jurisdiction and the possible eÅects of changes in such tax

laws.

25
UNDERWRITING

Subject to the terms and conditions set forth in the underwriting agreement (the ""Underwriting

Agreement''), we have agreed to sell to each of the underwriters named below (collectively, the ""Underwriters''), and each of the Underwriters, for whom Lehman Brothers Inc. (the ""Representative'') is acting as

representative, has severally agreed to purchase, the number of shares of Preferred Stock set forth opposite its

name below:

Underwriter Number of Shares

Lehman Brothers Inc. ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2,400,000

Goldman, Sachs & Co. ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 1,800,000

Bear, Stearns & Co. Inc. ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 600,000

Deutsche Bank Securities Inc. ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 600,000

Utendahl Capital Partners, L.P. ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 600,000

TotalÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 6,000,000

In the Underwriting Agreement, the Underwriters have severally agreed, subject to the terms and

conditions set forth therein, to purchase all the Preferred Stock oÅered hereby if any is purchased.

The Representative has advised us that the Underwriters propose initially to oÅer the Preferred Stock to

the public at the initial public oÅering price set forth on the cover page of this OÅering Circular, and to certain

dealers at such price less a concession not in excess of $0.2875 per share. The Underwriters may allow, and

such dealers may reallow, a discount not in excess of $0.15 per share on sales to certain other dealers. After the

initial public oÅering, the public oÅering price, concession and discount may be changed.

We have granted the Underwriters an option exercisable for 30 days after the date of this OÅering

Circular to purchase up to an aggregate of 900,000 additional shares of Preferred Stock solely to cover

overallotments, if any. If the Underwriters exercise their overallotment option, the Underwriters have severally

agreed, subject to certain conditions, to purchase approximately the same percentage thereof that the number

of shares to be purchased by each of them, as shown in the foregoing table, bears to the 6,000,000 shares of

Preferred Stock oÅered.

Prior to this oÅering, there has been no public market for the Preferred Stock. We will apply to list the

Preferred Stock on the NYSE under the symbol ""FNMprL.'' If accepted for listing, we expect that trading of

the Preferred Stock on the NYSE will commence within a thirty-day period after the initial delivery of the

Preferred Stock. The Representative has advised us that it intends to make a market in the Preferred Stock

prior to the commencement of trading on the NYSE, but are not obligated to do so and may discontinue any

such market making at any time without notice.

In the Underwriting Agreement, we and the Underwriters have agreed to indemnify each other against

and contribute toward certain liabilities.

The Underwriters and certain aÇliates thereof engage in transactions with and perform services for us in

the ordinary course of business.

The Underwriters may engage in certain transactions that stabilize the price of the Preferred Stock.

These transactions may include entering stabilizing bids, which means the placing of a bid or the eÅecting of a

purchase for the purpose of pegging, Ñxing or maintaining the price of the Preferred Stock. Neither we nor the

Underwriters make any representation or prediction as to the direction or magnitude of any eÅect that the

transactions described above may have on the price of the Preferred Stock. The Underwriters are not required

to engage in any of these transactions. When so doing, the Underwriters act on their own behalf and not as our

representatives. Any such transactions, if commenced, may be discontinued at any time.

26
RATING

Standard & Poor's Ratings Group, a Division of the McGraw-Hill Companies, has assigned the Preferred

Stock a rating of ""AA¿'', Moody's Investors Service, Inc. has assigned a rating of ""Aa3,'' and Fitch, Inc. has

assigned a rating of ""AA''. A security rating is not a recommendation to buy, sell or hold securities and may

be subject to revision or may be withdrawn at any time by the assigning rating organization.

ACCOUNTANTS

The audited Ñnancial statements of Fannie Mae as of December 31, 2002 and for each of the years in the

three-year period ended December 31, 2002, included in Appendix C and incorporated herein by reference,

have been included in reliance upon the report of KPMG LLP, independent certiÑed public accountants, and

upon the authority of that Ñrm as experts in accounting and auditing. The audit reports covering the

December 31, 2001 and 2002 Ñnancial statements refer to a change in the accounting for derivative Ñnancial

instruments.

VALIDITY OF THE PREFERRED STOCK

The validity of the Preferred Stock will be passed upon for us by Sidley Austin Brown & Wood LLP,

New York, New York, and for the Underwriters by Sullivan & Cromwell LLP, Washington, D.C. Certain

U.S. federal income tax matters will be passed upon for us by Dewey Ballantine LLP, Washington, D.C.

ADDITIONAL INFORMATION ABOUT FANNIE MAE

We are incorporating by reference in this OÅering Circular the documents listed below that we publish

from time to time. This means that we are disclosing information to you by referring you to those documents.

The documents incorporated by reference are considered part of this OÅering Circular, so you should read this

OÅering Circular, and any applicable supplements or amendments, together with those documents.

You should rely only on the information provided or incorporated by reference in this OÅering Circular,

and you should rely only on the most current information.

The following documents are incorporated by reference in this OÅering Circular:

‚ our most recent Form 10-K; and;

‚ any Form 10-K's, Quarterly Reports on Form 10-Q and Current Reports on Form 8-K (""Form 8-K'')

that we Ñle with the SEC after the date of this OÅering Circular and prior to the termination of the

oÅering of the Preferred Stock. Information we ""furnish'' to the SEC on Form 8-K shall not be

incorporated by reference in this OÅering Circular.

You may read our SEC Ñlings and other information about Fannie Mae at the oÇces of the New York

Stock Exchange, the Chicago Stock Exchange and the PaciÑc Exchange. Our SEC Ñlings also will be

available at the SEC's website at www.sec.gov. You also may read and copy any document we Ñle with the

SEC by visiting the SEC's Public Reference Room at 450 Fifth Street, NW, Washington, DC 20549. Please

call the SEC at 1-800-SEC-0330 for further information about the operation of the Public Reference Room.

We are providing the address of the SEC's internet site solely for the information of prospective investors. We

do not intend the internet address to be an active link. This means that information which appears on the

SEC's website is not incorporated into this OÅering Circular, except as speciÑcally stated in this OÅering

Circular.

You can obtain copies of the periodic reports we Ñle with the SEC and a copy of this OÅering Circular

without charge from our OÇce of Investor Relations, Fannie Mae, 3900 Wisconsin Avenue, NW, Washington, DC 20016, telephone: (202) 752-7115. The periodic reports that we Ñle with the SEC and this OÅering

Circular will be also available on our website at www.fanniemae.com.

Other than the documents speciÑcally incorporated by reference herein, the information on our website is

not part of or incorporated by reference in this OÅering Circular.

27
Appendix A

Reconciliation of Core Business Earnings to GAAP Reported Results

Dollars and shares in millions, except per share amounts

Quarter Ended Quarter Ended

March 31, 2003 March 31, 2002

Core Core

Business Reconciling Reported Business Reconciling Reported

Earnings Items Results Earnings Items Results

Net interest income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $3,368.4 $ Ì $3,368.4 $2,430.4 $ Ì $2,430.4

Purchased options amortization expense(1) ÏÏÏÏÏ (764.3) 764.3 Ì (310.2) 310.2 Ì

Core net interest income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2,604.1 764.3 3,368.4 2,120.2 310.2 2,430.4

Guaranty fee income (expense) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 546.6 Ì 546.6 407.6 Ì 407.6

Fee and other income (expense), netÏÏÏÏÏÏÏÏÏÏÏ 113.3 Ì 113.3 3.6 Ì 3.6

Credit-related expenses ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (20.3) Ì (20.3) (21.7) Ì (21.7)

Administrative expenses ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (343.8) Ì (343.8) (290.1) Ì (290.1)

Purchased options expense under FAS 133(2) ÏÏÏ Ì (624.6) (624.6) Ì (787.2) (787.2)

Debt extinguishments, net ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (392.2) Ì (392.2) (171.7) Ì (171.7)

Income before federal income taxes ÏÏÏÏÏÏÏÏÏÏÏÏ 2,507.7 139.7 2,647.4 2,047.9 (477.0) 1,570.9

Provision for federal income taxes(3) ÏÏÏÏÏÏÏÏÏÏ (658.0) (48.9) (706.9) (529.2) 166.9 (362.3)

Net income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $1,849.7 $ 90.8 $1,940.5 $1,518.7 $(310.1) $1,208.6

Preferred stock dividends ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ (30.3) $ Ì $ (30.3) $ (32.8) $ Ì $ (32.8)

Weighted average diluted common shares

outstanding ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 990.2 Ì 990.2 1,001.7 Ì 1,001.7

Diluted earnings per common share ÏÏÏÏÏÏÏÏÏÏÏ $ 1.84 $ 0.09 $ 1.93 $ 1.48 $ (0.31) $ 1.17

Core Business

Reported Results Earnings

Quarter Ended Quarter Ended

3/31/03 3/31/02 3/31/03 3/31/02

Net interest income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 3,368.4 $ 2,430.4 $ 3,368.4 $ 2,430.4

Taxable-equivalent adjustment on tax-exempt investments(4)ÏÏÏÏÏ 122.9 123.0 122.9 123.0

Taxable-equivalent net interest income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 3,491.3 $ 2,553.4 3,491.3 2,553.4

Purchased options amortization expense ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (764.3) (310.2)

Taxable-equivalent core net interest income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 2,727.0 $ 2,243.2

Average net investment balance ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $871,939 $780,769 $871,939 $780,769

Average investment yieldÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 5.94% 6.49% 5.94% 6.49%

Average borrowing cost ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 4.51% 5.36% 4.51% 5.36%

Purchased options amortization expense ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 0.37% 0.16%

Average core borrowing cost(5) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 4.88% 5.52%

Net interest yield, taxable-equivalent basis(6) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 1.60% 1.31%

Net interest margin, taxable-equivalent basis(7) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 1.25% 1.15%

Net interest income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 3,368.4 $ 2,430.4 $ 3,368.4 $ 2,430.4

Guaranty fee income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 546.6 407.6 546.6 407.6

Fee and other income (expense), net ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 113.3 3.6 113.3 3.6

Total revenuesÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 4,028.3 2,841.6 4,028.3 2,841.6

Investment tax credits(8) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 216.3 185.5 216.3 185.5

Tax-exempt investments(4) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 122.9 123.0 122.9 123.0

Total taxable-equivalent adjustments ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 339.2 308.5 339.2 308.5

Taxable-equivalent revenues ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 4,367.5 $ 3,150.1 4,367.5 3,150.1

Purchased options amortization expense ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (764.3) (310.2)

Core taxable-equivalent revenues ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 3,603.2 $ 2,839.9

A-1
(1) This amount represents the straight-line amortization of purchased options expense allocated to interest expense over

the original expected life of the options. Included in core business earnings instead of the unrealized gains and losses

on purchased options to make it consistent with the accounting for the embedded options in our callable debt and the

vast majority of our mortgages.

(2) This amount represents unrealized gains and losses on purchased options recorded in accordance with FAS 133.

(3) The reconciling item represents the net federal income tax eÅect of core business earnings adjustments based on the

applicable federal income tax rate of 35 percent.

(4) ReÖects non-GAAP adjustments to permit comparison of yields on tax-exempt and taxable assets based on a 35

percent marginal tax rate.

(5) Includes the eÅect of purchased options amortization expense allocated to interest expense over the original expected

life of the options.

(6) Annualized taxable-equivalent net interest income divided by the weighted average net investment balance.

(7) Annualized taxable-equivalent core net interest income divided by the weighted average net investment balance.

(8) Represents non-GAAP adjustments for tax credits related to losses on certain aÅordable housing tax-advantaged

equity investments and other investment tax credits using a 35% marginal tax rate.

A-2
APPENDIX B

CERTIFICATE OF DESIGNATION OF TERMS OF

5.125% NON-CUMULATIVE PREFERRED STOCK, SERIES L

1. Designation, Par Value and Number of Shares.

The designation of the series of preferred stock of the Federal National Mortgage Association (""Fannie

Mae'') created by this resolution shall be ""5.125% Non-Cumulative Preferred Stock, Series L'' (the ""Series L

Preferred Stock''), and the number of shares initially constituting the Series L Preferred Stock is 6,000,000*.

Shares of Series L Preferred Stock will have no par value and a stated value and liquidation preference of $50

per share. The Board of Directors of Fannie Mae, or a duly authorized committee thereof, in its sole

discretion, may reduce the number of shares of Series L Preferred Stock, provided such reduction is not below

the number of shares of Series L Preferred Stock then outstanding.

2. Dividends.

(a) Holders of record of Series L Preferred Stock (each individually a ""Holder'', or collectively the

""Holders'') will be entitled to receive, when, as and if declared by the Board of Directors of Fannie Mae, or a

duly authorized committee thereof, in its sole discretion out of funds legally available therefor, non-cumulative

quarterly cash dividends which will accrue from and including April 29, 2003 and will be payable on

March 31, June 30, September 30 and December 31 of each year (each, a ""Dividend Payment Date''),

commencing June 30, 2003 at the annual rate of $2.5625 per share or 5.125% of the stated value and

liquidation preference of $50 per share (without taking into account any adjustments referred to in clause

(b) below). If a Dividend Payment Date is not a Business Day, the related dividend (if declared) will be paid

on the next succeeding Business Day with the same force and eÅect as though paid on the Dividend Payment

Date, without any increase to account for the period from such Dividend Payment Date through the date of

actual payment. A ""Business Day'' shall mean any day other than a Saturday, Sunday, or a day on which

banking institutions in New York, New York are authorized by law to close. Dividends will be paid to Holders

on the record date Ñxed by the Board of Directors or a duly authorized committee thereof, which may not be

earlier than 45 days or later than 10 days prior to the applicable Dividend Payment Date. If declared, the

initial dividend, which will be for the period from and including April 29, 2003 to but excluding June 30, 2003,

will be $0.4342 per share and will be payable on June 30, 2003 and, thereafter, if declared, quarterly dividends

will be $0.6406 per share. After the initial dividend, the dividend period relating to a Dividend Payment Date

will be the period from and including the preceding Dividend Payment Date to but excluding the related

Dividend Payment Date. If Fannie Mae redeems the Series L Preferred Stock, the dividend that would

otherwise be payable for the then-current quarterly dividend period accrued to but excluding the date of

redemption will be included in the redemption price of the shares redeemed and will not be separately payable.

Dividends payable on the Series L Preferred Stock for any period greater or less than a full dividend period

will be computed on the basis of a 360-day year consisting of twelve 30-day months. The amount of dividends

per share payable at redemption will be rounded to the fourth digit after the decimal point. (If the Ñfth digit to

the right of the decimal point is Ñve or greater, the fourth digit will be rounded up by one.)

(b) If, prior to October 29, 2004, one or more amendments to the Internal Revenue Code of 1986, as

amended (the ""Code''), are enacted that eliminate or reduce the percentage of the dividends-received

deduction applicable to the Series L Preferred Stock as speciÑed in section 243(a)(1) of the Code or any

successor provision thereto (the ""Dividends-Received Percentage''), certain adjustments may be made in

respect of the dividends payable by Fannie Mae, and Post Declaration Date Dividends and Retroactive

Dividends (as such terms are deÑned below) may become payable, as described below.

The amount of each dividend payable (if declared) per share of Series L Preferred Stock for dividend

payments made on or after the eÅective date of such change in the Code will be adjusted by multiplying the

amount of the dividend payable pursuant to clause (a) of this Section 2 (before adjustment) by a factor,

* Plus up to 900,000 additional shares pursuant to the Underwriters' overallotment option.

B-1
which will be the number determined in accordance with the following formula (the ""DRD Formula''), and

rounding the result to the nearest cent (with one-half cent rounded up):

1¿.35(1¿.70)

1¿.35(1¿DRP)

For purposes of the DRD Formula, ""DRP'' means the Dividends-Received Percentage (expressed as a

decimal) applicable to the dividend in question; provided, however, that if the Dividends-Received Percentage

applicable to the dividend in question shall be less than 50%, then the DRP shall equal .50. No amendment to

the Code, other than a change in the percentage of the dividends-received deduction applicable to the Series L

Preferred Stock as set forth in section 243(a)(1) of the Code or any successor provision thereto, will give rise

to an adjustment. Notwithstanding the foregoing provisions, if, with respect to any such amendment, Fannie

Mae receives either an unqualiÑed opinion of nationally recognized independent tax counsel selected by

Fannie Mae or a private letter ruling or similar form of assurance from the Internal Revenue Service (the

""IRS'') to the eÅect that such an amendment does not apply to a dividend payable on the Series L Preferred

Stock, then such amendment will not result in the adjustment provided for pursuant to the DRD Formula with

respect to such dividend. The opinion referenced in the previous sentence shall be based upon the legislation

amending or establishing the DRP or upon a published pronouncement of the IRS addressing such legislation.

Unless the context otherwise requires, references to dividends herein will mean dividends as adjusted by the

DRD Formula. Fannie Mae's calculation of the dividends payable as so adjusted shall be Ñnal and not subject

to review.

Notwithstanding the foregoing, if any such amendment to the Code is enacted after the dividend payable

on a Dividend Payment Date has been declared but before such dividend is paid, the amount of the dividend

payable on such Dividend Payment Date will not be increased; instead, additional dividends (the ""Post

Declaration Date Dividends''), equal to the excess, if any, of (1) the product of the dividend paid by Fannie

Mae on such Dividend Payment Date and the DRD Formula (where the DRP used in the DRD Formula

would be equal to the greater of the Dividends-Received Percentage applicable to the dividend in question and

.50) over (2) the dividend paid by Fannie Mae on such Dividend Payment Date, will be payable (if declared)

to Holders on the record date applicable to the next succeeding Dividend Payment Date.

If any such amendment to the Code is enacted and the reduction in the Dividends-Received Percentage

retroactively applies to a Dividend Payment Date as to which Fannie Mae previously paid dividends on the

Series L Preferred Stock (each, an ""AÅected Dividend Payment Date''), Fannie Mae will pay (if declared)

additional dividends (the ""Retroactive Dividends'') to Holders on the record date applicable to the next

succeeding Dividend Payment Date (or, if such amendment is enacted after the dividend payable on such

Dividend Payment Date has been declared, to Holders on the record date applicable to the second succeeding

Dividend Payment Date following the date of enactment), in an amount equal to the excess of (1) the product

of the dividend paid by Fannie Mae on each AÅected Dividend Payment Date and the DRD Formula (where

the DRP used in the DRD Formula would be equal to the greater of the Dividends-Received Percentage and

.50 applied to each AÅected Dividend Payment Date) over (2) the sum of the dividend paid by Fannie Mae

on each AÅected Dividend Payment Date. Fannie Mae will only make one payment of Retroactive Dividends

for any such amendment. Notwithstanding the foregoing provisions, if, with respect to any such amendment,

Fannie Mae receives either an unqualiÑed opinion of nationally recognized independent tax counsel selected

by Fannie Mae or a private letter ruling or similar form of assurance from the IRS to the eÅect that such

amendment does not apply to a dividend payable on an AÅected Dividend Payment Date for the Series L

Preferred Stock, then such amendment will not result in the payment of Retroactive Dividends with respect to

such AÅected Dividend Payment Date. The opinion referenced in the previous sentence shall be based upon

legislation amending or establishing the DRP or upon a published pronouncement of the IRS addressing such

legislation.

Notwithstanding the foregoing, no adjustment in the dividends payable by Fannie Mae shall be made,

and no Post Declaration Date Dividends or Retroactive Dividends shall be payable by Fannie Mae, in respect

of the enactment of any amendment to the Code on or after October 29, 2004 that eliminates or reduces the

Dividends-Received Percentage.

B-2
In the event that the amount of dividends payable per share of Series L Preferred Stock is adjusted

pursuant to the DRD Formula and/or Post Declaration Date Dividends or Retroactive Dividends are to be

paid, Fannie Mae will cause notice of each such adjustment and, if applicable, Post Declaration Date

Dividends and Retroactive Dividends to be given as soon as practicable to the Holders of Series L Preferred

Stock.

(c) No dividend (other than dividends or distributions paid in shares of, or options, warrants or rights to

subscribe for or purchase shares of, the common stock of Fannie Mae or any other stock of Fannie Mae

ranking, as to the payment of dividends and the distribution of assets upon dissolution, liquidation or winding

up of Fannie Mae, junior to the Series L Preferred Stock) may be declared or paid or set apart for payment on

Fannie Mae's common stock (or on any other stock of Fannie Mae ranking, as to the payment of dividends,

junior to the Series L Preferred Stock) unless dividends have been declared and paid or set apart (or ordered

to be set apart) on the Series L Preferred Stock for the then-current quarterly dividend period; provided,

however, that the foregoing dividend preference shall not be cumulative and shall not in any way create any

claim or right in favor of the Holders of Series L Preferred Stock in the event that dividends have not been

declared or paid or set apart (or ordered to be set apart) on the Series L Preferred Stock in respect of any prior

dividend period. If the full dividend on the Series L Preferred Stock is not paid for any quarterly dividend

period, the Holders of Series L Preferred Stock will have no claim in respect of the unpaid amount so long as

no dividend (other than those referred to above) is paid on Fannie Mae's common stock (or any other stock of

Fannie Mae ranking, as to the payment of dividends, junior to the Series L Preferred Stock) for such dividend

period.

(d) The Board of Directors of Fannie Mae, or a duly authorized committee thereof, may, in its

discretion, choose to pay dividends on the Series L Preferred Stock without the payment of any dividends on

Fannie Mae's common stock (or any other stock of Fannie Mae ranking, as to the payment of dividends,

junior to the Series L Preferred Stock).

(e) No full dividends shall be declared or paid or set apart for payment on any stock of Fannie Mae

ranking, as to the payment of dividends, on a parity with the Series L Preferred Stock for any period unless full

dividends have been declared and paid or set apart for payment on the Series L Preferred Stock for the thencurrent quarterly dividend period. When dividends are not paid in full upon the Series L Preferred Stock and

all other classes or series of stock of Fannie Mae, if any, ranking, as to the payment of dividends, on a parity

with the Series L Preferred Stock, all dividends declared upon shares of Series L Preferred Stock and all such

other stock of Fannie Mae will be declared pro rata so that the amount of dividends declared per share of

Series L Preferred Stock and all such other stock will in all cases bear to each other the same ratio that

accrued dividends per share of Series L Preferred Stock (including any adjustments in dividends payable due

to changes in the Dividends-Received Percentage but without, in the case of any noncumulative preferred

stock, accumulation of unpaid dividends for prior dividend periods) and such other stock bear to each other.

(f) No dividends may be declared or paid or set apart for payment on any shares of Series L Preferred

Stock if at the same time any arrears exist or default exists in the payment of dividends on any outstanding

class or series of stock of Fannie Mae ranking, as to the payment of dividends, prior to the Series L Preferred

Stock.

(g) Holders of Series L Preferred Stock will not be entitled to any dividends, whether payable in cash or

property, other than as herein provided and will not be entitled to interest, or any sum in lieu of interest, in

respect of any dividend payment.

3. Optional Redemption.

(a) The Series L Preferred Stock shall not be redeemable prior to April 29, 2008. On or after that date,

subject to the notice provisions set forth in Section 3(b) below and subject to any further limitations which

may be imposed by law, Fannie Mae may redeem the Series L Preferred Stock, in whole or in part, at any

time or from time to time, out of funds legally available therefor, at the redemption price of $50 per share plus

an amount equal to the amount of the dividend (whether or not declared) for the then-current quarterly

dividend period accrued to but excluding the date of such redemption, including any adjustments in dividends

B-3
payable due to changes in the Dividends-Received Percentage but without accumulation of unpaid dividends

on the Series L Preferred Stock for prior dividend periods. If less than all of the outstanding shares of Series L

Preferred Stock are to be redeemed, Fannie Mae will select the shares to be redeemed from the outstanding

shares not previously called for redemption by lot or pro rata (as nearly as possible) or by any other method

that the Board of Directors of Fannie Mae, or a duly authorized committee thereof, in its sole discretion

deems equitable.

(b) In the event Fannie Mae shall redeem any or all of the Series L Preferred Stock as aforesaid, Fannie

Mae will give notice of any such redemption to Holders of Series L Preferred Stock not less than 30 days prior

to the date Ñxed by the Board of Directors of Fannie Mae, or duly authorized committee thereof, for such

redemption. Each such notice will state: (1) the number of shares of Series L Preferred Stock to be redeemed

and, if fewer than all of the shares of Series L Preferred Stock held by a Holder are to be redeemed, the

number of shares to be redeemed from such Holder; (2) the redemption price; (3) the redemption date; and

(4) the place at which a Holder's certiÑcate(s) representing shares of Series L Preferred Stock must be

presented upon such redemption. Failure to give notice, or any defect in the notice, to any Holder of Series L

Preferred Stock shall not aÅect the validity of the proceedings for the redemption of shares of any other

Holder of Series L Preferred Stock being redeemed.

(c) Notice having been given as herein provided, from and after the redemption date, dividends on the

Series L Preferred Stock called for redemption shall cease to accrue and such Series L Preferred Stock called

for redemption will no longer be deemed outstanding, and all rights of the Holders thereof as registered

holders of such shares of Series L Preferred Stock will cease. Upon surrender in accordance with said notice of

the certiÑcate(s) representing shares of Series L Preferred Stock so redeemed (properly endorsed or assigned

for transfer, if the Board of Directors of Fannie Mae, or a duly authorized committee thereof, shall so require

and the notice shall so state), such shares shall be redeemed by Fannie Mae at the redemption price aforesaid.

Any shares of Series L Preferred Stock that shall at any time have been redeemed shall, after such

redemption, be cancelled and not reissued. In case fewer than all the shares represented by any such certiÑcate

are redeemed, a new certiÑcate shall be issued representing the unredeemed shares without cost to the Holder

thereof.

(d) The Series L Preferred Stock will not be subject to any mandatory redemption, sinking fund or other

similar provisions. In addition, Holders of Series L Preferred Stock will have no right to require redemption of

any shares of Series L Preferred Stock.

4. Liquidation Rights.

(a) Upon any voluntary or involuntary dissolution, liquidation or winding up of Fannie Mae, after

payment or provision for the liabilities of Fannie Mae and the expenses of such dissolution, liquidation or

winding up, the Holders of outstanding shares of the Series L Preferred Stock will be entitled to receive out of

the assets of Fannie Mae or proceeds thereof available for distribution to stockholders, before any payment or

distribution of assets is made to holders of Fannie Mae's common stock (or any other stock of Fannie Mae

ranking, as to the distribution of assets upon dissolution, liquidation or winding up of Fannie Mae, junior to the

Series L Preferred Stock), the amount of $50 per share plus an amount equal to the dividend (whether or not

declared) for the then-current quarterly dividend period accrued to but excluding the date of such liquidation

payment, including any adjustments in dividends payable due to changes in the Dividends-Received

Percentage but without accumulation of unpaid dividends on the Series L Preferred Stock for prior dividend

periods.

(b) If the assets of Fannie Mae available for distribution in such event are insuÇcient to pay in full the

aggregate amount payable to Holders of Series L Preferred Stock and holders of all other classes or series of

stock of Fannie Mae, if any, ranking, as to the distribution of assets upon dissolution, liquidation or winding up

of Fannie Mae, on a parity with the Series L Preferred Stock, the assets will be distributed to the Holders of

Series L Preferred Stock and holders of all such other stock pro rata, based on the full respective preferential

amounts to which they are entitled (including any adjustments in dividends payable due to changes in the

B-4
Dividends-Received Percentage but without, in the case of any noncumulative preferred stock, accumulation

of unpaid dividends for prior dividend periods).

(c) Notwithstanding the foregoing, Holders of Series L Preferred Stock will not be entitled to be paid

any amount in respect of a dissolution, liquidation or winding up of Fannie Mae until holders of any classes or

series of stock of Fannie Mae ranking, as to the distribution of assets upon dissolution, liquidation or winding

up of Fannie Mae, prior to the Series L Preferred Stock have been paid all amounts to which such classes or

series are entitled.

(d) Neither the sale, lease or exchange (for cash, shares of stock, securities or other consideration) of all

or substantially all of the property and assets of Fannie Mae, nor the merger, consolidation or combination of

Fannie Mae into or with any other corporation or the merger, consolidation or combination of any other

corporation or entity into or with Fannie Mae, shall be deemed to be a dissolution, liquidation or winding up,

voluntary or involuntary, for the purposes of this Section 4.

(e) After payment of the full amount of the distribution of assets upon dissolution, liquidation or winding

up of Fannie Mae to which they are entitled pursuant to paragraphs (a), (b) and (c) of this Section 4, the

Holders of Series L Preferred Stock will not be entitled to any further participation in any distribution of assets

by Fannie Mae.

5. No Conversion or Exchange Rights.

The Holders of shares of Series L Preferred Stock will not have any rights to convert such shares into or

exchange such shares for shares of any other class or classes, or of any other series of any class or classes, of

stock or obligations of Fannie Mae.

6. No Pre-Emptive Rights.

No Holder of Series L Preferred Stock shall be entitled as a matter of right to subscribe for or purchase,

or have any pre-emptive right with respect to, any part of any new or additional issue of stock of any class

whatsoever, or of securities convertible into any stock of any class whatsoever, or any other shares, rights,

options or other securities of any class whatsoever, whether now or hereafter authorized and whether issued for

cash or other consideration or by way of dividend.

7. Voting Rights; Amendments.

(a) Except as provided below, the Holders of Series L Preferred Stock will not be entitled to any voting

rights, either general or special.

(b) Without the consent of the Holders of Series L Preferred Stock, Fannie Mae will have the right to

amend, alter, supplement or repeal any terms of this CertiÑcate or the Series L Preferred Stock (1) to cure

any ambiguity, or to cure, correct or supplement any provision contained in this CertiÑcate of Designation that

may be defective or inconsistent with any other provision herein or (2) to make any other provision with

respect to matters or questions arising with respect to the Series L Preferred Stock that is not inconsistent with

the provisions of this CertiÑcate of Designation so long as such action does not materially and adversely aÅect

the interests of the Holders of Series L Preferred Stock; provided, however, that any increase in the amount of

authorized or issued Series L Preferred Stock or the creation and issuance, or an increase in the authorized or

issued amount, of any other class or series of stock of Fannie Mae, whether ranking prior to, on a parity with or

junior to the Series L Preferred Stock, as to the payment of dividends or the distribution of assets upon

dissolution, liquidation or winding up of Fannie Mae, or otherwise, will not be deemed to materially and

adversely aÅect the interests of the Holders of Series L Preferred Stock.

(c) Except as set forth in paragraph (b) of this Section 7, the terms of this CertiÑcate or the Series L

Preferred Stock may be amended, altered, supplemented, or repealed only with the consent of the Holders of

at least two-thirds of the shares of Series L Preferred Stock then outstanding, given in person or by proxy,

either in writing or at a meeting of stockholders at which the Holders of Series L Preferred Stock shall vote

B-5
separately as a class. On matters requiring their consent, Holders of Series L Preferred Stock will be entitled

to one vote per share.

(d) The rules and procedures for calling and conducting any meeting of Holders (including, without

limitation, the Ñxing of a record date in connection therewith), the solicitation and use of proxies at such a

meeting, the obtaining of written consents, and any other aspect or matter with regard to such a meeting or

such consents shall be governed by any rules that the Board of Directors of Fannie Mae, or a duly authorized

committee thereof, in its discretion, may adopt from time to time, which rules and procedures shall conform to

the requirements of any national securities exchange on which the Series L Preferred Stock are listed at the

time.

8. Additional Classes or Series of Stock.

The Board of Directors of Fannie Mae, or a duly authorized committee thereof, shall have the right at

any time in the future to authorize, create and issue, by resolution or resolutions, one or more additional

classes or series of stock of Fannie Mae, and to determine and Ñx the distinguishing characteristics and the

relative rights, preferences, privileges and other terms of the shares thereof. Any such class or series of stock

may rank prior to, on a parity with or junior to the Series L Preferred Stock as to the payment of dividends or

the distribution of assets upon dissolution, liquidation or winding up of Fannie Mae, or otherwise.

9. Priority.

For purposes of this CertiÑcate of Designation, any stock of any class or series of Fannie Mae shall be

deemed to rank:

(a) Prior to the shares of Series L Preferred Stock, either as to the payment of dividends or the

distribution of assets upon dissolution, liquidation or winding up of Fannie Mae, if the holders of such class or

series shall be entitled to the receipt of dividends or of amounts distributable upon dissolution, liquidation or

winding up of Fannie Mae, as the case may be, in preference or priority to the Holders of shares of Series L

Preferred Stock.

(b) On a parity with shares of Series L Preferred Stock, either as to the payment of dividends or the

distribution of assets upon dissolution, liquidation or winding up of Fannie Mae, whether or not the dividend

rates or amounts, dividend payment dates or redemption or liquidation prices per share, if any, be diÅerent

from those of the Series L Preferred Stock, if the holders of such class or series shall be entitled to the receipt

of dividends or of amounts distributable upon dissolution, liquidation or winding up of Fannie Mae, as the case

may be, in proportion to their respective dividend rates or amounts or liquidation prices, without preference or

priority, one over the other, as between the holders of such class or series and the Holders of shares of Series L

Preferred Stock.

(c) Junior to shares of Series L Preferred Stock, either as to the payment of dividends or the distribution

of assets upon dissolution, liquidation or winding up of Fannie Mae, if such class shall be common stock of

Fannie Mae or if the Holders of shares of Series L Preferred Stock shall be entitled to the receipt of dividends

or of amounts distributable upon dissolution, liquidation or winding up of Fannie Mae, as the case may be, in

preference or priority over the holders of such class or series.

(d) The shares of Preferred Stock of Fannie Mae designated ""5.25% Non-Cumulative Preferred Stock,

Series D'' (the ""Series D Preferred Stock''), ""5.10% Non-Cumulative Preferred Stock, Series E'' (the

""Series E Preferred Stock''), ""Variable Rate Non-Cumulative Preferred Stock, Series F'' (the ""Series F

Preferred Stock''), ""Variable Rate Non-Cumulative Preferred Stock, Series G'' (the ""Series G Preferred

Stock''), ""5.81% Non-Cumulative Preferred Stock, Series H'' (the ""Series H Preferred Stock'') , ""5.375%

Non-Cumulative Preferred Stock, Series I'' (the ""Series I Preferred Stock''), ""Variable Rate NonCumulative Preferred Stock, Series J (the ""Series J Preferred Stock'') and ""Variable Rate Non-Cumulative

Preferred Stock, Series K'' (the ""Series K Preferred Stock'') shall be deemed to rank on a parity with shares

of Series L Preferred Stock as to the payment of dividends and the distribution of assets upon dissolution,

liquidation or winding up of Fannie Mae. Accordingly, the holders of record of Series D Preferred Stock, the

B-6
holders of record of Series E Preferred Stock, the holders of record of Series F Preferred Stock, the holders of

record of Series G Preferred Stock, the holders of record of Series H Preferred Stock, the holders of record of

Series I Preferred Stock, the holders of record of Series J Preferred Stock, the holders of record of Series K

Preferred Stock and the holders of record of Series L Preferred Stock shall be entitled to the receipt of

dividends and of amounts distributable upon dissolution, liquidation or winding up of Fannie Mae, as the case

may be, in proportion to their respective dividend rates or amounts or liquidation prices, without preference or

priority, one over the other.

10. Transfer Agent, Dividend Disbursing Agent and Registrar.

Fannie Mae hereby appoints EquiServe Trust Company, N.A., as its initial transfer agent, dividend

disbursing agent and registrar for the Series L Preferred Stock. Fannie Mae may at any time designate an

additional or substitute transfer agent, dividend disbursing agent and registrar for the Series L Preferred Stock.

11. Notices.

Any notice provided or permitted by this CertiÑcate of Designation to be made upon, or given or

furnished to, the Holders of Series L Preferred Stock by Fannie Mae shall be made by Ñrst-class mail, postage

prepaid, to the addresses of such Holders as they appear on the books and records of Fannie Mae. Such notice

shall be deemed to have been suÇciently made upon deposit thereof in the United States mail. Notwithstanding anything to the contrary contained herein, in the case of the suspension of regular mail service or by reason

of any other cause it shall be impracticable, in Fannie Mae's judgment, to give notice by mail, then such

notiÑcation may be made, in Fannie Mae's discretion, by publication in a newspaper of general circulation in

The City of New York or by hand delivery to the addresses of Holders as they appear on the books and records

of Fannie Mae.

Receipt and acceptance of a share or shares of the Series L Preferred Stock by or on behalf of a Holder

shall constitute the unconditional acceptance by such Holder (and all others having beneÑcial ownership of

such share or shares) of all of the terms and provisions of this CertiÑcate of Designation. No signature or

other further manifestation of assent to the terms and provisions of this CertiÑcate of Designation shall be

necessary for its operation or eÅect as between Fannie Mae and the Holder (and all such others).

B-7
®THIS PAGE INTENTIONALLY LEFT BLANK©
Appendix C

Annual Report on Form 10-K

For the fiscal year ended December 31, 2002, Ñled with the SEC on March 31, 2003
®THIS PAGE INTENTIONALLY LEFT BLANK©
UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-K

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934

For the Ñscal year ended December 31, 2002

Commission File No.: 0-50231

Federal National Mortgage Association

(Exact name of registrant as speciÑed in its charter)

Fannie Mae

Federally chartered corporation 52-0883107

(State or other jurisdiction of (I.R.S. Employer

incorporation or organization) IdentiÑcation No.)

3900 Wisconsin Avenue, NW 20016

Washington, DC (Zip Code)

(Address of principal executive oÇces)

Registrant's telephone number, including area code:

 (202) 752-7000

Securities registered pursuant to Section 12(b) of the Act:

None

Securities registered pursuant to Section 12(g) of the Act:

Common Stock, without par value

(Title of class)

Indicate by check mark whether the registrant (1) has Ñled all reports required to be Ñled by Section 13

or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period

that the registrant was required to Ñle such reports), and (2) has been subject to such Ñling requirements for

the past 90 days. Yes n No ¥

Indicate by check mark if disclosure of delinquent Ñlers pursuant to Item 405 of Regulation S-K is not

contained herein, and will not be contained, to the best of registrant's knowledge, in deÑnitive proxy or

information statements incorporated by reference in Part III of this Form 10-K or any amendment to this

Form 10-K. ¥

Indicate by check mark whether the registrant is an accelerated Ñler (as deÑned in Exchange Act

Rule 12b-2). Yes n No ¥

As of the close of business on February 28, 2003, there were 986,925,508 shares of common stock

outstanding. As of June 28, 2002 (the last business day of Registrant's most recent second Ñscal quarter), the

aggregate market value of the common stock held by non-aÇliates of the registrant was approximately

$73,217 million. As of February 28, 2003, the aggregate market value of the common stock held by nonaÇliates of the registrant was approximately $63,262 million.

DOCUMENTS INCORPORATED BY REFERENCE

Material contained in the registration statement of Fannie Mae on Form 10 Ñled with the Securities and

Exchange Commission on March 31, 2003 is incorporated by reference in Part II, Item 5, and Part III of this

Form 10-K.
TABLE OF CONTENTS

Page

PART I ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 1

Item 1. Business ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 1

Overview ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 1

Introduction ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 1

Business SegmentsÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 1

Additional Information ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2

The Residential Mortgage MarketÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 3

Residential Mortgage Debt Outstanding ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 3

Our Role in the Secondary Mortgage Market ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 4

Fannie Mae Business StandardsÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 4

Principal Balance LimitsÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 4

Loan-to-Value Ratios ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 5

Underwriting Guidelines ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 5

The Mortgage Seller or Servicer ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 6

Mortgage Committing and Servicing Arrangements ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 6

Single-Family Mortgage Commitments ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 6

Servicing Arrangements ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 6

Business SegmentsÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 7

Portfolio Investment Business ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 7

Credit Guaranty Business ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 10

Fee-Based Services ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 13

Housing Goals ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 14

Competition ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 14

Employees ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 16

Government Regulation and Charter Act ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 16

Charter Act ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 16

Regulatory Approval and OversightÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 17

Capital Requirements ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 18

Dividend Restrictions ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 18

Item 2. Properties ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 19

Item 3. Legal Proceedings ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 19

Item 4. Submission of Matters to a Vote of Security HoldersÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 19

PART IIÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 19

Item 5. Market for Registrant's Common Equity and Related Stockholder Matters ÏÏÏÏÏÏÏÏÏÏÏÏ 19

Item 6. Selected Financial Data ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 20

Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations ÏÏÏ 22

Forward-Looking Information ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 22

Organization of Information ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 23

2002 Overview ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 23

About Fannie Mae ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 25

Results of Operations ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 26

Net Interest Income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 27

Guaranty Fee Income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 29

Fee and Other Income (Expense)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 30

Credit-Related ExpensesÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 30

Administrative Expenses ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 31

Special Contribution ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 32

Purchased Options Expense ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 32

Debt Extinguishments ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 32

i
Page

Income TaxesÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 33

Cumulative EÅect of Change in Accounting Principle ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 33

Core Business Earnings and Business Segment Results ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 33

Core Business EarningsÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 33

Taxable-Equivalent RevenuesÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 37

Core Net Interest Income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 38

Business Segment ResultsÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 40

OÅ-Balance Sheet Transactions ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 53

Guaranteed MBS and Other Mortgage-Related Securities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 53

CommitmentsÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 54

Application of Critical Accounting Policies ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 55

Allowance for Loan Losses and Guaranty Liability for MBS ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 55

Deferred Price Adjustments ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 57

Time Value of Purchased OptionsÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 59

Risk Management ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 61

Interest Rate Risk Management ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 61

Credit Risk Management ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 75

Operations Risk Management ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 94

Liquidity and Capital Resources ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 96

Liquidity ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 96

Capital Resources ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 97

Performance Outlook ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 100

New Accounting Standards ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 100

Accounting for Stock Compensation ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 100

Guarantor's Accounting and Disclosure Requirements for Guarantees ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 101

Special Purpose Entities (""SPEs'') ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 101

Item 7A. Quantitative and Qualitative Disclosures About Market Risk ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 102

Item 8. Financial Statements and Supplementary Data ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 103

Item 9. Changes in and Disagreements With Accountants on Accounting and Financial 

Disclosure ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 151

PART III ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 151

Item 10. Directors and Executive OÇcers of the Registrant ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 151

Section 16(a) BeneÑcial Ownership Reporting Compliance ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 151

Item 11. Executive CompensationÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 151

Item 12. Security Ownership of Certain BeneÑcial Owners and Management and Related 

Stockholder Matters ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 151

Item 13. Certain Relationships and Related Transactions ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 151

Item 14. Controls and Procedures ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 151

PART IV ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 152

Item 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 152

SIGNATURES ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 153

CERTIFICATIONS ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 155

ii
PART I

Item 1. Business

Overview

Introduction

At Fannie Mae (formally, the Federal National Mortgage Association), our purpose is to facilitate the

Öow of low-cost mortgage capital in order to increase the availability and aÅordability of homeownership for

low-, moderate-, and middle-income Americans. We operate under a federal charter and our primary

regulator is the OÇce of Federal Housing Enterprise Oversight (""OFHEO''). However, we are a private,

shareholder-owned company. The U.S. government does not guarantee, directly or indirectly, Fannie Mae's

debt securities or other obligations.

Fannie Mae is the nation's largest source of funds for mortgage lenders and investors, providing resources

for our customers to make additional mortgage loans or investments in mortgage-related securities. We

provide liquidity to the mortgage market for the beneÑt of borrowers; however, we do not lend money directly

to consumers. We operate exclusively in the secondary mortgage market by purchasing mortgages and

mortgage-related securities, including Fannie Mae mortgage-related securities, from primary market institutions, such as commercial banks, savings and loan associations, mortgage companies, securities dealers and

other investors. We provide additional liquidity in the secondary mortgage market by issuing and guaranteeing

mortgage-related securities.

We also oÅer fee-based services to our customers that facilitate our purpose and mission. These services

include issuing and administering a variety of mortgage-related securities, providing credit enhancements and

oÅering technology products to aid in originating and underwriting mortgage loans.

Fannie Mae expands equal housing access and opportunity in America by helping our lender customers

reach the nation's underserved families and communities. In 1994, we launched our Trillion Dollar

Commitment to provide $1 trillion in home Ñnancing for 10 million families traditionally underserved by

mainstream mortgage Ñnance. After achieving that goal ahead of plan, in 2000 Fannie Mae announced a new,

redoubled aÅordable housing plan, our $2 trillion American Dream Commitment», to serve 18 million

underserved families by 2010.

Under the American Dream Commitment, Fannie Mae has pledged to promote mortgage consumer

rights, including broader, more equal access to lowest-cost mortgage credit; Ñght mortgage discrimination and

lead the housing market in serving minority families, including a pledge to provide $700 billion in Ñnancing for

4.6 million minority households; address the unique housing needs of women-headed households, young

families, new immigrants, seniors, and urban and rural dwellers; strengthen inner-city communities and older

suburban areas; provide new technologies to mortgage lenders and consumers in order to lower mortgage

Ñnancing costs; and increase the supply of aÅordable rental housing.

Fannie Mae was established in 1938 as a United States government-owned entity to provide supplemental liquidity to the secondary market for residential mortgages and to promote access to mortgage credit

throughout the nation. We became a stockholder-owned and privately-managed corporation by legislation

enacted in 1968, which we refer to as the ""Charter Act'' (the Federal National Mortgage Association Charter

Act, 12 U.S.C. Û1716 et seq.). Our common stock is traded primarily on the New York Stock Exchange under

the symbol ""FNM.''

Business Segments

We provide liquidity in the secondary mortgage market through our two primary business segments: the

portfolio investment business and the credit guaranty business.

In the portfolio investment business, we purchase loans and mortgage-related securities from mortgage

lenders, which replenishes those lenders' funds for making additional mortgage loans. We also purchase loans,

mortgage-related securities and other investments from securities dealers, investors and other market

1
participants. In addition, our liquid investment portfolio invests in high quality, short-term, non-mortgage

assets that can provide us with liquidity as the need arises. We acquire the funds to purchase these loans,

mortgage-related securities and other investments from our equity capital and by selling debt securities to

domestic and international capital markets investors. By doing so, we expand the total amount of funds

available to Ñnance housing in the United States. Income from our portfolio investment business comes

primarily from the diÅerence, or spread, between the yield on mortgage loans and other investments in our

portfolio and our borrowing costs.

In the credit guaranty business, we receive fees for our guaranty of timely payment of scheduled principal

and interest on mortgage-related securities guaranteed by Fannie Mae and held by investors other than Fannie

Mae. For segment reporting purposes, we also allocate a fee comparable to an MBS guaranty fee from the

portfolio investment business to the credit guaranty business for management of the credit risk on mortgage

portfolio investments. The guaranty fees we charge are based on the credit risk we assume, the costs of

administering the mortgage-related securities and market and competitive factors. In a typical mortgagerelated securities transaction, a lender will deliver mortgage loans to us that it has originated or purchased. We

place these loans in a trust and issue certiÑcates evidencing beneÑcial interests in the trust, then deliver the

certiÑcates with our guaranty to the lender or its designee. The lender may then hold the mortgage-related

securities as an investment or sell the securities in the market to replenish its funds for additional lending. This

activity provides liquidity to the lender because mortgage-related securities, with Fannie Mae's guaranty, are

more readily marketable than mortgage loans without this guaranty.

We have described our business segments in more detail under ""Business Ì Overview Ì Business

Segments.''

Additional Information

In this document, we refer to both whole loans and participation interests in loans as ""loans,'' ""mortgage

loans'' and ""mortgages.'' The term ""mortgage'' also is used to refer to the deed of trust or other security

instrument securing a loan. The terms ""loans'' and ""mortgage loans'' may include loans secured by

manufactured housing. Mortgage loans secured by four or fewer dwelling units are referred to as ""singlefamily'' mortgage loans and mortgage loans secured by more than four dwelling units are referred to as

""multifamily'' mortgage loans. We use the term ""mortgage-related securities'' generally to refer to mortgage

pass-through trust certiÑcates representing beneÑcial interests in pools of mortgage loans or other mortgagerelated securities. The term ""MBS'' (mortgage-backed securities) speciÑcally refers to mortgage-related

securities we issue and on which we guarantee timely payment of scheduled principal and interest.

Debt, equity and mortgage-related securities we issue are exempt from registration under the Securities

Act of 1933 and are ""exempted securities'' under the Securities Exchange Act of 1934. In July 2002, we

announced a voluntary initiative to register our common stock, without par value, with the Securities and

Exchange Commission under Section 12(g) of the Securities Exchange Act of 1934. The registration of our

common stock became eÅective on March 31, 2003. Registration of our common stock does not impact the

exempt status of debt, equity and mortgage-related securities we issue.

We Ñle reports, proxy statements and other information with the Securities and Exchange Commission,

beginning in 2003. You may read and copy any materials we Ñle with the SEC at the SEC's Public Reference

Room at 450 Fifth Street, NW, Washington, DC 20549. You may obtain information on the operation of the

Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC maintains an Internet site

(http://www.sec.gov) that contains reports, proxy statements, and other information that we Ñle with the

SEC. You may also inspect our SEC reports and other information at the New York Stock Exchange, Inc.,

20 Broad Street, New York, NY 10005 or obtain them, free of charge, from our website at

http://www.fanniemae.com. We are providing the addresses of the SEC's and our Internet sites solely for the

information of investors. We do not intend the Internet addresses to be active links.

2
The Residential Mortgage Market

Residential Mortgage Debt Outstanding

The housing market in which we operate consists of the supply, or ""stock,'' of total outstanding residential

mortgages. In its Flow of Funds Accounts, the Board of Governors of the Federal Reserve System estimates

and publishes Ñgures each quarter on the stock of residential mortgages. The total residential mortgage debt

outstanding Ñgures published by the Federal Reserve include loans secured by single-family properties and

multifamily properties. As of December 31, 2002, the latest date for which information is available, the

Federal Reserve's estimate for total residential mortgage debt outstanding was $7 trillion. (See ""Business Ì

Fannie Mae Business Standards Ì Principal Balance Limits'' for a discussion of the limits on mortgages we

purchase.) The following table shows the Federal Reserve's estimate for residential mortgage debt outstanding

for the last 12 years.

Multifamily

Mortgage Debt

Outstanding

Single-family

Mortgage Debt

Outstanding 0

2000

1000

4000

3000

6000

5000

$8000

7000

1990

1992

1994

1996

1998

2000

2002

We expect growth in residential mortgage debt outstanding over the next ten years to be driven by the

following factors:

‚ Household Formation. Household formation represents the number of new households that will need

homes. Household formation is a principal driver of demand for homes. Growth in household

formation is driven by growth in the population and ""headship rates,'' the rate at which the population

forms into households.

‚ Homeownership Rates. Homeownership rates reÖect the percentage of the population that owns a

home. As reported by the Census Bureau, Department of Commerce, the national homeownership rate

grew at approximately one-half a percent a year during the decade of the 1990s, rising from 64 percent

to over 67 percent. The growth in homeownership rates was driven by increased aÅordability of homes,

improved technology (e.g., automated underwriting), and low downpayment lending. We expect future

growth in homeownership rates to be driven by economic growth, increases in minority homeownership

rates, and demographic trends as baby-boomers move into age groups that traditionally experience

higher homeownership rates. We anticipate that minority homeownership rates will beneÑt from a

shortage in rental housing, the expansion of more Öexible, low downpayment lending, and tax

incentives.

‚ Home Price Appreciation. Home price appreciation reÖects the combined eÅect of two components:

the underlying rate of inÖation and the amount that home prices appreciate net of inÖation. Home

price appreciation allows current homeowners to borrow against the additional equity in their homes

and causes new homebuyers to borrow more to Ñnance the purchase of a home. Home prices have

typically appreciated faster than inÖation. While inÖation and home price appreciation over inÖation

were relatively low for most of the 1990s, home price appreciation over inÖation returned to more

historical levels in the latter part of the decade. Home price appreciation in the current decade will

depend upon the demand and supply for housing. We expect the supply of housing to be somewhat

constrained relative to demand due to limited availability of land and the increase of land use controls.

3
‚ Debt-to-Value Ratios. The debt-to-value ratio represents the percentage of total housing value that is

Ñnanced with mortgage debt. Over the past 50 years, homeowners have steadily increased the

percentage of their home value that is Ñnanced with debt, from around 20 percent to 44.4 percent at

the end of 2002. This increase reÖects the rising prices of homes, the increased popularity of cash-out

reÑnancing as a means to tap equity wealth, availability of home equity lines of credit, and increased

lower downpayment lending. Growth in the mortgage debt-to-value ratio over the coming decade will

be driven by continued expansion of lower downpayment lending, and increased use by homeowners of

the equity, or value, in their homes for other purposes.

As of December 31, 2002, Fannie Mae held 11 percent of total residential mortgage debt outstanding in

our mortgage portfolio, which includes mortgage-related securities. MBS issued by Fannie Mae and held by

investors other than Fannie Mae represented an additional 15 percent of total residential mortgage debt

outstanding.

Our Role in the Secondary Mortgage Market

Our lender customers are part of the primary mortgage market, where mortgages are originated and funds

are loaned to borrowers. Primary market lenders include mortgage companies, savings and loan associations,

commercial banks, credit unions, and state and local housing Ñnance agencies.

Lenders sell mortgages into the ""secondary market,'' where mortgages are bought and sold by various

investors. Secondary market investors include Fannie Mae, the Federal Home Loan Mortgage Corporation

(""Freddie Mac''), the Federal Home Loan Banks, pension funds, insurance companies, securities dealers, and

other Ñnancial institutions. Lenders may sell their mortgages into the secondary market in the form of whole

loans or in the form of mortgage-related securities. For lenders that want to hold or sell mortgages in the form

of mortgage-related securities, we may create those securities for them.

As the secondary market leader, Fannie Mae's central role in providing a steady stream of mortgage

funds to lenders across the country is supported by technologies that help us manage our risks and make the

process of buying a home quicker, easier, and less expensive. We have developed an automated underwriting

system for single-family mortgage loans that our lender customers are using nationwide, and allows consumers

to obtain loan approval more quickly and consistently, and with lower closing costs than ever before.

We purchase mortgage loans for our portfolio and exchange mortgage-related securities for mortgage

loans from over two thousand primary market lenders that have a selling and servicing contract with us. Five

of those customers accounted for approximately 50 percent of the single-family mortgage loans that we

purchased or guaranteed in 2002. Ten lender customers accounted for approximately 63 percent of the singlefamily mortgage loans that we purchased or guaranteed in 2002. In addition, we purchase mortgage loans and

mortgage-related securities from securities dealers, investors and other participants in the secondary market.

Fannie Mae Business Standards

The mortgage loans we purchase or guarantee must meet standards required by the Charter Act,

including maximum principal balance limits and credit enhancement requirements. The Charter Act also

requires that, so far as practicable and in our judgment, the mortgage loans be of a quality, type, and class that

meet, generally, the purchase standards imposed by private institutional mortgage investors. Consistent with

those requirements, and with the purposes for which we were chartered, we establish additional eligibility

criteria and policies for the mortgage loans we purchase or guaranty, and for the sellers and servicers of those

mortgage loans. Servicers are the entities that collect loan payments and perform other administrative

functions with respect to the mortgage loans we purchase or guarantee.

Principal Balance Limits

Our purchase and guaranty of single-family ""conventional'' mortgage loans (loans not federally insured or

guaranteed) are subject to certain maximum original principal balance limits, often referred to as the

""conforming loan limit.'' For 2002, the limit for a one-family residence was $300,700 (except for loans secured

4
by properties in Alaska, Hawaii, Guam, and the Virgin Islands). Higher principal balance limits apply to loans

secured by properties in those areas or secured by two- to four-family residences. We can adjust the maximum

principal balance limits applicable to conventional single-family mortgage loans annually based on the year-toyear change in the national average price of a one-family house as surveyed by the Federal Housing Finance

Board each October. In November 2002, the limit for loans acquired in 2003, secured by a one-family

residence, was increased to $322,700. There are no statutory limits on the maximum principal balance of

multifamily mortgage loans that we purchase or guarantee. Mortgage loans insured by the Federal Housing

Administration (""FHA'') are subject to separate statutory maximum amount limitations. There are no

statutory limits on the principal balance of loans guaranteed by the Department of Veterans AÅairs (""VA'')

or by the Rural Housing Service (""RHS'').

Loan-to-Value Ratios

The loan-to-value ratio requirements for loans we purchase or guaranty may vary depending upon a

variety of factors such as the loan purpose, the number of dwelling units in the property securing the loan, the

repayment terms, borrower credit history, and FHA or VA loan-to-value limits. Depending upon these factors,

the loan-to-value ratio for loans we purchase or guarantee can be in excess of 100 percent.

The Charter Act requires credit enhancement on any conventional single-family mortgage loan that we

purchase or guarantee if it has a loan-to-value ratio over 80 percent at the time of purchase or guaranty. Credit

enhancement may take several forms, including insurance or a guaranty issued by a qualiÑed insurer,

repurchase arrangements with the seller of the mortgage loans, and seller-retained participation interests. We

may require credit enhancement in excess of the minimum required to satisfy this provision of the Charter

Act.

Underwriting Guidelines

We have established underwriting guidelines for the purchase or guaranty of mortgage loans to eÅectively

manage the risk of loss from borrower defaults. Lenders determine whether to make mortgage loans and

frequently have several investors to whom they sell loans. When originating loans to be purchased or

guaranteed by Fannie Mae, lenders look to our underwriting guidelines. We designed these guidelines to assess

the creditworthiness of the borrower, as well as the value of the mortgaged property relative to the amount of

the mortgage loan. At our discretion, we may grant waivers from these underwriting guidelines. We also

review and change these guidelines from time to time. As part of our aÅordable housing initiatives, we

continue to introduce new underwriting criteria in an attempt to make the mortgage Ñnance system more

accessible to minorities, low- and moderate-income families, underserved and rural residents, and people with

special housing needs. In addition, we continue to look for more eÅective methods of assessing the

creditworthiness of potential borrowers and property values.

We generally rely on lender representations and warranties that the mortgage loans we purchase or

guaranty conform to our applicable guidelines. We also perform quality control reviews of selected loans to

monitor compliance with the guidelines. In the event that a lender is found to have breached its

representations with respect to a loan's compliance with the guidelines, we can require that the lender

repurchase the loan, indemnify us against any loss or, in some cases, share a greater percentage of any loss.

Over the last several years, we have enhanced Desktop Underwriter», our automated underwriting

system, to assist lenders in applying Fannie Mae underwriting standards for single-family loans. Desktop

Underwriter is designed to help lenders process mortgage applications in a more eÇcient and accurate manner

and to apply our underwriting criteria consistently, objectively, and in a more customized manner to all

prospective borrowers. If Desktop Underwriter provides an ""approve/eligible'' or ""expanded approval/

eligible'' recommendation to a lender regarding a loan application, we waive certain representations by the

lender as long as the information that was submitted by the lender through Desktop Underwriter is accurate

and the lender complies with other speciÑed requirements.

5
The Mortgage Seller or Servicer

Before we approve a lender or other customer to become a seller or servicer, we require that it meet

certain standards which include demonstrating, to our satisfaction, that it:

‚ has a proven ability to originate or service the type of mortgages for which our approval is being

requested;

‚ employs a staÅ with adequate experience;

‚ has as one of its principal business purposes the origination or servicing of residential mortgages;

‚ is properly licensed, or otherwise authorized, to originate, sell, or service residential mortgages in each

of the jurisdictions in which it does business;

‚ meets Ñnancial criteria and standards;

‚ has quality control and management systems to evaluate and monitor the overall quality of its loan

production and servicing activities; and

‚ is adequately covered by a Ñdelity bond and errors and omissions insurance.

We enter into a written mortgage selling and servicing contract with each approved customer. In this

contract, the customer agrees to a number of obligations, including ongoing compliance with the foregoing

provisions to our satisfaction.

Mortgage Committing and Servicing Arrangements

Single-Family Mortgage Commitments

We enter into master agreements with lenders to facilitate ongoing transactions. Mortgage loans delivered

to us for pooling into MBS generally require a master agreement, while mortgage loans purchased in cash

transactions may or may not be under a master agreement. Pursuant to a master agreement, a lender agrees to

deliver a speciÑed volume of mortgage loans over a speciÑed period of time, usually 12 months.

The master agreement usually requires mandatory delivery by the lender of an agreed upon volume, but

may also contain an amount that is optional for the lender to deliver after it has met the required mandatory

delivery commitment. If a lender does not deliver the mandatory portion of the speciÑed volume, we may

assess a buyout fee based on the undelivered amount. The optional portion of the volume does not obligate the

lender to sell loans to us.

Whether or not there is a master agreement, we purchase mortgage loans for our portfolio pursuant to

""mandatory delivery commitments,'' which can be for either standard or negotiated loan products. Under

these commitments, lenders are obligated to sell to us the mortgage loans described in the commitment at an

agreed-upon price and within an agreed-upon time period (generally from one to ninety days for Ñxed-rate

mortgages and from one to sixty days for adjustable-rate mortgages). If a lender is unable to deliver some or

all of the mortgage loans required under a mandatory delivery commitment during the term of the

commitment, the lender may repurchase the remaining balance of the commitment for a ""pair-oÅ'' fee. We

may assess the pair-oÅ fee based on the amount of the commitment being paired oÅ and the diÅerence

between the commitment price and the current price.

Servicing Arrangements

Mortgage loans held in our mortgage portfolio or in a trust for holders of our MBS may be serviced only

by an approved servicer. We do not service mortgage loans directly. Typically, lenders who sell single-family

mortgage loans and conventional multifamily loans to Fannie Mae initially service the mortgage loans they sell

to us. There is an active market in which lenders sell servicing rights to other servicers. In addition, we may at

times engage a servicing entity to service loans on our behalf due to termination of a servicer or for other

reasons.

6
Mortgage servicers collect and remit principal and interest payments, administer escrow accounts,

evaluate transfers of ownership interests, respond to requests for partial releases of security, and handle

proceeds from casualty and condemnation losses. For problem loans, servicing includes negotiating workouts

and, if necessary, inspecting and preserving properties and processing foreclosures and bankruptcies. In the

case of multifamily loans, servicing also may include performing routine property inspections, evaluating the

Ñnancial condition of owners, and administering various types of agreements (including agreements regarding

replacement reserves, completion or repair, and operations and maintenance). We compensate servicers

primarily by permitting them to retain a speciÑed portion of each interest payment on a serviced mortgage

loan, called a ""servicing fee.'' The weighted average servicing fee for conventional single-family loans owned

or guaranteed by Fannie Mae in 2002 was .389 percent. We have the right to remove servicing responsibilities

from any lender under criteria established in our contractual arrangements with lenders.

Business Segments

Portfolio Investment Business

Overview. Our portfolio investment business has two principal components: a mortgage portfolio and a

liquid investment portfolio. The mortgage portfolio purchases mortgage loans, mortgage-related securities, and

other investments from lenders, securities dealers, investors, and other market participants. The liquid

investment portfolio primarily purchases readily marketable, high credit quality, non-mortgage securities from

securities dealers. The securities have short term maturities or can be sold as a source of funds to meet our

cash Öow needs. We fund the purchase of assets for our mortgage and liquid investment portfolios primarily by

borrowing money in the domestic and international capital markets through the sale of debt securities. We

derive income from the diÅerence, or ""spread,'' between the yield we earn on our portfolio investments and the

interest we pay on our borrowings.

The following diagram illustrates the basic structure of how we purchase a loan and fund that mortgage

portfolio investment.

7
1

2 3

Mortgage Portfolio Loan Purchase

Fannie Mae

Consumers

Lenders

Mortgages

Mortgages

$$$

$$$

$$$

Lender sells 

mortgage loans 

to Fannie Mae

Fannie Mae issues debt 

securities to investors to 

finance loan purchase

Lender 

originates 

mortgage loans 

with consumer

Debt Securities

Lenders originate mortgages with consumers and may decide to sell them as whole loans. 

Fannie Mae purchases the loans for its portfolio, and issues debt in the capital markets to fund 

the purchases.

Investors

Most of the single-family mortgage loans in our mortgage portfolio or backing mortgage-related securities

in our portfolio may be prepaid by the borrower at any time without penalty. We, therefore, bear the risk that

if our mortgage assets are paid oÅ as interest rates decline, or as a result of other factors, we may not be able to

prepay the outstanding indebtedness used to Ñnance those assets or to reinvest the prepayment proceeds at a

rate at or above our borrowing costs. If interest rates rise, our debt costs could rise faster than the yield on our

mortgage assets and thereby reduce our interest spread. In contrast, most multifamily loans contain a

prepayment premium that compensates us for the loss of yield in the event of a prepayment, or provide some

other mechanism to protect us from prepayment risk. We actively manage our mortgage portfolio to mitigate

prepayment risks. Our approach to managing interest rate risk includes three central elements. First, we

attempt to fund purchases of mortgage assets with liabilities that have similar cash Öow patterns through time

and in diÅerent interest rate environments. We use a combination of debt securities and interest rate

derivatives to achieve the appropriate funding mix. Second, we regularly assess the mortgage portfolio's

exposure to changes in interest rates using a diverse set of analyses and measures. Third, we establish

appropriate parameters for taking rebalancing actions that meet our objectives, and undertake rebalancing

actions as necessary.

Our mortgage portfolio is also exposed to the credit risk that borrowers may fail to repay mortgage loans

held in our portfolio or backing mortgage-related securities held in our portfolio. Our credit guaranty business

is responsible for managing mortgage credit risk on loans and mortgage-related securities held in our portfolio

and mortgage-related securities guaranteed by us that are held by other investors. Accordingly, for segment

reporting purposes, we allocate a fee comparable to an MBS guaranty fee from the portfolio investment

business to the credit guaranty business for management of the credit risk on the mortgage loans and

mortgage-related securities held in the portfolio. Likewise, all mortgage-related credit expenses are allocated

to the credit guaranty business. We establish a loss reserve for credit risk allocated to the credit guaranty

8
business. This intersegment allocation of a credit risk management fee and mortgage-related credit expenses

has no impact on Fannie Mae's reported net income.

Mortgage Portfolio

Assets Purchased. Fannie Mae purchases primarily single-family, conventional, Ñxed- or adjustablerate, Ñrst lien mortgage loans, or mortgage-related securities backed by such loans. In addition, we purchase

loans insured by the FHA, loans guaranteed by the VA or RHS, manufactured housing loans, multifamily

mortgage loans, subordinate mortgage loans (e.g., loans secured by second liens) and other mortgage-related

securities. See ""Item 7 Ì Management's Discussion and Analysis of Financial Condition and Results of

Operations Ì Business Segment Results Ì Portfolio Investment Business Ì Mortgage Portfolio Ì Table 8''

for information on the composition of our mortgage portfolio.

Maturities. Fannie Mae purchases conventional, single-family Ñxed-rate mortgages with original

maturities of up to 30 years and conventional, single-family adjustable-rate mortgages (""ARMs'') with

maturities of up to 40 years. Only a small portion of ARMs we purchase have maturities of more than

30 years. The multifamily mortgage loans we purchase generally are Ñxed-rate loans with maturities of up to

30 years.

Payment Structure; Balloon Payments. The majority of Ñxed-rate mortgage loans we purchase provide

for equal or ""level'' monthly installments of principal and interest. Some of these loans have larger or

""balloon'' payments due 5, 7, or 10 years after origination, but with monthly payments based on longer (e.g.,

30-year) amortization schedules. Most of the 7-year balloon single-family mortgage loans permit the borrower

to reÑnance the balloon payment at maturity with a 23-year Ñxed-rate mortgage loan if certain requirements

are satisÑed. Many of the multifamily mortgage loans have balloon payments due 5, 7, 10, or 15 years after

origination, but with payments based on 25- or 30-year amortization schedules.

Adjustable-Rate Mortgage Loans. The interest rates on ARMs are determined by formulas providing

for automatic adjustment, up or down, at speciÑed intervals in accordance with changes in speciÑed indices.

Fixed-period ARMs have an interest rate that is Ñxed for the Ñrst 2 to 10 years, and is adjusted at speciÑed

intervals after the initial period. The payments of interest, or principal and interest, on substantially all ARMs

adjust (up or down) after the interest rate on the loan is adjusted because of changes in the applicable index.

We currently purchase single-family ARMs only if the ARMs limit the amount the interest rate may change

over the life of the loan. We purchase a small amount of ARMs that may permit negative amortization. We

generally require that those loans be reamortized at least annually to limit the amount of negative amortization

that may accrue.

We also purchase certain ARMs, called reverse mortgages, that provide for periodic installments of

principal to be paid to the borrower. Over the life of these loans, interest and certain other fees accrue on the

balance of the payments made to the borrower. Generally, the loan is due when the borrower no longer

occupies the property. We currently purchase reverse mortgages only if the reverse mortgages are subject to a

limit on the amount the interest rate may change over the life of the loan. Most of the reverse mortgages we

purchase are guaranteed by the Federal government.

Liquid Investment Portfolio

The liquid investment portfolio serves principally as a source of liquidity and an investment vehicle for

our surplus capital. If our access to the debt capital markets is ever impeded, we Ñrst will utilize assets in our

liquid investment portfolio to generate cash to meet our liquidity needs. We may use funds received at

maturity of the short-term investments in the portfolio or sell assets from the portfolio to generate those funds.

The liquid investment portfolio primarily invests in high quality securities that are readily marketable or have

short-term maturities. The liquid investment portfolio does not invest in mortgage loans or mortgage-related

securities.

We have set a goal to maintain liquid assets equal to at least 5 percent of total on balance-sheet assets.

Our ratio of liquid assets to total assets at December 31, 2002 and 2001 was 6.9 percent and 9.5 percent,

9
respectively. Because our liquid assets are maintained for liquidity purposes and not principally as an

investment business, the income generated from these investments is considerably lower than the income

generated by mortgage portfolio investments. See ""Item 7 Ì Management's Discussion and Analysis of

Financial Condition and Results of Operations Ì Business Segment Results Ì Portfolio Investment Business Ì Nonmortgage Investments Ì Tables 11 and 12'' for information on our liquid investment portfolio.

Credit Guaranty Business

Overview. Our credit guaranty business has primary responsibility for managing our mortgage credit

risk. Credit risk is the risk of nonpayment by borrowers and counterparties. The primary source of income for

the credit guaranty business is fees we receive for our guaranty of the timely payment of scheduled principal

and interest on MBS that are held by other investors, less the cost of providing this service. In addition, the

portfolio investment business compensates the credit guaranty business, for segment reporting purposes,

through a fee comparable to an MBS guaranty fee. Consequently, we generally allocate mortgage credit

expenses, including credit losses, to the credit guaranty business for business segment reporting purposes. The

credit guaranty business also provides investment capital to the portfolio investment business for which it is

allocated income, and earns interest income on the temporary investment of principal and interest payments

on mortgage loans underlying MBS prior to remittance to investors.

Our credit guaranty business manages Fannie Mae's mortgage credit risk through sound asset acquisition

practices, use of credit enhancements, active management of the credit book of business, and aggressive

problem loan management. We share mortgage credit risk with third parties as an integral part of our risk

management strategy. In our credit enhancement arrangements, we bear institutional counterparty risk that

the parties assuming credit enhancement obligations may be unable to meet their contractual obligations.

Mortgage credit enhancements are primarily mortgage insurance, lender recourse, and other risk sharing

contracts. We routinely monitor the risks associated with credit enhancement and other risk sharing

arrangements. We have provided a detailed description of how we manage the mortgage-related credit risk

associated with the credit guaranty business, as well as other types of credit risk, in ""Item 7 Ì Management's

Discussion and Analysis of Financial Condition and Results of Operations Ì Risk Management Ì Credit

Risk Management.''

The following diagram illustrates the basic structure of how we create a typical MBS in the case where a

lender chooses to sell the MBS to a third party.

10
3

2

1

MBS Guaranty Process

Lender sells 

guaranteed 

MBS to 

investors

Fannie Mae

Fannie Mae creates MBS from 

pools of mortgages and returns 

MBS to Lenders. Fannie Mae 

retains credit risk, for which we 

receive a guaranty fee.

Lender 

originates loan 

with consumer

Consumers

Lenders

Mortgage

MBS

MBS Mortgages

$$$

$$$

Investors

In the credit guaranty business, lenders originate mortgages with consumers. They “swap” the loans for 

MBS with Fannie Mae assuming the credit risk on the loans and guaranteeing the timely payment of 

scheduled principal and interest on the MBS, for which Fannie Mae receives a guaranty fee. Fannie Mae 

returns the MBS to the lender, who sells it to investors.

MBS. We create both single-class and multi-class MBS. The MBS represent beneÑcial interests in

pools of mortgage loans or in other mortgage-related securities. The MBS, and the mortgage loans and

mortgage-related securities backing MBS, are not assets of Fannie Mae, except when we acquire them for

mortgage portfolio investment purposes.

We create MBS backed by mortgage loans bearing interest at either Ñxed or adjustable rates, and secured

by Ñrst or subordinate liens on either single-family or multifamily residential properties. Mortgage loans can be

either conventional mortgage loans or government guaranteed or insured mortgage loans. Conventional singlefamily and multifamily loans are subject to the underwriting guidelines applicable to our loan purchases. The

majority of our outstanding MBS represent beneÑcial interests in conventional Ñxed-rate Ñrst mortgage loans

secured by single-family dwellings.

We are the trustee for each trust and hold the underlying mortgage loans or mortgage-related securities

separate and apart from our assets, for the beneÑt of the certiÑcateholders.

Single-Class MBS. Single-class MBS are MBS that are typically created through single-lender

transactions in which a lender delivers mortgage loans in exchange for MBS representing beneÑcial interests in

those mortgage loans and our guaranty. Another form of single-class MBS, referred to as ""Fannie Majors»'',

allows multiple lenders to pool mortgage loans that are delivered to us and, in exchange, receive MBS

representing each lender's proportionate share of the larger pool. We also create single-class MBS referred to

as ""Fannie Megas»'' or ""Megas.'' Megas are pass-through certiÑcates backed by pooled multiple single-class

MBS with similar characteristics and/or other pooled Megas with similar characteristics. Megas are issued in

transactions in which a lender or investment banker exchanges pooled single-class MBS and/or other pooled

Megas for newly issued Mega certiÑcates.

11
Principal and interest from the mortgage loans underlying the single-class MBS are passed through to the

certiÑcateholders less a fee for servicing the mortgage loans and a fee for our guaranty. We guarantee the

timely payment of scheduled principal due on the underlying mortgage loans and interest at the MBS passthrough rate to the certiÑcateholders, even if we have not received the payments on the underlying mortgage

loans. In other words, through our guaranty to certiÑcateholders, we assume the credit risk of borrower

defaults on the underlying mortgage loans, as well as any risk arising from a default or bankruptcy of the seller

and servicer of the loans.

We have a responsibility to certiÑcateholders for the servicing of the mortgage loans underlying the MBS

and certain other mortgage-related securities, although we do not directly service the mortgage loans. See

""Item 1 Ì Business Ì Fannie Mae Business Standards Ì Servicing Arrangements.'' We are also responsible

for certain administrative functions, such as the collection and receipt of payments from the contract servicer,

maintaining accounting records for each trust, and for the distribution of payments and reports due to

certiÑcateholders.

The MBS TBA Market. Single-class MBS outstanding constituted approximately 75 percent of Fannie

Mae's total MBS outstanding as of December 31, 2002. The vast majority of these MBS are sold by lenders

into the ""TBA'' (""to be announced'') securities market. A TBA trade represents a contract for the purchase

or sale of single-family mortgage-related securities to be delivered at a future agreed-upon date. The speciÑc

pool numbers that will be delivered to fulÑll the trade obligation or terms of the contract are unknown at the

time of the trade. Parties to a TBA trade agree upon the issuer and product type to be delivered (denoted by a

pool preÑx), the coupon or interest rate of the security to be delivered, the settlement date of the trade, the

amount of securities to be delivered, and the price of those securities. The single-class MBS that ultimately

will be delivered, and the loans backing that MBS, frequently have not been created or originated at the time

of the TBA trade, even though a price for the securities is agreed to at that time. A TBA trade may be entered

into as much as several months before actual settlement of that trade. TBA sales enable the originating lender

to hedge its interest rate risk and ""lock-in'' interest rates for mortgage loan applicants throughout the loan

origination process. A lender may satisfy its delivery requirement under a TBA trade by delivering any

mortgage-related security meeting the agreed-upon terms.

Multi-Class MBS. We also create and guarantee multi-class MBS, such as real estate mortgage

investment conduits, commonly referred to as ""REMICs'', certain grantor trust certiÑcates, and stripped

mortgage-backed certiÑcates, commonly referred to as ""SMBS''. REMICs are a vehicle by which an issuer

can restructure interest and principal payments on mortgage assets into separately tradeable interests. By

redirecting the cash Öows from the underlying mortgage assets, we can create a security having several classes,

also called ""tranches,'' which, among other things, may have diÅerent coupon rates, average lives, repayment

sensitivities and Ñnal maturities. SMBS operate in a manner similar to REMICs, though we typically use

SMBS to create tranches that pay only principal or only interest. We generally receive one-time fees for

swapping mortgage loans, MBS and other mortgage-related securities for our multi-class MBS. If the multiclass MBS are backed by whole loans or securities we have not already guaranteed, we may receive a guaranty

fee in addition to a transaction fee. We otherwise receive no separate guaranty fees for these transactions

because we have already assumed the credit risk on the underlying securities and receive guaranty fees for that

assumption on the underlying securities.

Multi-class MBS provide a variety of cash Öow options for investors. In multi-class MBS, each class is

entitled to diÅerent cash Öows. For example, these cash Öows may consist of (1) principal only payments from

the underlying mortgage loans, (2) interest only payments from the underlying mortgage loans, or (3) diÅerent percentages of principal and interest payments. In addition, the timing of payments may vary among the

classes of REMIC certiÑcates. For example, a REMIC class may receive payments for only a limited period

during the life of the trust. Our multi-class MBS may be backed directly by mortgage loans or by other

mortgage-related securities, including single-class MBS, REMIC certiÑcates, grantor trust certiÑcates, or

mortgage-related securities of an issuer other than Fannie Mae. In general, our guaranty for multi-class

mortgage-related securities covers timely payment of scheduled principal and interest due on these certiÑcates

and ultimate payment of principal by the date speciÑed for each class of certiÑcates. We have created a

limited number of subordinated REMIC classes that are not guaranteed by Fannie Mae. Most Fannie Mae

12
multi-class mortgage-related securities are created in transactions in which an investment banker, or less

frequently a lender or a mortgage banker, exchanges mortgage loans or mortgage-related securities, or a

combination of both, for the newly-issued Fannie Mae multi-class MBS.

Guaranty Fees. We receive guaranty fees for our guaranty of timely payment of scheduled principal and

interest on MBS. When we create an MBS, we establish a guaranty fee for the MBS, taking into consideration

the credit risk associated with the loans backing the MBS. We either (1) determine a weighted average

guaranty fee based on the characteristics of the loans in the trust and assign that fee to each loan in the trust or

(2) assign each loan in the trust a guaranty fee based on its risk characteristics. In the latter instance, our

weighted average guaranty fee for the MBS may increase or decrease over time depending upon prepayment

activity. Guaranty fees generally are paid to us on a monthly basis from a portion of the interest payments

received on the underlying mortgage loans, as long as the loans are in the MBS. Guaranty fees are typically

calculated for MBS at the loan level as a percent of the unpaid principal balance remaining on a loan. The

monthly guaranty fee may be adjusted up or down through a cash payment to or from the lender at the time

the MBS is issued.

The aggregate amount of guaranty fees we receive in any Ñnancial statement period depends primarily

upon the amount of Fannie Mae MBS outstanding during that Ñnancial statement period and on the

applicable guaranty fee rates. The amount of MBS outstanding is inÖuenced by factors including the rates at

which the underlying mortgage loans are repaid, the rate of defaults on loans or breaches of lender

representations resulting in repurchases from the pool, and the rate at which we issue new MBS and purchase

or sell MBS in our mortgage portfolio business. In general, when prevailing interest rates decline below the

interest rates on loans underlying outstanding MBS, both the rate of mortgage loan prepayments and the

issuance of new MBS are likely to increase. Conversely, when interest rates rise above the interest rates on

mortgage loans underlying our outstanding MBS, the rate of mortgage loan prepayments and new MBS

issuance is likely to slow. The rate of principal prepayments also is inÖuenced by a variety of economic,

demographic, and other factors.

Delinquencies and REO. We manage loans in partnership with our servicers to minimize the frequency

of foreclosure and the severity of loss in the event of foreclosure. When a loan is in default, generally the

servicer takes appropriate loss mitigation steps or, if necessary, pursues foreclosure on behalf of Fannie Mae. If

a mortgage is liquidated through foreclosure or deed in lieu of foreclosure we would acquire the underlying

property (as real estate owned, or ""REO'') and attempt to sell the REO. If the defaulted loan backs an MBS,

we may repurchase the loan out of the MBS trust and pay the principal balance on the loan to the MBS

certiÑcateholders when the loan is delinquent by four or more consecutive monthly payments (or eight

biweekly installments.) This is generally our current practice given the level of interest rates, because it is

often less expensive for us to fund the purchase of the loan at our lower borrowing cost than to continue to pass

through to the investor the coupon rate of the MBS. We have a policy to repurchase the loan if it is delinquent

by twenty-four consecutive months or at the time of foreclosure, if it is still in the MBS trust at that time. As

long as the loan or REO remains in the MBS trust, we continue to pay scheduled principal and interest to the

certiÑcateholders and defer payment of the remaining principal balance until the earlier of the repurchase of

the loan from the MBS trust, the sale of the REO or the third year following foreclosure.

The level of delinquencies and number of REO are aÅected by economic conditions, loss mitigation

eÅorts (which include contacting delinquent borrowers to oÅer a repayment plan, loan modiÑcation,

preforeclosure sale, or other options), contractual provisions in credit enhancements, and a variety of other

factors. We manage the risk of delinquencies and REO, including the risk on loans and mortgage-related

securities held in our mortgage portfolio, as described in ""Item 7 Ì Management's Discussion and Analysis of

Financial Condition and Results of Operations Ì Risk Management Ì Credit Risk Management.''

Fee-Based Services

We oÅer services to lenders and other customers in return for fees. These include transaction fees for

issuing and administering REMICs, SMBS, Fannie Megas and certain grantor trust securities, and facilitating

securities transactions.

13
We also receive fee income in return for providing technology-related services, such as Desktop

Underwriter, Desktop Originator», and other on-line services. These services provide lenders the ability to

underwrite mortgage loans electronically, communicate with third-party originators, access our loan pricing

schedules, and enter into sale commitments with us on a real-time basis.

We also facilitate securities transactions for customers. For this service, we may earn a spread on the

purchase and sale of MBS and certain other mortgage-related securities, such as Ginnie Mae certiÑcates, or

may receive a fee from the customer. In addition, we receive fee income through other activities, such as

providing credit enhancements and other investment alternatives for customers.

Housing Goals

The Federal Housing Enterprises Financial Safety and Soundness Act (the ""1992 Act'') requires the

Secretary of the U.S. Department of Housing and Urban Development (""HUD'') to establish a low-and

moderate-income, an underserved areas, and a special aÅordable housing goal for loans purchased or

guaranteed by Fannie Mae. We are required to submit an annual report to the House Committee on Financial

Services, the Senate Committee on Banking, Housing and Urban AÅairs, and the Secretary of HUD

regarding our performance in meeting the housing goals. By regulation, HUD has established the low- and

moderate-income housing goal at 50 percent of the total number of dwelling units Ñnanced by eligible

mortgage purchases annually, the underserved areas housing goal at 31 percent, and the special aÅordable

housing goal, a more targeted measure, at 20 percent. ""Eligible mortgage purchases'' include MBS guarantees

but exclude several activities, including the purchase or guaranty of non-conventional mortgages and

mortgages on second homes, commitments to purchase or guarantee mortgages at a later date, and equity

investments in low-income housing tax credits. For the year ended December 31, 2002, ""eligible mortgage

purchases'' represented approximately 97% of our business volume. In addition, HUD has established Fannie

Mae's targeted multifamily subgoal at $2.85 billion.

Each of these goals applies annually during 2001 through 2003. If HUD does not establish diÅerent goals

for 2004 and after, the goals will continue at the current levels. The goals also include certain provisions that

reduce penalties for missing data and provide incentive points for serving small multifamily and owneroccupied rental housing. A loan may be counted in more than one category of goals. If HUD determines that

Fannie Mae has failed to meet its housing goals and that achievement of the goals was feasible, taking into

account market and economic conditions and Fannie Mae's Ñnancial condition, Fannie Mae must submit a

housing plan to HUD describing the actions it will take to meet the goal in the next calendar year. If HUD

determines that Fannie Mae has failed to submit a housing plan or failed to make a good faith eÅort to comply

with the plan, HUD may take certain administrative actions. The following table shows Fannie Mae's housing

goals and results for the past three years.

2002 2001 2000

Housing Goals Goal(1) Result Goal(1) Result Goal(1) Result

(Dollars in billions)

Low- and moderate-income housing ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 50.0% 51.8% 50.0% 51.6% 42.0% 49.5%

Underserved areas ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 31.0 32.8 31.0 32.5 24.0 31.0

Special aÅordable housing ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 20.0 21.4 20.0 21.6 14.0 22.3

Multifamily minimum in special aÅordable housing ÏÏÏÏÏÏÏ $2.85 $7.22 $2.85 $7.40 $1.30 $3.78

(1) Goals are expressed as a percentage of the total number of dwelling units Ñnanced through eligible mortgage

purchases during the period, except for the targeted multifamily goal.

Competition

In the case of single-family mortgage loans, Fannie Mae competes, within the limits prescribed by the

Charter Act, for the purchase of mortgage loans for our own portfolio, for the guaranty of mortgage credit risk,

and for the issuance in the secondary mortgage market of mortgage-related securities. For single-family

products, we compete with Freddie Mac (another government-sponsored enterprise with a mission, authority,

and regulatory oversight that are virtually identical to our own), commercial banks, savings and loan

14
associations, savings banks, pension funds, insurance companies, securities dealers, and other Ñnancial entities

that purchase single-family mortgage loans or mortgage-related securities for their own portfolio or pool

single-family mortgage loans for sale to investors as whole loans or mortgage-related securities. We compete

with the Federal Home Loan Banks, which also Ñnance single-family mortgage loans through a variety of

programs that were initiated in 1997. We compete with mortgage insurers, bond insurers, and other Ñnancial

guarantors that provide mortgage credit guaranty services on loans and pools of loans.

Commercial banks and thrifts are the largest participants in the U.S. mortgage industry. Banks and thrifts

originate mortgages (which we are not empowered to do under the Charter Act), have access to low cost,

FDIC-insured deposits and can borrow advances from Federal Home Loan Banks. There has been signiÑcant

consolidation among commercial banks and thrifts, increasing the size of individual organizations and

resulting in concentration in the banking industry. This has created larger institutions with the scale necessary

to permit them to securitize their own mortgages and manage large and complex portfolios. As institutions

become larger, they have increasing bargaining power in their negotiations with Fannie Mae, and are able to

oÅer us volume in return for lower guaranty fees and customization of services.

We compete with the FHA insurance program, a program of HUD, for the business of guaranteeing the

credit performance of mortgage loans and, because of the eligibility of such FHA-insured loans for

securitization by the Government National Mortgage Association (""Ginnie Mae''), an entity within HUD,

with Ginnie Mae as well. The base maximum principal balance for loans eligible for the FHA insurance

program is 48 percent of our loan limit. The loan limit for FHA-insured loans in high-cost areas is as much as

87 percent of our limit. These higher FHA limits may result in increased competition for our credit guaranty

business.

We compete primarily on the basis of price, products, structures, and services oÅered. Competition based

on advances in technology-related and other fee-based services continues to increase, as do the types and

nature of the products oÅered by us and other market participants. Our market share of loans purchased for

cash or swapped for mortgage-related securities is aÅected by the volume of mortgage loans oÅered for sale in

the secondary market by loan originators and other market participants and the amount purchased by our

competitors.

In the case of multifamily mortgage loans, we generally compete with government housing programs,

Freddie Mac, insurance companies, and the same kinds of entities we compete with in the single-family

market. In addition, there is competition for multifamily mortgage loans from certain entities typically

sponsored by investment banks and commercial banks that purchase such loans and pool them for sale to

investors in the commercial mortgage-related securities market. Such entities are referred to as ""conduits,''

and their role in the multifamily mortgage market has increased signiÑcantly over the last Ñve years. Conduits

continue to be a strong source of competition.

Competition is particularly intense for multifamily mortgage loans eligible for government subsidies,

which have low-income rent and occupancy restrictions. Commercial banks contemplating merger or

expansion plans seek to fund such loans to secure favorable review under the Community Reinvestment Act

and may either hold such loans as an investment or sell them to a secondary market investor. We compete for

these investments in the secondary market to meet our housing goals.

Under the 1992 Act, the Secretary of HUD must approve any new Fannie Mae or Freddie Mac

conventional mortgage program that is signiÑcantly diÅerent from those approved or engaged in prior to that

Act's enactment. Our ability to compete could be aÅected by this requirement. See ""Government Regulation

and Charter Act.''

Competition also is a consideration in connection with the issuance of Fannie Mae's debt securities. We

compete with Freddie Mac, the Federal Home Loan Bank system, and other government-sponsored entities

for funds raised through the issuance of unsecured debt in the ""agency'' debt market. Increases in the issuance

of unsecured debt by other government-sponsored entities generally, and in the issuance of callable debt in

particular, may have an adverse eÅect on the issuance of our unsecured debt or result in the issuance of such

debt at higher interest rates than would otherwise be the case. In addition, the availability and cost of funds

15
raised through the issuance of certain types of unsecured debt may be adversely aÅected by regulatory

initiatives that may reduce investments by depository institutions in unsecured debt with greater than normal

volatility or interest-rate sensitivity.

Employees

As of February 28, 2003, Fannie Mae employed approximately 4,800 permanent personnel.

Government Regulation and Charter Act

Charter Act

We were established in 1938 under Title III of the National Housing Act as a government owned entity.

In 1954, under the Federal National Mortgage Association Charter Act, the entity became a mixed-ownership

corporate instrumentality of the United States. Under the Housing and Urban Development Act of 1968, the

entity was divided into two separate institutions, the present Fannie Mae and Ginnie Mae. Fannie Mae

became an entirely stockholder-owned corporation, organized and existing under the Charter Act. The

Charter Act provides that the corporation will continue until dissolved by an act of Congress. The Charter Act

was further amended by the 1992 Act.

Under the Charter Act, our purpose is:

""to (1) provide stability in the secondary market for residential mortgages, (2) respond appropriately to

the private capital market, (3) provide ongoing assistance to the secondary market for residential

mortgages (including activities relating to mortgages on housing for low-and moderate-income families

involving a reasonable economic return that may be less than the return earned on other activities) by

increasing the liquidity of mortgage investments and improving the distribution of investment capital

available for residential mortgage Ñnancing, ®and© (4) promote access to mortgage credit throughout the

nation (including central cities, rural areas and underserved areas) by increasing the liquidity of mortgage

investments and improving the distribution of investment capital available for residential mortgage

Ñnancing.''

The Charter Act authorizes us to ""deal in'' conventional mortgage loans, and ""purchase,'' ""sell,''

""service,'' and ""lend on the security of'' such mortgages, subject to limitations on the quality of mortgages

purchased and credit enhancement requirements. Fannie Mae can act as a depositary, custodian, or Ñscal

agent ""for its own account or as Ñduciary, and for the account of others.'' The Charter Act expressly enables

Fannie Mae ""to lease, purchase, or acquire any property, real, personal, or mixed, or any interest therein, to

hold, rent, maintain, modernize, renovate, improve, use, and operate such property, and to sell, for cash or

credit, lease, or otherwise dispose of the same, at such time and in such manner as and to the extent that it

may deem necessary or appropriate.'' The Charter Act also permits Fannie Mae to ""purchase,'' ""service,''

""sell,'' ""lend on the security of'' and otherwise deal in loans or advances of credit for the purchase and

installation of home improvements (so long as the loans are secured by a lien against the property to be

improved).

Under the Charter Act, we may not originate mortgage loans or advance funds on an interim basis

pending the sale of a mortgage in the secondary market. We may not purchase loans in excess of the amount

of the current loan limits. (See ""BusinessÌFannie Mae Business StandardsÌPrincipal Balance Limits.'') We

may conduct business only in the United States, its territories and possessions, the District of Columbia and

the Commonwealth of Puerto Rico. Our activities must relate to housing, mortgages and related Ñnancial

products.

Thirteen members of our eighteen-member Board of Directors are elected by the holders of our common

stock. The President of the United States appoints the remaining Ñve members. The appointed directors must

include one person from the home building industry, one person from the mortgage lending industry, one

person from the real estate industry, and one person from a consumer or community interest organization or

who has demonstrated a career commitment to providing low-income housing. Any member of the Board of

Directors that is appointed by the President of the United States may be removed by the President for good

cause. All members of the Board of Directors are elected or appointed annually.

16
In general, HUD and OFHEO oversee the activities of Fannie Mae. HUD has ""general regulatory

power'' over Fannie Mae. The 1992 Act established OFHEO to ensure that Fannie Mae is adequately

capitalized and is operating safely.

The Secretary of the Treasury has the authority to approve Fannie Mae's issuance of debt obligations and

mortgage-related securities. At the discretion of the Secretary of the Treasury of the United States, the

U.S. Treasury may purchase obligations of Fannie Mae up to a maximum of $2.25 billion outstanding at any

one time. This facility has not been used since our transition from government ownership in 1968. Neither the

United States nor any agency thereof is obligated to Ñnance our operations or to assist us in any other manner.

The Federal Reserve Banks are authorized to act as depositories, custodians, and Ñscal agents for Fannie Mae,

for the Bank's own account, or as Ñduciary.

Securities we issue are ""exempt securities'' under laws administered by the SEC to the same extent as

securities that are obligations of, or guaranteed as to principal and interest by, the United States. Registration

statements with respect to oÅerings of our securities are not Ñled with the SEC. In July 2002, we announced

our voluntary initiative to register our common stock with the SEC under Section 12(g) of the Securities

Exchange Act of 1934. The registration of our common stock became eÅective on March 31, 2003. As a

result, we will Ñle periodic reports with the SEC, including annual reports on Form 10-K, quarterly reports on

Form 10-Q, and current reports on Form 8-K, together with any required exhibits. These Ñlings will be

available on the SEC's Electronic Data Gathering, Analysis, and Retrieval (""EDGAR'') system at

www.sec.gov. Registration of our common stock with the SEC will not impact the status of our securities

(including equity, debt and MBS) as exempt securities within the meaning of the laws administered by the

SEC.

We are exempt from taxation by states, counties, municipalities, or local taxing authorities, except for

taxation by those authorities on our real property. We are not exempt from payment of federal corporate

income taxes. We also may conduct our business without regard to any qualiÑcation or similar statute in any

state of the United States, including the District of Columbia, the Commonwealth of Puerto Rico, and the

territories and possessions of the United States.

Regulatory Approval and Oversight

As a federally chartered corporation, Fannie Mae is subject to Congressional legislation and oversight and

is regulated for various purposes by HUD, OFHEO and the U.S. Department of the Treasury, to the extent

authorized by statute. In addition, the Ñnancial institutions with whom we do business are subject to extensive

federal and state law and regulation. Changes to legislation, regulations or policy that impact us or our

business partners could adversely or favorably aÅect the performance, development, or results of our business.

OFHEO, an independent oÇce within HUD, is responsible for ensuring that we are adequately

capitalized and operating safely in accordance with the 1992 Act. OFHEO conducts on-site examinations of

Fannie Mae for purposes of ensuring our Ñnancial safety and soundness. We are required to submit annual and

quarterly reports of our Ñnancial condition and operations to OFHEO. OFHEO is authorized to levy annual

assessments on Fannie Mae and Freddie Mac, pursuant to annual Congressional appropriations, to cover

OFHEO's reasonable expenses. OFHEO's formal enforcement powers include the power to impose temporary

and Ñnal cease-and-desist orders and civil monetary penalties on us and on our directors and executive oÇcers,

provided certain conditions are met. OFHEO may use other informal supervisory tools of the type that are

generally used by agencies with authority to regulate other Ñnancial institutions. In accordance with OFHEO

regulation, Fannie Mae has elected to follow the applicable corporate governance practices and procedures of

the Delaware General Corporation Law, as it may be amended from time to time. On January 21, 2003,

OFHEO proposed regulations that would require Fannie Mae to Ñle with the SEC all reports, statements and

forms relating to our common stock that are required to be Ñled under Sections 14(a) and (c) of the

Exchange Act and the rules and regulations under those sections and require Fannie Mae's directors and

oÇcers to Ñle all reports and forms relating to our common stock that are required to be Ñled under Section 16

of the Exchange Act and the rules and regulations under that section.

The Secretary of the Treasury has the authority to approve Fannie Mae's issuance of debt obligations and

mortgage-related securities. The General Accounting OÇce is authorized to audit the programs, activities,

17
receipts, expenditures, and Ñnancial transactions of Fannie Mae. The Secretary of HUD has general

regulatory authority to promulgate rules and regulations to carry out the purposes of the Charter Act,

excluding authority over matters granted exclusively to OFHEO. The Secretary of HUD has authority to

approve any new conventional mortgage program that is signiÑcantly diÅerent from those approved or engaged

in prior to the 1992 Act. The Secretary must approve any new program unless it is not authorized by the

Charter Act or the Secretary Ñnds that it is not in the public interest. The Secretary has adopted regulations

related to the program approval requirement. We are also required to meet certain goals established by the

Secretary of HUD to promote aÅordable housing and to serve the housing needs of those in underserved areas.

See ""Business Ì Housing Goals.''

Capital Requirements

The 1992 Act established minimum capital, risk-based capital, and critical capital requirements for

Fannie Mae. See also ""Item 7 Ì Management's Discussion and Analysis of Financial Condition and Results

of Operations Ì Liquidity and Capital Resources Ì Capital Resources Ì Regulatory Environment.''

OFHEO issued a Ñnal rule in 1996 that sets forth the minimum capital requirements for Fannie Mae and

Freddie Mac, which are to be calculated, reported, and classiÑed on a quarterly basis. We were in compliance

with the minimum capital rule as of December 31, 2002, and have been in compliance for every reporting

period since the rule became eÅective. OFHEO issued regulations in September 2001, as subsequently

amended, to establish a risk-based capital test to be used to determine the amount of total capital Fannie Mae

must hold to meet the risk-based capital standard. Fannie Mae and Freddie Mac are required to hold enough

capital to withstand a severe 10-year stress period, characterized by extreme interest-rate movements and

credit losses occurring simultaneously, plus 30 percent of that amount for management and operations risk.

The risk-based capital test evaluates combined interest-rate and credit stress for both rising and declining

interest-rate scenarios. The more stringent of these two scenarios determines the required risk-based capital.

The test assumes that (1) interest rates increase or decrease by up to 600 basis points over the Ñrst year, and

remain constant at this new level for the remaining 9 years of the test; (2) severe credit conditions apply

nationwide; and (3) we acquire no new business during this period except to meet outstanding mortgage

commitments. The regulations specify that ""benchmark loss experience'' will be combined with other

assumptions and applied each quarter to our book of business to establish expected credit losses based on the

stress assumptions under the risk-based capital standard. The regulations also specify the housing price index

that OFHEO will use in connection with the standard and how the test will be used to determine Fannie

Mae's risk-based capital requirements. On March 31, 2003, OFHEO announced that Fannie Mae complied

with the risk-based capital rule as of December 31, 2002. See ""Item 7 Ì Management's Discussion and

Analysis of Financial Condition and Results of Operations Ì Liquidity and Capital Resources Ì Capital

Resources Ì Regulatory Environment.''

If we fail to meet the capital standards, OFHEO is permitted or required to take remedial measures,

depending on the standards we fail to meet. Compliance with the capital standards could limit operations that

require intensive use of capital and restrict our ability to repay debt or pay dividends on our common stock.

We are required to submit a capital restoration plan if we fail to meet any of the capital standards. If OFHEO

determines that we are engaging in conduct not approved by the Director that could result in a rapid depletion

of core capital or that the value of the property subject to mortgages we hold or have securitized has decreased

signiÑcantly, or if OFHEO does not approve the capital restoration plan or determines that we have failed to

make reasonable eÅorts to comply with the plan, OFHEO may take remedial measures as if we were not

meeting the capital standards we otherwise meet. The 1992 Act gives OFHEO authority, after following

prescribed procedures, to appoint a conservator if we do not meet the critical capital level.

Dividend Restrictions

The Charter Act as amended by the 1992 Act restricts the ability of our Board of Directors to make

capital distributions, including any dividends, in the following circumstances:

‚ Fannie Mae may not pay any dividend, without the approval of OFHEO, if the dividend payment

would decrease our total capital below the risk-based capital level or our core capital below the

minimum capital level.

18
‚ If we do not meet the risk-based capital standard but do meet the minimum capital standard, we may

not make any dividend payment that would cause us to fail to meet the minimum capital standard.

‚ If we meet neither the risk-based capital standard nor the minimum capital standard but do meet the

critical capital standard established under the 1992 Act, we may make a dividend payment only if we

would not fail to meet the critical capital standard as a result of the payment and the Director of

OFHEO approves the payment after Ñnding that the payment satisÑes certain statutory conditions.

The Director has the authority to require us to submit a report to the Director regarding any capital

distribution we declare before we make the distribution.

Item 2. Properties

We own our principal oÇce, which is located at 3900 Wisconsin Avenue, NW, Washington, DC, oÇces

at 3939 Wisconsin Avenue, NW, and 4250 Connecticut Avenue, NW, in Washington, DC, and two facilities

in Herndon, Virginia. These owned facilities total approximately 829,000 square feet of space. In addition, we

lease 375,000 square feet of oÇce space at 4000 Wisconsin Avenue, NW, which is adjacent to Fannie Mae's

principal oÇce. The present lease for 4000 Wisconsin Avenue expires in 2008, and we have options to extend

the lease for up to 10 additional years, in 5-year increments. We also lease an additional 377,000 square feet of

oÇce space in four locations in Washington, D.C. and suburban Virginia.

We maintain oÇces in leased premises in Pasadena, California; Atlanta, Georgia; Chicago, Illinois;

Philadelphia, Pennsylvania; and Dallas, Texas. In addition, we have 54 ""Fannie Mae Partnership OÇces'' in

leased premises around the United States which work with cities, rural areas, and underserved communities.

Item 3. Legal Proceedings

In the ordinary course of business, we are involved in legal proceedings that arise in connection with

properties acquired either through foreclosure on properties securing delinquent mortgage loans we own or by

receiving deeds to those properties in lieu of foreclosure. For example, claims related to possible tort liability

arise from time to time, primarily in the case of single-family REO.

We are a party to legal proceedings from time to time arising from our relationships with our seller/

servicers. Disputes with lenders concerning their loan origination or servicing obligations to us, or disputes

concerning termination by us (for any of a variety of reasons) of a lender's authority to do business with us as

a seller and/or servicer, can result in litigation. Also, loan servicing and Ñnancing issues have resulted from

time to time in claims against us brought as putative class actions for borrowers. We also are a party to legal

proceedings from time to time arising from other aspects of our business and administrative policies.

Claims and proceedings of all types are subject to many uncertain factors that generally cannot be

predicted with assurance. However, in the case of the legal proceedings and claims that are currently pending

against us, management believes that their outcome will not have a material adverse eÅect on our Ñnancial

condition, results of operations or cashÖows.

Item 4. Submission of Matters to a Vote of Security Holders

None.

PART II

Item 5. Market for Registrant's Common Equity and Related Stockholder Matters

Information on the market for our common stock and related stockholder matters is set forth under

Item 9 of the Form 10 we Ñled on March 31, 2003 (the ""Form 10'') and incorporated by reference herein.

19
Item 6. Selected Financial Data

The following selected Ñnancial data have been summarized or derived from our audited Ñnancial

statements. This Ñnancial information should be read in conjunction with ""Item 7 Ì Management's

Discussion and Analysis of Financial Condition and Results of Operations,'' ""Item 1 Ì Business,'' and our

Ñnancial statements and related notes, included elsewhere in this report.

Year Ended December 31,

Income Statement Data: 2002 2001 2000 1999 1998

(Dollars and shares in millions, except per common share amounts)

Interest income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 50,853 $ 49,170 $ 42,781 $ 35,495 $ 29,995

Interest expenseÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (40,287) (41,080) (37,107) (30,601) (25,885)

Net interest income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 10,566 8,090 5,674 4,894 4,110

Guaranty fee incomeÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 1,816 1,482 1,351 1,282 1,229

Fee and other income (expense), net ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 232 151 (44) 191 275

Provision for losses ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (128) (94) (122) (151) (245)

Foreclosed property income (expense) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 36 16 28 24 (16)

Administrative expense ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (1,219) (1,017) (905) (800) (708)

Special contribution ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Ì (300) Ì Ì Ì

Purchased options expense(1) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (4,545) (37) Ì Ì Ì

Debt extinguishments, net ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (710) (524) 49 (14) (40)

Income before federal income taxes and cumulative eÅect

of change in accounting principle ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 6,048 7,767 6,031 5,426 4,605

Provision for federal income taxesÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (1,429) (2,041) (1,583) (1,514) (1,187)

Income before cumulative eÅect of change in accounting

principle ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 4,619 5,726 4,448 3,912 3,418

Cumulative eÅect of change in accounting principle, net

of tax eÅect(2) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Ì 168ÌÌÌ

Net income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 4,619 $ 5,894 $ 4,448 $ 3,912 $ 3,418

Preferred stock dividends ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (99) (138) (121) (78) (66)

Net income available to common stockholders ÏÏÏÏÏÏÏÏÏÏ $ 4,520 $ 5,756 $ 4,327 $ 3,834 $ 3,352

Basic earnings per common share:

Earnings before cumulative eÅect of change in

accounting principle ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 4.56 $ 5.58 $ 4.31 $ 3.75 $ 3.26

Cumulative eÅect of change in accounting principle ÏÏÏ Ì .17 Ì Ì Ì

Net earningsÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 4.56 $ 5.75 $ 4.31 $ 3.75 $ 3.26

Diluted earnings per common share:

Earnings before cumulative eÅect of change in

accounting principle ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 4.53 $ 5.55 $ 4.29 $ 3.72 $ 3.23

Cumulative eÅect of change in accounting principle ÏÏÏ Ì .17 Ì Ì Ì

Net earningsÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 4.53 $ 5.72 $ 4.29 $ 3.72 $ 3.23

Cash dividends per common share ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 1.32 $ 1.20 $ 1.12 $ 1.08 $ .96

December 31,

Balance Sheet Data: 2002 2001 2000 1999 1998

Mortgage portfolio, net ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $797,693 $705,324 $607,551 $522,921 $415,355

Liquid assets ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 61,554 76,072 55,585 41,850 59,258

Total assets ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 887,515 799,948 675,224 575,308 485,146

Borrowings:

Due within one year ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 382,412 343,492 280,322 226,582 205,413

Due after one year ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 468,570 419,975 362,360 321,037 254,878

Total liabilities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 871,227 781,830 654,386 557,679 469,693

Preferred stockÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2,678 2,303 2,278 1,300 1,150

Stockholders' equity ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 16,288 18,118 20,838 17,629 15,453

20
Year ended December 31,

Core Business Earnings Data(3): 2002 2001 2000 1999 1998

(Dollars and Shares in millions, except per common share amounts)

Core business earnings(4) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 6,394 $ 5,367 $ 4,448 $ 3,912 $ 3,418

Total taxable-equivalent revenues(5)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 11,896 10,187 7,825 6,975 6,272

Net interest margin ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 1.15% 1.11% 1.01% 1.01% 1.03%

Return on average assets(6) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ .76 .71 .71 .73 .78

Return on average realized common equity(7) ÏÏÏÏÏÏÏÏÏ 26.1 25.4 25.2 25.0 25.2

December 31,

Other Data: 2002 2001 2000 1999 1998

Average eÅective guaranty fee rate ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ .191% .190% .195% .193% .202%

Credit loss ratio(8) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ .005 .006 .007 .011 .027

Administrative expense ratio(9) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ .072 .071 .072 .071 .074

EÇciency ratio(10) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 10.2 10.0 11.6 11.5 11.3

Dividend payout ratio ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 29.0 20.9 26.0 28.8 29.5

Ratio of earnings to combined Ñxed charges and

preferred stock dividends(11) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 1.15:1 1.19:1 1.16:1 1.17:1 1.17:1

Mortgage purchases ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 370,641 $270,584 $154,231 $195,210 $188,448

MBS issues acquired by others(12) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 478,260 344,739 105,407 174,850 220,723

Outstanding MBS(13) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 1,029,456 858,867 706,684 679,169 637,143

Weighted-average diluted common shares outstanding ÏÏ 997 1,006 1,009 1,031 1,037

Return on average assets ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ .55% .78% .71% .73% .78%

Average equity to average assets ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2.1 2.3 3.1 3.1 3.3

Return on common equityÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 30.2 39.8 25.6 25.2 25.2

Core capital(14) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 28,079 $ 25,182 $ 20,827 $ 17,876 $ 15,465

Total capital(15)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 28,871 25,976 21,634 18,677 16,257

(1) Represents the change in the fair value of the time value of purchased options under FAS 133, ""Accounting for Derivative

Instruments and Hedging Activities'' (FAS 133).

(2) Represents the after-tax eÅect on income of the adoption of FAS 133 on January 1, 2001.

(3) Core business earnings data are non-GAAP (generally accepted accounting principles) measures management uses to track

and analyze our Ñnancial performance. See ""Management's Discussion and Analysis of Financial Condition and Results of

OperationsÌCore Business Earnings and Business Segment Results'' for additional discussion of these measures.

(4) Core business earnings is a non-GAAP measure developed by management, in conjunction with the adoption of FAS 133,

to evaluate and assess the quality of Fannie Mae's earnings from its principal business activities on a consistent basis. Core

business earnings is presented on a net of tax basis and excludes the transition adjustment from the adoption of FAS 133

and unrealized gains and losses on purchased options recorded under FAS 133, and includes purchased options premiums

amortized on a straight-line basis over the original estimated life of the option.

(5) Includes revenues net of operating losses on low-income housing tax credit limited partnerships (accounted for using the

equity method of accounting) and amortization expense of purchased options premiums, plus taxable-equivalent adjustments for tax-exempt income and investment tax credits using the applicable federal income tax rate. This is a non-GAAP

measure.

(6) Core business earnings less preferred stock dividends divided by average assets. This is a non-GAAP measure.

(7) Core business earnings less preferred stock dividends divided by average realized common stockholders' equity (common

stockholders' equity excluding accumulated other comprehensive income). This is a non-GAAP measure.

(8) Charge-oÅs, net of recoveries, and foreclosed property income (expense) as a percentage of average mortgage portfolio (on

an amortized cost basis) and average outstanding MBS.

(9) Administrative expenses as a percentage of average net mortgage portfolio and average outstanding MBS.

(10) Administrative expenses as a percentage of taxable-equivalent revenues.

(11) ""Earnings'' consists of (a) income before federal income taxes and cumulative eÅect of accounting changes and (b) Ñxed

charges. Fixed charges represent interest expense.

(12) Includes MBS and other mortgage-related securities guaranteed by Fannie Mae.

(13) Includes MBS and other mortgage-related securities guaranteed by Fannie Mae and held by investors other than Fannie

Mae.

(14) The sum of (a) the stated value of common stock, (b) the stated value of outstanding noncumulative perpetual preferred

stock, (c) paid-in capital, and (d) retained earnings, less treasury stock. Core capital represents a regulatory measure of

capital. Refer to Note 11 of the Ñnancial statements, ""Dividend Restrictions and Regulatory Capital Ratios,'' for a

discussion of core capital.

(15) The sum of (a) core capital and (b) the total allowance for loan losses and guaranty liability for MBS, less (c) the speciÑc

loss allowance. Total capital represents a regulatory measure of capital. SpeciÑc loss allowances totaled $19 million,

$13 million, $2 million, $3 million, and $10 million for the years ended December 31, 2002, 2001, 2000, 1999, and 1998,

respectively. Refer to Note 11 of the Ñnancial statements, ""Dividend Restrictions and Regulatory Capital Ratios,'' for a

discussion of total capital.

21
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations

Forward-Looking Information

From time to time, we make forward-looking statements relating to matters such as our anticipated

Ñnancial performance, business prospects, future business plans, Ñnancial condition, or other matters. This

report includes forward-looking statements that are not historical facts or explanations of historical data. The

words ""believes,'' ""anticipates,'' ""expects,'' ""should'' and similar expressions generally identify forwardlooking statements.

Forward-looking statements reÖect our management's expectations based on various assumptions and

management's estimates of trends and economic factors in the markets in which we are active, as well as our

business plans. As such, forward-looking statements are subject to risks and uncertainties, and our actual

results may diÅer (possibly signiÑcantly) from those indicated in such statements. Among the factors that

may aÅect the performance, development, or results of our business, and thereby cause actual results to diÅer

from management's expressed expectations, are the following:

‚ signiÑcant changes in borrower preferences for Ñxed- or adjustable-rate mortgages, originator preferences for selling mortgages in the secondary market, investor preferences for our securities versus other

investments, the availability of funding at attractive spreads in the Ñnancial markets (in particular from

callable debt), and other factors aÅecting the overall mix of mortgage loans available for purchase, our

funding opportunities, or our net interest margins;

‚ signiÑcant changes in housing price valuations, employment rates, or other factors aÅecting delinquency or foreclosure levels and credit losses;

‚ signiÑcant changes in our policies or strategies, such as our underwriting requirements or our interest

rate risk management, credit loss mitigation, or investment strategies;

‚ regulatory or legislative changes aÅecting us, our competitors, or the markets in which we are active,

including changes in tax law or capital requirements applicable to us or our activities, or loss of certain

exemptions or the Treasury's ability to purchase our obligations (see ""Item 1 Ì Business Ì Government Regulation and Charter Act'');

‚ competitive developments in the markets for mortgage purchases and for the sale of mortgage-related

and debt securities, or signiÑcant changes in the rate of growth in conforming residential mortgage

debt;

‚ signiÑcant changes in the amount and rate of growth of our expenses, and the costs (and eÅects) of

legal or administrative proceedings (see ""Item 3 Ì Legal Proceedings'') or changes in accounting

policies or practices;

‚ signiÑcant changes in general economic conditions or the monetary or Ñscal policy of the United

States;

‚ unanticipated, substantial changes in interest rates. It is possible that sudden, severe swings in interest

rates could have at least a short-term signiÑcant eÅect on our results; and

‚ political events in the United States and internationally.

We do not undertake to update any forward-looking statement in this document or that we may make

from time to time.

22
ORGANIZATION OF INFORMATION

Management's Discussion and Analysis (""MD&A'') provides a narrative on Fannie Mae's Ñnancial

performance and condition that should be read in conjunction with the accompanying Ñnancial statements. It

includes the following sections:

‚ 2002 Overview

‚ About Fannie Mae

‚ Results of Operations

‚ Core Business Earnings and Business Segment Results

‚ OÅ-Balance Sheet Transactions

‚ Application of Critical Accounting Policies

‚ Risk Management

‚ Liquidity and Capital Resources

‚ Performance Outlook

‚ New Accounting Standards

2002 OVERVIEW

2002 was a year of notable achievements for Fannie Mae. We produced strong Ñnancial results and made

continued progress on our key strategic initiatives in an uncertain economic environment marked by signiÑcant

interest rate volatility and more intense competition for mortgages in the secondary market. We reported net

income of $4.619 billion and diluted earnings per share (""diluted EPS'') of $4.53 in 2002, compared with

$5.894 billion and $5.72 in 2001, and $4.448 billion and $4.29 in 2000. Our reported results are based on

generally accepted accounting principles (""GAAP''), which include the eÅects of our January 1, 2001

adoption of Financial Accounting Standard No. 133 (""FAS 133''), Accounting for Derivative Instruments and

Hedging Activities. FAS 133 generates signiÑcant volatility in our reported net income because it requires that

we record in our income changes in the time value portion of purchased options that we use to manage interest

rate risk, but it does not allow us to record in earnings changes in the intrinsic value portion of some of those

options or similar changes in the fair value of options in all of our callable debt or mortgage assets. We expect

purchased options expense to vary, often substantially, from period to period with changes in interest rates,

expected interest rate volatility, and derivative activity.

The 22 percent decrease in our 2002 net income resulted primarily from a $4.508 billion increase in

purchased options expense, which occurred due to an increase in the notional amount of purchased options

outstanding and the declining interest rate environment. We recorded $4.545 billion in purchased options

expense in 2002, compared with $37 million in 2001. Excluding the impact of purchased options expense, we

experienced solid growth in our business operations. Taxable-equivalent net interest income increased

29 percent over 2001 because of strong growth in our average net mortgage portfolio and actions taken during

2002 and 2001 to lower our debt costs. Guaranty fee income increased 23 percent, primarily due to an increase

in the volume of outstanding MBS. These increases were partially oÅset by a modest rise in credit-related

expenses and higher administrative expenses and losses on debt extinguishments.

Management also tracks and analyzes Fannie Mae's Ñnancial results based on a supplemental nonGAAP measure called ""core business earnings'' (previously referred to by us as ""operating net income'').

While core business earnings is not a substitute for GAAP net income, we rely on core business earnings in

operating our business because we believe core business earnings provides our management and investors with

a better measure of our Ñnancial results and better reÖects our risk management strategies than our GAAP net

income. We developed core business earnings in conjunction with our January 1, 2001 adoption of FAS 133 to

adjust for accounting diÅerences between alternative transactions we use to hedge interest rate risk that

produce similar economic results but require diÅerent accounting treatment under FAS 133. For example, our

23
core business earnings measure allows management and investors to evaluate the quality of earnings from

Fannie Mae's principal business activities in a way that accounts for comparable hedging transactions in a

similar manner. We discuss our core business earnings results in ""MD&AÌCore Business Earnings and

Business Segment Results.''

While the overall U.S. economy was weak during 2002, the U.S. housing market remained strong, with

both home sales and mortgage originations reaching record levels. The decline in mortgage interest rates

during the third quarter of 2002 to the lowest levels since the 1960s sparked a reÑnance boom and fueled

record reÑnance as well as purchase originations. Single-family mortgage originations in 2002 totaled

$2.6 trillion, surpassing 2001's record of $2.0 trillion by 29 percent. Our marketÌresidential mortgage debt

outstandingÌincreased 12 percent in 2002 to $7.0 trillion as the demand for housing continued to grow,

marking the Ñrst two consecutive years of double-digit residential mortgage debt outstanding (""MDO'')

growth since 1988-1989.

During 2002, we made progress on several key strategic initiatives to support our mission of increasing

homeownership and aÅordable rental housing for all Americans. We align our strategies with and measure our

performance against six long-term corporate goals.

1. Acknowledged Leadership in Increasing Access to AÅordable Housing: One of our most signiÑcant

initiatives to increase homeownership rates and serve 18 million targeted American families is our tenyear, $2 trillion American Dream Commitment. In 2002, we provided $670 billion for 5.5 million targeted

families to own or rent a home, bringing us almost two-thirds of the way toward achieving this ten-year

goal in three years.

2. Leading Presence in the Secondary Market and Partner of Choice: Our goal is to be the secondary

market partner of choice for mortgage lenders. We now have alliance agreements with 17 of the 30 largest

lenders, and our business with smaller lenders has grown by over 150 percent during the past year. We

achieved a net gain in major partnership accounts during 2002. We have provided increased liquidity to

mortgage markets by owning approximately 11 percent of mortgage debt outstanding and guaranteeing

15 percent owned by other investors.

3. Optimal Risk Management: Our Ñnancial success depends on the ability of our two core lines of business

to eÅectively manage interest rate risk and credit risk on home mortgages. By taking an active, highly

disciplined approach in managing these risks, we have honed our risk management tools over the years to

reduce our risk exposure, expand our service to American homebuyers, and deliver double-digit core

business earnings growth for the last 16 years through all kinds of economic scenarios.

4. Record Financial Performance: One of our key Ñnancial performance goals, announced in 1999, is a Ñveyear goal to double Fannie Mae's core business diluted earnings per share to $6.46 by the end of 2003.

With an increase in core business earnings of nearly 90 percent over the last 4 years, we are on track to

achieve this Ñve-year goal.

5. Corporate Culture to Enhance Strategy Execution: Developing a corporate culture that ensures a diverse

and fully engaged workforce is critical in executing our key strategic initiatives and fulÑlling Fannie Mae's

mission to help more families achieve the American Dream of homeownership. In 2002, Fannie Mae

received several awards in recognition of our commitment to being a world-class, diverse organization.

6. E-Commerce Company Infrastructure to Increase Capabilities and Lower Costs: Our e-commerce

strategy is intended to help us grow our business, while lowering the cost of mortgages and reducing our

underwriting risk. For example, by expanding utilization of Desktop Underwriter» (""DU''), our automated underwriting system, we can help lenders streamline their processes and enhance further our credit

risk management eÅectiveness. Today, approximately 60 percent of our total single-family business is

processed through DU. In addition, we committed signiÑcant resources in 2002 to upgrading our core

technology infrastructure to enhance the acquisition of mortgages through multiple channels, facilitate

new products, and generate cost reductions for our customers.

24
Because of Fannie Mae's critical role in the housing Ñnance system, one of our core commitments is to

maintain the highest standard of transparency in our Ñnancial disclosures. In our on-going eÅorts to enhance

Fannie Mae's transparency, we announced in 2002 our voluntary initiative to register Fannie Mae's common

stock with the Securities and Exchange Commission under Section 12(g) of the Securities Exchange Act of

1934. This report is our Ñrst periodic report Ñled pursuant to our voluntary initiative.

ABOUT FANNIE MAE

Fannie Mae's purpose is to facilitate the Öow of low-cost mortgage capital to increase the availability and

aÅordability of homeownership for low-, moderate-, and middle-income Americans. We operate under a

federal charter, and our primary regulator is the OÇce of Federal Housing Enterprise Oversight (""OFHEO'').

However, we are a private, shareholder-owned company. The U.S. government does not guarantee, directly or

indirectly, Fannie Mae's debt securities or other obligations.

As the nation's largest source of funds for mortgage lenders and investors, Fannie Mae provides resources

for our customers to make additional mortgage loans or investments in mortgage-related securities. We

provide liquidity to the mortgage market for the beneÑt of borrowers; however, we do not lend money directly

to consumers. We operate exclusively in the secondary mortgage market by purchasing mortgages and

mortgage-related securities, including Fannie Mae MBS, from primary market institutions, such as commercial banks, savings and loan associations, mortgage companies, securities dealers, and other investors. We

provide additional liquidity in the secondary market by issuing and guaranteeing mortgage-related securities.

We have two lines of business that generate revenue. These business lines also focus on managing our key

business risks. We measure the results of our lines of business based on core business earnings. We evaluate

the results of our business lines as though each were a stand-alone business. Hence, we allocate certain income

and expenses to each line of business for purposes of business segment reporting. We eliminate certain intersegment allocations in our consolidated core business earnings results (see ""MD&AÌCore Business Earnings

and Business Segment Results'').

Portfolio Investment Business: The Portfolio Investment business has two principal components: a

mortgage portfolio and a liquid investment portfolio (""LIP''). The mortgage portfolio purchases mortgage

loans, mortgage-related securities, and other investments from lenders, securities dealers, investors, and other

market participants. The LIP serves as an alternative source of funds to meet our cash Öow needs by investing

in high quality, short-term investments that provide an ongoing supply of funds. We can use these funds as

necessary for liquidity purposes or to reinvest in readily marketable, high credit quality securities that can be

sold to raise cash. We fund the purchase of the assets in our Portfolio Investment business from our equity

capital and by issuing debt in the global capital markets. The Portfolio Investment business generates proÑts

by ensuring that the interest income from the mortgages, MBS, mortgage-related securities, and liquid

investments we purchase is greater than our borrowing costs. A primary measure of proÑtability for the

Portfolio Investment business is our ""net interest margin''. Our net interest margin reÖects the diÅerence

between taxable-equivalent income on our mortgage assets and non-mortgage investments and our borrowing

expense divided by average interest earning assets.

Our Portfolio Investment business focuses on managing Fannie Mae's interest rate risk. Interest rate risk

is the risk that changes in interest rates could change cash Öows on our mortgage assets and debt in a way that

adversely aÅects Fannie Mae's earnings or long-term value.

Credit Guaranty Business: Our Credit Guaranty business has primary responsibility for managing all of

our mortgage credit risk. Credit risk is the risk of loss to future earnings and future cash Öows that may result

from the failure of a borrower or counterparty to fulÑll its contractual obligation to Fannie Mae. The Credit

Guaranty business primarily generates income from guaranty fees for guaranteeing the timely payment of

scheduled principal and interest on mortgage-related securities we guarantee that are not owned by the

Portfolio Investment business. The primary source of income for the Credit Guaranty business is the

25
diÅerence between the guaranty fees earned and the costs of providing this service. Income is also allocated to

the Credit Guaranty business for the following activities:

‚ Managing the credit risk on mortgage-related assets held by the Portfolio Investment business. The

Portfolio Investment business compensates the Credit Guaranty business through a guaranty fee

comparable to an MBS guaranty fee. These fees are recognized as guaranty fee income by the Credit

Guaranty business. Similarly, all credit expenses, including credit losses on loans and on MBS and

other mortgage-related securities held in Fannie Mae's mortgage portfolio, are allocated to the Credit

Guaranty business for business segment reporting purposes. Net interest income for the Credit

Guaranty business is net of charges paid to the Portfolio Investment business for forgone interest on

delinquent loans.

‚ Providing capital to the Portfolio Investment business. The Portfolio Investment business also

compensates the Credit Guaranty business for the temporary use of capital generated by the Credit

Guaranty business, which the Portfolio Investment business uses to fund investments. This compensation is classiÑed as net interest income.

‚ Temporarily investing principal and interest payments on loans underlying MBS and other mortgagerelated securities prior to remittance to investors. Interest income on the temporary investment of

these funds is allocated to the Credit Guaranty business.

Our Credit Guaranty business manages Fannie Mae's mortgage credit risk by managing the proÑle and

quality of mortgages in the mortgage credit book of business, using credit enhancements to reduce our losses,

assessing the sensitivity of credit losses to changes in economic conditions, and aggressively managing problem

assets to mitigate losses.

Revenue growth in our business lines is driven fundamentally by growth in residential mortgage debt

outstanding. This market has usually been one of the strongest growth markets in the U.S. economy, typically

growing faster than the gross domestic product (""GDP''). During the 1990s, mortgage debt outstanding grew

7 percent annually. Since 2000, MDO has grown at an average annual rate of 11.3 percent. Our economic

projections indicate an average annual growth rate of 8 to 10 percent during the current decade due to four

fundamental demographic and economic drivers: (1) projected growth in immigration, population, and

household formation; (2) increased rates of homeownership particularly by minorities, whose homeownership

rates lag the average by 20 percentage points; (3) continued growth in property values as the average home

grows larger, demand remains strong, and supply remains constrained because of land shortages and growth

restrictions; and (4) projected growth in debt-to-value ratios as consumers increasingly use the equity in their

homes as a Ñnancial investment option. In addition, our business has typically grown faster than our market

because of our eÇciency, innovation, and low costs, which have helped make Fannie Mae a preferred source

of liquidity for Ñxed-rate mortgages.

The expenses related to our lines of business stem largely from costs incurred to manage our two primary

business risksÌinterest rate risk and credit risk. We have highly skilled teams of experienced risk

management professionals who take an active, highly disciplined approach in managing these risks to meet our

objective of delivering consistent earnings growth and target returns on capital in a wide range of economic

environments. They have been successful in dispersing Fannie Mae's risk and loss exposure over the years

within the global Ñnancial system by developing various mortgage risk management tools that increase our

level of expertise and eÇciency in managing mortgage prepayment and credit risk.

RESULTS OF OPERATIONS

The following discussion of our results of operations is based on Fannie Mae's reported results. We have

reclassiÑed certain amounts in our prior years' reported results to conform to our current presentation. We

provide a separate discussion of our core business earnings and business segment results in ""MD&AÌCore

Business Earnings and Business Segment Results.''

26
Net Interest Income

Reported net interest income is the diÅerence between interest income and interest expense. Net interest

income represents a principal source of earnings for Fannie Mae and is aÅected by net volume, asset yield, and

the cost of debt and certain derivatives. Reported net interest income subsequent to our adoption of FAS 133

only includes a portion of the cost associated with using purchased options to hedge the borrowers' prepayment

option in mortgages. Prior to the adoption of FAS 133, we amortized purchased options premiums on a

straight-line basis and reÖected the cost in our net interest income as a component of our interest expense.

With the adoption of FAS 133, we now report the change in the fair value of the time value of purchased

options in a separate income statement category ""purchased options expense.'' We also present net interest

income and the related net interest yield on a taxable-equivalent basis to consistently reÖect income from

taxable and tax-exempt investments based on a 35 percent marginal tax rate.

Table 1 presents Fannie Mae's net interest yield based on our reported net interest income adjusted for

tax-exempt investments and average balances of mortgage assets, nonmortgage investments, and debt. The net

interest yield calculation subsequent to our adoption of FAS 133 does not fully reÖect the cost of our

purchased options (see ""MD&AÌCore Business Earnings and Business Segment ResultsÌCore Net Interest

Income'' for a discussion of our supplemental non-GAAP measures, core net interest income and net interest

margin).

Table 1: Taxable-Equivalent Net Interest Income and Average Balances

2002 2001 2000

(Dollars in millions)

Interest income:

Mortgage portfolio ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 49,265 $ 46,478 $ 39,403

Nonmortgage investments and cash equivalents ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 1,588 2,692 3,378

Total interest income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 50,853 49,170 42,781

Interest expense(1):

Short-term debt ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2,978 5,897 4,204

Long-term debtÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 37,309 35,183 32,903

Total interest expenseÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 40,287 41,080 37,107

Net interest income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 10,566 8,090 5,674

Taxable-equivalent adjustment on tax-exempt investments(2) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 502 470 414

Taxable-equivalent net interest income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 11,068 $ 8,560 $ 6,088

Average balances(3):

Interest-earning assets(4):

Mortgage portfolio, net ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $735,943 $658,195 $553,531

Nonmortgage investments and cash equivalents ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 68,658 58,811 51,490

Total interest-earning assets ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 804,601 717,006 605,021

Interest-free funds(5) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (23,992) (23,630) (20,595)

Total interest-earning assets funded by debt ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $780,609 $693,376 $584,426

Interest-bearing liabilities(1):

Short-term debt ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $141,727 $137,078 $ 73,351

Long-term debtÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 638,882 556,298 511,075

Total interest-bearing liabilitiesÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $780,609 $693,376 $584,426

Average interest rates(2, 3):

Interest-earning assets:

Mortgage portfolio, net ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 6.73% 7.11% 7.16%

Nonmortgage investments and cash equivalents ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2.34 4.63 6.60

Total interest-earning assets ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 6.35 6.90 7.11

Interest-free return(5) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ .18 .21 .25

Total interest-earning assets funded by debt ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 6.53 7.11 7.36

Interest-bearing liabilities(1):

Short-term debt ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 1.90 4.16 5.70

Long-term debtÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 5.88 6.35 6.44

Total interest-bearing liabilitiesÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 5.15 5.92 6.35

Net interest yield ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 1.38% 1.19% 1.01%

(1) ClassiÑcation of interest expense and interest-bearing liabilities as short-term or long-term is based on eÅective maturity or repricing date,

taking into consideration the eÅect of derivative Ñnancial instruments.

(2) ReÖects non-GAAP adjustments to permit comparison of yields on tax-exempt and taxable assets based on 35 percent marginal tax rate.

(3) Averages have been calculated on a monthly basis based on amortized cost.

(4) Includes average balance of nonaccrual loans of $4.6 billion in 2002, $2.6 billion in 2001, and $2.1 billion in 2000.

(5) Interest-free funds represent the portion of our investment portfolio funded by equity and non-interest bearing liabilities.

27
Taxable-equivalent net interest income totaled $11.068 billion in 2002, compared with $8.560 billion in

2001 and $6.088 billion in 2000. The increase of $2.508 billion, or 29 percent, in taxable-equivalent net interest

income was due primarily to 12 percent growth in our average net mortgage portfolio and a higher net interest

yield, which was favorably aÅected by the low interest rate environment and unusually steep yield curve. As

mortgage interest rates fell to the lowest level in 40 years and Ñxed-rate mortgage originations reached record

levels, we took advantage of opportunities to grow our mortgage portfolio at attractive spreads relative to our

debt costs. Our net interest yield continued to beneÑt and remained elevated during 2002 because of actions

we took during 2002 and 2001 to lower our debt costs by calling or retiring higher-cost debt and temporarily

replacing it with shorter-term, lower-cost debt.

During 2001, taxable-equivalent net interest income increased $2.472 billion or 41 percent over 2000,

partially due to the eÅect of the change in accounting for our purchased options under FAS 133. Our taxableequivalent net interest income in 2001 does not include all of the cost of purchased options. However, our

taxable-equivalent net interest income in 2000 includes $231 million of expense related to the amortization of

purchased options premiums on a straight-line basis. Prior to the adoption of FAS 133, we recorded purchased

options premiums as interest expense in our reported net interest income. FAS 133 changed our accounting for

purchased options, requiring that we report changes in the fair value of the time value of purchased options

instead of expensing purchased options premiums on a straight-line basis. We report changes in the fair value

of the time value of our purchased options in a separate income statement category ""purchased options

expense.'' Our taxable-equivalent net interest income in 2001 also beneÑted from 19 percent growth in our

average net mortgage portfolio and a signiÑcant decrease in our debt costs that elevated our net interest yield.

A reduction in intermediate-term rates during 2001 boosted mortgage reÑnancings and originations, fueling an

increase in the supply of mortgage assets in the secondary market and attractive mortgage-to-debt spreads.

Table 2 shows the changes in our reported and taxable-equivalent net interest income between 2002 and

2001 and 2001 and 2000 attributable to changes in rates and volume on our mortgage assets, nonmortgage

investments, and debt.

Table 2: Rate/Volume Analysis of Reported Net Interest Income

Attributable to

Changes in(1)

Increase

(Decrease) Volume Rate

(Dollars in millions)

2002 vs. 2001

Interest income:

Mortgage portfolio ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 2,787 $5,292 $(2,505)

Nonmortgage investments and cash equivalents ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (1,104) 394 (1,498)

Total interest income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 1,683 5,686 (4,003)

Interest expense:(2)

Short-term debt ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (2,919) 194 (3,113)

Long-term debtÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2,126 4,959 (2,833)

Total interest expense ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (793) 5,153 (5,946)

Change in net interest income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 2,476 $ 533 $ 1,943

Change in taxable-equivalent adjustment on tax-exempt investments(3) ÏÏÏÏÏÏÏÏÏÏÏÏ 32

Change in taxable-equivalent net interest income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 2,508

28
Attributable to

Changes in(1)

Increase

(Decrease) Volume Rate

(Dollars in millions)

2001 vs. 2000

Interest income:

Mortgage portfolio ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 7,075 $7,393 $ (318)

Nonmortgage investments and cash equivalents ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (686) 434 (1,120)

Total interest income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 6,389 7,827 (1,438)

Interest expense:(2)

Short-term debt ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 1,693 2,945 (1,252)

Long-term debtÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2,280 2,868 (588)

Total interest expense ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 3,973 5,813 (1,840)

Change in net interest income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 2,416 $2,014 $ 402

Change in taxable-equivalent adjustment on tax-exempt investments(3) ÏÏÏÏÏÏÏÏÏÏÏÏ 56

Change in taxable-equivalent net interest income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 2,472

(1) Combined rate/volume variances, a third element of the calculation, are allocated to the rate and volume variances

based on their relative size.

(2) ClassiÑcation of interest expense and interest-bearing liabilities as short-term or long-term is based on eÅective

maturity or repricing date, taking into consideration the eÅect of derivative Ñnancial instruments.

(3) ReÖects non-GAAP adjustments to permit comparison of yields on tax-exempt and taxable assets based on a

35 percent marginal tax rate.

Guaranty Fee Income

Guaranty fee income reported in our total corporate results and our average guaranty fee rate primarily

include guaranty fees we receive on mortgage-related securities we issue that are held by other investors. We

classify guaranty fees on Fannie Mae mortgage-related securities held in our portfolio as net interest income.

The guaranty fee income allocated for line of business reporting purposes to the Credit Guaranty business on

mortgage-related securities held in our portfolio is eliminated by an equal and oÅsetting allocation of guaranty

expense to the Portfolio Investment business. We exclude the administrative costs of managing outstanding

MBS and other mortgage-related securities from guaranty fee income.

Guaranty fee income increased 23 percent or $334 million in 2002 to $1.816 billion and 10 percent in

2001 to $1.482 billion. The increases were driven primarily by a 22 percent increase in average outstanding

MBS (MBS and other mortgage-related securities guaranteed by Fannie Mae and held by investors other

than Fannie Mae) during 2002 and a 12 percent increase during 2001.

Our average guaranty fee rate on outstanding MBS during 2002 increased slightly to 19.1 basis points

from 19.0 basis points in 2001. During the last half of 2002, our average eÅective guaranty fee rate rose as a

result of higher fee rates on new business and the faster amortization of deferred fees as we adjusted our

prepayment amortization rates to reÖect the acceleration of mortgage prepayments in the heavy reÑnance

environment. Our average eÅective guaranty fee rate declined by .5 basis points between 2000 and 2001,

primarily due to increased competition and general market conditions. Recently, rates on new credit guaranty

products have been higher because of our eÅorts to better align our pricing with the relative underlying risks of

loans we guarantee and expansion into market segments that demand higher guaranty fees. As a result of these

trends, we anticipate a modest increase in our average eÅective guaranty fee rates in the future. Table 3

presents our average eÅective guaranty fee rate for the past three years.

29
Table 3: Guaranty Fee Data

Year Ended December 31,

2002 2001 2000

(Dollars in millions)

Guaranty fee incomeÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 1,816 $ 1,482 $ 1,351

Average balance of outstanding MBS(1)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 950,232 779,647 694,165

Average eÅective guaranty fee rate (basis points) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 19.1 19.0 19.5

(1) ""Outstanding MBS'' refers to MBS and other mortgage-related securities guaranteed by Fannie Mae and held by

investors other than Fannie Mae. If an MBS has been resecuritized into another MBS, we only include the principal

amount once in the outstanding balance.

Fee and Other Income (Expense), Net

Fee and other income (expense) consists of transaction fees, technology fees, multifamily fees, and other

miscellaneous items and is net of costs associated with the purchase of additional mortgage insurance to

protect against credit losses (""credit enhancement expense'') and operating losses from certain tax-advantaged

investments in aÅordable housing projects. These tax-advantaged investments represent equity interests in

limited partnerships that own rental housing and generate tax credits, which reduce Fannie Mae's eÅective

federal income tax rate. We account for the majority of these investments using the equity method. We do not

guarantee any obligations of these partnerships, and our exposure is limited to the amount of our investments.

We record the tax beneÑt related to these investments as a reduction in the provision for federal income taxes

and as an increase in taxable-equivalent revenues.

We recorded $232 million of fee and other income in 2002, up from $151 million of income in 2001. The

$81 million increase in fee and other income was driven by a $114 million increase in transaction and

technology fees resulting primarily from increased REMIC transaction volumes and a $69 million increase in

net gains from the sale of securities. These increases were oÅset partially by a $78 million increase in credit

enhancement expenses and a $61 million increase in impairment write-downs on a variety of investments. The

increase in credit enhancement expenses was attributable to an increase in the volume of business covered by

credit enhancements purchased directly by Fannie Mae, stemming from our expansion into new products and

markets.

Fee and other income totaled $151 million for 2001, up $195 million over expense of $44 million recorded

in 2000 primarily because of a $146 million increase in technology and transaction fees. The increase in

technology and transaction fees resulted largely from greater use of Fannie Mae's Desktop Underwriter and

Desktop Originator systems and higher structured transaction fees, such as REMIC fees, attributable to

record mortgage business volumes. A hedging loss on an anticipated Benchmark Notes» issuance that

occurred in April 2000 also contributed to the year-over-year increase in fee and other income in 2001.

Credit-Related Expenses

Credit-related expenses include foreclosed property expenses (income) and the provision for losses. In

2002, we reclassiÑed recoveries in excess of charged-oÅ amounts on foreclosed properties from ""charge-oÅ

recoveries'' to ""foreclosed property expense (income).'' In addition, with the rescission of the American

Institute of CertiÑed Public Accountants (""AICPA'') Statement of Position 92-3, ""Accounting for Foreclosed

Assets'' (""SOP 92-3'') in the fourth quarter of 2002, we now include estimated selling costs in the

determination of our initial charge-oÅ when we foreclose on a loan. We adjusted our provision for losses to

reÖect a charge equal to the net change in charge-oÅs. We have also retroactively reclassiÑed any excess

recoveries in previous periods for comparability purposes.

Credit-related expenses increased $14 million over 2001 to $92 million, primarily due to an increase in

multifamily credit-related losses stemming from two properties. We recorded a provision for losses of

$128 million in 2002, an increase of $34 million over 2001. The increase in our provision was partially oÅset by

$20 million in additional foreclosed property income primarily due to gains on foreclosed property dispositions.

Foreclosed property income totaled $36 million in 2002, compared with $16 million in 2001. The 2002

30
increase in credit-related expenses follows a $16 million decline in 2001 that was largely due to a reduction in

our provision for losses. Our provision for losses decreased $28 million in 2001 to $94 million. We also had

forgone interest on non-performing assets that reduced our net interest income by $148 million in 2002,

$70 million in 2001, and $43 million in 2000. Although foreclosed single-family property acquisitions

increased in 2002 to 19,500 from 14,486 in 2001 and 14,351 in 2000, average severities declined due to strong

home prices and credit enhancement proceeds.

We previously recorded gains from the sale of foreclosed properties and related mortgage insurance

claims against our allowance for losses as a recovery of charge-oÅs. During 2002, we reclassiÑed these gains to

foreclosed property expense (income). Additionally, the AICPA rescinded SOP 92-3 during the fourth

quarter of 2002. Under SOP 92-3, we recorded selling costs related to the disposition of foreclosed properties

in our income statement under foreclosed property expense (income). We now include selling costs in our

initial charge-oÅ estimate. All prior periods have been reclassiÑed to conform to the current year presentation.

The reclassiÑed amounts result in equal and oÅsetting changes to our provision for losses and foreclosed

property expense (income) line items within our previously reported income statements. These reclassiÑcations have no impact on previously reported net income, total credit-related expenses, total credit-related

losses, or the combined balance of the allowance for loan losses and guaranty liability.

Despite signiÑcant growth in our book of business and overall weaker economic conditions during 2002

and 2001, credit losses as a percentage of Fannie Mae's average book of business have steadily declined to .5

basis points in 2002, from .6 basis points in 2001, and .7 basis points in 2000. Our book of business includes

mortgages and MBS in our mortgage portfolio and outstanding MBS held by other investors. Credit losses

include charge-oÅs (net of recoveries) and foreclosed property income. The strong appreciation in home

prices during 2002 and 2001 helped in strengthening the credit risk proÑle of our book of business. In addition,

we have been able to eÅectively manage credit risk by using credit enhancements to minimize our credit losses

during the economic slowdown, monitoring and assessing the sensitivity of our credit risk to changes in the

economic environment, and taking an aggressive approach to problem asset management.

Administrative Expenses

Administrative expenses include those costs incurred to run our daily operations, such as personnel costs

and technology expenses.

Administrative expenses increased 20 percent to $1.219 billion in 2002. The above average growth in

administrative expenses was due primarily to costs incurred on a multi-year project initiated in 2001 to reengineer our core infrastructure systems and expenses associated with relocating our primary data center. In

addition, compensation expense increased 13 percent to $683 million in 2002, resulting primarily from a

5 percent increase in the number of employees and annual salary increases.

Administrative expenses grew 12 percent to $1.017 billion in 2001 from $905 million in 2000, primarily

due to increased compensation expense related to 8 percent growth in the number of employees and annual

salary increases, increased costs related to the multi-year core infrastructure project, and a contribution of

$10 million in 2001 to support victims and families of victims aÅected by the September 11 tragedy.

We evaluate growth in administrative expenses based on growth in taxable-equivalent revenues and our

average book of business. Taxable-equivalent revenues is a supplemental non-GAAP measure discussed

further in ""MD&A Ì Core Business Earnings and Business Segment Results.'' While administrative

expenses have grown in the past two years, the ratio of administrative expenses to taxable-equivalent revenues,

which we refer to as our eÇciency ratio, has increased only modestly to 10.2 percent from 10.0 percent in

2001. Our eÇciency ratio for 2002 and 2001 remained fairly steady and improved over the 11.6 percent level of

2000 primarily due to strong growth in net interest income during both years. The ratio of administrative

expenses to our average book of business has also remained relatively stable at .072 percent in 2002, compared

with .071 percent in 2001, and .072 percent in 2000.

31
Special Contribution

Special contribution expense reÖects a contribution we made to the Fannie Mae Foundation.

We committed during the fourth quarter of 2001 to contribute $300 million of our common stock to the

Fannie Mae Foundation. The Fannie Mae Foundation creates aÅordable homeownership and housing

opportunities through innovative partnerships and initiatives that build healthy, vibrant communities across

the United States. It is a separate, private, nonproÑt organization that we do not consolidate, but is supported

solely by Fannie Mae. We expect the 2001 contribution to the Fannie Mae Foundation to reduce the

Foundation's need for contributions over the next several years. We acquired the shares through open market

purchases and contributed them to the Foundation in the Ñrst quarter of 2002.

Purchased Options Expense

Purchased options expense includes the change in the fair value of the time value of purchased options in

accordance with FAS 133. The change in the fair value of the time value of purchased options will vary from

period to period with changes in interest rates, market pricing of options, and our derivative activity.

Our reported income results for 2002 were unfavorably aÅected by $4.545 billion in purchased options

expense related to changes in the time value of purchased options, signiÑcantly more than the $37 million

expense recorded in 2001. The substantial increase in expense during 2002 was caused by an increase in the

average notional balance of caps and swaptions, two types of purchased options we commonly use to manage

interest rate risk, to $287 billion in 2002 from $154 billion in 2001, coupled with a sharp decline in interest

rates that resulted in a decrease in time value. Under FAS 133, we are not allowed to recognize in earnings

changes in the intrinsic value of some of these options, which, in combination with the fair value of options in

our mortgage assets and callable debt, would have more than oÅset the decrease in the time value of these

options during 2002. Prior to the adoption of FAS 133 on January 1, 2001, we amortized premiums on

purchased options into interest expense on a straight-line basis. In 2000, we recorded $231 million in

purchased options amortization expense that is included as a component of net interest income.

During the fourth quarter of 2002, we reÑned our methodology for estimating the initial time value of

interest rate caps at the date of purchase and prospectively adopted a preferred method that resulted in a

$282 million pre-tax reduction in purchased options expense and increased our diluted EPS for 2002 by $.18.

Under our previous valuation method, we treated the entire premium paid on purchased ""at-the-money'' caps

as time value with no allocation to intrinsic value. Our new methodology allocates the initial purchase price to

reÖect the value of individual caplets, some of which are above the strike rate of the cap, which results in a

higher intrinsic value and corresponding lower time value at the date of purchase. This approach is more

consistent with our estimation of time value subsequent to the initial purchase date. This change does not

aÅect the total expense that will be recorded in our income statement over the life of our caps and has no

eÅect on our non-GAAP core business earnings measure.

Debt Extinguishments

Fannie Mae strategically repurchases or calls debt securities and related interest rate swaps on a regular

basis as part of our interest rate risk management eÅorts and to reduce future debt costs. We record gains and

losses on debt extinguishments in this category.

We recognized a pre-tax loss of $710 million in 2002 from the call and repurchase of debt, compared with

a pre-tax loss of $524 million in 2001. Market conditions during 2002 and 2001 made it advantageous for us to

repurchase $8 billion and $9 billion, respectively, of debt securities that were trading at historically wide

spreads to other Ñxed-income securities. We also called over $174 billion of high-coupon debt securities and

notional principal of interest rate swaps in 2002 and $173 billion in 2001. The weighted-average cost of

redeemed debt and interest rate swaps in 2002 and 2001 was 5.36 percent and 6.23 percent, respectively.

During 2000, we repurchased or called $18 billion in debt securities and notional principal of interest rate

swaps carrying a weighted-average cost of 7.10 percent and recognized a gain of $49 million.

During the second quarter of 2002, we adopted Financial Accounting Standard No. 145, Rescission of

FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections

(""FAS 145''). This standard eliminates the extraordinary treatment of the gains and losses on our debt

32
repurchases because debt extinguishment is a normal and recurring component of our interest rate risk

management strategy. For comparative purposes, we have reclassiÑed all prior periods to conform to the

current presentation.

Income Taxes

The provision for federal income taxes, including tax related to the cumulative eÅect of change in

accounting principle, decreased to $1.429 billion in 2002 from $2.131 billion in 2001. The 2002 decrease in tax

expense was primarily related to the tax beneÑt recorded on the increased purchased options expense. Our tax

provision totaled $1.583 billion in 2000. The combined eÅect of our low income housing tax credits and the

reduction in our 2002 pre-tax income from purchased options expense caused our eÅective tax rate on reported

net income to decline to 24 percent from 27 percent in 2001 and 26 percent in 2000. Our eÅective tax rate

based on our core business earnings, which is adjusted for the impact of FAS 133 on our purchased options,

was 27 percent in 2002 and 26 percent in 2001 and 2000. See ""MD&AÌCore Business Earnings and Business

Segment Results.''

Cumulative EÅect of Change in Accounting Principle

EÅective January 1, 2001, we adopted FAS 133, as amended by Financial Accounting Standard No. 138,

Accounting for Derivative Instruments and Certain Hedging ActivitiesÌan amendment of FASB Statement

No. 133. Our adoption of FAS 133 on January 1, 2001, resulted in a cumulative after-tax increase to income of

$168 million ($258 million pre-tax) in 2001. The cumulative eÅect on earnings from the change in accounting

principle was primarily attributable to recording the fair value of the time value of purchased options, which

are used as a substitute for callable debt securities.

CORE BUSINESS EARNINGS AND BUSINESS SEGMENT RESULTS

Management relies primarily on core business earnings, a supplemental non-GAAP measure developed

in conjunction with our January 1, 2001 adoption of FAS 133, to evaluate Fannie Mae's Ñnancial

performance. While core business earnings is not a substitute for GAAP net income, we rely on core business

earnings in operating our business because we believe core business earnings provides our management and

investors with a better measure of our Ñnancial results and better reÖects our risk management strategies than

our GAAP net income. Core business earnings excludes the unpredictable volatility in the time value of

purchased options because we generally intend to hold these options to maturity, and we do not believe the

period-to-period variability in our reported net income from changes in the time value of our purchased

options accurately reÖects the underlying risks or economics of our hedging strategy. Core business earnings

includes amortization of purchased options premiums on a straight-line basis over the original expected life of

the options. The net amount of purchased options amortization expense recorded under our core business

earnings measure will equal the net amount of purchased options expense ultimately recorded under FAS 133

in our reported net income over the life of our options. However, our amortization treatment is more consistent

with the accounting for embedded options in our callable debt and more accurately reÖects the underlying

economics of our use of purchased options as a substitute for issuing callable debtÌtwo alternate hedging

strategies that are economically very similar but require diÅerent accounting under FAS 133.

Management also relies on several other non-GAAP performance measures related to core business

earnings to evaluate Fannie Mae's performance. These key performance measures include taxable-equivalent

revenues, core net interest income, and net interest margin. We discuss these measures further in this section

and provide a discussion of our business segments, which we also evaluate based on core business earnings.

Our core business earnings measures are not deÑned terms within GAAP and may not be comparable to

similarly titled measures reported by other companies.

Core Business Earnings

We delivered record core business earnings in 2002 for the 16th consecutive year. Core business earnings

increased 19 percent over 2001 to $6.394 billion due primarily to strong mortgage portfolio and net interest

33
margin growth. Our core business earnings in 2001 grew 21 percent over 2000 to $5.367 billion, also due to

strong portfolio and net interest margin growth.

2002 Ñnancial highlights include:

‚ 17 percent increase in total taxable-equivalent revenues

‚ 12 percent growth in the average net mortgage portfolio

‚ 16 percent increase in the total book of business

‚ 4 basis point increase in the net interest margin

‚ Decline in our credit loss ratio to .5 basis points from .6 basis points in 2001

While our core business earnings measures should not be construed by investors as an alternative to net

income and other measures determined in accordance with GAAP, they are critical performance indicators for

Fannie Mae's management. Core business earnings is the primary Ñnancial performance measure used by

Fannie Mae's management not only in developing the Ñnancial plans of our lines of business and tracking

results, but also in establishing corporate performance targets and determining incentive compensation. In

addition, the investment analyst community has traditionally relied on our core business earnings measures to

evaluate Fannie Mae's earnings performance and to issue earnings guidance. We believe these measures also

can serve as valuable assessment tools for investors to judge the quality of our earnings because they provide

more consistent accounting and reporting for economically similar interest rate risk hedging transactions,

which allows investors to more readily identify sustainable trends and gauge potential future earnings trends.

Table 4 shows our line of business and consolidated core business earnings results for 2002, 2001, and

2000. We have reclassiÑed certain amounts in our prior years' results to conform to our current presentation.

The only diÅerence in core business earnings and reported net income relates to the FAS 133 accounting

treatment for purchased options, which aÅects our Portfolio Investment business. The FAS 133 related

reconciling items between our core business earnings and reported results have no eÅect on our Credit

Guaranty business.

34
Table 4: Reconciliation of Core Business Earnings to Reported Results

2002(1)

Reconciling

Total Core Items Related

Portfolio Credit Business to Purchased Reported

Investment Guaranty Earnings Options Results

(Dollars in millions)

Net interest income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 9,869 $ 697 $10,566 $ Ì $10,566

Purchased options amortization expense ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (1,814) Ì (1,814) 1,814 (a) Ì

Core net interest income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 8,055 697 8,752 1,814 10,566

Guaranty fee income (expense) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (1,374) 3,190 1,816 Ì 1,816

Fee and other income (expense), net ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 348 (116) 232 Ì 232

Credit-related expenses(2) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Ì (92) (92) Ì (92)

Administrative expenses ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (357) (862) (1,219) Ì (1,219)

Purchased options expense under FAS 133ÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Ì Ì Ì (4,545)(b) (4,545)

Debt extinguishments, net ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (710) Ì (710) Ì (710)

Income before federal income taxesÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 5,962 2,817 8,779 (2,731) 6,048

Provision for federal income taxes ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (1,747) (638) (2,385) 956 (d) (1,429)

Net income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 4,215 $2,179 $ 6,394 $(1,775) $ 4,619

2001(1)

Reconciling

Total Core Items Related

Portfolio Credit Business to Purchased Reported

Investment Guaranty Earnings Options Results

Net interest income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 7,369 $ 721 $ 8,090 $ Ì $ 8,090

Purchased options amortization expense ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (590) Ì (590) 590 (a) Ì

Core net interest income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 6,779 721 7,500 590 8,090

Guaranty fee income (expense) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (1,109) 2,591 1,482 Ì 1,482

Fee and other income (expense), net ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 211 (60) 151 Ì 151

Credit-related expenses(2) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Ì (78) (78) Ì (78)

Administrative expenses ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (302) (715) (1,017) Ì (1,017)

Special contribution ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (192) (108) (300) Ì (300)

Purchased options expense under FAS 133ÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Ì Ì Ì (37)(b) (37)

Debt extinguishments, net ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (524) Ì (524) Ì (524)

Income before federal income taxes and eÅect of

accounting change ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 4,863 2,351 7,214 553 7,767

Cumulative eÅect of accounting change, net of tax eÅectÏÏ Ì Ì Ì 168 (c) 168

Provision for federal income taxes ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (1,374) (473) (1,847) (194)(d) (2,041)

Net income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 3,489 $1,878 $ 5,367 $ 527 $ 5,894

2000

Reconciling

Total Core Items Related

Portfolio Credit Business to Purchased Reported

Investment Guaranty Earnings Options Results

Net interest income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 5,055 $ 619 $ 5,674 $Ì $ 5,674

Purchased options amortization expense ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Ì Ì Ì Ì Ì

Core net interest income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 5,055 619 5,674 Ì 5,674

Guaranty fee income (expense) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (1,079) 2,430 1,351 Ì 1,351

Fee and other income (expense), net ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 27 (71) (44) Ì (44)

Credit-related expenses(2) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Ì (94) (94) Ì (94)

Administrative expenses ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (254) (651) (905) Ì (905)

Debt extinguishments, net ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 49 Ì 49 Ì 49

Income before federal income taxesÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 3,798 2,233 6,031 Ì 6,031

Provision for federal income taxes ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (1,053) (530) (1,583) Ì (1,583)

Net income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 2,745 $1,703 $ 4,448 $Ì $ 4,448

(1) Reported net income for 2002 and 2001 includes the eÅect of FAS 133, which was adopted on January 1, 2001.

(2) Credit-related expenses include the income statement line items ""Provision for losses'' and ""Foreclosed property

expense (income).''

35
While the reconciling items to derive our core business earnings are signiÑcant components in

understanding and assessing our reported results and Ñnancial performance, investors may not be able to

directly discern the underlying economic impact of our interest rate risk management strategies without our

core business results. We believe our core business earnings measures help to improve transparency and

enhance investors' understanding of our operations, as well as facilitate trend analysis. The speciÑc FAS 133

related adjustments aÅecting our Portfolio Investment business that we identify in Table 4 include:

(a) Purchased options amortization expense: This amount represents the straight-line amortization of

purchased options premiums over the original expected life of the options that we include in our core net

interest income. We include this amount in core business earnings instead of recording changes in the

time value of purchased options because it is more consistent with the accounting for the embedded

options in our callable debt and the vast majority of our mortgages.

(b) Purchased options expense: This amount, which is recorded in our income statement under purchased

options expense, represents changes in the fair value of the time value of purchased options recorded in

accordance with FAS 133. We exclude this amount from our core business earnings measure because the

period-to-period Öuctuations in the time value portion of our options does not reÖect the economics of our

current risk management strategy, which generally is to hold our purchased options to maturity or

exercise date. Consequently, we do not expect to realize the period-to-period Öuctuations in time value.

(c) Cumulative after-tax gain upon adoption of FAS 133: This non-recurring amount represents the onetime transition recorded upon the adoption of FAS 133 on January 1, 2001. We exclude the transition

gain from core business earnings because it relates to unrealized gains on purchased options that were

recorded when we adopted FAS 133.

(d) Provision for federal income taxes adjustment: Represents the net federal income tax eÅect of core

business earnings adjustments based on the applicable federal income tax rate of 35 percent.

Core business earnings does not exclude any other accounting eÅects related to the application of

FAS 133 or any other non-FAS 133 related adjustments. The guaranty fee income that we allocate to the

Credit Guaranty business for managing the credit risk on mortgage-related assets held by the Portfolio

Investment business is oÅset by a corresponding guaranty fee expense allocation to the Portfolio Investment

business in our line of business results. Thus, there is no inter-segment elimination adjustment between our

total line of business guaranty fee income and our reported guaranty fee income. We allocate transaction fees

received for structuring and facilitating securities transactions for our customers primarily to our Portfolio

Investment business. We allocate technology-related fees received for providing Desktop Underwriter and

other on-line services and fees received for providing credit enhancement alternatives to our customers

primarily to our Credit Guaranty business.

As discussed in ""MD&AÌRisk ManagementÌInterest Rate RiskÌDerivative Instruments,'' we use

various funding alternatives, including option-based derivative instruments, that produce similar economic

results to manage interest rate risk and protect against the prepayment option in mortgages. The adjustments

made to our Portfolio Investment business to derive core business earnings provide consistent accounting

treatment for purchased options and the embedded option in callable debt securitiesÌeconomically equivalent

funding transactionsÌby allocating the cost of purchased options on a straight-line basis over the original

expected life of the option in a manner similar to our accounting for options in callable debt. We calculate the

original expected life of ""European'' options based on the exercise date. We calculate the original expected life

of ""American'' options based on the expected life at the time the option is purchased. There is a diÅerence in

the original expected lives of European and American options because European options are exercisable only

on one speciÑc date in the future, while American options are exercisable any time after a speciÑc future date.

The actual life of an American option may diÅer from our original expected life because of movements in

interest rates subsequent to the exercise date that may aÅect the value and beneÑt of exercising the option at a

given time.

We can protect our net interest margin against changes in interest rates by either issuing callable debt to

fund the purchase of mortgages or using a combination of callable debt, purchased options, and noncallable

36
debt. We generally use the method that helps us achieve our desired funding Öexibility and lowest cost. If

interest rates fall and our mortgages prepay, we have the option of retiring callable debt and issuing debt at a

lower rate to preserve our interest spread on new mortgage purchases. If interest rates fall and we have instead

used a combination of noncallable debt and purchased optionsÌsuch as a swaption that would allow us to

enter into a pay-variable interest rate swapÌwe can exercise our option to allow us to pay a variable or lower

interest rate and receive a Ñxed rate of interest. The Ñxed rate of interest that we receive would oÅset the cost

of our noncallable, Ñxed-rate debt. This hedging strategy would lower our funding costs and preserve our net

interest margin as interest rates fall in a manner very similar to retiring callable debt and issuing new, lower

cost debt. However, because the accounting for this hedging strategy is diÅerent under FAS 133, the cost of

the purchased option would not be reÖected in our reported net interest yield. We would be required to record

the change in the fair value of the time value of the purchased option as a separate amount in our income

statement. On the other hand, if interest rates increase, we would not exercise the option to call debt since the

cost of issuing new debt would be higher. Similarly, we would not exercise the option provided by a purchased

swaption to enter a pay-variable swap because under a higher interest rate environment, we could enter into a

similar transaction with more favorable terms. See ""MD&AÌRisk ManagementÌInterest Rate Risk

ManagementÌDerivative Instruments'' for further discussion on how we use purchased options to simulate

callable debt.

If we issue noncallable debt and purchased options to fund the purchase of mortgages and protect against

the prepayment option in mortgages, we are required under FAS 133 to record the unrealized period-to-period

Öuctuations in the changes in time value of the purchased options in earnings. If instead, we issue callable debt

to fund the purchase of the same mortgages, the expense related to the option in our callable debt would be

recognized ratably over the option period as part of interest expense. Although the two transactions produce

similar economic results, GAAP requires diÅerent accounting treatment. Under our core business earnings

measure, the accounting treatment for purchased options is consistent and also comparable to the accounting

treatment applied to these items in periods prior to the adoption of FAS 133.

Taxable-Equivalent Revenues

Taxable-equivalent revenues represent total revenues adjusted to reÖect the beneÑts of investment tax

credits and tax-exempt income based on applicable federal income tax rates and is net of the straight-line

amortization of purchased options expense that would have been recorded prior to the adoption of FAS 133.

For analytical purposes, we calculate revenues on a taxable-equivalent basis to measure income from lower

yielding investments that are tax-exempt or generate tax credits on a basis comparable to higher yielding

taxable investments.

Table 5 compares taxable-equivalent revenues and the components for 2002, 2001, and 2000.

37
Table 5: Taxable-Equivalent Revenues

Year Ended December 31,

2002 2001 2000

(Dollars in millions)

Net interest income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $10,566 $ 8,090 $5,674

Guaranty fee incomeÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 1,816 1,482 1,351

Fee and other income (expense), net(1) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 232 151 (44)

Total revenues ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 12,614 9,723 6,981

Taxable-equivalent adjustments:

Investment tax credits(2)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 594 584 430

Tax-exempt investments(3) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 502 470 414

Purchased options amortization expense(4)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (1,814) (590) Ì

Taxable-equivalent revenuesÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $11,896 $10,187 $7,825

(1) Includes net losses on certain tax-advantaged investments totaling $225 million, $222 million, and $188 million in

2002, 2001, and 2000, respectively.

(2) Represents non-GAAP taxable-equivalent adjustments for tax credits related to losses on certain aÅordable housing

tax-advantaged equity investments and other investment tax credits using the applicable federal income tax rate of

35 percent.

(3) ReÖects non-GAAP adjustments to permit comparisons of yields on tax-exempt and taxable assets based on a

35 percent marginal tax rate.

(4) Represents non-GAAP adjustment for straight-line amortization of purchased options premiums that would have

been recorded prior to the adoption of FAS 133 in 2001. This expense is included in net interest income in 2000.

Taxable-equivalent revenues increased 17 percent to $11.896 billion in 2002, compared with a 30 percent

increase in 2001 to $10.187 billion. The increase in both years was primarily attributable to growth in net

interest income resulting from the low rate environment that contributed to strong mortgage portfolio growth

and a reduction in our average cost of debt relative to our mortgage asset yields. Tighter mortgage-to-debt

spreads reduced mortgage portfolio growth during the Ñrst half of 2002 and slowed the increase in taxableequivalent revenues to levels more in line with our expectations. Our 2001 growth rate was higher than

expected because of the increased supply of mortgages in the secondary market and attractive mortgage-todebt spreads.

Core Net Interest Income

Core net interest income and our related net interest margin are supplemental non-GAAP measures that

management uses to evaluate Fannie Mae's performance. Core net interest income includes our reported net

interest income adjusted for the non-GAAP amortization of purchased options premiums on a straight-line

basis over the original expected life of the options to reÖect the cost associated with using purchased options to

hedge the borrowers' prepayment option in mortgages. We also calculate core net interest income on a taxableequivalent basis to determine our net interest margin. We believe these measures are beneÑcial in understanding and analyzing Fannie Mae's performance because they reÖect consistent accounting for purchased options

and callable debt, two of the principal instruments we use interchangeably to hedge the prepayment option in

our mortgage investments. These measures also consistently reÖect income from taxable and tax-exempt

investments.

Table 6 reconciles taxable-equivalent core net interest income to our reported net interest income and

presents an analysis of our net interest margin based on the average balances and yields of mortgage assets,

nonmortgage investments, and debt. Our taxable-equivalent core net interest income and net interest margin

are signiÑcantly diÅerent than our reported taxable-equivalent net interest income and net interest yield

because our core measures include the amortization of our purchased options premiums on a straight-line

basis over the life of the option, which is not in accordance with GAAP.

38
Table 6: Taxable-Equivalent Core Net Interest Income and Average Balances

2002 2001 2000

(Dollars in millions)

Net interest income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 10,566 $ 8,090 $ 5,674

Purchased options amortization expense(1)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (1,814) (590) Ì

Core net interest income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 8,752 7,500 5,674

Taxable-equivalent adjustment on tax-exempt investments(2) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 502 470 414

Taxable-equivalent core net interest income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 9,254 $ 7,970 $ 6,088

Average balances:(3)

Interest-earning assets:(4)

Mortgage portfolio, net ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $735,943 $658,195 $553,531

Nonmortgage investments and cash equivalents ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 68,658 58,811 51,490

Total interest-earning assets ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 804,601 717,006 605,021

Interest-free funds(5) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (23,992) (23,630) (20,595)

Total interest-earning assets funded by debt ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $780,609 $693,376 $584,426

Interest-bearing liabilities:(6)

Short-term debt ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $141,727 $137,078 $ 73,351

Long-term debt ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 638,882 556,298 511,075

Total interest-bearing liabilities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $780,609 $693,376 $584,426

Average interest rates:(2, 3)

Interest-earning assets:

Mortgage portfolio, net ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 6.73% 7.11% 7.16%

Nonmortgage investments and cash equivalents ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2.34 4.63 6.60

Total interest-earning assets ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 6.35 6.90 7.11

Interest-free return(5) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ .18 .21 .25

Total interest-earning assets funded by debt ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 6.53 7.11 7.36

Interest-bearing liabilities:(6)

Short-term debt ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2.15 4.28 5.70

Long-term debt ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 6.10 6.43 6.44

Total interest-bearing liabilities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 5.38 6.00 6.35

Net interest margin ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 1.15% 1.11% 1.01%

(1) ReÖects non-GAAP adjustment for straight-line amortization of purchased options premiums that would have been

recorded prior to the adoption of FAS 133 in 2001.

(2) ReÖects non-GAAP adjustments to permit comparison of yields on tax-exempt and taxable assets based on a

35 percent marginal tax rate.

(3) Averages have been calculated on a monthly basis based on amortized cost.

(4) Includes average balance of nonaccrual loans of $4.6 billion in 2002, $2.6 billion in 2001, and $2.1 billion in 2000.

(5) Interest-free funds represent the portion of our investment portfolio funded by equity and non-interest bearing

liabilities.

(6) ClassiÑcation of interest expense and interest-bearing liabilities as short-term or long-term is based on eÅective

maturity or repricing date, taking into consideration the eÅect of derivative Ñnancial instruments. The cost of debt

includes expense for the amortization of purchased options.

Taxable-equivalent core net interest income totaled $9.254 billion in 2002, compared with $7.970 billion

in 2001 and $6.088 billion in 2000. The $1.284 billion or 16 percent increase in taxable-equivalent core net

interest income during 2002 was due primarily to a 12 percent increase in our average net mortgage portfolio

and a 4 basis point increase in the net interest margin to 1.15 percent. During 2001, taxable-equivalent core

net interest income increased $1.882 billion or 31 percent as the average net mortgage portfolio grew by

19 percent, and the net interest margin expanded by 10 basis points to 1.11 percent. Table 7 shows the changes

in taxable-equivalent core net interest income for 2002 and 2001 attributable to changes in rates and the

39
volume of our mortgage assets, nonmortgage investments, and debt and changes in purchased options

amortization expense and taxable-equivalent adjustments.

Table 7: Rate/Volume Analysis of Core Net Interest Income

Attributable to

Changes in(1)

Increase

(Decrease) Volume Rate

(Dollars in millions)

2002 vs. 2001

Interest income:

Mortgage portfolio ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 2,787 $5,292 $(2,505)

Nonmortgage investments and cash equivalents ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (1,104) 394 (1,498)

Total interest income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 1,683 5,686 (4,003)

Interest expense(2):

Short-term debt ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (2,919) 194 (3,113)

Long-term debtÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2,126 4,959 (2,833)

Total interest expense ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (793) 5,153 (5,946)

Change in net interest income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 2,476 $ 533 $ 1,943

Change in purchased options amortization expense(3) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (1,224)

Change in core net interest income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 1,252

Change in taxable-equivalent adjustment on tax-exempt investments(4) ÏÏÏÏÏÏÏÏÏÏ 32

Change in taxable-equivalent core net interest income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 1,284

2001 vs. 2000

Interest income:

Mortgage portfolio ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 7,075 $7,393 $ (318)

Nonmortgage investments and cash equivalents ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (686) 434 (1,120)

Total interest income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 6,389 7,827 (1,438)

Interest expense(2):

Short-term debt ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 1,693 2,945 (1,252)

Long-term debtÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2,280 2,868 (588)

Total interest expense ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 3,973 5,813 (1,840)

Change in net interest income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 2,416 $2,014 $ 402

Change in purchased options amortization expense(3) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (590)

Change in core net interest income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 1,826

Change in taxable-equivalent adjustment on tax-exempt investments(4) ÏÏÏÏÏÏÏÏÏÏ 56

Change in taxable-equivalent core net interest income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 1,882

(1) Combined rate/volume variances, a third element of the calculation, are allocated to the rate and volume variances

based on their relative size.

(2) ClassiÑcation of interest expense and interest-bearing liabilities as short-term or long-term is based on eÅective

maturity or repricing date, taking into consideration the eÅect of derivative Ñnancial instruments.

(3) ReÖects non-GAAP adjustment for straight-line amortization of purchased options premiums that would have been

recorded prior to the adoption of FAS 133 in 2001.

(4) ReÖects non-GAAP adjustments to permit comparison of yields on tax-exempt and taxable assets based on a

35 percent marginal tax rate.

Business Segment Results

Portfolio Investment Business

Core business earnings for our Portfolio Investment business totaled $4.215 billion in 2002, compared

with $3.489 billion in 2001, and $2.745 billion in 2000. Core business earnings grew 21 percent in 2002, down

from 27 percent growth in 2001. Growth in mortgage debt outstanding, combined with our ability to oÅer

reliable, low-cost mortgage funds, helped us grow our average net mortgage portfolio by 12 percent in 2002

40
despite a record level of liquidations. The Portfolio Investment business also capitalized on opportunities

presented by the decline in interest rates that began in 2001 to reduce our debt costs and increase the net

interest margin 4 basis points to 115 basis points. In 2001, the average net mortgage portfolio grew 19 percent

and the net interest margin increased 10 basis points to 111 basis points.

Low mortgage rates boosted originations of Ñxed-rate mortgages in the primary market to record levels in

2002. However, during the Ñrst half of 2002, primary market lenders retained a higher than traditional level of

mortgage loans in their own portfolios. The demand for mortgage investments also increased among other

secondary market participants. We believe this occurrence was in response to equity market volatility and the

perceived safety of mortgage-related investments in a period of signiÑcant uncertainty about the impact of the

economy on corporate creditworthiness. In addition, the steep yield curve lowered borrowing costs for banks

and other primary market participants, which made it more attractive to hold mortgage investments. The

increased competition for mortgages in the Ñrst half of 2002 resulted in tighter spreads between mortgage

yields and our debt costs (mortgage-to-debt spreads), which slowed our overall portfolio growth. Our portfolio

growth accelerated in the second half of the year as a sharp drop in mortgage rates sparked a reÑnancing wave

that increased the supply of mortgages in the secondary market and generated wider mortgage-to-debt

spreads. We substantially increased our mortgage commitments in response to these more attractive spreads.

We also experienced higher portfolio growth in 2001 because of attractive mortgage-to-debt spreads stemming

from an increased supply of mortgage assets in the secondary market because of a reduction in intermediateterm rates that boosted mortgage reÑnancings and originations.

The sharp decline in short-term interest rates relative to long-term interest rates during 2001 resulted in a

steeper yield curve that persisted throughout 2002. Our net interest margin in 2002 continued to beneÑt from

actions taken during 2001 in response to opportunities presented by the unusually steep yield curve and low

short-term interest rates. The Portfolio Investment business was able to replace signiÑcant amounts of called

or maturing debt in 2001 with lower cost, shorter-term debt more quickly than our mortgage assets matured or

prepaid. These actions temporarily reduced our debt cost relative to asset yield and elevated our net interest

margin in 2001. Our net interest margin remained elevated in 2002 as the unusually steep yield curve and low

interest rate environment persisted, and we called or otherwise retired additional high-cost debt.

Primary investing activities for the Portfolio Investment business include purchasing mortgage loans,

mortgage-related securities, and other investments from lenders, securities dealers, investors, and other market

participants. The Portfolio Investment business also issues real estate mortgage investment conduits

(""REMICs''), Megas, and SMBS as a source of fee income. The Portfolio Investment business maintains the

LIP, which consists of nonmortgage investments and serves as an alternative source of liquidity and an

investment vehicle for our surplus capital. Our primary Ñnancing activities involve issuing various debt

securities to fund our mortgage purchases and other business activities.

Mortgage Portfolio

Our mortgage portfolio includes whole loan mortgages, mortgage-related securities, and other mortgage

investments, including other agency securities purchased from lenders, securities dealers, investors, and other

market participants. We grew our net mortgage portfolio by 13 percent to $798 billion at December 31, 2002.

In comparison, we expanded our net mortgage portfolio by 16 percent in 2001. We grew our portfolio more

selectively and at a slower pace in 2002 in accordance with our disciplined approach to growth because of

tighter mortgage-to-debt spreads during the Ñrst half of 2002. Table 8 shows the distribution of Fannie Mae's

mortgage portfolio by product type.

41
Table 8: Mortgage Portfolio Composition(1)

2002 2001 2000 1999 1998

(Dollars in millions)

Mortgages

Single-family:

Government insured or guaranteed ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 5,458 $ 5,070 $ 4,762 $ 4,472 $ 4,404

Conventional:

Long-term, Ñxed-rate ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 103,220 96,417 87,005 86,787 87,739

Intermediate-term, Ñxed-rate(2) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 54,503 43,522 39,134 43,878 47,818

Adjustable-rate ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 9,045 10,410 13,243 6,058 7,632

Total conventional single-family ÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 166,768 150,349 139,382 136,723 143,189

Total single-family ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 172,226 155,419 144,144 141,195 147,593

Multifamily:

Government insured or guaranteed ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 1,353 1,551 1,814 2,347 2,594

Conventional ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 12,218 8,987 6,547 5,564 5,591

Total multifamilyÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 13,571 10,538 8,361 7,911 8,185

Total mortgages ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $185,797 $165,957 $152,505 $149,106 $155,778

Mortgage-related securities

Single-family:

Government insured or guaranteed ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 33,293 $ 37,111 $ 39,404 $ 36,557 $ 17,401

Conventional:

Long-term, Ñxed-rate ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 510,435 456,046 367,344 298,534 209,367

Intermediate-term, Ñxed-rate(2) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 39,409 25,890 27,965 25,317 23,948

Adjustable-rate ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 13,946 10,355 13,892 8,049 4,241

Total conventional single-family ÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 563,790 492,291 409,201 331,900 237,556

Total single-family ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 597,083 529,402 448,605 368,457 254,957

Multifamily:

Government insured or guaranteed ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 7,370 6,481 5,370 4,392 2,765

Conventional ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 7,050 5,636 3,642 1,986 1,015

Total multifamilyÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 14,420 12,117 9,012 6,378 3,780

Total mortgage-related securitiesÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $611,503 $541,519 $457,617 $374,835 $258,737

Mortgage portfolio, net

Single-family:

Government insured or guaranteed ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 38,751 $ 42,181 $ 44,166 $ 41,029 $ 21,805

Conventional:

Long-term, Ñxed-rate ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 613,655 552,463 454,349 385,321 297,106

Intermediate-term, Ñxed-rate(2) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 93,912 69,412 67,099 69,195 71,766

Adjustable-rate ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 22,991 20,765 27,135 14,107 11,873

Total conventional single-family ÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 730,558 642,640 548,583 468,623 380,745

Total single-family ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 769,309 684,821 592,749 509,652 402,550

Multifamily:

Government insured or guaranteed ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 8,723 8,032 7,184 6,739 5,359

Conventional ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 19,268 14,623 10,189 7,550 6,606

Total multifamilyÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 27,991 22,655 17,373 14,289 11,965

Total mortgage portfolio ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 797,300 707,476 610,122 523,941 414,515

Unamortized premium (discount) and deferred price

adjustments, net(3)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 472 (2,104) (2,520) (964) 919

Allowance for loan losses(4) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (79) (48) (51) (56) (79)

Mortgage portfolio, net ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $797,693 $705,324 $607,551 $522,921 $415,355

(1) Amounts presented have been restated to conform to the current year presentation. Data represents unpaid principal

balance adjusted to include mark-to-market gains and losses on available-for-sale securities.

(2) Intermediate-term, Ñxed-rate consists of portfolio loans with contractual maturities at purchase equal to or less than

20 years and MBS and other mortgage-related securities held in portfolio with maturities of 15 years or less at issue

date.

(3) Includes net unamortized premiums of $135 million, $536 million, and $559 million at December 31, 2002, 2001, and

1998, respectively, and net unamortized discounts of $2,311 million and $586 million at December 31, 2000 and 1999,

respectively, related to available-for-sale and held-to-maturity mortgage-related securities.

(4) Guaranty liability for probable losses on loans underlying Fannie Mae guaranteed MBS is included in ""Guaranty

liability for MBS.''

42
The average yield on our net mortgage portfolio decreased to 6.73 percent in 2002, from 7.11 percent in

2001, and 7.16 percent in 2000. The decrease in yield during 2002 and 2001 resulted largely from the general

decline in mortgage rates on loans originated in the primary market and sold into the secondary market plus an

increase in the level of liquidations of older, higher-rate loans. The liquidation rate on mortgages in portfolio

(excluding sales) increased to 37 percent in 2002 from 25 percent in 2001Ìmore than triple the 2000

liquidation rate of 10 percent. Mortgage liquidations in 2002, 2001, and 2000 totaled $277 billion, $164 billion,

and $57 billion, respectively. Liquidations increased signiÑcantly in 2002 and 2001 largely because of extensive

reÑnancing in response to falling mortgage interest rates.

Table 9 summarizes mortgage portfolio activity on a gross basis and average yields from 2000 through

2002.

Table 9: Mortgage Portfolio Activity(1)

Purchases Sales Repayments(2)

2002 2001 2000 2002 2001 2000 2002 2001 2000

(Dollars in millions)

Single-family:

Government insured or

guaranteedÏÏÏÏÏÏÏÏÏÏÏÏ $ 9,493 $ 6,001 $ 6,940 $ 139 $ Ì $ 521 $ 13,057 $ 8,125 $ 3,423

Conventional:

Long-term, fixed-rate ÏÏÏ 280,815 226,516 113,444 8,253 7,621 9,219 216,218 120,787 35,208

Intermediate-term,

Ñxed-rate ÏÏÏÏÏÏÏÏÏÏÏ 62,102 26,146 11,607 464 442 599 37,544 23,391 13,105

Adjustable-rate ÏÏÏÏÏÏÏÏ 10,739 3,777 17,683 347 228 374 8,806 9,937 4,293

Total conventional singlefamilyÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 353,656 256,439 142,734 9,064 8,291 10,192 262,568 154,115 52,606

Total single-family ÏÏÏÏÏÏÏ 363,149 262,440 149,674 9,203 8,291 10,713 275,625 162,240 56,029

Multifamily ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 7,492 8,144 4,557 379 690 269 1,794 2,172 1,204

Total ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $370,641 $270,584 $154,231 $9,582 $8,981 $10,982 $277,419 $164,412 $57,233

Average net yield ÏÏÏÏÏÏÏÏÏÏ 5.92% 6.56% 7.62% 6.83% 7.23% 7.18%

Repayments as a percentage

of average mortgage

portfolio ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 37.4% 24.7% 10.3%

(1) Excludes premiums, discounts, and other deferred price adjustments.

(2) Includes mortgage loan prepayments, scheduled amortization, and foreclosures.

We classify mortgage loans on our balance sheet as either held-for-investment or held-for-sale. Our

mortgage portfolio also includes MBS and other mortgage-related securities that we classify as either held-tomaturity or available-for-sale. On September 13, 2002, concurrent with the implementation of a new riskbased capital rule issued by OFHEO, we reclassiÑed $124 billion of securities in our mortgage portfolio from

held-to-maturity to available-for-sale in accordance with Financial Accounting Standard No. 115, Accounting

for Certain Investments in Debt and Equity Securities (""FAS 115''). At the time of this noncash transfer,

these mortgage-related securities had gross unrealized gains of $5.364 billion and unrealized losses of

$53 million. Table 10 shows gross unrealized gains and losses on our MBS and mortgage-related securities at

the end of 2002, 2001, and 2000.

43
Table 10: Mortgage-Related Securities in Mortgage Portfolio

2002

Gross Gross

Amortized Unrealized Unrealized Fair

Cost(1) Gains Losses Value

(Dollars in millions)

Held-to-maturity:

MBS(2) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $286,422 $11,173 $ (1) $297,594

REMICs and Stripped MBS ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 110,423 4,339 (87) 114,675

Other mortgage-related securities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 41,087 2,813 (45) 43,855

Total ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $437,932 $18,325 $(133) $456,124

Available-for-sale:

MBS(2) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $116,081 $ 5,425 $ (1) $121,505

REMICs and Stripped MBS ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 33,763 678 (369) 34,072

Other mortgage-related securities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 17,358 782 (11) 18,129

Total ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $167,202 $ 6,885 $(381) $173,706

2001

Gross Gross

Amortized Unrealized Unrealized Fair

Cost(1) Gains Losses Value

Held-to-maturity:

MBS(2) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $333,896 $3,536 $ (54) $337,378

REMICs and Stripped MBS ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 127,675 2,432 (579) 129,528

Other mortgage-related securities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 47,584 1,411 (87) 48,908

Total ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $509,155 $7,379 $(720) $515,814

Available-for-sale:

MBS(2) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 9,119 $ 105 $ (27) $ 9,197

REMICs and Stripped MBS ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 1,083 211 (240) 1,054

Other mortgage-related securities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 22,236 425 (12) 22,649

Total ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 32,438 $ 741 $(279) $ 32,900

2000

Gross Gross

Amortized Unrealized Unrealized Fair

Cost(1) Gains Losses Value

Held-to-maturity:

MBS(2) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $272,829 $3,414 $(1,414) $274,829

REMICs and Stripped MBS ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 114,022 1,736 (652) 115,106

Other mortgage-related securities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 57,021 760 (178) 57,603

Total ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $443,872 $5,910 $(2,244) $447,538

Available-for-sale:

MBS(2) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 2,814 $ 18 $ (7) $ 2,825

REMICs and Stripped MBS ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 220 57 (64) 213

Other mortgage-related securities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 8,403 33 (40) 8,396

Total ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 11,437 $ 108 $ (111) $ 11,434

(1) Amortized cost includes unamortized premiums, discounts, and other deferred price adjustments.

(2) Excludes REMICs and Stripped MBS.

Nonmortgage Investments

Nonmortgage investments consist of the LIP and other investments. We classify and account for these

investments as either held-to-maturity or available-for-sale according to FAS 115. Concurrent with the

September 13, 2002 implementation of our new risk-based capital rule, we reclassiÑed securities in our

nonmortgage investment portfolio that had an amortized cost of $11 billion from held-to-maturity to availablefor-sale in accordance with FAS 115. These nonmortgage securities had gross unrealized gains of $139 million

and unrealized losses of $6 million at the time of this noncash transfer. Nonmortgage investments decreased

20 percent to $60 billion at December 31, 2002, from $75 billion at December 31, 2001. Our nonmortgage

investments totaled $55 billion at December 31, 2000. Tables 11 and 12 show the composition, weightedaverage maturities, and credit ratings of our held-to-maturity and available-for-sale nonmortgage investments.

44
Table 11: Nonmortgage Investments ClassiÑed as Held-to-Maturity

2002

WeightedGross Gross Average

Amortized Unrealized Unrealized Fair Maturity % Rated A

Cost Gains Losses Value in Months or Better

(Dollars in millions)

Held-to-maturity:

Repurchase agreements ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $20,732 $Ì $Ì $20,732 .5 100.0

Eurodollar time deposits ÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 1,398 Ì Ì 1,398 .8 100.0

Auction rate preferred stock ÏÏÏÏÏÏÏÏÏÏÏ 402 Ì Ì 402 1.0 100.0

Federal funds ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 150 Ì Ì 150 1.9 100.0

Commercial paper ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 100 Ì Ì 100 .7 100.0

Other ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 268 1 Ì 269 4.9 100.0

Total ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $23,050 $ 1 $Ì $23,051 .6 100.0

2001

WeightedGross Gross Average

Amortized Unrealized Unrealized Fair Maturity % Rated A

Cost Gains Losses Value in Months or Better

Held-to-maturity:

Repurchase agreements ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 9,380 $ Ì $Ì $ 9,380 .5 100.0

Eurodollar time deposits ÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 11,185 Ì Ì 11,185 .3 100.0

Auction rate preferred stock ÏÏÏÏÏÏÏÏÏÏÏ 2,127 Ì Ì 2,127 1.7 100.0

Federal funds ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 4,904 Ì Ì 4,904 .4 100.0

Commercial paper ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2,844 1 Ì 2,845 .6 100.0

Asset-backed securities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 6,065 89 (1) 6,153 10.6 100.0

Other ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2,166 73 Ì 2,239 16.7 56.4

Total ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $38,671 $163 $(1) $38,833 3.0 97.5

2000

WeightedGross Gross Average

Amortized Unrealized Unrealized Fair Maturity % Rated A

Cost Gains Losses Value in Months or Better

Held-to-maturity:

Repurchase agreements ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 2,722 $Ì $ Ì $ 2,722 .5 100.0

Eurodollar time deposits ÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 4,046 Ì Ì 4,046 1.2 100.0

Auction rate preferred stock ÏÏÏÏÏÏÏÏÏÏÏ 1,812 Ì Ì 1,812 1.9 98.6

Federal funds ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 3,493 Ì Ì 3,493 2.1 100.0

Commercial paper ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 8,893 2 Ì 8,895 .7 90.1

Asset-backed securities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 9,043 30 (7) 9,066 22.6 100.0

Other ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 3,823 40 (11) 3,852 17.6 100.0

Total ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $33,832 $72 $(18) $33,886 8.7 97.3

45
Table 12: Nonmortgage Investments ClassiÑed as Available-for-Sale

2002

WeightedGross Gross Average

Amortized Unrealized Unrealized Fair Maturity % Rated A

Cost Gains Losses Value in Months or Better

(Dollars in millions)

Available-for-sale:

Asset-backed securities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $22,281 $ 98 $ (68) $22,311 30.0 100.0

Floating-rate notes(1) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 11,754 10 (29) 11,735 10.6 87.6

Corporate bonds ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 1,149 42 Ì 1,191 12.8 25.2

Taxable auction notes ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 949 Ì Ì 949 .2 100.0

Auction rate preferred stock ÏÏÏÏÏÏÏÏÏÏÏ 112 Ì (4) 108 2.5 43.5

Commercial paper ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 100 Ì Ì 100 2.2 100.0

Other ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 400 Ì Ì 400 1.1 100.0

Total ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $36,745 $150 $(101) $36,794 22.0 93.5

2001

WeightedGross Gross Average

Amortized Unrealized Unrealized Fair Maturity % Rated A

Cost Gains Losses Value in Months or Better

Available-for-sale:

Asset-backed securities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $14,876 $21 $(25) $14,872 26.2 99.9

Floating-rate notes(1) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 12,114 12 (45) 12,081 18.2 84.3

Commercial paper ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 8,879 1 Ì 8,880 .9 100.0

Other ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 50 Ì Ì 50 9.5 100.0

Total ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $35,919 $34 $(70) $35,883 17.2 94.7

2000

WeightedGross Gross Average

Amortized Unrealized Unrealized Fair Maturity % Rated A

Cost Gains Losses Value in Months or Better

Available-for-sale:

Asset-backed securities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 8,469 $Ì $ Ì $ 8,469 49.6 100.0

Floating-rate notes(1) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 12,237 4 (17) 12,224 18.5 99.7

Commercial paper ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 443 Ì Ì 443 .6 100.0

Other ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Ì Ì Ì Ì Ì Ì

Total ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $21,149 $ 4 $(17) $21,136 30.6 99.8

(1) As of December 31, 2002, 2001, and 2000, 100 percent of Öoating-rate notes repriced at intervals of 90 days or less.

46
Nonmortgage investments rated below single A totaled $2.4 billion and equaled 8.5 percent of our core

capital at December 31, 2002, $2.9 billion and 11.4 percent of core capital at December 31, 2001, and

$1 billion and 4.6 percent of core capital at December 31, 2000.

Our nonmortgage investments serve as Fannie Mae's primary source of liquidity and an investment

vehicle for our surplus capital. Nonmortgage investments include our early funding portfolio, which consists

primarily of repurchase agreements, and our LIP. Our LIP consists primarily of high-quality securities that

are short-term or readily marketable and includes investments in nonmortgage assets, such as federal funds

and time deposits, commercial paper, asset-backed securities, and corporate Öoating-rate notes. The majority

of LIP investments classiÑed as held-to-maturity consist of federal funds and time deposits and auction rate

preferred stock with maturities of three months or less. We obtain liquidity from our LIP through maturity of

short-term investments or the sale of assets. Investments in our LIP totaled $39 billion at December 31, 2002,

compared with $65 billion at year-end 2001 and $52 billion at year-end 2000. At the end of 2001, our LIP

balance was at the highest level of the past three years because of delayed settlement of 2001 portfolio

purchase commitments, which resulted in additional temporary capital for short-term investment in the LIP.

The LIP combined with our early funding portfolio and cash and cash equivalents represent our total

liquid investments. The average yield on liquid investments during 2002, 2001, and 2000 was 2.34 percent,

4.63 percent, and 6.60 percent, respectively. The average yield decreased during 2002 and 2001 because of the

sharp drop in short-term interest rates.

Debt Securities

As part of our disciplined interest rate risk management strategy, we issue a variety of noncallable and

callable debt securities in the domestic and global capital markets in a wide range of maturities to meet our

large and consistent funding needs. We strive to structure debt products that match the needs of our portfolio

with the interests of debt investors. A description of our principal debt securities follows.

‚ Benchmark Securities» Program

Our Benchmark Securities program encompasses large, regularly scheduled issues of noncallable and

callable debt securities designed to provide enhanced liquidity to investors while reducing the relative cost

of debt. By issuing Benchmark Securities, we have consolidated much of our debt issuances from a large

number of smaller, unscheduled issues to a smaller number of larger, more liquid scheduled issues.

During 2002, we issued noncallable and callable Benchmark Securities in every month. Benchmark Bills»

served as our weekly source for three-month and six-month discount debt issuances during the year. We

issued one-year Benchmark Bills on a biweekly schedule during 2002 and 2001. Our issuances of

Benchmark Bills totaled $420 billion, $437 billion, and $334 billion in 2002, 2001, and 2000, respectively.

Issuances of Benchmark Bonds» and Benchmark Notes totaled $89 billion, $100 billion, and $77 billion,

respectively, during the same period. Benchmark Notes have maturities of one to ten years, and

Benchmark Bonds have maturities of more than ten years. We reintroduced Fannie Mae's Callable

Benchmark Notes in June 2001 and issued $22 billion and $10 billion of these securities during 2002 and

2001, respectively.

‚ Discount Notes and Other Debt Securities

We also issue other debt securities outside Fannie Mae's Benchmark Securities program. These debt

securities have various maturities, interest rates, and call provisions. We issue short-term debt securities

called ""Discount Notes'' outside of our Benchmark Bills program. We sell discount notes at a market

discount from the principal amount payable at maturity. They have maturities ranging from overnight to

360 days from the date of issuance and are available in minimum amounts of $1,000. We issued

$1.107 trillion and $1.216 trillion of Discount Notes during 2002 and 2001, respectively. Outstanding

discount notes increased to $134 billion at year-end 2002 from $93 billion at year-end 2001.

47
‚ Subordinated Debt

As part of our voluntary safety and soundness initiatives announced in October 2000, we began issuing

Subordinated Benchmark Notes in the Ñrst quarter of 2001 on a periodic basis, which created a new class

of Ñxed-income investments for investors under the Benchmark Securities program. We issued subordinated debt securities totaling $3.5 billion and $5.0 billion during 2002 and 2001, respectively. Outstanding

Subordinated Benchmark Notes totaled $8.5 billion at December 31, 2002, versus $5.0 billion at the end

of 2001.

Total debt outstanding increased 11 percent to $851 billion at December 31, 2002, from $763 billion at

December 31, 2001. Table 13 summarizes our outstanding debt due within one year at the end of 2002, 2001,

and 2000. Table 14 shows a comparison of our debt issuances and repayments for 2002, 2001, and 2000, the

total outstanding at the end of each year, and the average cost.

48
Table 13: Outstanding Debt Due Within One Year

2002

Maximum Outstanding at Average Outstanding Outstanding December 31, During Year at Any

Amount Cost(1) Amount Cost(1) Month-end

(Dollars in millions)

Short-term notes ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $290,091 1.55% $252,857 1.98% $290,091

Other short-term debtÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 12,522 1.33 18,512 1.70 28,126

Current portion of borrowings due after one year(2):

Universal Standard Debt ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 41,681 2.25

Universal Benchmark Debt ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 37,376 4.89

Universal Retail Debt ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 73 9.52

Other ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 669 3.24

Total due within one year ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $382,412 1.95%

2001

Maximum Outstanding at Average Outstanding Outstanding December 31, During Year at Any

Amount Cost(1) Amount Cost(1) Month-end

Short-term notes ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $256,905 2.58% $247,060 4.31% $265,953

Other short-term debtÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 29,891 1.96 31,479 4.40 43,811

Current portion of borrowings due after one year(2):

Universal Standard Debt ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 34,413 3.67

Universal Benchmark Debt ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 21,987 5.31

Universal Retail Debt ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Ì Ì

Other ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 296 4.96

Total due within one year ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $343,492 2.81%

2000

Maximum Outstanding at Average Outstanding Outstanding December 31, During Year at Any

Amount Cost(1) Amount Cost(1) Month-end

Short-term notes ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $178,292 6.50% $150,242 6.33% $178,292

Other short-term debtÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 42,157 6.58 37,880 6.36 42,157

Current portion of borrowings due after one year(2):

Universal Standard Debt ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 51,185 6.02

Universal Benchmark Debt ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 6,984 5.71

Universal Retail Debt ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 785 6.62

Other ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 919 6.57

Total due within one year ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $280,322 6.38%

(1) Represents weighted-average cost, which includes the amortization of discounts, premiums, issuance costs, hedging

results, and the eÅects of currency and debt swaps. Averages have been calculated on a monthly average basis.

(2) Information on average amount and cost of debt outstanding during the year and maximum amount outstanding at

any month-end is not meaningful. See ""Table 14ÌShort-Term and Long-Term Debt Activity'' for additional

information.

49
Table 14: Short-Term and Long-Term Debt Activity

2002 2001 2000

(Dollars in millions)

Issued during the year:

Short-term(1):

Amount ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $1,635,919 $1,756,691 $1,143,131

Average cost ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 1.67% 3.69% 6.27%

Long-term(1):

Amount ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 238,467 $ 249,352 $ 110,215

Average cost ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 3.78% 4.83% 6.92%

Total issued:

Amount ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $1,874,386 $2,006,043 $1,253,346

Average cost ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2.21% 3.97% 6.34%

Repaid during the year:

Short-term(1):

Amount ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $1,620,644 $1,691,240 $1,106,956

Average cost ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 1.84% 4.22% 6.15%

Long-term(1):

Amount ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 175,809 $ 196,610 $ 50,335

Average cost ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 4.85% 6.03% 6.33%

Total repaid:

Amount ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $1,796,453 $1,887,850 $1,157,291

Average cost ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2.34% 4.47% 6.14%

Outstanding at year-end:

Due within one year:

Net amountÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 382,412 $ 343,492 $ 280,322

Cost(2) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 1.95% 2.81% 6.40%

Average term in months(4) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 5 4 5

Due after one year:

Net amountÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 468,570 $ 419,975 $ 362,360

Cost(2) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 5.14% 5.52% 6.46%

Average term in months(4) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 67 70 76

Total debt:

Net amountÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 850,982 $ 763,467 $ 642,682

Cost(3) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 4.81% 5.49% 6.47%

Average term in months(4) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 58 66 69

(1) ""Short-term'' refers to the face amount of debt issued with an original term of one year or less. ""Long-term'' refers to

the face amount of debt issued with an original term greater than one year.

(2) Cost includes the eÅects of currency, debt, and amortization of premiums, discounts, issuance costs, and hedging

results.

(3) Cost includes the eÅects of currency, debt, and interest rate swaps and amortization of premiums, discounts, issuance

costs, and hedging results.

(4) Average term includes the eÅects of interest rate swaps.

We took advantage of opportunities to repurchase $8 billion of debt in 2002 and $9 billion of debt in 2001

that was trading at historically wide spreads to other Ñxed-income securities. In addition, we continued to call

signiÑcant levels of debt in 2002 as a result of the sharp decline in interest rates that began in 2001. We called

$174 billion in debt and interest rate swaps in 2002 and $173 billion in 2001. We reissued much of this debt

with short-term maturities in anticipation of the expected increase in mortgage liquidations. Interest rate

swaps lengthened the weighted-average Ñnal maturity of our outstanding debt by 20 months at December 31,

2002, down from 26 months at December 31, 2001. Table 15 shows our adjusted eÅective short- and longterm debt at the end of 2002, 2001, and 2000.

50
Table 15: EÅective Short-Term and Long-Term Debt

2002 2001 2000

(Dollars in millions)

Outstanding at year-end:

Short-term(1):

Net amount ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $192,702 $138,986 $103,852

CostÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 1.52% 2.75% 6.13%

Weighted-average maturity (in months) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 3 5 5

Percent of total debt outstandingÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 23% 18% 16%

Long-term(2):

Net amount ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $651,827 $627,196 $543,964

CostÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 5.48% 5.96% 6.48%

Weighted-average maturity (in months) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 75 78 79

Percent of total debt outstandingÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 77% 82% 84%

Total:

Net amount(3) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $844,529 $766,182 $647,816

CostÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 4.81% 5.49% 6.47%

Weighted-average maturity (in months) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 58 66 69

(1) Represents the redemption value of short-term debt adjusted to include the eÅect of derivative instruments that

replicate short-term, variable-rate debt securities and exclude short-term debt securities that have been economically

converted into long-term debt funding through interest rate swaps.

(2) Represents the redemption value of long-term debt adjusted to include the eÅect of short-to-long interest rate swaps

that economically convert short-term debt securities into long-term debt securities and exclude long-term debt

securities that have been economically converted into short-term funding through interest rate swaps.

(3) Represents the redemption value of outstanding debt at year-end. Excludes the eÅect of amortization of premiums,

discounts, issuance costs, and hedging results.

Our asset-liability management strategies, combined with favorable market conditions for borrowing, had

the following eÅect on the debt portfolio:

‚ The average cost of outstanding debt during 2002 decreased to 5.38 percent from 6.00 percent in 2001.

At December 31, 2002 and 2001, the cost of debt outstanding was 4.81 percent and 5.49 percent,

respectively.

‚ EÅective long-term debt, which takes into consideration the eÅect of derivative instruments on the

maturity of long- and short-term debt, decreased to 77 percent of total debt outstanding at

December 31, 2002 from 82 percent at year-end 2001.

‚ The weighted-average maturity of eÅective long-term, Ñxed-rate debt outstanding decreased to

75 months at year-end 2002 from 78 months at year-end 2001.

‚ EÅective long-term debt as a percentage of the net mortgage portfolio decreased to 82 percent at the

end of 2002 from 89 percent at the end of 2001.

‚ Option-embedded debt outstanding as a percentage of the net mortgage portfolio temporarily increased

above historic levels to 75 percent at year-end 2002 versus 54 percent at the end of 2001. Table 16

presents option-embedded debt instruments as a percentage of our net mortgage portfolio for the past

three years. Option-based derivative instruments represented 42 percent and callable debt accounted

for 58 percent of the $601 billion in option-embedded debt outstanding at December 31, 2002. In

comparison, option-based derivative instruments and callable debt represented 38 percent and

62 percent, respectively of the $378 billion in option-embedded debt outstanding at December 31,

2001.

51
Table 16: Option-Embedded Debt Instruments

2002 2001 2000

(Dollars in billions)

Issued during the year ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $384 $286 $ 65

Outstanding at year-end ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 601 378 280

Percentage of total net mortgage portfolio ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 75% 54% 46%

Credit Guaranty Business

Core business earnings for our Credit Guaranty business grew 16 percent in 2002 to $2.179 billion and

10 percent in 2001 to $1.878 billion. The increase in 2002 core business earnings was driven primarily by a

23 percent increase in guaranty fee income. Guaranty fee income for our Credit Guaranty business increased

largely due to 17 percent growth in our average book of business and a .9 basis point increase in the average fee

rate to 18.9 basis points. The average fee rate for our Credit Guaranty business includes the eÅect of guaranty

fee income allocated to the Credit Guaranty business for managing the credit risk on mortgage-related assets

held by the Portfolio Investment business. It therefore diÅers from our consolidated eÅective average guaranty

fee rate, which excludes guaranty fees on Fannie Mae MBS held in our portfolio because these fees are

reported as interest income. Growth in earnings for the Credit Guaranty business lagged growth in guaranty

fee income primarily due to increases in credit enhancement expenses, higher administrative expenses, and an

increase in the eÅective tax rate. Administrative expenses increased primarily due to higher compensation

costs and expenses related to re-engineering our core infrastructure systems and relocating our primary data

center.

Record expansion of residential mortgage debt outstanding during 2002 and 2001, combined with our

ability to oÅer reliable, low-cost mortgage funds, fueled growth in our book of business. The demand for

housing was strong throughout 2002 and 2001, and borrowers also took advantage of the low interest rate

environment to reÑnance their mortgages and extract equity from the appreciation in their homes. Residential

mortgage debt outstanding increased 12.4 percent in 2002 to $7.0 trillion, 10.3 percent in 2001 to $6.2 trillion,

and 8.9 percent in 2000 to $5.6 trillion. ReÑnancings represented 62 percent of total market originations in

2002 and 57 percent in 2001, compared with 19 percent in 2000. Growth in Fannie Mae's mortgage credit

book of business outpaced growth in residential mortgage debt outstanding during 2002, 2001, and 2000.

Earnings growth in 2001 for the Credit Guaranty business was also driven by an increase in guaranty fees.

Guaranty fees rose 7 percent, stemming from 15 percent growth in the average book of business that more

than oÅset a 1.4 basis point drop in the average fee rate to 18.0 basis points. Despite signiÑcant growth in our

mortgage credit book of business and a softer economy, the Credit Guaranty business was successful in

reducing credit losses as a percentage of Fannie Mae's average book of business to .5 basis points in 2002, from

.6 basis points in 2001 and .7 basis points in 2000.

In the third quarter of 2002, we announced increases in the upfront-price adjustment Fannie Mae charges

on cash-out reÑnance mortgages with loan-to-value (""LTV'') ratios between 70.01 and 85 percent that we

plan to implement during 2003. As a result of these increases, which will better compensate us for the higher

risk on these loans, the upfront-price adjustments on cash-out reÑnance mortgages we purchase or guarantee

with LTV ratios greater than 70 percent will range from 50 to 75 basis points.

In conjunction with these increases and to better align our underwriting, pricing policy, and relative risk

proÑle of reÑnance transactions, we modiÑed our loan purpose deÑnitions on reÑnance transactions. We now

deÑne cash-out reÑnance transactions as a reÑnance transaction in which the funds are used for purposes other

than to pay oÅ an existing Ñrst mortgage lien, to pay oÅ any permissible subordinate mortgage liens, and to

provide limited unrestricted cash proceeds to the borrower. We expect the increased price adjustments, which

will be allocated to our Credit Guaranty business, to modestly increase our future guaranty fees.

52
OFF-BALANCE SHEET TRANSACTIONS

We enter into certain oÅ-balance sheet Ñnancial arrangements to facilitate our statutory purpose of

providing mortgage funds to the secondary market and reduce Fannie Mae's exposure to interest rate

Öuctuations. These arrangements, which may involve elements of credit and interest rate risk in excess of

amounts recognized on Fannie Mae's balance sheet, primarily include guaranteed MBS and other mortgagerelated securities and commitments to purchase mortgage assets or issue and guarantee MBS. Following is an

overview of our oÅ-balance sheet exposure related to these transactions, including a description of how our

MBS are created and our role in the process.

Guaranteed MBS and Other Mortgage-Related Securities

We issue MBS that are backed by mortgage loans from a single lender or from multiple lenders, or that

are transferred from our held-for-sale mortgage portfolio. Single-lender MBS are typically issued through

lender swap transactions whereby a lender exchanges pools of mortgages for MBS. Multiple-lender MBS

allow several lenders to pool mortgages and receive, in return, MBS (referred to as ""Fannie Majors'')

representing a proportionate share of a larger pool. Lenders may retain the MBS or sell them to other

investors. When we issue MBS, we assume trustee responsibilities. The loans underlying MBS are not our

assets. Therefore, we do not record them on our balance sheet except when acquired and held in our mortgage

portfolio for investment purposes, nor do we record them as liabilities. In some instances we buy mortgage

loans or mortgage-related securities and concurrently enter into a forward sale commitment. We designate

these loans as held-for-sale when acquired, and we sell them from the mortgage portfolio as MBS.

The Credit Guaranty business receives a guaranty fee for assuming the credit risk and guaranteeing

timely payment of scheduled principal and interest to MBS investors and investors in other mortgage-related

securities. The guaranty fee varies, depending on factors such as the risk proÑle of the loans securitized as well

as the level of credit risk we assume. We are ultimately responsible for guaranteeing timely payment of

scheduled principal and interest to investors whether or not we share primary default risk on loans underlying

outstanding MBS. We accrue a liability on our balance sheet for our guaranty obligation based on the

probability that mortgages underlying the $1.029 trillion of outstanding MBS will not perform according to

contractual terms. At December 31, 2002, we have accrued a liability of $471 million for estimated losses on

our guaranty of outstanding MBS, compared with $598 million at December 31, 2001. These amounts are a

component of the ""Guaranty liability for MBS'' line on our balance sheet.

We issue REMICs backed by single-class MBS, Stripped MBS (""SMBS''), Government National

Mortgage Association (""Ginnie Mae'') mortgage-related securities, other REMIC securities, or whole loans

that are not owned or guaranteed by Fannie Mae. The Portfolio Investment business receives transaction fees

for structuring REMICs backed by MBS, SMBS, Ginnie Mae securities, or existing Fannie Mae REMIC

classes. When we issue REMICs, we assume trustee responsibilities. REMICs backed by guaranteed MBS do

not subject us to any additional mortgage credit risk. We are only subject to additional credit risk if Fannie

Mae guarantees REMICs backed by whole loans owned by other entities or private label securities. REMICs

are not our assets except when acquired and held in our mortgage portfolio for investment purposes, nor do we

record them as liabilities.

Table 17 summarizes issued and outstanding amounts for guaranteed MBS and other mortgage-related

securities, including REMICs, for the years ended December 31, 2002, 2001, and 2000.

53
Table 17: Guaranteed MBS and Other Mortgage-Related Securities(1)

Outstanding Issues

Held by Acquired Total

Other Investors Total(2) by Others Issued(3)

(Dollars in millions)

2002 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $1,029,456 $1,538,287 $478,260 $723,299

2001 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 858,867 1,290,351 344,739 525,321

2000 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 706,684 1,057,750 105,407 210,311

(1) MBS may be resecuritized to back Fannie Megas, SMBS, or REMICs. With respect to those MBS, the amounts

shown only include the principal amount of the MBS once. Amounts also include REMICs created from whole loans

not owned or guaranteed by Fannie Mae.

(2) Includes $509 billion, $431 billion, and $351 billion at December 31, 2002, 2001, and 2000, respectively, of MBS and

other mortgage-related securities in Fannie Mae's portfolio.

(3) Total issued includes $245 billion, $181 billion, and $105 billion of MBS purchased by Fannie Mae in 2002, 2001, and

2000, respectively. Total issued excludes $16 billion, $3 billion, and $2 billion of MBS in 2002, 2001, and 2000,

respectively, that Fannie Mae issued from loans in our portfolio.

Guaranteed MBS and other mortgage-related securities held by investors other than Fannie Mae, which

we refer to as outstanding MBS, grew 20 percent to $1.029 trillion at December 31, 2002, from $859 billion at

December 31, 2001. REMICs that could subject Fannie Mae to additional credit exposure totaled $35 billion

at December 31, 2002 or 3 percent of outstanding MBS held by investors other than Fannie Mae. Total MBS,

which includes guaranteed MBS and other mortgage-related securities held in our mortgage portfolio, grew

19 percent to $1.538 trillion at year-end 2002 from $1.290 trillion at year-end 2001.

MBS issues acquired by investors other than Fannie Mae increased $134 billion to $478 billion in 2002,

while liquidations of outstanding MBS increased $124 billion to $324 billion. The increase in MBS issuances

and liquidations in 2002 was attributable to the decline in mortgage interest rates during the year resulting in

higher levels of mortgage originations, including reÑnancings. Total MBS issues, excluding MBS issued from

Fannie Mae's portfolio, increased 38 percent to $723 billion in 2002 from $525 billion in 2001, while total

MBS liquidations grew 69 percent to $499 billion from $296 billion in 2001.

REMIC issuances totaled $144 billion in 2002, compared with $124 billion in 2001. Our REMIC

issuances rebounded in 2001 with the rest of the REMIC market and steadily increased in 2002. The steeper

yield curve made the REMIC market more attractive, resulting in an increased demand for REMICs. In

addition, lower interest rates contributed to higher MBS issuances and increased collateral available for

REMICs. The outstanding balance of REMICs (including REMICs held in Fannie Mae's portfolio) was

$347 billion at December 31, 2002, compared with $346 billion at December 31, 2001.

Commitments

Fannie Mae enters into master delivery commitments on either a mandatory or an optional basis. Under a

mandatory master commitment, a lender must either deliver loans under an MBS contract at a speciÑed

guaranty fee rate or enter into a mandatory portfolio commitment with the yield established upon executing

the portfolio commitment. We also accept mandatory or lender-option delivery commitments not issued

pursuant to a master commitment. These commitments may be for our portfolio or for issuances of Fannie

Mae MBS. The guaranty fee rate on MBS lender-option commitments is speciÑed in the contract, while the

yield for portfolio lender-optional commitments is set at the date of conversion to a mandatory commitment.

We generally hedge the cost of funding future portfolio purchases upon issuance of, or conversion to, a

mandatory commitment. Therefore, we largely mitigate the interest rate risk relating to loans purchased

pursuant to those commitments. Our outstanding mandatory portfolio commitments, excluding commitments

under master agreements, totaled $85 billion and $55 billion at December 31, 2002 and 2001, respectively.

54
APPLICATION OF CRITICAL ACCOUNTING POLICIES

Fannie Mae's Ñnancial statements and reported results are based on GAAP, which requires us in some

cases to use estimates and assumptions that may aÅect our reported results and disclosures. We describe our

signiÑcant accounting policies in the Notes to Financial Statements under Note 1, ""Summary of SigniÑcant

Accounting Policies.'' Several of our accounting policies involve the use of accounting estimates we consider

to be critical because: (1) they are likely to change from period to period because they require signiÑcant

management judgment and assumptions about highly complex and uncertain matters; and (2) the use of a

diÅerent estimate or a change in estimate could have a material impact on our reported results of operations or

Ñnancial condition. Our critical accounting estimates include determining the adequacy of the allowance for

loan losses and guaranty liability for MBS; projecting mortgage prepayments to calculate the amortization of

deferred price adjustments on mortgages and mortgage-related securities held in portfolio and guaranteed

mortgage-related securities; and estimating the time value of our purchased options. Management has

speciÑcally discussed the development and selection of each critical accounting estimate with the Audit

Committee of Fannie Mae's Board of Directors. Our Audit Committee has also reviewed our disclosures in

this MD&A regarding Fannie Mae's critical accounting estimates.

Allowance for Loan Losses and Guaranty Liability for MBS

We establish an allowance for loan losses and guaranty liability for MBS on single-family and multifamily

loans in our book of business. We maintain a separate allowance for loan losses and guaranty liability for MBS.

However, we use the same methodology to determine the amounts of each because the risks are the same. The

allowance for loan losses is held against loans in our mortgage portfolio. We also have a guaranty liability for

our guaranty of MBS held by us or by other investors. Our allowance and guaranty liability for MBS consist of

the following key elements:

‚ Single-family: We evaluate various risk characteristics such as product type, original loan-to-value

ratio, and loan age to determine the allowance and guaranty liability for single-family assets. We

estimate defaults for each risk characteristic based on historical experience and apply a historical

severity to each risk category in accordance with Financial Accounting Standard No. 5, Accounting for

Contingencies (""FAS 5''). Severity refers to the amount of loss suÅered on a default relative to the

unpaid principal balance of the loan. In addition, we apply Financial Accounting Standard No. 114,

Accounting by Creditors for Impairment of a Loan (""FAS 114''), to determine the amount of

impairment on speciÑc loans that have been restructured. We charge-oÅ single-family loans when we

foreclose on the loans.

‚ Multifamily: We determine the multifamily allowance and guaranty liability by separately evaluating

loans that are impaired and all other loans. Impaired loans consist of loans that are not performing

according to their original contractual terms. For loans that we consider impaired, we apply FAS 114 to

estimate the amount of impairment. For all other loans, we apply FAS 5 to establish an allowance and

guaranty liability by rating each loan not individually evaluated for impairment and segmenting the

loan into one of the main risk categories we use to monitor the multifamily portfolio. We then apply

historical default rates, adjusted for current conditions, and a corresponding severity to the loans in

each segment to estimate the probable loss amount at each balance sheet date.

We believe the accounting estimate related to our allowance for loan losses and guaranty liability for

MBS is a ""critical accounting estimate'' because it requires us to make signiÑcant judgments about probable

future losses in our book of business as of the balance sheet date based on assumptions that are uncertain. We

may have to increase or decrease the size of our overall allowance for loan losses and guaranty liability based

on changes in delinquency levels, loss experience, economic conditions in areas of geographic concentration,

and proÑle of mortgage characteristics. DiÅerent assumptions about default rates, severity, counterparty risk,

and other factors that we could use in estimating our allowance for loan losses and guaranty liability could

have a material eÅect on our results of operations.

We include the allowance for loan losses in the balance sheet under ""Mortgage portfolio, net.'' We

include the guaranty liability for estimated losses on MBS held by us or other investors as a liability under

55
""Guaranty liability for MBS.'' Table 18 shows the amounts of these components and summarizes the changes

for the years 1998 to 2002.

Table 18: Allowance for Loan Losses and Guaranty Liability for MBS

2002 2001 2000 1999 1998

(Dollars in millions)

Allowance for loan losses(1):

Beginning balance ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 48 $ 51 $ 56 $ 79 $ 131

Provision ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 44 7 9 (5) (16)

Charge-oÅs(2) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (13) (10) (14) (18) (36)

Ending balance ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 79 $ 48 $ 51 $ 56 $ 79

Guaranty liability for MBS(1): Beginning balance ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 755 $755 $ 745 $ 720 $ 668

Provision ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 84 87 113 156 261

Charge-oÅs ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (110) (87) (103) (131) (209)

Ending balance ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 729 $755 $ 755 $ 745 $ 720

Combined allowance for loan losses and guaranty liability for MBS(3):

Beginning balance ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 803 $806 $ 801 $ 799 $ 799

Provision ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 128 94 122 151 245

Charge-oÅs(2) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (123) (97) (117) (149) (245)

Ending balance ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 808 $803 $ 806 $ 801 $ 799

Balance at end of each period attributable to(3):

Single-familyÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 641 $636 $ 639 $ 634 $ 632

Multifamily ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 167 167 167 167 167

$ 808 $803 $ 806 $ 801 $ 799

Percent of allowance and guaranty liability in each category to related

total book of business(4):

Single-familyÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ .037% .042% .051% .055% .063%

Multifamily ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ .211 .247 .313 .359 .412

.044% .051% .061% .067% .076%

Charge-oÅs(2):

Single-familyÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 104 $ 96 $ 114 $ 145 $ 237

Multifamily ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 19 1348

$ 123 $ 97 $ 117 $ 149 $ 245

Charge-oÅs as a percentage of average book of businessÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ .007% .007% .009% .013% .026%

Credit losses as a percentage of average book of businessÏÏÏÏÏÏÏÏÏÏÏÏÏÏ .005 .006 .007 .011 .027

(1) In 2002, we reclassiÑed from our ""Allowance for loan losses'' to a ""Guaranty liability for MBS'' the amount

associated with the guaranty obligation for MBS that we own. Prior period balances, the provision for losses, and

charge-oÅ amounts have been reclassiÑed to reÖect the current year's presentation.

(2) Charge-oÅs exclude $1 million in 2002 and $1 million in 1998 on charge-oÅs related to foreclosed Federal Housing

Administration loans that are reported in the balance sheet under ""Acquired property and foreclosure claims, net.''

(3) The total excludes $2 million at year-end 2002 and $3 million at the end of 2001, 2000, 1999, and 1998 related to

foreclosed Federal Housing Administration loans that are reported in the balance sheet under ""Acquired property and

foreclosure claims, net.''

(4) Represents ratio of allowance and guaranty liability balance by loan type to book of business by loan type.

Over the past Ñve years, our combined allowance for loan losses and guaranty liability for MBS have

remained relatively stable although our book of business has expanded. This trend reÖects improvements in

the credit performance of our book of business. Fannie Mae's allowance and guaranty liability as a percentage

of the book of business has declined to .04 percent in 2002, from .05 percent in 2001 and .06 percent in 2000,

based on positive credit trends. Over the last three years, our credit loss ratio has declined in each year to

.5 basis points in 2002, from .6 basis points in 2001, and .7 basis points in 2000. We recorded a provision for

losses of $128 million, $94 million, and $122 million, respectively, in 2002, 2001, and 2000. Our provision

represented between 1 and 2 percent of our pre-tax reported income and core business earnings in each of the

past three years. Management believes the combined balance of our allowance for loan losses and guaranty

liability for MBS are adequate to absorb losses inherent in Fannie Mae's book of business.

56
Deferred Price Adjustments

When Fannie Mae buys MBS, loans, or mortgage-related securities, we may not pay the seller the exact

amount of the unpaid principal balance (""UPB''). If we pay more than the UPB and purchase the mortgage

assets at a premium, the premium reduces the yield we recognize on the assets below the coupon amount. If

we pay less than the UPB and purchase the mortgage assets at a discount, the discount increases the yield

above the coupon amount. In addition, we may charge an upfront payment in lieu of a higher guaranty fee for

certain loan types that have higher credit risk. To facilitate the pooling of mortgages into a Fannie Mae MBS,

we also may adjust the monthly MBS guaranty fee rate that we receive by either negotiating an upfront cash

disbursement to the lender (a ""buy-up'') or an upfront cash receipt from the lender (a ""buy-down'') when the

MBS is formed. The upfront payment results in an adjustment to the monthly guaranty fee so that the

coupons on MBS are always in increments of whole or half interest rates, which are more easily traded.

We recognize the impact of premiums, discounts, and other purchase price adjustments over the

estimated life of the purchased assets as an adjustment to income in accordance with Financial Accounting

Standard No. 91, Accounting for Nonrefundable Fees and Costs Associated with Originating or Acquiring

Loans and Initial Direct Costs of Leases (""FAS 91''). We amortize deferred premium and discount into

interest income, which aÅects the results of our Portfolio Investment business. Amortization of deferred price

adjustments relating to our guaranty fees aÅects guaranty fee income, which aÅects the results of our Credit

Guaranty business.

We apply the interest method to amortize the premiums, discounts, and other purchase price adjustments

into income. We estimate future mortgage prepayments to calculate the constant eÅective yield necessary to

apply the interest method. We believe the accounting estimates related to deferred premium/discount and

deferred guaranty fees are ""critical accounting estimates'' because they require us to make signiÑcant

judgments and assumptions about borrower prepayment patterns in various interest rate environments that

involve a signiÑcant degree of uncertainty. On a periodic basis, we evaluate whether we should change the

estimated prepayment rates used in the amortization calculation. We reassess our estimate of the sensitivity of

prepayments to changes in interest rates and compare actual prepayments versus anticipated prepayments. If

changes are necessary, we recalculate the constant eÅective yield and adjust net interest income or guaranty

fee income for the amount of premiums, discounts, and other purchase price adjustments that would have

been recorded if we had applied the new eÅective yield since acquisition of the mortgage assets or inception of

a guaranty. Table 19 presents an analysis of the eÅect of our deferred price adjustments in 2002, 2001, and

2000.

57
Table 19: Deferred Price Adjustments

2002 2001 2000

Deferred Deferred Deferred

Premium/ Deferred Premium/ Deferred Premium/ Deferred

(Discount) Guaranty Fees (Discount) Guaranty Fees (Discount) Guaranty Fees

(Dollars in millions)

Unamortized premium (discount) and

deferred price adjustments, net(1) ÏÏ $472 $(1,454) $(2,104) $(382) $(2,520) $305

Increase (decrease) in net interest

income/guaranty fee income from

net amortization(2)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 71 104 358 (87) 207 (22)

Percentage eÅect on reported net

income(3) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 1% 1% 4% (1)% 3% Ì%

Percentage eÅect on net interest

income/guaranty fee income of:(4)

100 basis point increase in interest

rates ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (.3) Ì Ì .1 Ì .8

50 basis point increase in interest

rates ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Ì Ì Ì Ì Ì Ì

Percentage eÅect on net interest

income/guaranty fee income of:(4)

50 basis point decrease in interest

rates ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 1.0 .8 .3 (.3) 1.0 (6.1)

100 basis point decrease in interest

rates ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2.4 3.1 2.2 (2.7) 1.9 (9.9)

(1) Includes unamortized premium (discount) and deferred price adjustments for available-for-sale and held-to-maturity

mortgage-related securities and loans held-for-investment.

(2) Amortization of premium/discount amounts is recorded in net interest income, while amortization of deferred price

adjustments related to guaranty fees is recorded in guaranty fee income.

(3) ReÖects after-tax eÅect on reported net income from the change in net amortization based on the applicable federal

income tax rate of 35 percent.

(4) Calculated based on an instantaneous change in interest rates.

Deferred Premium/Discount

As shown in Table 19, Fannie Mae moved to a net premium position of $472 million in our mortgage

portfolio at the end of 2002 from a net discount position of $2.104 billion at year-end 2001 and $2.520 billion

at year-end 2000. Because of declining interest rates throughout 2002, we paid premiums on a higher than

average proportion of our mortgage purchases during the year. Net interest income recognized from the

amortization of deferred price adjustments related to our mortgage portfolio increased our reported net income

by 1 percent in 2002, 4 percent in 2001, and 3 percent in 2000.

Table 19 discloses the estimated adjustments that we would have to make to our net interest income

based on 50 and 100 basis point instantaneous changes in interest rates at year-end beyond the levels assumed

in our base prepayment rate models. Our prepayment sensitivity analysis indicates that a 100 basis point

instantaneous increase in interest rates beyond the levels assumed in base prepayment rate models would have

resulted in less than a .4 percent decrease in net interest income in 2002, 2001, and 2000. We estimate that a

100 basis point decrease in interest rates at December 31, 2002, 2001, and 2000 would have increased our net

interest income in each of those years by approximately 2 percent.

The eÅect of declines in interest rates has a larger impact on net interest income than interest rate

increases because declines in interest rates result in prepayments that lower the weighted-average coupon of

our mortgage assets more signiÑcantly than instantaneous increases in interest rates raise the weighted-average

coupon of our mortgage assets. As a result, the adjustment of net interest income from a downward shift in

interest rates would be larger than the adjustment of net interest income from a rising shift in interest rates.

Despite being in a net premium position at year-end 2002, an instantaneous decrease in interest rates would

58
have a positive impact on 2002 net interest income largely because those mortgage assets in a net premium

position have a lower average coupon than those mortgage assets in a net discount position. Consequently, the

estimated downward adjustment of 2002 net interest income for the amortization of the premium after an

instantaneous decline in interest rates would be lower than the estimated upward adjustment of 2002 net

interest income for the amortization of the discount.

This sensitivity analysis is only one component of Fannie Mae's overall net interest income at risk

assessment. It does not include the eÅect of new business or the impact of changes in interest rates on our debt

costs or net cash Öows related to our derivatives contracts. A comprehensive analysis of the impact of interest

rate changes on projected net interest income is presented in ""MD&AÌRisk ManagementÌInterest Rate

Risk ManagementÌNet Interest Income at Risk.''

Deferred Guaranty Fees

Our net discount position on deferred guaranty fee price adjustments increased to $1.454 billion at yearend 2002 from a net discount position of $382 million at year-end 2001 and a net premium position of

$305 million at year-end 2000. A net discount position reÖects that the combined up-front payments we

collect in lieu of higher guaranty fees on more risky loans and the up-front payments we receive from lenders

in exchange for a lower guaranty fee rate over time exceed the up-front payments we make to lenders in

exchange for a higher guaranty fee rate over time. A net premium position indicates that our upfront payments

to lenders exceed the upfront fees collected from lenders. The signiÑcant increase in our net discount position

on deferred guaranty fees in 2002 was largely attributable to an increase in up-front payments collected on

loans with higher credit risk.

Amortization of deferred guaranty fee adjustments increased guaranty fee income by $104 million in

2002 (1 percent of reported net income) and reduced guaranty fee income by $87 million in 2001 (1 percent

of reported net income) and $22 million in 2000 (less than 1 percent of reported net income). The upward

adjustment to guaranty fee income in 2002 was primarily related to accelerating the recognition of discount

during the second half of 2002 as interest rates fell to historically low levels and prepayments accelerated. In

addition, we made enhancements in 2002 to better reÖect the impact of interest rates on prepayment behavior

and guaranty fee income that accelerated the recognition of discount.

Our prepayment sensitivity analysis at the end of each year for deferred guaranty fees indicates that a 100

basis point instantaneous increase in interest rates beyond the levels assumed in base prepayment rate models

at year-end would have less than a 1 percent upward eÅect on guaranty fee income in 2002, 2001, and 2000. A

100 basis point instantaneous decrease in interest rates at year-end would have increased our guaranty fee

income by approximately 3 percent in 2002 and reduced our guaranty fee income by approximately 3 percent

and 10 percent in 2001 and 2000, respectively. The growth and age of the net discount position in 2002 is the

primary driver of the positive impact on guaranty fee income from an instantaneous 100 basis point decrease in

interest rates.

Time Value of Purchased Options

Fannie Mae issues various types of debt to Ñnance the acquisition of mortgages. We typically use

derivative instruments to supplement our issuance of debt in the capital markets and hedge against the eÅect

of Öuctuations in interest rates on our debt costs to preserve our net interest margin. With the adoption of

FAS 133, we began recording all derivatives on our balance sheet at estimated fair value. We record changes

in the fair value of derivatives designated as cash Öow hedges in accumulated other comprehensive income

(""AOCI''). We recognize in our reported earnings changes in the fair value of the time value associated with

purchased options and changes in the fair value of derivatives designated as fair value hedges.

Fannie Mae's purchased options portfolio currently includes swaptions and caps, which are discussed in

more detail under ""MD&AÌRisk ManagementÌInterest Rate Risk ManagementÌDerivative Instruments.'' The total fair value for purchased options consists of the time value plus the intrinsic value. Under

FAS 133, the mark-to-market on the time value component of our purchased options Öows through our

reported earnings. The time value of purchased options will vary from period to period with changes in interest

59
rates, expected interest rate volatility, and derivative activity. However, the total expense included in earnings

over the original expected life of an option will generally equal the initial option premium paid. Since adopting

FAS 133, we have reported signiÑcant Öuctuations in our reported net income because of unrealized

Öuctuations in the estimated time value of purchased options. As a result of the declining interest rate

environment in 2002 and the increase in the notional value of our purchased options, we recorded

$4.545 billion in purchased options expense in 2002, compared with $37 million in 2001.

Our methodology for valuing purchased options is based on commonly used market conventions and

assumptions. We obtain quoted market prices for a benchmark set of interest rate options, which include caps

and swaptions. Based on these quoted market prices, we apply our valuation model, which eÅectively utilizes

these prices to estimate the fair value of our purchased options. We then allocate the fair value of our

purchased options into the time value and intrinsic value components. Because the benchmark securities are

only a subset of the purchased options that we hold, the estimation of time value is not exact and can vary

depending on the market source and methodology used. This variation could have a material eÅect on our

reported net income. Hence, we believe our estimate of the time value component of purchased options is a

""critical accounting estimate.''

During the fourth quarter of 2002, we reÑned our methodology for estimating the initial time value of

interest rate caps at the date of purchase. Under our previous valuation method, we treated the entire premium

paid on purchased ""at-the-money'' caps as time value with no allocation to intrinsic value. We now allocate

the purchase price to reÖect the value of individual caplets, some of which are above the strike rate of the cap.

This approach, which is more consistent with our estimation of time value subsequent to the initial purchase

date, results in a higher intrinsic value and lower time value at the date of purchase. We adopted this preferred

valuation method prospectively on caps purchased after third quarter 2002, which resulted in a $282 million

pre-tax reduction in our 2002 purchased options expense. The change has no eÅect on the total expense that

will be recorded in our income statement over the life of our caps and no eÅect on our core business earnings.

To gauge the potential sensitivity of changes in the estimated time value of our purchased options, we

recalculated our estimates based on plus and minus changes of 5 percent and 10 percent in the time value

portion of our outstanding purchased options at December 31, 2002 and 2001. An increase in the estimated

time value of our purchased options would reduce our purchased options expense and increase our reported net

income and stockholders' equity, while a decrease in the estimated time value would increase purchased

options expense and reduce our reported net income and stockholders' equity. These changes are generally

greater than changes we have observed historically in our valuation process. Table 20 shows the potential

eÅect on our 2002 and 2001 reported results from these changes in time value. There would be no eÅect on our

2000 results as we adopted FAS 133 on January 1, 2001.

Table 20: Impact of Changes in the Time Value of Purchased Options

Percentage of

Change in Fair Reported Net Percentage of Total

Value Adjustment Income(1) Stockholders' Equity

2002 2001 2000 2002 2001 2000 2002 2001 2000

(Dollars in millions)

10% change in time value ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $543 $493 NA 8% 5% NA 2% 2% NA

5% change in time value ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 271 246 NA 4 3 NA 1 1 NA

(1) ReÖects after-tax eÅect of time value adjustment based on applicable federal income tax rate of 35 percent.

Table 20 reveals that a plus or minus change of 10 percent in the time value portion of our purchased

options at December 31, 2002 and 2001 would change our reported net income by 8 percent and 5 percent,

respectively. A plus or minus change of 5 percent in the time value portion of our purchased options at

December 31, 2002 and 2001 would change our reported net income by approximately 4 percent and

3 percent, respectively. Changing the time value portion of our purchased options by 10 percent or 5 percent

would change our total stockholders' equity by approximately 2 percent or 1 percent, respectively, at

December 31, 2002 and 2001. Our core business earnings results would not be aÅected by these estimates

60
because we amortize purchased options premiums on a straight-line basis over the original expected life of the

option in measuring core business earnings and do not include mark-to-market changes in the fair value of

purchased options.

RISK MANAGEMENT

Fannie Mae is subject to three major areas of risk: interest rate risk, credit risk, and operations risk.

Active management of these risks is an essential part of our operations and a key determinant of our ability to

maintain steady earnings growth. The following discussion highlights the strategies we use to manage these

three risks.

Interest Rate Risk Management

Interest rate risk is the risk of loss to future earnings or long-term value that may result from changes in

interest rates. Our interest rate risk is concentrated primarily in our mortgage portfolio where nearly 90 percent

of our mortgages are intermediate-term or long-term, Ñxed-rate loans that borrowers have the option to prepay

at any time without penalty. We are exposed to interest rate risk because the cash Öows of our mortgage assets

and the liabilities that fund them are not perfectly matched through time and across all possible interest rate

scenarios. The cash Öows from our mortgage assets are highly sensitive to changes in interest rates because of

the borrower's prepayment option. As interest rates decrease, borrowers are more likely to reÑnance Ñxed-rate

mortgages, resulting in increased prepayments and mortgage cash Öows that are received earlier than

expected. Replacing the higher-rate loans that prepay with lower-rate loans has the potential of reducing our

interest spread unless we are able to also reduce our debt cost. Conversely, an increase in interest rates may

result in slower than expected prepayments and mortgage cash Öows that are received later than expected. In

this case, we have the risk that our debt may reprice faster than our mortgage assets and at a higher cost,

which could also reduce our interest spread. The objective of our interest rate risk management process is to

maintain long-term value through a low variability of future earnings due to changes in interest rates, while

preserving stable earnings growth and a competitive return on equity over time.

The Board of Directors oversees interest rate risk management through the adoption of corporate goals

and objectives and the review of regular reports on performance against them. Senior management is

responsible for ensuring that appropriate long-term strategies are in place to achieve the goals and objectives.

Management establishes reference points for the key performance measures that we use to signal material

changes in risk and to assist in determining whether we should adjust portfolio strategy to achieve long-term

objectives. Management regularly reports these measures and reference points to the Board of Directors.

The Portfolio Investment Committee, which includes our senior mortgage portfolio managers, meets

weekly and reviews current Ñnancial market conditions, portfolio risk measures, and performance targets. The

Committee develops and monitors near-term strategies and the portfolio's standing relative to its long-term

objectives. The results of Portfolio Investment Committee meetings are reported to the weekly Asset and

Liability Management Committee, which is comprised of senior management and includes our Chief

Executive OÇcer.

Fannie Mae's overall objective in managing interest rate risk is to deliver consistent net interest income

growth and target returns on capital over a wide range of interest rate environments. Central elements of our

approach to managing interest rate risk include: (1) funding assets by issuing liabilities that have similar cash

Öow patterns through time and in diÅerent interest rate environments, (2) regularly assessing the portfolio's

exposure to changes in interest rates using a diverse set of analyses and measures, and (3) setting parameters

for rebalancing actions to help attain corporate objectives.

1. Funding mortgage assets with liabilities that have similar cash Öow patterns through time and in

diÅerent interest rate environments.

When we purchase mortgages we attempt to match the initial estimated life, or duration, of our

liabilities to our assets within a range to achieve a stable and competitive net interest margin. We issue a

mix of debt securities across a broad spectrum of Ñnal maturities to achieve the desired liability durations.

Because the estimated lives of mortgage assets change as interest rates change, we frequently issue

61
callable debt or use derivatives to alter the estimated life of our liabilities to partially match the expected

change in duration of our mortgage assets. The duration of callable debt, like that of a mortgage, shortens

when interest rates decrease and lengthens when interest rates increase. If interest rates decrease, we are

likely to call debt that carries an interest rate higher than the current market. We use interest rate swaps

and other derivatives with embedded interest rate options to achieve our desired liability structure and to

better match both the duration and prepayment risk of our mortgage assets. These derivatives, coupled

with appropriate debt securities, are close substitutes for callable and noncallable debt. Through the use

of these derivatives, we can synthetically create debt with cash Öows similar to our mortgage assets.

2. Regularly assessing the portfolio's exposure to changes in interest rates using a diverse set of analyses

and measures.

Interest Rate Risk Measurement

We utilize a wide range of risk measures and analyses to manage the interest rate risk inherent in the

mortgage portfolio. We categorize these risk measures and analyses into three types: ongoing business risk

measures and analyses, run-oÅ measures of the existing portfolio, and stress test scenarios. The

combination of ongoing business and run-oÅ risk measures and analyses present a comprehensive picture

of Fannie Mae's current risk position that we use for day-to-day risk management decisions. Stress test

scenarios provide information on our risk to more extreme but lower probability events.

Our ongoing business risk measures and analyses include net interest income at risk and repricing

gap analyses. We base net interest income at risk measures on the mortgage portfolio as of a certain date

plus projections of future business activity. Future business activity includes projected mortgage

purchases and funding actions. Management believes that ongoing business risk measures and analyses

provide a better perspective on the interest rate risk we face as a continuing business and a more

comprehensive depiction of our risk proÑle than run-oÅ measures. However, they contain more

assumption risk due to the inherent uncertainty in projecting future business activity.

Run-oÅ measures of interest rate risk include duration, convexity, and repricing gaps. We base runoÅ measures on the mortgage portfolio as of a certain date without incorporating future business activity.

Run-oÅ measures provide an assessment of the interest rate risk of the existing portfolio without the

assumption risk inherent in projecting future business activity. However, we believe it is important to

manage interest rate risk in the context of ongoing business activity because future business is highly

probable and has a pronounced eÅect on our interest rate risk proÑle.

Stress test scenarios include extreme movements in risk factors on both ongoing business and run-oÅ

measures of risk. We periodically measure and analyze the eÅects that extreme movements in the level of

interest rates and the slope of the yield curve would have on the company's risk position. In addition, we

evaluate stress scenarios that include severe changes in expected prepayment speeds and the level of

interest rate volatility. While stress testing is an integral part of our risk management process, the ongoing

business and run-oÅ measures of risk are the primary inputs in daily risk management decisions.

Many of our projections of mortgage cash Öows in our interest rate risk measures depend on our

proprietary prepayment models. While we are highly conÑdent in the quality of these models, we

recognize the historical patterns that serve as input for our models may not continue in the future. The

models contain many assumptions, including those regarding borrower behavior in certain interest rate

environments and borrower relocation rates. Other assumptions such as projections of interest rates,

shape of the yield curve, and interest rate volatility are also critical components to our interest rate risk

measures. We maintain a research program to constantly evaluate, update, and enhance these assumptions, models, and analytical tools as appropriate to reÖect management's best assessment of the

environment.

62
‚ Net Interest Income at Risk

Net interest income at risk is our primary ongoing business measure of interest rate risk. Net interest

income at risk measures the projected impact of changes in the level of interest rates and the shape of the

yield curve on the mortgage portfolio's expected or ""base'' core net interest income over the immediate

future one- and four-year periods. To determine our base core net interest income, we estimate core net

interest income over a wide range of interest rate environments using stochastic interest rate simulations.

Stochastic interest rate simulations are a widely used statistical method to estimate the path and pattern

of interest rates. Our stochastic simulations produce probability distributions of future interest rates based

on expected interest rate volatility and are based on proprietary interest rate models. We generate several

hundred interest rate paths distributed around the current Fannie Mae yield curve from these simulations. The Fannie Mae yield curve represents market assumptions regarding our expected cost of funds

over a variety of maturities and takes into account the risk premium on our debt relative to benchmark

interest rates. We project core net interest income for four years along each path based on the

characteristics of the current mortgage portfolio and projected future business activity. The expected or

""base'' core net interest income is calculated based on the average core net interest income across all

simulation paths and serves as the basis for determining our interest rate risk proÑle. Our projections of

future business activity used in these simulations are reported to senior management and our Board of

Directors and provide the basis for Fannie Mae's current earnings forecasts.

We determine the amount of net interest income at risk by assuming a sudden change or shock to

the current yield curve and repeating the simulation. We regularly evaluate a wide range of instantaneous

shocks to both the level and shape of the yield curve and create the net interest income at risk proÑle by

comparing the percentage change in core net interest income between each shocked simulation and the

base simulation. Our net interest income at risk disclosures, which we report to the public on a monthly

basis, represent the extent to which our core net interest income over the next one-year and four-year

periods is at risk due to a plus or minus 50 basis point parallel change in the current Fannie Mae yield

curve and from a 25 basis point change in the slope of Fannie Mae's yield curve. We selected these

shocks for our monthly disclosure because they capture approximately 95 percent of historical changes in

interest rates over a one-month reporting period.

‚ Duration Gap

The portfolio duration gap is a run-oÅ measure of interest rate risk. The duration gap is the

diÅerence between the estimated durations of portfolio assets and liabilities. Duration gap summarizes

the extent to which estimated cash Öows for assets and liabilities are matched, on average, over time and

across interest rate scenarios. A positive duration gap signals a greater exposure to rising interest rates

because it indicates that the duration of our assets exceeds the duration of our liabilities. A negative

duration gap signals a greater exposure to declining interest rates because the duration of our assets is less

than the duration of our liabilities. We apply the same interest rate process, prepayment models, and

volatility assumptions used in our net interest income at risk measure to generate the portfolio duration

gap. The duration gap reÖects the current mortgage portfolio, including priced asset and debt commitments. We do not incorporate projected future business activity or nonmortgage investments into our

duration gap measure.

We regularly evaluate the sensitivity of the duration gap over a wide range of instantaneous changes

to both the level and shape of the yield curve. The duration gap provides a relatively concise and simple

measure of the interest rate risk inherent in the existing mortgage portfolio, but it is not directly linked to

expected future earnings performance. Future business activity, which is not reÖected in the duration gap,

can have a signiÑcant eÅect even over a very short horizon. We disclose on a monthly basis our duration

gap at the end of each month along with our net interest income at risk, which together we believe

provide a more informative proÑle of our overall interest rate risk position than either measure alone.

63
3. Setting the parameters for rebalancing actions to help attain corporate objectives.

Management develops rebalancing actions based on a number of factors that include the relative

standing of both net interest income at risk and duration gap, as well as analyses based on additional risk

measures and current market activities and conditions. We establish internal reference points, or

indicators, for our risk measures to signal when we should re-examine the risk proÑle of our assets. Our

reference points are set by Fannie Mae's management, not by any external or regulatory requirement, to

provide a tool for determining when and to what extent we should consider rebalancing actions. These

reference points do not represent absolute risk limits. They are generally consistent with levels of interest

rate risk that we project will not result in signiÑcant variability in future earnings and long-term value.

As these risk measures begin to move beyond our internally established reference points, we consider

actions to bring them within our preferred ranges in a manner that is consistent with achieving Fannie

Mae's earnings objectives. As a risk measure moves further outside our preferred range, we place

signiÑcantly greater emphasis on reducing our risk exposure and less emphasis on earnings objectives. We

have not established a speciÑc time horizon over which rebalancing actions must take place.

Risk Management Results

2002 was a year of signiÑcant interest rate movements coupled with unprecedented levels of interest rate

volatility. Fannie Mae's disciplined risk management process was critical to successfully meeting the

company's interest rate risk objectives throughout this challenging environment. During the Ñrst half of 2002,

our interest rate risk measures were within our reference points, and no signiÑcant rebalancing actions were

considered necessary. Between June and September 2002, interest rates declined signiÑcantly and our primary

risk measures began to move outside of our preferred range. As these risk measures approached our internally

established reference points, we developed strategies to moderately rebalance the portfolio. As rates continued

to fall, we increased the pace of rebalancing signiÑcantly. After our interest rate risk measures reached peak

levels in August 2002, we continued to aggressively rebalance to bring our risk measures within our established

reference points. We utilized a wide range of tools to execute this rebalancing, including increased mortgage

purchases, reduced Ñxed-rate debt issuances, debt repurchases, and derivative transactions.

‚ Net Interest Income at Risk

At December 31, 2002, our one-year and four-year net interest income at risk measures for a 50 basis

point change across the Fannie Mae yield curve were .6 percent and 1.6 percent, respectively, compared with

5.1 percent and 4.5 percent, respectively, at December 31, 2001. The one-year and four-year net interest

income at risk measures for a 25 basis point change in the slope of the Fannie Mae yield curve were

4.7 percent and 6.6 percent, respectively, compared with 2.4 percent and 4.3 percent, respectively, at

December 31, 2001.

The following graphs show the monthly net interest income at risk for each of the last three years under

both a 50 basis point change across the Fannie Mae yield curve and a 25 basis point change in the slope of the

Fannie Mae yield curve. Compared to 2001 and 2000, the net interest income at risk was at somewhat higher

levels and more variable during 2002. The results for 2002 reÖect the extreme low level of interest rates as well

as unprecedented levels of interest rate volatility related to uncertainty about the economic outlook.

64
Dec-99

Feb-00

Apr-00

Jun-00

Aug-00

Oct-00

Dec-00

Feb-01

Apr-01

Jun-01

Aug-01

Oct-01

Dec-01

Feb-02

Apr-02

Jun-02

Aug-02

Oct-02

Dec-02

Mortgage Portfolio Net Interest Income at Risk - 50 Basis Point Level Shock 

One-year NII at risk Four-year NII at risk

NII at Risk

10%

9

8

7

6

5

4

3

2

1

0

Dec-99

Feb-00

Apr-00

Jun-00

Aug-00

Oct-00

Dec-00

Feb-01

Apr-01

Jun-01

Aug-01

Oct-01

Dec-01

Feb-02

Apr-02

Jun-02

Aug-02

Oct-02

Dec-02

NII at Risk

One-year NII at risk Four-year NII at risk

Mortgage Portfolio Net Interest Income at Risk - 25 Basis Point Slope Shock 

10%

9

8

7

6

5

4

3

2

1

0

65
Table 21 presents our net interest income at risk based on an instantaneous 100 basis point increase and a

50 basis point decrease in interest rates. The risk measure is an extension of our voluntary monthly net interest

income at risk disclosure, and we use the same data, assumptions, and methodology. We consider our net

interest income at risk at December 31, 2002 to be low as our exposure to a 100 basis point instantaneous

increase in interest rates was estimated not to exceed 4 percent and 6 percent over a 1-year and 4-year horizon,

respectively, and our exposure to a 50 basis point instantaneous decrease in rates was estimated not to exceed

more than 1 percent over a 1-year and 4-year horizon. In comparison, we had what we consider to be a

moderate level of risk exposure at December 31, 2001 to increasing rates and a beneÑt from decreasing rates.

The changes in the proÑle of net interest income at risk from December 31, 2001 to December 31, 2002 were

driven by changes in the level of interest rates and shape of the yield curve, changes in the composition of the

portfolio, and changes in forecast assumptions. Actual portfolio net interest income may diÅer from these

estimates because of speciÑc interest rate movements, changing business conditions, changing prepayments,

and management actions.

Table 21: Net Interest Income at Risk

December 31, 2002 December 31, 2001

1-Year Portfolio 4-Year Portfolio 1-Year Portfolio 4-Year Portfolio

Net Interest Net Interest Net Interest Net Interest

Income at Risk Income at Risk Income at Risk Income at Risk

Assuming a 100 basis point increase in interest

rates ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 4% 6% 10% 10%

Assuming a 50 basis point decrease in interest

rates ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 1 Ì (4) (2)

‚ Duration Gap

Fannie Mae's duration gap was minus 5 months at December 31, 2002, versus plus 5 months at

December 31, 2001. The negative shift in our duration gap during 2002 was primarily the result of historically

low interest rates that resulted in a surge in expected reÑnancings. The signiÑcant increase in our expectation

of mortgage prepayments caused the durations of our mortgages to shorten by more than the durations of our

debt during 2002. Our monthly duration gap turned sharply negative during the year, falling to minus

14 months at the end of August 2002 before narrowing to minus 5 months by the end of the year. The

movement in the duration gap during 2002 was not unusual given our historical experience during previous

reÑnance waves or periods of signiÑcant interest rate volatility. Our duration gap also moved signiÑcantly

during each of the prior major reÑnancing waves in 2001, 1998, and 1993. Over the past decade, Fannie Mae's

duration gap has been wider than plus or minus 6 months approximately one-third of the time. During 2002,

our monthly duration gap was wider than plus or minus 6 months three times.

Although periods of heavy reÑnancing are typically associated with somewhat higher risk levels, these

periods historically have provided positive opportunities for our portfolio. Through our normal business

activities of buying mortgages and issuing debt, we historically have been able to bring our duration gap

measure within our target range in a manner and pace that does not put undue demands on the market.

Opportunities to add new business during the latter half of 2002 developed at about the pace we anticipated in

a low rate environment. The increased business activity fueled our purchase of long-term, Ñxed-rate

mortgages, which helped to lengthen the duration of our mortgage assets and oÅset our negative duration gap.

In addition, we took a number of speciÑc rebalancing actions in the latter half of 2002 to reduce our negative

duration gap, including funding our longer duration mortgage purchases with shorter-term debt, repurchasing

long-term outstanding debt, terminating certain long-term pay-Ñxed interest rate swaps, and entering into

option-based derivatives transactions. If interest rates increase, some of our rebalancing actions could result in

lower portfolio returns than would have occurred without the rebalancing. However, our objective is to

maintain an interest rate risk proÑle that is balanced to protect us against both increases and decreases in

interest rates. Because managing our duration gap through rebalancing actions is a routine part of our interest

rate risk management strategy, we do not expect these actions to have a material adverse eÅect on our future

earnings objectives.

66
The graph below shows Fannie Mae's monthly duration gap compared with the yield on Fannie Mae

10-year debt for the last three years. Dec-99 Feb-00 Apr-00 Jun-00 Aug-00

Oct-00

Dec-00

Feb-01Apr-01

Jun-01

Aug-01

Oct-01

Dec-01

Feb-02Apr-02

Jun-02

Aug-02

Oct-02

Dec-02

Duration Gap 10-Year Fannie Mae Debt Cost

Duration Gap (months)

10-Year Fannie Mae Debt (%)

15

12

9

6

3

0

-3

-6

-9

-12

-15

8.0%

7.5

7.0

6.5

6.0

5.5

5.0

4.5

4.0

‚ Convexity

Convexity measures are commonly used as a supplement to duration measures to reÖect the degree to

which durations are likely to change in response to movements in interest rates. Convexity provides us with

information on how quickly and by how much the portfolio's duration gap may change in diÅerent interest rate

environments. Our primary strategy for managing convexity risk is to either issue callable debt or purchase

interest-rate derivatives with embedded options. We may also change the mix of assets we purchase to manage

convexity risk. For example, ARMs, shorter-term Ñxed rate mortgages, and some seasoned loans have less

prepayment risk relative to new 30-year Ñxed rate mortgages, and as a result, reduce convexity risk. Generally,

our preferred option is to issue callable debt or purchase optionality rather than change the mix of our assets

because we Ñnd greater value in investing in longer term, Ñxed-rate loans.

During 2002, we continued to take advantage of the opportunity to reduce our debt costs by redeeming

signiÑcant amounts of callable debt in response to the sharp decline in short-term interest rates that began in

2001. At the same time, we continued to reduce the portfolio's convexity by aggressively increasing the

amount of option protection through the issuance of callable debt or the purchase of interest-rate derivatives

with embedded options. These instruments give us the option to reduce the duration of our liabilities to oÅset

potential increases in mortgage prepayments that usually occur when mortgage rates fall.

By the end of 2002, we had increased our option-embedded debt, which includes callable debt and

option-based derivatives, as a percentage of our net mortgage portfolio to 75 percent from 54 percent at the

end of 2001. As part of our rebalancing strategy during the last half of 2002, we increased our use of shortterm European options, which temporarily increased the percentage of our mortgage portfolio with optionembedded rate protection beyond the average range of the past 3 years. At December 31, 2002, the remaining

outstanding notional amount of these options totaled approximately 9 percent of our net mortgage portfolio.

Callable debt and option-based derivative instruments debt represented 58 percent and 42 percent, respec67
tively of the $601 billion in option-embedded debt outstanding at December 31, 2002. In comparison, callable

debt and option based derivative instruments, represented 62 percent and 38 percent, respectively of the

$378 billion in option-embedded debt outstanding at December 31, 2001.

‚ Interest Rate Sensitivity of Net Asset Value

Another indicator of the interest rate exposure of Fannie Mae's existing business is the sensitivity of the

fair value of net assets (net asset value) to changes in interest rates. Table 22 presents our estimated net asset

value as of December 31, 2002 and 2001, and the impact on our estimated net asset value of a hypothetical

plus 100 and minus 50 basis point instantaneous shock in interest rates. Our analysis is based on these interest

rates changes because we believe they reÖect reasonably possible near-term outcomes.

Table 22: Interest Rate Sensitivity of Net Asset Value

2002 2001

Net Asset Percentage ofNet Asset Percentage of

Value Net Asset Value Value Net Asset Value

(Dollars in millions)

December 31 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $22,130 Ì% $22,675 Ì%

Assuming a 100 basis point increase in interest rates ÏÏ 22,727 103 18,502 82

Assuming a 50 basis point decrease in interest ratesÏÏÏ 18,819 85 22,215 98

Changes in net asset value incorporate various factors, including:

‚ estimated changes in the values of all mortgage assets and the debt funding these assets,

‚ estimated changes in the value of net guaranty fee income from oÅ-balance-sheet MBS obligations,

‚ estimated changes in the value of interest rate derivatives.

As indicated in Table 22, the projected fair value of our net assets at December 31, 2002 for a 100 basis

point instantaneous increase would increase by approximately 3 percent, while a 50 basis point instantaneous

decline in interest rates would reduce the fair value by approximately 15 percent. The sensitivities at

December 31, 2002 reÖect that we have greater risk exposure to a decline in interest rates, similar to the

results generated by our duration gap, but slightly diÅerent than the results of our net interest income at risk

measure due to the eÅects of the future business activity included in that measure. The diÅerence in the risk

proÑle from December 31, 2002 and December 31, 2001 is largely due to lower interest rates and a change in

the mix of the portfolio.

The net asset value at December 31, 2002, as presented in Table 22, is the same as that disclosed in the

Notes to Financial Statements under Note 16, ""Disclosures of Fair Value of Financial Instruments.'' We

derived the net asset values for the hypothetical interest rate scenarios in a manner consistent with the

estimation procedures described in Note 16. The net asset value sensitivities do not necessarily represent the

changes that would actually occur because the sensitivities are based on liquidating business and do not

include the going-concern eÅects of adding new business.

Derivative Instruments

Purpose and BeneÑt of Derivatives

Derivative instruments are important tools that we use to manage interest rate risk and supplement our

issuance of debt in the capital markets. We are an end user of derivatives and do not take speculative positions

with derivatives or any other Ñnancial instrument. We use a combination of option embedded and non-option

embedded derivatives to better match the cash Öow variability inherent in mortgages. We also use derivative

instruments to hedge against changes in interest rates prior to debt issuance. Interest rate derivatives allow us

to essentially lock in our funding cost at the time we commit to purchase mortgages rather than at the time of

our next benchmark debt issuance. In addition, we use currency derivatives to convert debt issued in foreign

currencies to U.S. dollars to minimize or negate any currency risk.

68
Fannie Mae primarily uses derivatives as a substitute for notes and bonds we issue in the debt markets.

When we purchase mortgage assets, we fund the purchases with a combination of equity and debt. The debt

we issue is a mix that typically consists of short- and long-term, noncallable debt and callable debt. The varied

maturities and Öexibility of these debt combinations help us in reducing the cash Öow mismatch between the

performance of our assets and liabilities.

We can use a mix of debt issuances and derivatives to achieve the same duration matching that would be

achieved by issuing only debt securities. The following is an example of funding alternatives that we could use

to achieve similar economic results:

‚ Rather than issuing a 10-year noncallable Ñxed-rate note, we could issue short-term debt and enter into

a 10-year interest rate swap with a highly rated counterparty. The derivative counterparty would pay a

Öoating rate of interest to us on the swap that we would use to pay the interest expense on the shortterm debt, which we would continue to reissue periodically. We would pay the counterparty a Ñxed rate

of interest on the swap, thus achieving the economics of a 10-year Ñxed-rate note issue.

‚ Similarly, instead of issuing a 10-year Ñxed-rate note callable after three years, we could issue a 3-year

note and enter into a pay-Ñxed swaption that would have the same economics as a 10-year callable

note. If we want to extend the debt beyond three years, the swaption would give us the option to enter

into a swap agreement where we would pay a Ñxed rate of interest to the derivative counterparty over

the remaining 7-year period.

The ability to either issue debt securities or modify debt through the use of derivatives increases our

funding Öexibility and potentially reduces our overall funding costs. We may be able to obtain a speciÑc

funding structure using derivatives that we cannot obtain through the issuance of callable debt. In addition, it

can be less expensive to use the mix of debt securities and derivatives to achieve a given funding objective. We

generally use the method that provides the lowest funding costs and desired Öexibility.

Table 23 gives an example of equivalent funding alternatives for a mortgage purchase with funding

derived solely from debt securities versus funding with a blend of debt securities and derivatives. As illustrated

by Table 23, we can achieve similar economic results by funding our mortgage purchases with either debt

securities or a combination of debt securities and derivatives.

Table 23: Equivalent Debt and Derivative Funding

Fund With:(1)

Debt Securities Debt Securities and Derivatives

Percentage Type of Debt Percentage Type of Debt

10% Short-term debt 10% Short-term debt

15 3-year noncallable debt 15 3-year noncallable debt

25 10-year noncallable debt 25 Short-term debt plus 10-year swap

50 10-year callable in 3 years 50 3-year noncallable debt plus pay-Ñxed swaption

100% 100%

(1) This example indicates the possible funding mix and does not represent how an actual purchase would necessarily be

funded.

Fannie Mae also uses derivatives to hedge against Öuctuations in interest rates on planned debt issuances.

The hedging of anticipated debt issuances enables us to maintain an orderly and cost-eÅective debt issuance

schedule so we can fund daily loan purchase commitments without signiÑcantly increasing our interest rate

risk or changing the spread of our funding costs versus other market interest rates. Most of the mortgages that

Fannie Mae commits to purchase are for a future settlement date, typically two weeks to three months into the

future. Fannie Mae would be exposed to additional interest rate risk from changes in market rates prior to

settlement if we did not issue debt at the time of the commitment or did not lock in an interest rate by hedging

the anticipated debt issuance. By hedging anticipated debt issuance versus issuing debt at the time of

69
commitment, we are able to issue debt in larger size and on a regular schedule so that liquidity is enhanced

while our relative cost of funds is reduced.

Fannie Mae uses derivatives to hedge foreign currency exposure. We occasionally issue debt in a foreign

currency. Because all of our assets are denominated in U.S. dollars, we enter into currency swaps to eÅectively

convert the foreign-denominated debt into U.S. dollar-denominated debt. By swapping out of foreign

currencies completely at the time of the debt issue, we minimize our exposure to any currency risk. Our

foreign denominated debt represents less than one percent of total debt outstanding.

Primary Types of Derivatives Used

Table 24 summarizes the primary derivative instruments Fannie Mae uses along with the key hedging

strategies we employ to manage our various interest rate risk exposures.

Table 24: Primary Types of Derivatives Used

Derivative Hedging Instrument Hedged Item Purpose of the Hedge Transaction

Pay-Ñxed, receive-variable interest- Variable-rate debt To protect against an increase in

rate swap Anticipated issuance of debt interest rates by converting the debt's

variable rate to a Ñxed rate.

Receive-Ñxed, pay-variable interest- Noncallable Ñxed-rate debt To protect against a decline in interest

rate swap rates. Converts the debt's Ñxed rate to

a variable rate.

Basis swap or spread-lock Variable-rate assets and liabilities To ""lock in'' or preserve the spread

between variable-rate, interest-earning

assets and variable-rate, interestbearing liabilities.

Pay-Ñxed swaption Variable-rate debt To protect against an increase in

interest rates by having an option to

convert Öoating-rate debt to a Ñxed

rate.

Caps Variable-rate debt To protect against an increase in

interest rates by providing a limit on

the interest costs on our debt in a

rising rate environment.

Receive-Ñxed swaption Noncallable Ñxed-rate debt To protect against a decline in interest

rates by having an option to convert

Ñxed-rate debt to Öoating-rate debt.

Foreign currency swaps Foreign currency-denominated debt To protect against Öuctuations in

exchange rates on non-U.S. dollardenominated debt by converting the

interest expense and principal payment

on foreign-denominated debt to U.S.

dollar-denominated debt.

As Table 24 indicates, we use what the marketplace generally regards as relatively straightforward types

of interest rate derivative instruments, primarily interest-rate swaps, basis swaps, swaptions, and caps. Swaps

provide for the exchange of Ñxed and variable interest payments based on contractual notional principal

amounts. These may include callable swaps (a combination of a swap and swaptions), which gives

counterparties or Fannie Mae the right to terminate interest rate swaps before their stated maturities. They

may also include foreign currency swaps in which Fannie Mae and counterparties exchange payments in

diÅerent types of currencies. Basis swaps provide for the exchange of variable payments that have maturities

similar to hedged debt, but have payments based on diÅerent interest rate indices. Swaptions give Fannie Mae

the right to enter into a swap at a future date. Interest rate caps provide ceilings on the interest rates of

70
variable-rate debt. Purchased options are another important risk management tool we use to reduce the cash

Öow mismatches driven by the prepayment option in mortgages. American homeowners have ""options'' to pay

oÅ their mortgages at any time. We use options of our own to manage this prepayment option risk on the loans

we hold in portfolio. We obtain these options by either issuing callable debt or purchasing stand-alone options

and linking them to the debt they are hedging.

Summary of Derivative Activity

Table 25 summarizes the notional balances and fair values of our derivatives by type for the years ended

December 31, 2002 and 2001.

Table 25: Derivative Notional Amounts and Net Fair Values

December 31, 2002 December 31, 2001

Notional Net Fair Notional Net Fair

Amounts Values(1) Amounts Values(1)

(Dollars in millions)

Pay-Ñxed swaps ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $168,512 $(17,892) $213,680 $(9,792)

Receive-Ñxed swaps ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 52,370 4,010 39,069 899

Basis swaps ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 25,525 4 47,054 1

Caps and swaptionsÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 397,868 12,834 219,943 6,267

Other ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 12,320 (987) 13,393 (1,490)

Total ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $656,595 $ (2,031) $533,139 $(4,115)

(1) Based on year-end fair values, estimated by calculating the cost, on a net present value basis, to settle at current

market rates all outstanding derivative contracts.

Table 26 shows the additions and maturities of derivatives by type during 2001 and 2002, along with the

expected maturities of derivatives outstanding at December 31, 2002.

71
Table 26: Derivative Activity and Maturity Data

Pay-Fixed/ReceiveVariable Swaps(2)

Receive-Fixed

Pay Receive Pay-Variable/ Basis Caps and

Amount Rate(3) Rate(3) Swaps Swaps Swaptions Other(4) Total

(Dollars in millions)

Notional Amounts:(1)

Balance at January 1, 2001 ÏÏÏÏ $153,737 6.74% 6.79% $59,174 $14,559 $ 82,528 $14,742 $324,740

Additions ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 90,787 5.39 3.95 33,230 46,150 168,350 100 338,617

Maturities(5)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 30,844 6.41 4.20 53,335 13,655 30,935 1,449 130,218

Balance at December 31, 2001 213,680 6.21 2.47 39,069 47,054 219,943 13,393 533,139

Additions ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 35,117 5.17 1.90 57,949 13,275 239,925 7,889 354,155

Maturities(5)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 80,285 5.00 1.70 44,648 34,804 62,000 8,962 230,699

Balance at December 31, 2002 $168,512 6.07% 1.67% $52,370 $25,525 $397,868 $12,320 $656,595

Future Maturities of Notional

Amounts:(6)

2003 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 26,230 5.03% 1.68% $15,422 $18,090 $122,718 $ Ì $182,460

2004 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 15,330 5.60 1.68 4,875 6,795 39,100 4,147 70,247

2005 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 10,600 6.28 1.67 6,355 170 28,200 1,200 46,525

2006 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 11,450 6.19 1.60 3,650 100 12,350 616 28,166

2007 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 15,350 5.45 1.69 6,050 100 23,275 Ì 44,775

Thereafter ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 89,552 6.51 1.66 16,018 270 172,225 6,357 284,422

Total ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $168,512 6.07% 1.67% $52,370 $25,525 $397,868 $12,320 $656,595

(1) Dollars represent notional amounts that indicate only the amount on which payments are being calculated and do not

represent the amount at risk of loss.

(2) Notional amounts include callable swaps of $35 billion and $32 billion with weighted-average pay rates of

6.75 percent and 6.72 percent and weighted-average receive rates of 1.68 percent and 2.54 percent at December 31,

2002 and December 31, 2001, respectively.

(3) The weighted-average interest rate payable and receivable is as of the date indicated. The interest rates of the swaps

may be variable-rate, so these rates may change as prevailing interest rates change.

(4) Includes foreign currency swaps, futures contracts, and derivative instruments that provide a hedge against interest

rate Öuctuations.

(5) Includes matured, called, exercised, and terminated amounts.

(6) Based on stated maturities. Assumes that variable interest rates remain constant at December 31, 2002 levels.

Derivative Counterparty Risk

At December 31, 2002, over 99 percent of the $657 billion notional amount of our outstanding derivative

transactions were with counterparties rated A or better both by Standard & Poor's (""S&P'') and Moody's.

Our derivative instruments were diversiÑed among 21 and 23 counterparties at year-end 2002 and 2001,

respectively, to reduce our credit risk concentrations. At December 31, 2002, eight counterparties with credit

ratings of A or better represented approximately 76 percent of the total notional amount of outstanding

derivatives transactions. The outstanding notional amount for each of these eight counterparties ranged

between 5 percent and 15 percent of our total outstanding notional amount at December 31, 2002. Each of the

remaining counterparties accounted for less than 5 percent of the total outstanding notional amount at

December 31, 2002. In comparison, eight counterparties with credit ratings of A or better accounted for

approximately 78 percent of the total notional outstanding amount at December 31, 2001.

The primary credit exposure that we have on a derivative transaction is that a counterparty might default

on payments due, which could result in having to replace the derivative with a diÅerent counterparty at a

higher cost. The exposure to counterparty default after oÅsetting arrangements, such as master netting

72
agreements and the value of related collateral, is the appropriate measure of the actual credit risk of derivative

contracts.

We believe the risk of loss on Fannie Mae's derivatives book is low for three primary reasons: (1) our

stringent counterparty eligibility standards, (2) our conservative collateral policy, which has provisions

requiring collateral on our derivative contracts in gain positions, and (3) our intensive exposure monitoring

and management.

Fannie Mae has never experienced a loss on a derivative transaction due to credit default by a

counterparty. The credit risk on our derivative transactions is low because our counterparties are of very high

credit quality. Our counterparties consist of large banks, broker-dealers, and other Ñnancial institutions that

have a signiÑcant presence in the derivatives market, most of whom are based in the United States. We

manage derivative counterparty credit risk by contracting only with experienced counterparties that have high

credit ratings. We initiate derivative contracts only with counterparties rated A or better. As an additional

precaution, we have a conservative collateral management policy with provisions for requiring collateral on our

derivative contracts in gain positions.

We also monitor credit exposure on our derivatives daily by valuing them using internal pricing models

and dealer quotes. We make collateral calls daily based on the results of our internal models and dealer quotes.

We enter into master agreements that provide for netting of amounts due to us and amounts due to

counterparties under those agreements. New York law governs all of our master derivatives agreements.

The estimated total notional balance of the global derivatives market was $152 trillion at June 30, 2002

based on combined data from the Bank for International Settlements for over-the-counter derivatives and

published Ñgures for exchange-traded derivatives. Fannie Mae's outstanding notional principal balance of

$657 billion at December 31, 2002 represented less than .5 percent of the total estimated derivatives market.

Although notional principal is a commonly used measure of volume in the derivatives market, it is not a

meaningful measure of market or credit risk since the notional amount does not change hands other than in

the case of foreign currency swaps. Counterparties use the notional amounts of derivative instruments to

calculate contractual cash Öows to be exchanged. However, the notional amount is signiÑcantly greater than

the potential market or credit loss that could result from such transactions. The fair value of derivatives in a

gain position is a more meaningful measure of our current market exposure on derivatives. Table 27 shows our

exposure on derivatives by maturity at December 31, 2002 and 2001 and counterparty credit ratings based on

these maturities.

Table 27: Derivative Credit Loss Exposure(1)

December 31, 2002 December 31, 2001

Credit Rating Credit Rating

AAA AA A BBB Total AAA AA A BBB Total

(Dollars in millions)

Less than 1 year ÏÏÏÏÏÏÏÏÏÏÏÏÏ $ Ì $ 69 $ 6 $ Ì $ 75 $ Ì $ Ì $ Ì $ Ì $ Ì

1 to 5 years ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Ì 486 116 Ì 602 Ì 43 43 Ì 86

Over 5 yearsÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 21 1,334 2,328 Ì 3,683 136 671 826 Ì 1,633

Subtotal ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 21 1,889 2,450 Ì 4,360 136 714 869 Ì 1,719

Maturity distribution

netting(2)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (21) (368) (670) Ì (1,059) (136) (528) (289) Ì (953)

ExposureÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Ì 1,521 1,780 Ì 3,301 Ì 186 580 Ì 766

Collateral held ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Ì 1,382 1,722 Ì 3,104 Ì 95 561 Ì 656

Exposure net of collateralÏÏÏÏÏÏ $ Ì $ 139 $ 58 $ Ì $ 197 $ Ì $ 91 $ 19 $ Ì $ 110

Notional amount ÏÏÏÏÏÏÏÏÏÏÏÏÏ $21,045 $316,813 $318,487 $250 $656,595 $71,173 $316,588 $145,128 $250 $533,139

Number of counterparties ÏÏÏÏÏ 2 11 7 1 21 3 16 3 1 23

(1) Represents the exposure to credit loss on derivative instruments, which is estimated by calculating the cost, on a present value basis,

to replace all outstanding derivative contracts in a gain position. Reported on a net-by-counterparty basis where a legal right of oÅset

exists under an enforceable master settlement agreement. Derivative gains and losses with the same counterparty in the same

maturity category are presented net within the maturity category.

(2) Represents impact of netting of derivatives in a gain position and derivatives in a loss position for the same counterparty across

maturity categories.

73
We estimate exposure to credit loss on derivative instruments by calculating the replacement cost, on a

present value basis, to settle at current market prices all outstanding derivative contracts in a gain position.

Fannie Mae's exposure on derivative contracts (taking into account master settlement agreements that allow

for netting of payments and excluding collateral received) was $3.301 billion at December 31, 2002, compared

with $766 million at December 31, 2001. We expect the credit exposure on derivative contracts to Öuctuate

with both changes in interest rates and implied volatility. We held $3.104 billion of collateral through

custodians for derivative instruments at December 31, 2002 and $656 million of collateral at December 31,

2001. Assuming the highly unlikely event that all of our derivative counterparties to which Fannie Mae was

exposed at December 31, 2002 were to default simultaneously, it would have cost an estimated $197 million to

replace the economic value of those contracts. This replacement cost represents approximately 2 percent of

our 2002 pre-tax core business earnings. The replacement cost, or exposure after consideration of collateral

held was $110 million at December 31, 2001. Changes in both interest rates and the type of derivative

transactions with speciÑc counterparties increased our exposure at the end of 2002.

At December 31, 2002 and December 31, 2001, 100 percent of our exposure on derivatives, before

consideration of collateral held, was with counterparties rated A or better by S&P and Moody's. Five

counterparties with credit ratings of A or better accounted for approximately 92 percent and 98 percent of our

exposure on derivatives before consideration of collateral held at December 31, 2002 and 2001, respectively.

Seventy-one percent of our net exposure of $197 million at December 31, 2002 was with six counterparties

rated AA or better by S&P and Aa or better by Moody's. The percentage of our exposure with these six

counterparties ranged from 2 to 23 percent. In comparison, Ñve counterparties rated AA or better by S&P and

Aa or better by Moody's accounted for 83 percent of our net exposure of $110 million at December 31, 2001.

The percentage of our net exposure with counterparties rated AA or better by S&P and Aa or better by

Moody's fell during 2002 because of a change in the relative mix of our derivative products in response to

changes in market conditions that shifted the relative level of activity and exposure between individual

counterparties. We mitigate our net exposure on derivative transactions through a collateral management

policy, which consists of four primary components: (1) minimum collateral thresholds; (2) collateral

valuation percentages; (3) overcollateralization based on rating downgrades; and (4) daily monitoring

procedures.

‚ Minimum Collateral Thresholds

Derivative counterparties are obligated to post collateral to Fannie Mae when we are exposed to credit

losses exceeding agreed-upon thresholds that are based on counterparty credit ratings. We determine the

collateral amount that counterparties are required to post based on their credit rating and our level of credit

exposure. The amount of collateral generally must equal the excess of Fannie Mae's exposure over the

threshold amount. Table 28 presents Fannie Mae's general ratings-based collateral thresholds.

Table 28: Fannie Mae Ratings-Based Collateral Thresholds

Credit Rating

S&P Moody's Exposure Threshold

(Dollars in millions)

AAA Aaa ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Mutually agreed on

AA° Aa1 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $100

AA Aa2 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 50

AA¿ Aa3 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 50

A° A1 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 25

A A2 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 10

A¿ or below A3 or below ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 0 (see Table 29)

‚ Collateral Valuation Percentages

We require counterparties to post speciÑc types of collateral to meet their collateral requirements. The

collateral posted by our counterparties at December 31, 2002 was principally in the form of cash or

74
U.S. Treasury securities with a small amount of agency MBS. All of the collateral posted by our

counterparties was in the form of cash or U.S. Treasury securities at December 31, 2001. We assign each type

of collateral a speciÑc valuation percentage based on its relative risk. For example, cash receives a 100 percent

valuation, while certain U.S. Treasury instruments may receive only a 98 percent valuation percentage. In

cases where the valuation percentage for a certain type of collateral is less than 100 percent, we require

counterparties to post an additional amount of collateral to meet their requirements.

‚ Overcollateralization Based on Low Credit Ratings

We further reduce our net exposure on derivatives by generally requiring overcollateralization from

counterparties whose credit ratings have dropped below predetermined levels. Counterparties falling below

these levels must post collateral beyond the amounts previously noted to meet their overall requirements.

Table 29 presents Fannie Mae's standard valuation percentages for overcollateralization based on counterparty

credit ratings. The percentage of additional collateral is applied to the initial amount of collateral required to

be posted.

Table 29: Fannie Mae Standard Collateral Valuation Percentages

Additional

Percentage

of Collateral

Credit Rating to be Posted

A/A2 or above ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 0%

A¿/A3 to BBB°/Baa1ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 10

BBB/Baa2 or below ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 25

‚ Frequent Monitoring Procedures

We mark our collateral position daily against exposure using both internal and external pricing models

and compare these calculations to our counterparties' valuations. Both Fannie Mae and our derivative

counterparties transfer collateral within two business days based on the agreed-upon valuation. Pursuant to

Fannie Mae's collateral agreements we reserve the right to value exposure and collateral adequacy at any time.

A New York-based third-party custodian holds all of the collateral posted to Fannie Mae and monitors the

value on a daily basis.

Credit Risk Management

Credit risk is the risk of loss to future earnings or future cash Öows that may result from the failure of a

borrower or institution to fulÑll its contractual obligation to make payments to Fannie Mae or an institution's

failure to perform a service for us. We assume and manage mortgage credit risk and institutional credit risk

that arise through a variety of transactions. We actively manage credit risk to maintain credit losses within

levels that generate attractive proÑtability and returns on capital and meet our expectations for consistent

Ñnancial performance.

The Chief Credit OÇcer has primary responsibility for setting strategies to achieve the credit risk goals

and objectives set by our Board of Directors. The Chief Credit OÇcer, who reports to our Chief Financial

OÇcer, chairs Fannie Mae's Credit Risk Policy Committee. The Credit Risk Policy Committee works in

concert with the Portfolios and Capital Committee and the Operations, Transactions and Investments

(""OTI'') Committee to provide corporate governance over Fannie Mae's credit risk. Fannie Mae's business

units have primary responsibility for managing our business activities in conformity with the credit strategies

and requirements set by our committees. Within each business unit, we have a credit oÇcer who has

responsibility for certain credit risk decisions outlined in a written delegation of credit authority approved by

the Credit Risk Policy Committee. Our business unit credit oÇcers report directly to the business unit leaders

and indirectly to the Chief Credit OÇcer.

75
In addition, we have corporate credit risk management teams that report to the Chief Credit OÇcer and

work with the business units to identify, measure, and manage credit risks. Our Policy and Standards team

establishes and monitors credit policies, standards, and delegations of credit authority throughout the

organization. Our Credit Research and Portfolio Management team is responsible for understanding and

managing the aggregate risk exposure, risk sensitivity, and usage of risk capital. Our Counterparty Risk

Management team is responsible for setting company-wide policies governing Fannie Mae's contractual

exposures to institutional counterparties and identifying and measuring these exposures. Our Credit Management Information Systems team prepares analysis that monitors and identiÑes key credit risk trends in the

credit book of business.

Our business units monitor and enforce compliance with credit risk standards and identify changes in

market conditions that may warrant changes to credit policies and standards. For example, business units

provide quality control oversight by requiring lenders to maintain a rigorous quality control process and by

maintaining our own quality assurance process. Our regional oÇces, which are responsible for managing

customer relationships, also play an important risk management role. Working with the business unit leaders,

regional customer management teams ensure that pricing and transaction terms are structured appropriately to

meet the unique needs and risks of Fannie Mae's various lender partners. Regional oÇcers have credit

authority to make credit decisions or develop customized mortgage solutions up to certain thresholds as

outlined in the Credit Risk Policy Committee's written delegation of authority. Delegating certain credit

authority and responsibility to our regional oÇces has allowed us to work closely with our lender partners,

which has been integral to achieving a track record of eÅective credit risk management.

Mortgage Credit Risk

Our mortgage credit risk stems from our mortgage credit book of business, where we bear the risk that

borrowers fail to make payments required on their mortgages. Our mortgage credit book of business consists of

mortgages we own, mortgages and MBS we guarantee, and other contractual arrangements or guarantees. The

Credit Guaranty business manages our mortgage credit risk. We are exposed to credit risk on our mortgage

credit book of business because we either own the assets or have guaranteed the timely payment of scheduled

principal and interest to third parties. For example, in the event of the default of a borrower on a mortgage

underlying an MBS, we absorb any losses, net of the proceeds of any credit enhancements, that result and pay

to the MBS investor all accrued interest and the full outstanding principal balance of the defaulted loan.

A certain level of credit losses is an inherent consequence of engaging in the Credit Guaranty business.

Our risk management focus is on controlling the level and volatility of credit losses that result from changes in

economic conditions. Table 30 presents the composition of our mortgage credit book of business for 2002,

2001, and 2000.

76
Table 30: Composition of Mortgage Credit Book of Business

December 31, 2002

Single-family Multifamily Total

Conventional Government Conventional Government Conventional Government

(Dollars in millions)

Mortgage portfolio:(1)

Mortgage loans ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 166,772 $ 5,458 $12,217 $1,354 $ 178,989 $ 6,812

Fannie Mae MBS ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 497,818 2,447 6,765 1,801 504,583 4,248

Agency mortgage securities(2)ÏÏÏÏÏÏÏÏÏ 31,959 16,453 Ì Ì 31,959 16,453

Other mortgage-related securities(3)ÏÏÏÏ 27,833 Ì 284 Ì 28,117 Ì

Mortgage revenue bonds ÏÏÏÏÏÏÏÏÏÏÏÏÏ Ì 14,086 Ì 5,552 Ì 19,638

724,382 38,444 19,266 8,707 743,648 47,151

Outstanding MBS(4) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 953,729 24,616 50,671 440 1,004,400 25,056

Other(5) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 360 Ì 11,479 Ì 11,839 Ì

Mortgage credit book of business ÏÏÏÏÏÏÏÏ $1,678,471 $63,060 $81,416 $9,147 $1,759,887 $72,207

December 31, 2001

Single-family Multifamily Total

Conventional Government Conventional Government Conventional Government

Mortgage portfolio:(1)

Mortgage loans ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 150,350 $ 5,069 $ 8,987 $1,551 $ 159,337 $ 6,620

Fannie Mae MBS ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 420,631 3,438 5,315 2,002 425,946 5,440

Agency mortgage securities(2)ÏÏÏÏÏÏÏÏÏ 42,105 19,607 Ì Ì 42,105 19,607

Other mortgage-related securities(3)ÏÏÏÏ 29,259 Ì 321 Ì 29,580 Ì

Mortgage revenue bonds ÏÏÏÏÏÏÏÏÏÏÏÏÏ Ì 13,903 Ì 4,476 Ì 18,379

642,345 42,017 14,623 8,029 656,968 50,046

Outstanding MBS(4) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 800,411 13,546 44,428 482 844,839 14,028

Other(5) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 930 Ì 15,491 Ì 16,421 Ì

Mortgage credit book of business ÏÏÏÏÏÏÏÏ $1,443,686 $55,563 $74,542 $8,511 $1,518,228 $64,074

December 31, 2000

Single-family Multifamily Total

Conventional Government Conventional Government Conventional Government

Mortgage portfolio:(1)

Mortgage loans ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 139,382 $ 4,763 $ 6,547 $1,814 $ 145,929 $ 6,577

Fannie Mae MBS ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 342,299 3,364 3,308 2,057 345,607 5,421

Agency mortgage securities(2)ÏÏÏÏÏÏÏÏÏ 32,987 24,137 Ì Ì 32,987 24,137

Other mortgage-related securities(3)ÏÏÏÏ 33,931 Ì 333 Ì 34,264 Ì

Mortgage revenue bonds ÏÏÏÏÏÏÏÏÏÏÏÏÏ 3 11,890 1 3,309 4 15,199

548,602 44,154 10,189 7,180 558,791 51,334

Outstanding MBS(4) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 662,621 8,076 35,460 527 698,081 8,603

Other(5) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 993 Ì 12,323 Ì 13,316 Ì

Mortgage credit book of business ÏÏÏÏÏÏÏÏ $1,212,216 $52,230 $57,972 $7,707 $1,270,188 $59,937

(1) Excludes mark-to-market gains at December 31, 2002 and 2001 of $6.501 billion and $462 million, respectively. Excludes mark-tomarket losses at December 31, 2000 of $3 million.

(2) Includes mortgage-related securities issued by Freddie Mac and Ginnie Mae.

(3) Includes mortgage-related securities issued by entities other than Fannie Mae, Freddie Mac, or Ginnie Mae.

(4) MBS and other mortgage-related securities guaranteed by Fannie Mae and held by investors other than Fannie Mae. The principal

balance on resecuritized MBS is included only once.

(5) Includes additional single-family and multifamily credit enhancements not otherwise reÖected in the table.

Fannie Mae's overall objective in managing mortgage credit risk is to deliver consistent earnings growth

and target returns on capital in a wide range of economic environments. Central elements of our approach

include: (1) managing the proÑle and quality of mortgages in the mortgage credit book, (2) using credit

enhancements to reduce credit losses, (3) assessing the sensitivity of the proÑtability of the mortgage credit

book of business to changes in composition and the economic environment, and (4) managing problem assets

to mitigate credit losses.

Given the important diÅerences in the nature and management of credit risk between single-family and

multifamily loans, we manage and discuss these two types of loans separately.

77
Single-family

The single-family mortgage credit book primarily consists of loans, MBS in our mortgage portfolio, MBS

and other mortgage-related securities guaranteed by Fannie Mae and held by other investors (""outstanding

MBS''), and other mortgage-related securities we own backed by loans on properties that have four or fewer

residential units. This section details our single-family risk management practices, risk characteristics, and

performance. While we manage the credit risk on the entire single-family mortgage credit book, in some cases

we may not have certain loan-level information to report risk characteristics and performance disclosures.

Therefore, unless otherwise noted, the credit statistics on Fannie Mae's conventional single-family mortgage

credit book presented in this section will generally include only mortgage loans in portfolio, MBS in portfolio,

and outstanding MBS where we have more comprehensive, detailed loan-level transaction information. These

loans represent 96 percent of our single-family mortgage credit book at the end of 2002. Most of the remaining

4 percent of our conventional single-family mortgage credit book consists of mortgage-related securities rated

AAA at acquisition, including mortgage-related securities guaranteed by Freddie Mac and Ginnie Mae.

1. Managing the proÑle and quality of mortgages in the single-family mortgage credit book.

Mortgage credit risk on a particular single-family loan is aÅected by numerous characteristics, including

the type of loan, the down-payment amount, and the strength of the borrower's credit history. These and other

factors, such as home price appreciation, aÅect both the level of expected credit loss on a given loan and the

sensitivity of that loss to changes in the economic environment. We attempt to understand the overall credit

risk in our loans, earn an attractive risk-adjusted return from appropriate guaranty fee pricing, and mitigate our

risks through the use of credit enhancements and eÅective asset management. Our risk mitigating activities

reduce the incidence and severity of loss and minimize the volatility of credit losses, which helps Fannie Mae

in achieving stable earnings growth and a competitive return on equity over time.

We establish detailed policies and employ various processes to validate that the characteristics of the

loans purchased or guaranteed comply with key underwriting and eligibility criteria. We also assess the

characteristics and quality of a lender's loans and processes through an audit program and our customer

relationship management teams. Mortgage loans that we buy or guarantee must comply with certain

underwriting and eligibility characteristics to ensure that the overall risk of the particular loan is within

acceptable limits.

Lenders represent and warrant compliance with our asset acquisition requirements when they sell

mortgage loans or securities to us or seek a guarantee from us. We may require the lender to repurchase a loan

or enforce some other remedy if we identify any deÑciencies. Since 1995, we have developed and reÑned DU

to assist lenders in underwriting and complying with our other loan eligibility criteria. DU consistently and

objectively applies risk analytics, underwriting, and eligibility standards to prospective mortgage loans.

Approximately 60 percent of the single-family conventional loans we purchased or guaranteed in 2002 were

processed through DU, up from 59 percent in 2001 and 56 percent in 2000. We also buy or guarantee loans

underwritten manually or through other automated underwriting systems, subject to appropriate lender

representations and warranties. In certain circumstances involving use of automated underwriting, we may

relieve lenders of a limited number of the standard representations and warranties.

2. Using credit enhancements to reduce credit losses.

Credit enhancements are contracts in which a third party agrees to pay Fannie Mae if there is a credit

event, such as a loan default. Credit enhancements enable us to transform the risk and return proÑle of the

mortgage credit book of business to be consistent with our objectives. Single-family credit enhancements

include primary loan-level mortgage insurance, pool mortgage insurance, recourse arrangements with lenders,

and other customized risk-sharing contracts.

The majority of our single-family credit enhancement is primary loan-level mortgage insurance. When we

require primary loan-level mortgage insurance on loans with loan-to-value ratios above 80 percent, we

typically require greater coverage than the minimum level of credit enhancement required by our Charter Act

if primary mortgage insurance is the only source used to meet our credit enhancement requirement. Subject to

our policies and to the Homeowners Protection Act of 1998, primary loan-level mortgage insurance can be

78
cancelled either automatically or at the borrower's option in certain circumstances where the loan-to-value

ratio has decreased below 80 percent. We also may require or acquire supplemental credit enhancement on

loans based on risk and pricing. While credit enhancements reduce our mortgage-related credit losses, they

also generate institutional counterparty risk that we discuss in the ""Institutional Counterparty Credit Risk''

section. We focus credit enhancement coverage on loans in our mortgage credit book of business with a higher

risk proÑle. The percentage of our conventional single-family credit book of business with credit enhancements

was 27 percent at December 31, 2002, down from 32 percent at December 31, 2001. The decrease in credit

enhancement coverage during 2002 was primarily due to the high level of reÑnance loans acquisitions with

lower loan-to-value ratios that did not require credit enhancement. Because of the lower risk proÑle of these

loans, we elected not to purchase credit enhancement on these loans.

3. Assessing the sensitivity of the proÑtability of the single-family mortgage credit book of business to

changes in composition and the economic environment.

We use analytical tools to measure credit risk exposures, assess performance of our single-family

mortgage credit book of business, and evaluate risk management alternatives. We continually reÑne our

methods of measuring credit risk, setting risk and return targets, and transferring risk to third parties. We use

our analytical models to establish forecasts and expectations for the credit performance of loans in the

mortgage credit book of business and compare actual performance to those expectations. Comparison of actual

versus projected performance and changes in other key trends may signal a change in risk or return proÑles

and provide the basis for changing policies, standards, guidelines, credit enhancements, or guaranty fees.

For example, we use models to project guaranty fee income and credit losses, including forgone interest

on nonperforming assets, for the single-family mortgage credit book across a wide range of potential interest

rate and home price environments. We use current data on home values, borrower payment patterns, nonmortgage consumer credit history, and management's economic outlook to assess our sensitivity to credit

losses. We closely examine a range of potential economic scenarios to monitor the sensitivity of credit losses.

As part of our voluntary safety and soundness initiatives, we elected to disclose on a quarterly lagged basis the

sensitivity of the present value of future single-family credit losses to an immediate 5 percent decline in home

prices. Table 31 shows the results at the end of 2002, 2001, and 2000. Our models indicate that home price

movements are an important predictor of credit performance. We selected a 5 percent immediate decline in

home prices because it is a stressful scenario. Based on housing data from OFHEO, the national average rate

of home price appreciation over the last twenty years has been about 4.7 percent, while the lowest national

average growth rate in any single year has been .2 percent. Historical statistics from OFHEO's housing index

report indicate that there has never been a nationwide decline of 5 percent in home prices within a one-year

period since the federal government began tracking this data in 1975.

79
Table 31: Single-Family Credit Loss Sensitivity(1)

December 31,

2002 2001 2000

(Dollars in millions)

Gross credit loss sensitivity(2) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 1,838 $ 1,332 $ 1,065

Projected credit risk sharing proceeds ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 1,242 845 770

Net credit loss sensitivity ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 596 $ 487 $ 295

(1) Represents total economic credit losses, which include net chargeoÅs/recoveries, foreclosed property expenses,

forgone interest, and the cost of carrying foreclosed properties.

(2) Measures the gross sensitivity of our expected future economic credit losses to an immediate 5 percent decline in

home values for all single-family mortgages held in our single-family mortgage credit book, followed by an increase in

home prices at the rate projected by Fannie Mae's credit pricing models.

4. Managing problem assets to mitigate credit losses.

We closely manage single-family loans in partnership with the servicers of our loans to minimize both the

frequency of foreclosure and the severity of loss in the event of foreclosure. We have developed detailed

servicing guidelines and work closely with the loan servicers to ensure that they take appropriate loss

mitigation steps on our behalf. Our loan management strategy begins with payment collection guidelines and

work rules designed to minimize the number of borrowers who fall behind on their obligations and help

borrowers who are delinquent from falling further behind on their payments. We seek alternative resolutions of

problem loans to reduce the legal and management expenses associated with foreclosing on a home. Early

intervention is critical to controlling credit expenses. Most of our servicers use Risk ProÑlerSM, a default

prediction model created by Fannie Mae, to monitor the performance and risk of each loan and identify loans

requiring problem loan management. Risk ProÑler uses credit risk indicators such as mortgage payment

record, updated borrower credit data, current property values, and mortgage product characteristics to

evaluate the risk of the loan. In 2002, 86 percent of our conventional single-family loans were scored through

Risk ProÑler, up from 82 percent in 2001.

We may pursue various resolutions of problem loans as an alternative to foreclosure, including:

(1) repayment plans in which borrowers repay past due principal and interest over a reasonable period of time

(generally no longer than 4 months) through a temporarily higher monthly payment, (2) loan modiÑcations in

which past due principal and interest, net of any borrower contribution, are added to the loan amount and

recovered over the remaining life of the loan and other terms of the loan may be adjusted, (3) deeds in lieu of

foreclosure in which the borrower signs over title to the property without the added expense of a foreclosure

proceeding, and (4) preforeclosure sales in which the borrower, working with the servicer, sells the home and

pays oÅ all or part of the outstanding loan, accrued interest, and other expenses with the sale proceeds. We use

analytical models and work rules to determine which alternative resolution, if any, may be appropriate for each

problem loan. We track the ultimate performance of alternative resolutions and adjust our models and rules as

appropriate. Of the loans that recover through modiÑcation and repayment plans, our performance experience

after at least three years following the inception of such plans has been that approximately two-thirds of these

loans remain current or pay oÅ in full. If we acquire the property in the event of default, we seek to maximize

the sales proceeds and ensure we receive all credit enhancement payments. We maintain a centralized

property disposition unit to manage the foreclosure process to minimize foreclosure costs. Table 32 presents

statistics on our problem loans for 2002, 2001, and 2000.

80
Table 32: Statistics on Conventional Single-Family Problem Loans

Number of Loans

2002 2001 2000

Repayment plans ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 5,470 4,237 5,320

ModiÑcations ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 14,552 10,506 9,503

Pre-foreclosure salesÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 1,410 1,182 1,572

Properties acquired through foreclosure(1)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 19,500 14,486 14,351

Total conventional single-family problem loans ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 40,932 30,411 30,746

Conventional single-family loans at December 31(2) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 14,492,034 13,414,100 12,092,295

(1) Includes properties acquired via deeds-in-lieu of foreclosure, which totaled 192 in 2002, 163 in 2001, and 235 in 2000.

(2) Represents approximately 96 percent of our conventional single-family mortgage credit book where we have more

comprehensive, detailed loan-level transaction information.

Single-Family Mortgage Credit Book Characteristics and Performance

Economic conditions and home values strongly aÅect the credit risk proÑle of our single-family mortgage

credit book and our credit losses and impact the likelihood of default and the severity of any losses.

‚ Economic Trends

Beginning in 2001 and extending through early 2002, the U.S. economy experienced a mild recession.

Economic growth, as measured by the change in GDP, began to slowly recover in 2002. GDP growth was very

robust at 5.0 percent in the Ñrst quarter of 2002, but fell to 1.4 percent during the fourth quarter.

Unemployment, a lagging economic indicator, peaked at 6.0 percent in April 2002, gradually declined to

5.6 percent in September 2002, before rising again to 6.0 percent by year-end. In spite of these trends, home

prices continued to grow at a rate above long-term historical averages in 2002 although home price growth has

slowed from the record levels attained in the past few years. Based on OFHEO's fourth quarter 2002 House

Price Index report, average home prices at the national level increased 6.89 percent in 2002. No census region

or state experienced negative home price growth in 2002. Over the last Ñve years, U.S. home appreciation has

averaged 7.66 percent annually.

‚ Single-Family Loan Risk Characteristics

We monitor an array of risk characteristics to assess the sensitivity of our credit losses to economic

changes. Some of these risk characteristics are described below and quantiÑed in Tables 33 and 34. We

typically obtain the data for these statistics from the sellers or servicers of the mortgage loans. We receive

representations and warranties as to the accuracy of the information from those providing it. Except for quality

assurance eÅorts, we do not independently verify the reported information. We generally collect loan level

statistics only on conventional single-family mortgage loans held in our portfolio and loans backing Fannie

Mae guaranteed MBS. These loans, collectively, represent the vast majority of our single-family mortgage

credit book of business.

‚ Loan-to-value (""LTV'') ratio: LTV ratio is the ratio of UPB to the value of the property that serves

as collateral. Original LTV is based on the value reported to Fannie Mae at acquisition of the loan.

Current LTV is based on current UPB and original value updated for subsequent changes in home

values using Fannie Mae's internal home valuation models. LTV ratio is a strong predictor of credit

performance. The likelihood of default and the gross severity of a loss in the event of default are lower

as the LTV ratio decreases, all other factors held equal. The estimated average current LTV ratio on

the mortgage credit book of business (which is a weighted average based on current UPB) increased

marginally to 62 percent at December 31, 2002 from 60 percent at the end of 2001, largely due to the

substantial volume of new business purchased or guaranteed in 2002 that has not yet had the

opportunity to experience home price appreciation.

81
‚ Product type: Product type is deÑned by the nature of the interest rate applicable to the mortgage

(Ñxed for the duration of the loan or adjustable subject to contractual terms) and by the maturity of

the loan. We divide our business into three categories: long-term, Ñxed-rate mortgages with original

terms of greater than 20 years; intermediate-term, Ñxed-rate mortgages with original terms of 20 years

or less; and adjustable-rate mortgages (ARMs) of any term. ARMs tend to have higher default risk

than Ñxed-rate loans, all other factors held equal. Our single-family mortgage credit book of business

continues to be heavily concentrated in long- and intermediate-term, Ñxed-rate products that are

generally regarded as lower risk investments. At December 31, 2002, 93 percent of our single-family

book of business consisted of long-term, Ñxed-rate or intermediate-term, Ñxed-rate mortgages.

‚ Property type: We classify mortgages secured by housing with up to four living units as single-family.

Mortgages on one-unit properties tend to have lower credit risk than mortgages on multiple-unit

properties, such as duplexes, all other factors held equal. The majority of Fannie Mae's book of

business consists of loans secured by one-unit properties. The proportion of loans secured by multipleunit properties has remained relatively stable over the past two years.

‚ Occupancy type: Borrowers may purchase a home as a primary residence, second or vacation home,

or investment rental property. Mortgages on properties occupied by the borrower as a principal or

second residence tend to have lower credit risk than mortgages on investment properties, all other

factors held equal. The vast majority of Fannie Mae's book of business consists of mortgages on

properties occupied by the borrower as the principal residence. The proportion of loans secured by

investment properties has remained relatively stable over the past three years.

‚ Credit score: Borrower credit history is a record of the use and repayment of varying forms of credit

by the borrower. Since this information is typically complex and voluminous, statistical models are

employed to summarize the informationÌtypically into a single numeric indicator of borrower credit

quality. We use several internal proprietary models to assess borrower credit quality at acquisition.

Credit score is one measure often used by the Ñnancial services industry, and by Fannie Mae in some

cases, to assess borrower credit quality. Credit scores are generated by credit repositories and

calculated based on proprietary statistical models that evaluate many types of information on a

borrower's credit report and compare this information to the patterns in other credit reports. One

statistical model used widely in the Ñnancial services industry was developed by Fair, Isaac &

Company, Inc. (""Fair Isaac''). This model is used to create a credit score called the FICO» score.

FICO» scores can vary depending on which credit repository is using the Fair Isaac model to supply

the score. FICO» scores, as reported by the credit repositories, may range from a low of 150 to a high

of 950. According to Fair Isaac, a high FICO» score indicates a lesser degree of risk. A higher credit

score is an indicator of lower default risk, while a lower credit score indicates higher risk, all other

factors held equal. On approximately two-thirds of the mortgages on which we acquire credit risk

through purchase or guaranty, lenders provide credit scores that typically reÖect the borrower's credit

history just prior to our acquisition of the loan. For most of the remaining loans, we obtain credit scores

soon after acquisition. For a small proportion of loans, credit scores are not available. The credit score

of an individual borrower can vary depending upon several factors, including the timing of when the

score is calculated and the credit repository from which the score is obtained. Management believes,

however, that the average credit score across our book of business is a strong indicator of default risk

within the single-family mortgage credit book of business. The credit quality of borrowers in our book

remained high at December 31, 2002, as evidenced by an average credit score of 714 at the time of loan

purchase or guarantee.

‚ Loan purpose: Loan purpose indicates how the borrower intends to use the funds. We designate the

loan purpose as either purchase, cash-out reÑnance, or other reÑnance. The funds in a purchase

transaction are used to acquire a property. The funds in a cash-out reÑnance transaction are used for

purposes other than to pay oÅ an existing Ñrst mortgage lien, to pay oÅ any permissible subordinate

mortgage liens, and to provide limited unrestricted cash proceeds to the borrower. All other reÑnance

transactions are deÑned as other reÑnancings. Cash-out reÑnance transactions generally have a higher

risk proÑle than purchase or other reÑnance transactions, all other factors held equal. The signiÑcant

82
reÑnance activity of the past two years resulted in a substantial shift in the proportion of reÑnance loans

in our conventional single-family mortgage credit book to 62 percent at December 31, 2002 from

54 percent at the end of 2001.

‚ Geographic concentration: Local economic conditions aÅect borrowers' ability to repay loans and the

value of the collateral underlying a loan, all other factors held equal. We analyze geographic exposure

at a variety of levels of geographic aggregation, including at the regional level. Geographic diversiÑcation reduces mortgage credit risk, and our geographic distributions have been consistently well

diversiÑed. We have signiÑcant business volumes in the West, with 26 percent at the end of 2002, 2001,

and 2000. However, this exposure is low relative to the distribution of the overall mortgage market

because of our conforming loan limit, which restricts us in serving the Ñnancing needs of borrowers in

higher cost areas such as California.

‚ Loan age: We closely track year of origination and loan age, deÑned as the number of years since

origination. The peak ages for default are from three to seven years after origination. The average age

of our portfolio has decreased in the past year largely due to the high level of reÑnancings. As of

December 31, 2002, approximately 69 percent of our portfolio was three years old or less and only

26 percent of the loans were in the peak default years, down from 42 percent at the end of 2001. At

December 31, 2001, 57 percent of the loans were three years old or less. At the end of 2000, 61 percent

were three years old or less and 48 percent were within their peak default years.

Table 33 shows our conventional single-family mortgage credit book of business at December 31, 2002,

2001, and 2000, based on these risk characteristics. Table 34 shows conventional single-family purchase and

guaranty acquisition volumes for the mortgage credit book of business based on these risk characteristics,

while Table 35 presents a comparison of conventional single-family loans with some level of credit

enhancement and loans without any credit enhancement based on selected risk characteristics. As we work to

expand Fannie Mae's presence, activities, and customer base in underserved markets through products such as

Expanded Approval/Timely Payment Rewards‚, the overall credit risk proÑle of our conventional singlefamily mortgage credit book of business may change.

Table 33: Characteristics of Conventional Single-Family Mortgage Credit Book

Percent of Book of Business(1)

2002 2001 2000

Original loan-to-value ratio(2):

G• 60.00% ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 20% 17% 16%

60.01% to 70.00% ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 15 14 14

70.01% to 80.00% ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 42 43 42

80.01% to 90.00% ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 13 14 15

Greater than 90.00% ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 10 12 13

Total ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 100% 100% 100%

Weighted average ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 73% 74% 75%

Current loan-to-value ratio(2):

G• 60.00% ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 41% 47% 45%

60.01% to 70.00% ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 18 19 24

70.01% to 80.00% ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 28 23 20

80.01% to 90.00% ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 9 7 8

Greater than 90.00% ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 4 4 3

Total ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 100% 100% 100%

Weighted average ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 62% 60% 60%

Average loan amount ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 111,169 $ 102,095 $ 94,360

Product type(3):

Long-term, Ñxed-rate ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 70% 74% 73%

Intermediate-term, Ñxed-rate ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 23 20 20

Adjustable-rate ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 7 6 7

Total ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 100% 100% 100%

83
Percent of Book of Business(1)

2002 2001 2000

Property type:

1 unit ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 96% 96% 97%

2-4 units ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 4 4 3

Total ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 100% 100% 100%

Occupancy type:

Principal residence ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 93% 94% 94%

Second/vacation home ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 3 2 2

InvestorÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 4 4 4

Total ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 100% 100% 100%

Credit score:

G 620ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 6% 5% 4%

620 to G 660ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 11 11 10

660 to G 700ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 18 17 16

700 to G 740ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 22 22 21

H• 740 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 36 33 30

Not available ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 7 12 19

Total ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 100% 100% 100%

Weighted average ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 714 713 713

Loan purpose:

Purchase ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 38% 46% 53%

Cash-out reÑnance ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 27 22 17

Other reÑnance ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 35 32 30

Total ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 100% 100% 100%

Geographic concentration(4):

Midwest ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 18% 19% 19%

Northeast ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 19 18 18

Southeast ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 21 21 21

SouthwestÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 16 16 16

West ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 26 26 26

Total ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 100% 100% 100%

Origination year:

G• 1993 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 6% 11% 18%

1994 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2 3 4

1995 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 1 3 4

1996 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2 3 6

1997 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2 5 7

1998 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 11 18 27

1999 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 7 13 20

2000 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 4 9 14

2001 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 27 35 Ì

2002 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 38 Ì Ì

Total ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 100% 100% 100%

(1) Percentages calculated based on unpaid principal balance at the end of each period.

(2) Excludes loans for which this information is not readily available.

(3) Intermediate-term, Ñxed-rate includes second mortgage loans.

(4) Midwest includes IL, IN, IA, MI, MN, NE, ND, OH, SD, and WI. Northeast includes CT, DE, ME, MA, NH, NJ, NY, PA, PR,

RI, VT, and VI. Southeast includes AL, DC, FL, GA, KY, MD, MS, NC, SC, TN, VA, and WV. Southwest includes AZ, AR, CO,

KS, LA, MO, NM, OK, TX, and UT. West includes AK, CA, GU, HI, ID, MT, NV, OR, WA, and WY.

84
Table 34: Characteristics of Conventional Single-Family Mortgage Acquisitions

Percent of Acquisition Volume(1)

2002 2001 2000

Original loan-to-value ratio(2):

G• 60.00% ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 23% 17% 13%

60.01% to 70.00% ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 16 14 11

70.01% to 80.00% ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 42 45 45

80.01% to 90.00% ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 11 13 15

Greater than 90.00%ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 8 11 16

Total ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 100% 100% 100%

Weighted average ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 71% 74% 77%

Average loan amount ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 145,553 $ 136,376 $ 118,776

Product type(3):

Long-term, Ñxed-rate ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 63% 73% 73%

Intermediate-term, Ñxed-rateÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 27 21 12

Adjustable-rate ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 10 6 15

Total ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 100% 100% 100%

Property type:

1 unit ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 96% 96% 96%

2-4 units ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 4 4 4

Total ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 100% 100% 100%

Occupancy type:

Principal residence ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 92% 93% 91%

Second/vacation home ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 3 3 3

Investor ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 5 4 6

Total ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 100% 100% 100%

Credit score:

G 620 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 6% 6% 6%

620 to G 660 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 11 12 12

660 to G 700 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 18 20 20

700 to G 740 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 23 24 24

H• 740 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 41 37 36

Not available ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 1 1 2

Total ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 100% 100% 100%

Weighted average ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 717 712 712

Loan purpose:

PurchaseÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 30% 37% 72%

Cash-out reÑnance ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 32 30 15

Other reÑnance ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 38 33 13

Total ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 100% 100% 100%

Geographic concentration(4):

Midwest ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 20% 21% 19%

Northeast ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 18 17 17

Southeast ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 20 20 21

SouthwestÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 15 16 17

West ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 27 26 26

Total ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 100% 100% 100%

(1) Percentages calculated based on unpaid principal balance.

(2) Excludes loans for which this information is not readily available.

(3) Intermediate-term, Ñxed-rate includes second mortgage loans.

(4) See Table 33 for states included in each geographic region.

85
Table 35: Conventional Single-Family Mortgage Credit Book Characteristics

Weighted Average Credit Characteristics Based on UPB(1)

2002 2001 2000

Credit Non-Credit Credit Non-Credit Credit Non-Credit

Enhanced Enhanced Total Enhanced Enhanced Total Enhanced Enhanced Total

Weighted average original

LTV ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 87% 67% 73% 87% 68% 74% 86% 68% 75%

Weighted average current

LTV ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 75 58 62 71 55 60 72 53 60

Weighted average credit

score ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 694 721 714 699 719 713 702 720 713

(1) Indicates the principal amount of loans that have credit enhancement but does not reÖect the level of credit

enhancement. Excludes assets for which loan level data is not available.

‚ Serious Delinquency

A key measure of credit performance and future defaults for the single-family mortgage credit book is the

serious delinquency rate, although not all loans that become seriously delinquent result in a default. A serious

delinquency occurs when a borrower has missed three or more consecutive monthly payments, and the loan

has not yet been brought current or been extinguished through foreclosure, payoÅ, or other resolution. A loan

referred to foreclosure but not yet foreclosed is also considered seriously delinquent. The serious delinquency

rate is the number of mortgages that are seriously delinquent divided by the total number of loans outstanding.

The rate at which new loans become seriously delinquent and the rate at which existing seriously delinquent

loans are resolved signiÑcantly aÅects the level of future credit losses.

EÅective December 31, 2002, we changed how we report our single-family serious delinquency rate to be

more consistent with our current business and credit risk management practices. Traditionally, we reported

our single-family serious delinquency rate for those loans where we have the primary risk of default. For

example, we did not include loans that had substantial recourse to lenders or were covered by signiÑcant

supplemental pool insurance from mortgage insurance companies in our serious delinquency statistics. A

signiÑcant portion of our business represents loans where we bear some risk, but share a portion of that risk

with others. As a result, we believe it is more meaningful to report our single-family delinquency rate on all of

our conventional loans and distinguish between loans on which we beneÑt from credit enhancement and loans

on which we do not beneÑt from credit enhancement. We have reclassiÑed prior period statistics to conform to

the current year's presentation. Table 36 compares the serious delinquency rates for conventional single-family

loans with credit enhancements and without credit enhancements.

Table 36: Conventional Single-Family Serious Delinquency Rates

2002 2001 2000

Serious Serious Serious

Book Delinquency Book Delinquency Book Delinquency

Outstanding(1) Rate(2) Outstanding(1) Rate(2) Outstanding(1) Rate(2)

Credit enhanced ÏÏÏÏÏÏÏÏÏÏÏ 27% 1.29% 32% 1.05% 38% .77%

Non-credit enhanced ÏÏÏÏÏÏÏ 73 .31 68 .33 62 .29

Total conventional loans ÏÏ 100% .57% 100% .55% 100% .45%

(1) Reported based on unpaid principal balance.

(2) Reported based on number of loans.

For conventional loans in our single-family mortgage credit book, our total serious delinquency rate

increased modestly to .57 percent at December 31, 2002, from .55 percent at December 31, 2001. This

increase was primarily due to an increase in the serious delinquency rate of our credit-enhanced book. The

serious delinquency rate for conventional loans in our single-family mortgage credit book without credit

enhancement declined to .31 percent at December 31, 2002, from .33 percent at December 31, 2001, a level

86
more consistent with our delinquency rates prior to the September 11, 2001 terrorist attacks and reÖective of

the low risk proÑle of these loans. The serious delinquency rate for conventional loans in our single-family

mortgage credit book with credit enhancement increased to 1.29 percent from 1.05 percent in 2001. These

loans have a higher risk proÑle and tend to be more sensitive to changes in the economy than loans without

credit enhancement.

‚ Nonperforming Single-Family Loans

We stop accruing interest on single-family loans that we own, including delinquent loans purchased from

an MBS trust pursuant to the terms of the trust indenture, when: a) principal and interest on these loans is at

least 90 days past due and b) collection of principal and interest is doubtful. These loans are classiÑed as

nonperforming. Table 37 provides a summary for each of the past Ñve years of the following information on

our single-family nonperforming loans: the amount of nonaccrual loans that we owned within our single-family

mortgage portfolio at the end of each year, the amount of forgone interest income that we would have recorded

each year if these loans had performed according to contractual terms during the year, and the amount of

interest income recognized during the year on the loans when they were performing.

Table 37: Nonperforming Single-Family Loans

2002 2001 2000 1999 1998

(Dollars in millions)

Nonaccrual loans at December 31 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $5,463 $3,691 $1,931 $2,635 $3,135

Interest income forgone(1) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 155 101 91 119 110

Interest income recognized during year(2) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 245 173 56 87 141

Accruing loans past due 90 days and greater at December 31(3) ÏÏÏÏÏ 663 560 297 335 395

(1) Forgone interest income represents the amount of interest income that would have been recorded during the year on

nonperforming loans at December 31 had the loans performed according to contractual terms.

(2) Represents estimated interest income recognized during the year on loans classiÑed as nonperforming at

December 31.

(3) Principal balance of loans at December 31 that are 90 days or greater past due and continuing to accrue interest

because we believe collection of principal and interest is reasonably assured.

Forgone interest income on non-accrual loans increased signiÑcantly in 2002 because we purchased a

higher level of seriously delinquent loans out of MBS pools and added them to our portfolio. We take this

action pursuant to the terms of the relevant securities when the cost of advancing interest to MBS investors at

the security coupon rate exceeds the cost of holding the nonperforming loan in our mortgage portfolio. Any net

interest remitted to MBS investors but not received from the servicer is included as part of the charge-oÅs

should the loan be foreclosed. Subsequent to a decision to purchase the seriously delinquent loan out of the

MBS, the cost of holding the loan in our portfolio is reÖected as a reduction to net interest income. We may

recover a portion of forgone interest income when we liquidate foreclosed properties and collect credit

enhancement proceeds.

‚ Single-Family Credit Losses

The application of various credit risk management strategies throughout a loan's life helped minimize

single-family credit losses in 2002 despite weak economic conditions.

Single-family credit losses include charge-oÅs plus foreclosed property expense (income). Interest

forgone on nonperforming loans and other assets in our mortgage portfolio, which is presented in Table 37,

reduces our net interest income but is not reÖected in our credit loss total.

As shown in Table 38, single-family credit-related losses decreased $7 million in 2002 to $69 million. The

credit loss ratio (ratio of credit losses to the average mortgage portfolio and outstanding MBS) on our singlefamily credit book of business decreased by .2 basis points in 2002 to .4 basis points despite weaker economic

conditions.

87
Table 38: Single-Family Credit Loss Performance

2002 2001 2000

(Dollars in millions)

Charge-oÅs(1,2) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 105 $ 96 $ 114

Foreclosed property income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (36) (20) (29)

Credit-related losses ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 69 $ 76 $ 85

Credit loss ratio(3) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ .004% .006% .007%

Charge-oÅ ratio(4) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ .007 .007 .010

(1) Prior period amounts have been reclassiÑed to conform with the current year's presentation.

(2) Charge-oÅs for 2002 include $1 million in charge-oÅs related to foreclosed Federal Housing Administration loans

that are reported in the balance sheet under ""Acquired property and foreclosure claims, net.''

(3) Represents credit losses divided by average conventional single-family book of business.

(4) Represents charge-oÅs divided by average conventional single-family book of business.

Strong housing prices helped boost recoveries on foreclosed properties, which oÅset the increase in

foreclosed property expense associated with a larger number of foreclosed properties. The number of

properties acquired through foreclosure increased to 19,500 in 2002 from 14,486 in 2001, contributing to a

$9 million increase in charge-oÅs. While the number of acquired properties increased 35 percent credit-related

losses fell by $7 million as average severities continued to drop, especially in the Northeast and West regions

where foreclosure costs had been higher in the recent past. This trend is primarily due to the eÅect of strong

home prices and proceeds from credit enhancements. Finally, low interest rates led us to repurchase a higher

level of seriously delinquent loans out of MBS, resulting in an increased amount of forgone interest income.

Table 39 shows foreclosed property or REO activity in Fannie Mae's single-family mortgage credit book

for the last three years.

Table 39: Single-Family Foreclosed Property Activity

2002 2001 2000

Inventory of foreclosed properties (REO)(1) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 9,975 7,073 6,414

Dispositions of REO ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 16,598 13,827 15,041

Geographic analysis of acquisitions(2):

Midwest ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 4,742 2,836 2,138

Northeast ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2,053 2,165 2,788

Southeast ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 5,614 4,061 3,575

SouthwestÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 4,461 2,691 2,333

West ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2,630 2,733 3,517

Total properties acquired through foreclosure ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 19,500 14,486 14,351

(1) Includes deeds-in-lieu of foreclosure.

(2) See Table 33 for states included in each geographic region.

Multifamily

We also purchase or guarantee loans on multifamily properties Ì properties with more than four

residential units. We provide Ñnancing either in the form of a single asset loan, principally through the

Delegated Underwriting and Servicing (DUS) product line, or through a negotiated transaction involving a

pool of multifamily properties. The principal credit risks of multifamily property Ñnancings involve the

following:

‚ Physical condition and Ñnancial performance of the property

‚ Market conditions in the geographic location of the property

88
‚ Ability and intent of the borrower to repay the loan

‚ Structure of the Ñnancing

1. Managing the proÑle and quality of mortgages in the multifamily mortgage credit book.

Numerous characteristics impact the mortgage credit risk on a particular multifamily loan. These

characteristics include the type of mortgage loan, the type and location of the property, the condition and

value of the property, counterparty strength, and the current and anticipated cash Öows on the property. These

and other factors aÅect both the amount of expected credit loss on a given loan and the sensitivity of that loss

to changes in the economic environment. We attempt to understand and control the overall risk in each loan

we purchase or guarantee. Under the DUS product line, we purchase or securitize mortgages from approved

risk sharing lenders without prior review of the mortgages if the mortgages are less than $20 million. Lenders

represent and warrant that DUS loans they originate are consistent with our underwriting requirements.

Approximately 67 percent of our multifamily mortgage credit book consisted of DUS products or business at

December 31, 2002, compared with 62 percent at the end of 2001.

We manage multifamily mortgage credit risk throughout the investment life cycle. The cycle begins with

the formulation of sound underwriting and servicing policies and procedures. When application of these

policies and procedures is delegated to our lending partners, we actively monitor results through post-purchase

underwriting reviews of loans delivered to us. We conduct on-site assessments of DUS lenders' servicing and

their Ñnancial condition. We closely track property condition and Ñnancial performance throughout the life of

the assets we Ñnance. We also evaluate borrower, geographic, and other types of risk concentrations at the loan

and portfolio level.

2. Using credit enhancements to reduce credit losses.

We use credit enhancements to transform the risk and return proÑle of multifamily loans that we

purchase or guarantee consistent with our corporate credit risk management objectives. In most of our

business arrangements, lenders in the DUS product line bear losses on the Ñrst Ñve percent of UPB and share

in remaining losses up to a prescribed limit. On structured transactions, we generally have full or partial

recourse to lenders or third parties for loan losses. The recourse provider may back up its obligation with

letters of credit, investment agreements, or pledged collateral. Third-party recourse providers for structured

and other transactions include government and private mortgage insurers. While credit enhancements reduce

our mortgage-related credit losses, they also generate institutional counterparty risk, which we discuss further

in the Institutional Counterparty Credit Risk section. We seek to concentrate credit enhancement coverage on

the riskier loans. Table 40 presents our multifamily credit risk sharing proÑle at December 31, 2002, 2001, and

2000.

Table 40: Multifamily Credit Risk Sharing ProÑle(1)

December 31,

2002 2001 2000

Fannie Mae risk ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 15% 18% 16%

Shared risk(2)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 66 65 60

Recourse(3) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 19 17 24

Total ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 100% 100% 100%

(1) Prior year numbers have been restated to include Fannie Mae's credit enhancement of housing bonds issued by state

and local government entities.

(2) Includes loans in which the lender initially bears losses of up to 5 percent of UPB and shares any remaining losses

with Fannie Mae up to a prescribed limit.

(3) Includes loans not included in ""shared risk'' that have government mortgage insurance or full or partial recourse to

lenders or third parties.

89
3. Assessing the sensitivity of the proÑtability of the multifamily mortgage credit book of business to changes

in composition and the economic environment.

We use analytical tools to measure credit risk exposures, assess performance of our book, and evaluate

risk management alternatives. We combine these analyses with assessments of any problem loan situations to

develop forecasts of future guaranty fee revenue and credit losses. We carefully monitor the relevant local

market economic indicators that may signal changing risk or return proÑles in the book and cause a change in

risk management policies, credit enhancements, or guaranty fees. For example, we closely monitor rental

payment trends and vacancy levels in local markets to identify loans meriting closer attention or loss

mitigation actions.

4. Managing problem assets to mitigate credit losses.

As part of our risk management activities, we perform detailed loss reviews, address borrower and

geographic concentrations, assess lender qualiÑcations, evaluate counterparty risk, and track property performance and contract compliance. The loss mitigation team manages troubled assets from default through

foreclosure and property disposition, if necessary. Given the size of multifamily loans, we generally require

servicers to submit periodic operating information and property condition reviews to monitor the performance

of individual loans. We use this information to evaluate the credit quality of our book, identify potential

problem loans, and initiate appropriate loss mitigation activities.

Multifamily Mortgage Credit Book Performance

The economic downturn in the U.S. economy had a modest impact on multifamily credit losses in 2002

because property values have remained strong. If the economy weakens further and property values decline,

we would anticipate a higher level of credit losses in 2003 than we have experienced in the recent past.

Multifamily credit-related losses totaled $19 million in 2002, up $14 million from 2001. The higher level of

credit losses in 2002 was due primarily to two large properties in the Midwest. Although the level of

multifamily losses increased in 2002, we have had historically low credit loss ratios of less than 3 basis points

over the past three years as shown in Table 41.

Table 41: Multifamily Credit Loss Performance

Year Ended December 31,

2002 2001 2000

(Dollars in millions)

Charge-oÅsÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 19 $ 1 $ 3

Foreclosed property expenseÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Ì 4 1

Credit-related losses ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 19 $ 5 $ 4

Credit loss ratio(1) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ .025% .008% .007%

Serious delinquency rate(1) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ .05 .27 .07

Properties acquired through foreclosure ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2 1 3

(1) Prior year numbers have been restated to reÖect our new method of reporting delinquencies and include Fannie Mae's

credit enhancement of housing bonds issued by state and local government entities.

Multifamily serious delinquencies include loans that are 60 days or more past due. We base the

multifamily serious delinquency rate on the UPB of delinquent loans divided by the UPB of multifamily loans

we own or guarantee. Our multifamily serious delinquency rate declined to .05 percent at year-end 2002 from

.27 percent at the end of 2001. At the end of 2000, our multifamily serious delinquency rate was .07 percent.

The increase in 2001 was due to two seriously delinquent loans totaling $118 million on properties in New

York City aÅected by the World Trade Center disaster. These obligations were restructured or became current

in 2002.

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Over the last three years, multifamily credit losses and serious delinquencies have been at historically low

levels. Management anticipates that multifamily credit losses, over time, will return to a level more reÖective

of the current economic environment.

We generally stop accruing interest on multifamily loans that we own when principal and interest on these

loans is 90 days past due and collection of principal and interest is doubtful. Table 42 summarizes the amount

of nonaccrual multifamily loans at December 31, 1998 through December 31, 2002. In addition, it identiÑes

the amount of interest income that we would have recorded during those periods if nonperforming loans had

performed according to contractual terms during the year, the amount of interest income accrued on those

loans during the portion of the year when they were performing, and the amount of any interest income

accrued on loans past 90 days due.

Table 42: Nonperforming Multifamily Loans

2002 2001 2000 1999 1998

(Dollars in millions)

Nonaccrual loans at December 31 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $14 $22 $Ì $4 $29

Interest income forgone(1) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 1 Ì Ì Ì 2

Interest income recognized during year(2) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Ì 1 Ì Ì Ì

Accruing loans past due 90 days and greater at December 31(3) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 10 5 3 9 11

(1) Forgone interest income represents the amount of interest income that would have been recorded during the year on

nonperforming loans at December 31 had the loans performed according to contractual terms.

(2) Represents estimated interest income recognized during the year on loans classiÑed as nonperforming at

December 31.

(3) Principal balance of loans at December 31 that are 90 days or greater past due and continuing to accrue interest

because we believe collection of principal and interest is reasonably assured.

Equity Financing for Multifamily Properties

We also provide equity Ñnancing for multifamily properties. Equity Ñnancing typically takes the form of

limited partnership investments in aÅordable housing projects that produce low-income housing tax credits.

The tax beneÑts we receive from these properties represents our primary economic return on our equity

investments.

Because our equity Ñnancings have the same property-related credit risks as other multifamily Ñnancings,

we track property condition and Ñnancial performance throughout the life of these investments. We also

evaluate the strength of our investment sponsors and third party asset managers through periodic Ñnancial and

operational assessments. Approximately 33 percent of our equity investments in low-income housing tax credit

properties have an economic return guaranteed by an investment grade counterparty.

Internal Revenue Service requirements govern the recognition of tax credits. These requirements include

maintaining the properties with a speciÑed level of aÅordable housing units over a 15-year period. Failure to

meet IRS requirements can trigger a recapture of tax credits from the IRS. For the years ended December 31,

2002, 2001, and 2000 the amounts of tax credit recapture were not signiÑcant.

Institutional Counterparty Credit Risk

A secondary credit risk is the possibility that institutional counterparties may be unable to fulÑll their

contractual obligations to us. For example, our credit losses would increase if a credit enhancement

counterparty were unable to reimburse us in the event of loss on a covered mortgage loan. Accepting a certain

level of counterparty risk is integral to our interest rate and credit risk management and liquidity objectives.

We have a dedicated Counterparty Risk Management team that quantiÑes aggregate counterparty risk

exposures across business activities, maintains a corporate credit policy framework for managing counterparty

risk, and manages the counterparty risk associated with mortgage insurance companies.

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Our overall objective in managing institutional counterparty credit risk is to maintain individual

counterparty exposures within a range that allows us to achieve our overall Ñnancial performance objective of

stable and predictable earnings. Central elements of our approach to managing institutional counterparty

credit risk include: (1) stringent counterparty eligibility standards appropriate to each exposure type and level,

(2)collateralization of exposures where appropriate, (3) policies to ensure our counterparty exposures are

diversiÑed to avoid excessive concentration of risk, and (4) intensive exposure monitoring and management.

1. Maintaining stringent counterparty eligibility standards appropriate to each exposure type.

We generally require that our counterparties have an investment grade credit rating. A rating of

BBB¿/Baa3/BBB or higher by Standard & Poor's, Moody's Investor Service, and Fitch, respectively, is

considered an investment grade rating. For mortgage insurance counterparties, we have generally required a

minimum rating of AA¿/Aa3. For our risk sharing, recourse, and mortgage servicing counterparties, we do

not always require an investment grade credit rating because we believe the risk of loss is lower. We have

ongoing, extensive mortgage purchase and mortgage servicing relationships with these counterparties. In some

instances, we also have collateral, letters of credit, or investment agreements to secure the obligation.

Individual business units maintain policies and procedures governing the eligibility of counterparties and

approval requirements for accepting exposure to them. For example, we maintain requirements governing

eligibility of insurers to provide primary loan-level mortgage insurance on single-family loans we buy or

guarantee. We conduct a comprehensive counterparty analysis before approving a mortgage insurance

company. We review a mortgage insurer's business plan, Ñnancial statements, insurance portfolio characteristics, master insurance policies, reinsurance treaties, and ratings on ability to pay claims. We monitor approved

insurers through a quarterly reporting and analysis process combined with onsite business reviews.

2. Requiring collateralization of exposures, where appropriate.

We may require collateral, letters of credit, or investment agreements as a condition to accepting

exposure to a particular counterparty. We may also require that a counterparty post collateral in the event of

an adverse event such as a ratings downgrade.

We also have contractual rights that can oÅset exposure in the event of a counterparty default. For

example, if an insurer cannot provide mortgage insurance in accordance with our requirements, most of our

mortgages have provisions that allow us to use borrower paid mortgage insurance premiums to obtain

substantially equivalent protection. If this insurance is unavailable at an acceptable cost, we can retain the

premium and use it to obtain other credit enhancement or as a loss reserve. Similarly, we have the contractual

right to terminate a single-family or multifamily lender's status as a servicer in the event the lender fails to

fulÑll its servicing obligations or fails to reimburse Fannie Mae for losses that the lender assumed. In that

event, we would either sell the servicing rights or use the servicing fees to oÅset any losses related to the

lender's failure.

3. Establishing policies to ensure diversiÑcation of our exposure.

We monitor counterparty exposure in total by industry and by individual counterparty. In addition, we

have established exposure tolerance levels by counterparty based on our assessment of each counterparty's

credit strength. These tolerance thresholds allow us to prioritize our monitoring activities and avoid excessive

concentrations of credit risk.

4. Monitoring and managing exposures intensively within business lines and across Fannie Mae.

Individual business units are responsible for managing the counterparty exposures routinely associated

with their activities. The Counterparty Risk Management team reviews business unit policies, procedures, and

approval authorities, and the Credit Risk Policy Committee approves these internal controls.

Non-derivative institutional counterparty risk primarily includes exposure created by mortgage insurance

policies, other credit enhancement arrangements with lenders and others, mortgage servicing contracts with

lenders, and liquidity investments in corporate obligations or nonmortgage asset-backed securities.

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Lenders with Risk Sharing

The primary risk associated with lenders where we have risk sharing agreements is that they will fail to

reimburse us for losses as required under these agreements. We had recourse to lenders for losses on singlefamily loans totaling an estimated $44 billion at December 31, 2002 and $42 billion at December 31, 2001.

The quality of these counterparties is high, with investment grade counterparties accounting for 53 percent

and 59 percent of lender recourse obligations at the end of 2002 and 2001, respectively. We also require some

lenders to pledge collateral to secure their recourse obligations. At December 31, 2002 and 2001, we held

$204 million and $247 million in collateral, respectively, to secure single-family lender recourse transactions.

In addition, single-family lenders with recourse obligations received servicing fees on $1.452 trillion and

$1.288 trillion of mortgages at year-end 2002 and 2001, respectively. A portion of these servicing fees

eÅectively serves as collateral.

We had recourse to lenders on multifamily loans totaling $77 billion and $63 billion at December 31,

2002 and 2001, respectively. Our multifamily recourse obligations were secured by reserves held in custodial

accounts, insurance policies, letters of credit from investment grade counterparties rated A or better, and

investment agreements. In addition, all multifamily lenders with recourse obligations received servicing fees, a

portion of which eÅectively serves as collateral.

Mortgage Servicers

The primary risk associated with mortgage servicers is that they will fail to fulÑll their servicing

obligations. Mortgage servicers collect mortgage and escrow payments from borrowers, pay taxes and

insurance costs from escrow accounts, monitor and report delinquencies, and perform other required activities

on our behalf. A servicing contract breach could result in credit losses for us, or we could incur the cost of

Ñnding a replacement servicer, which could be substantial for loans that require a specialized servicer. We

mitigate this risk by requiring mortgage servicers to maintain a minimum reserve servicing fee rate to

compensate a replacement servicer in the event of a servicing contract breach. We also manage this risk by

requiring servicers to follow speciÑc servicing guidelines and by monitoring each servicer's performance using

loan-level data. We conduct on-site reviews of compliance with servicing guidelines and mortgage servicing

performance. We also work on-site with nearly all of our major servicers to facilitate loan loss mitigation

eÅorts and improve the default management process. In addition, we review quarterly Ñnancial information on

servicers. Our ten largest single-family mortgage servicers serviced 63 percent of our single-family book of

business at the end of 2002 and 2001. Fannie Mae's 15 largest multifamily mortgage servicers serviced

70 percent of our multifamily book of business at year-end 2002, compared with 67 percent at year-end 2001.

We have purchased mortgage-related securities secured by manufacturing housing that were issued by

entities other than Fannie Mae both for our portfolio and, to a limited extent, for securitization into REMIC

securities we have issued and guaranteed. We currently own or guarantee approximately $10 billion of these

securities. Due to weakness in the manufactured housing sector and the Ñnancial condition of Conseco

Finance Corp., which services approximately 70 percent of these securities, the major securities rating

agencies downgraded several of the securities. As of December 31, 2002, the vast majority of these securities

were rated AA¿ or better, and the entire $10 billion of securities either had investment grade ratings or were

insured by counterparties which had investment grade ratings. Management believes that any potential

impairment that might be recorded in the future will not be material to Fannie Mae's operating results.

On March 14, 2003, the U.S. Bankruptcy Court for the Northern District of Illinois issued a Ñnal order

approving the servicing arrangements for the securities serviced by Conseco Finance Corp. The order, based

upon an agreement reached between Conseco Finance, CFN Investment Holdings (the new owner and

servicer), Fannie Mae and other certiÑcate holders, provided for revised servicing fees and an enhanced

servicing protocol. CFN is expected to complete the acquisition in the second quarter of 2003.

Mortgage Insurers

The primary risk associated with mortgage insurers is that they will fail to fulÑll their obligations to

reimburse us for claims under insurance policies. We were the beneÑciary of primary mortgage insurance

coverage on $316 billion of single-family loans in portfolio or underlying MBS at December 31, 2002 and

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$314 billion at December 31, 2001. Seven mortgage insurance companies, all rated AA or higher by

Standard & Poor's, provided approximately 99 percent of the total coverage at the end of 2002 and 2001.

Liquid Investments

The primary credit risk associated with our liquid investments, which includes the LIP, our early funding

portfolio, and cash and cash equivalents, is that issuers will not repay us in accordance with contractual terms.

The level of credit risk in our liquid investments is low because these investments are primarily high-quality,

short and medium-term investments. These investments include our early funding portfolio, which consists

primarily of repurchase agreements, and other high-quality short-term investments in nonmortgage assets,

such as federal funds and time deposits, commercial paper, asset-backed securities, and corporate Öoating rate

notes. The majority of our nonmortgage asset-backed securities are rated AAA by Standard & Poor's.

Unsecured investments in the portfolio are generally rated A or higher by Standard & Poor's. Our LIP, which

accounts for the majority of our liquid investments, totaled $39 billion and $65 billion at the end of 2002 and

2001, respectively. Approximately 94 percent of our LIP had a credit rating of A or higher at December 31,

2002, compared with 96 percent at December 31, 2001.

Operations Risk Management

Operations risk is the risk of potential loss resulting from a breakdown in, or failure to establish, controls

and procedures. Examples of control breakdowns include circumvention of internal controls, human error,

systems failure and fraud. Management has implemented extensive policies and procedures to both establish

and monitor internal controls to decrease the likelihood of any control breakdowns. Fannie Mae's OÇce of

Auditing also independently tests the adequacy of, and adherence to, internal controls and related policies and

procedures. We actively manage Fannie Mae's operations risk through numerous oversight functions, such as:

‚ Exception reporting and management oversight of Ñnancial and forecasting information through

veriÑcation, reconciliation and independent testing

‚ Management questionnaires that identify key risks, controls in place to mitigate those risks, and control

weaknesses

‚ Key performance indicators (KPIs) that track operational metrics and potential risk exposure

‚ Quarterly senior and executive management internal control certiÑcations

‚ Internal audit work that substantiates the adequacy of the internal control environment as well as direct

reporting of this work to the Audit Committee of the Board of Directors

‚ Comprehensive disaster recovery planning and testing

Management regularly reconciles Ñnancial and accounting information and model results to source

documents to ensure completeness and accuracy of Ñnancial reporting. Financial forecast model results are

regularly reconciled to actual results and the models are recalibrated as necessary to mitigate modeling risk.

The OÇce of Auditing also periodically benchmarks the critical models, evaluates the reasonableness of the

underlying assumptions, and validates the key algorithms embedded within them. Control weaknesses are

identiÑed as well as the steps being taken to address them. The OÇce of Auditing reviews and validates these

assessments for reasonableness and accuracy.

KPIs have been established to monitor primary operational metrics and to facilitate quick and eÅective

senior management attention should any adverse trends develop. KPIs focus on the following operational risks:

‚ Modeling: Losses due to improperly modeled interest rate risk and credit risk

‚ Underwriting EÅectiveness: Losses due to the failure of management or our lender counterparties to

apply appropriate underwriting techniques

‚ Counterparty: Losses due to inadequate monitoring and risk mitigation resulting in exposure to

counterparties who fail to meet their obligations to Fannie Mae. These counterparties include

94
lender/servicers, providers of credit enhancement, document custodians, derivatives counterparties,

and other service providers

‚ Transaction Processing: Losses due to inadequate transaction processing controls, such as ineÅective

management oversight and reconciliation processes. Examples include erroneous wire transfers or loan

deliveries, fraud, trade failures, or release of inaccurate securities information

‚ Systems Availability: Inability to achieve corporate goals due to a lack of systems availability,

consistent performance, or capacity to recover from a disaster

‚ Information Security: Financial loss and incurrence of additional liability due to unauthorized systems

access, corruption or destruction of critical, proprietary or conÑdential data

‚ Mission Alignment: IneÅective leadership or inappropriate business models resulting in litigation,

regulatory sanctions, and reputation damage due to noncompliance with applicable laws, regulations,

and Charter Act requirements

‚ Financial Reporting: Economic and reputational loss or disruption due to erroneous or delayed release

of Ñnancial reports

Each KPI is based upon clearly deÑned and quantiÑable performance thresholds that are monitored by

our OÇce of Auditing. Senior managers are responsible for evaluating and monitoring KPI activity as well as

implementing prompt corrective action. The OÇce of Auditing also tests the integrity of this process on a

periodic basis. The Operations, Transactions and Investments Committee headed by our Chief Operating

OÇcer reviews the KPIs and ensures prompt and eÅective resolutions.

On a quarterly basis, senior and executive management certify that internal controls are adequate,

questionnaires and KPIs are accurate, and that all signiÑcant issues or control weaknesses that could have a

material impact on the Ñnancial statements have been disclosed. The OÇce of Auditing reviews these

certiÑcations for reasonableness. The quarterly certiÑcations are one of the key inputs for our Chief Executive

OÇcer and Chief Financial OÇcer's written certiÑcations that our Ñnancial statements fairly present Fannie

Mae's Ñnancial condition and results of operations in all material respects.

In addition to the oversight functions indicated above, the OÇce of Auditing assesses risk and the

underlying control environment annually throughout the company and then implements a comprehensive

audit plan to assess risk and validate key controls.

The OÇce of Auditing also performs third-party audits as an important part of assessing counterparty

exposure as well as to further substantiate adequacy of related internal controls. A primary example is

performing audits of entities that sell loans to Fannie Mae or who service loans for us. In these audits, we

evaluate the Ñnancial and operational controls of these entities by:

‚ reviewing the Ñnancial statements and assessing compliance with our net worth and insurance coverage

requirements to assess eligibility and capability of doing business with us;

‚ testing cash and custodial accounting controls to ensure both Fannie Mae and borrower funds are held

in qualiÑed institutions and that the funds are properly accounted for, safeguarded and remitted.

‚ determining that key controls associated with loan underwriting, accounting, reporting and servicing

are in place and operating eÅectively, that activity is reported to us accurately and that our mortgage

assets are protected.

Fannie Mae has also developed comprehensive disaster recovery plans covering both systems and

business operations that are designed to restore critical operations with minimal interruption. Major elements

of this plan are tested annually at established contingency sites.

Controls and Procedures

Within 90 days prior to the date of this report, we carried out an evaluation, under the supervision and

with the participation of our Chief Executive OÇcer and Chief Financial OÇcer, of the eÅectiveness of our

95
disclosure controls and procedures. Based on this evaluation, our Chief Executive OÇcer and Chief Financial

OÇcer concluded that our disclosure controls and procedures were eÅective. Disclosure controls and

procedures are controls and procedures that are designed to ensure that information we disclose in our periodic

reports is recorded, processed, summarized, and reported within the designated time periods.

In addition, based on this most recent evaluation, we have concluded that there were no signiÑcant

changes in our internal controls or in other factors that could signiÑcantly aÅect these controls subsequent to

the date of their last evaluation, including any corrective actions with regard to signiÑcant deÑciencies and

material weaknesses.

LIQUIDITY AND CAPITAL RESOURCES

Fannie Mae's statutory mission requires that we provide ongoing assistance to the secondary market for

mortgages. Our ability to continually raise low-cost capital is critical to fulÑlling our housing mission of

providing liquidity to the secondary mortgage market and promoting homeownership to low- and moderateincome families. We primarily rely on debt to purchase mortgage assets and to supply liquidity to the

secondary market. In 2002, our mortgage asset purchases totaled $371 billion based on unpaid principal

balance. We issued $1.874 trillion in debt to fund those purchases and to replace maturing, called or

repurchased debt. We take a long-term approach to our funding and capital management strategy because of

our continuous requirements for large amounts of funding. Fannie Mae's liquidity and capital position is

actively managed to preserve stable, reliable, and cost-eÅective sources of cash to meet all current and future

normal operating Ñnancial commitments, meet our regulatory capital requirements, and handle any unforeseen

liquidity crisis.

Liquidity

Fannie Mae's primary sources of liquidity include proceeds from the issuance of debt, principal and

interest received on our mortgage portfolio, guaranty fees earned on our MBS, and principal and interest

received on our liquid investment portfolio. Primary uses of liquidity include the purchase of mortgage assets,

repayment of debt, interest payments, administrative expenses, taxes, and fulÑllment of Fannie Mae's MBS

guaranty obligations. Our liquid assets totaled $62 billion at December 31, 2002, compared with $76 billion at

December 31, 2001. In 2001, we adopted the 14 principles for sound liquidity management established by the

Basel Committee on Banking Supervision as part of our voluntary safety and soundness initiatives. These

principles outline the appropriate structure for managing liquidity and market access, a process for measuring

and monitoring net funding requirements, the need for contingency plans, the necessary controls for liquidity

risk management, and the role of public disclosure and regulatory oversight. We monitor our liquidity position

through a combination of daily, weekly and monthly reports to help set strategies and make funding decisions.

Our analyses include:

‚ projected cash Öows and funding needs,

‚ targeted funding terms and various funding alternatives for achieving those terms,

‚ cost of debt and the most eÇcient ways to achieve desired funding, and

‚ market conditions and upcoming economic indicators and other factors that could impact the capital

markets and our funding capabilities.

We have historically had ready access to funding for the following reasons:

‚ Our Credit Quality: In February 2001, Standard & Poor's assigned Fannie Mae a AA¿ ""risk to the

government'' rating. In February 2002, Moody's Investors Service assigned us an A¿ Bank Financial

Strength Rating. The highest possible levels for these ratings are AAA from Standard & Poor's and A

from Moody's. These ratings are continuously monitored by each rating agency. Additionally, our

senior unsecured debt has been rated AAA, Aaa, and AAA by Fitch, Inc., Moody's Investors Service,

and Standard & Poor's, respectively. Fitch, Moody's, and Standard & Poor's rated our short-term debt

F1, Prime-1 or P-1, and A-1, respectively.

96
‚ Our Standing in the Capital Market: We are an active participant in the global Ñnancial markets and

one of the world's largest private issuers of debt securities. Our debt obligations are traded in the

""agency securities market.'' The agency securities market includes securities issued by governmentsponsored enterprises (GSEs). While the U.S. government does not guarantee our debt, directly or

indirectly, securities issued by GSEs are typically perceived to be of high credit quality.

‚ Our EÇciency: We have demonstrated a long-term commitment to investors in the organized way we

bring debt issues to market and monitor performance in the secondary market. We have successfully

developed new funding products and markets with a variety of terms and features to appeal to a wide

spectrum of investors. In addition, we may transform the debt into terms and other features that better

match our funding needs through our eÇcient use of derivatives.

Given the importance of debt to our funding strategy, we have a contingency plan to protect us in the

event of a major market disruption that would prevent us from issuing debt. As part of our voluntary safety and

soundness initiatives, we maintain contingency plans for handling a liquidity crisis under an assumption that

we cannot access the new-issue debt markets for a period of at least three months.

Each day we update and analyze cash commitments and anticipated cash Öows for the next 90 days. Our

analysis indicates how we expect to obtain funds during that period in the event we cannot access the capital

markets. In the event of a market disruption in which we could not issue debt, we could liquidate our liquid

investment portfolio or borrow against our mortgage portfolio to meet our operational needs:

‚ Fannie Mae's Liquid Investment Portfolio primarily consists of high-quality securities that are readily

marketable or have short-term maturities and serves as the primary means for ensuring that we

maintain suÇcient liquidity. If our access to the debt capital markets is ever impeded, we Ñrst will

utilize assets in our LIP to generate the cash necessary to meet our liquidity needs. Our initial source of

funds would come from the ongoing maturity of short-term investments in the portfolio. If additional

funds were needed, we would sell assets from the LIP to generate these funds. As part of our voluntary

commitments, we have publicly pledged to maintain a portfolio of high-quality, liquid, nonmortgagerelated securities equal to at least 5 percent of total on-balance-sheet assets. Our LIP and other liquid

assets together totaled $62 billion and $76 billion at December 31, 2002 and 2001, respectively. The

ratio of our liquid assets to total assets was 6.9 percent and 9.5 percent at December 31, 2002 and 2001,

respectively.

‚ Fannie Mae's Mortgage Portfolio consists of assets that could be pledged as collateral for Ñnancing in

the repurchase agreement market. We are able to borrow against Fannie Mae's mortgage assets in the

market for mortgage repurchase agreements. We test this capability through periodic issuance. At

December 31, 2002 and 2001, we had approximately $410 billion and $359 billion, respectively, in

eligible mortgage securities.

At December 31, 2002, we had $85 billion in outstanding mandatory commitments and $3 billion in

outstanding optional commitments for the purchase and delivery of mortgages in 2003. At December 31, 2001,

Fannie Mae had $55 billion in outstanding mandatory commitments and $2 billion in outstanding optional

commitments for the purchase and delivery of mortgages in 2002.

Capital Resources

Core capital (deÑned by OFHEO as the stated value of outstanding common stock, the stated value of

outstanding noncumulative perpetual preferred stock, paid-in capital, and retained earnings, less treasury

stock) grew to $28.1 billion at December 31, 2002 from $25.2 billion at December 31, 2001. Core capital

excludes accumulated other comprehensive income because AOCI incorporates unrealized gains (losses) on

derivatives and certain securities, but not the unrealized losses (gains) on the remaining mortgages and

securities or liabilities used to fund the purchase of these items. Total capital (deÑned by OFHEO as core

capital plus the general allowance for losses) grew to $28.9 billion at year-end 2002 from $26.0 billion at yearend 2001.

97
At December 31, 2002, AOCI totaled negative $11.8 billion, compared with a negative balance of

$7.1 billion at December 31, 2001. Upon adoption of FAS 133 on January 1, 2001, we recorded a $3.9 billion

reduction in AOCI, which was primarily attributable to recording derivatives (mostly pay-Ñxed interest rate

swaps) that qualify as cash Öow hedges on the balance sheet at fair value. The decline in interest rates during

2002 and 2001 caused a decline in the fair value of these derivatives and has reduced AOCI since the adoption

of FAS 133. In conjunction with the adoption of FAS 133, we also, in a non-cash transfer, reclassiÑed

investment securities and MBS with an amortized cost of approximately $20 billion and unrealized gains and

unrealized losses of $164 million and $32 million, respectively, from held-to-maturity to available-for-sale. On

September 13, 2002, concurrent with the implementation of a new risk-based capital rule issued by OFHEO,

we reclassiÑed $135 billion of securities in our mortgage and nonmortgage investment portfolios from held-tomaturity to available-for-sale in accordance with FAS 115. At the time of this noncash transfer, the securities

had gross unrealized gains of $5.503 billion and losses of $59 million. Prior to OFHEO's risk-based capital

rule, Fannie Mae was not subject to a risk-based capital standard. OFHEO's new risk-based capital rule

establishes a risk weight for Fannie Mae's assets. FAS 115 speciÑcally identiÑes ""a signiÑcant increase in the

risk weights of debt securities used for regulatory risk-based capital purposes'' as a change in circumstance

under which a company may reclassify securities from held-to-maturity to available-for-sale without calling

into question the intent to hold other securities to maturity in the future. See ""Government Regulation and

Charter Act Ì Capital Requirements'' for additional information on our risk-based capital rule.

Common shares outstanding, net of shares held in treasury, totaled approximately 989 million and

997 million at December 31, 2002 and 2001, respectively. During 2002, Fannie Mae issued 7.0 million

common shares from treasury to fund our 2001 commitment of $300 million to the Fannie Mae Foundation

and for employee and other stock compensation plans. We issued 4.5 million common shares from treasury

during 2001 for employee and other stock compensation plans. As part of the continuation of our capital

restructuring program, we repurchased 15.4 million common shares at a weighted average cost per share of

$76.01 in 2002 and 6.0 million common shares at a weighted average cost per share of $76.95 in 2001. We

repurchased the stock pursuant to our Board of Directors' approval to repurchase up to 6 percent of

outstanding common shares as of December 27, 1995 (adjusted for a stock split) and to oÅset the dilutive

eÅect of common shares issued in conjunction with various stock compensation programs.

We raised additional equity of $1 billion in 2002 and $400 million in 2001 by issuing Non-Cumulative

Preferred Stock. On February 28, 2002, we redeemed all outstanding shares of our 6.5 percent NonCumulative Preferred Stock, Series B at $50.51458 per share, which represents the stated redemption price of

$50.00 per share plus an amount equal to the dividend for the quarterly dividend period ending March 31,

2002, accrued to, but excluding the redemption date of February 28, 2002. On July 31, 2002, we redeemed all

outstanding shares of our 6.45 percent Non-Cumulative Preferred Stock, Series C at $50.27771 per share,

which represents the stated redemption price of $50.00 per share plus an amount equal to the dividend for the

quarterly dividend period ending September 30, 2002, accrued to, but excluding the redemption date of

July 31, 2002. Preferred stock accounted for 9.5 percent of our core capital at December 31, 2002, versus

9.1 percent at December 31, 2001. On March 18, 2003, we issued 8 million shares or $400 million of variable

rate Non-Cumulative Preferred Stock, Series K.

In January 2003, our Board of Directors approved a quarterly common stock dividend for 2003 of $.39 per

common share. The quarterly dividend rate per common share was $.33 and $.30 in 2002 and 2001,

respectively. Our Board of Directors also approved preferred stock dividends for the period commencing

December 31, 2002, up to but excluding March 31, 2003, as identiÑed in Table 43.

98
Table 43: Preferred Stock Dividends

Shares Issued Stated

and Value Annual Redeemable on or

Issue Date Outstanding per Share Dividend Rate After

Series D ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ September 30, 1998 3,000,000 $50 5.250% September 30, 1999

Series E ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ April 15, 1999 3,000,000 50 5.100 April 15, 2004

Series F ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ March 20, 2000 13,800,000 50 3.540(1) March 31, 2002(3)

Series G ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ August 8, 2000 5,750,000 50 1.830(2) September 30, 2002(3)

Series H ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ April 6, 2001 8,000,000 50 5.810 April 6, 2006

Series IÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ October 28, 2002 6,000,000 50 5.375 October 28, 2007

Series JÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ November 26, 2002 14,000,000 50 3.780(4) November 26, 2004

Total ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 53,550,000

(1) Rate eÅective March 31, 2002. Variable dividend rate that resets every two years thereafter at the Constant Maturity

U.S. Treasury Rate minus .16 percent with a cap of 11 percent per year.

(2) Rate eÅective September 30, 2002. Variable dividend rate that resets every two years thereafter at the Constant

Maturity U.S. Treasury Rate minus .18 percent with a cap of 11 percent per year.

(3) Represents initial call date. Redeemable every two years thereafter.

(4) Initial rate. Variable dividend rate that resets every two years thereafter at the two-year U.S. Dollar Swap Rate plus

1.38 percent with a cap of 8 percent per year.

During 2002, we issued $3.5 billion of subordinated debt securities that received ratings of AA¿ from

Standard & Poor's, Aa2 from Moody's Investors Service, and AA by Fitch Ratings. We issued $5 billion of

subordinated debt securities that received a rating of AA¿ from Standard & Poor's and Aa2 from Moody's

Investors Service in 2001. Subordinated debt serves as a supplement to our equity capital, although it is not a

component of core capital. It provides a risk-absorbing layer to supplement core capital for the beneÑt of

senior debt holders and is intended to serve as a consistent and early market signal of credit risk for investors.

By the end of 2003, we intend to issue suÇcient subordinated debt to bring the sum of total capital and

outstanding subordinated debt to at least 4 percent of on-balance-sheet assets, after providing adequate capital

to support oÅ-balance sheet MBS. Total capital and outstanding subordinated debt represented 3.7 percent of

on-balance-sheet assets at December 31, 2002, compared with 3.4 percent at December 31, 2001.

Regulatory Environment

Fannie Mae is subject to capital adequacy standards established by the Federal Housing Enterprises

Financial Safety and Soundness Act of 1992 (1992 Act) and continuous examination by OFHEO, which was

established by the 1992 Act. The capital adequacy standards require that our core capital equal or exceed a

minimum capital standard and a critical capital standard. The Portfolios and Capital Committee, chaired by

the Chief Financial OÇcer, ensures compliance with economic and regulatory risk-based capital requirements.

Table 44 shows our core capital and total capital at year-end 2002 and 2001 compared with the requirements.

99
Table 44: Capital Requirements

December 31,

2002 2001

(Dollars in

millions)

Core capital(1)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $28,079 $25,182

Required minimum capital(2)(5) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 27,203 24,182

Excess of core capital over minimum capital(5) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 877 $ 1,000

Total capital(3) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $28,871 $25,976

Required risk-based capital ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 17,434 NA

Excess of total capital over required risk-based capital ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $11,437 NA

Required critical capital(4)(5)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $13,880 $12,324

Excess of core capital over required critical capital(5) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 14,199 12,859

(1) The sum of (a) the stated value of common stock; (b) the stated value of outstanding noncumulative perpetual

preferred stock; (c) paid-in capital; and (d) retained earnings less, treasury stock. Core capital excludes accumulated

other comprehensive income (AOCI).

(2) The sum of (a) 2.50 percent of on-balance sheet assets; (b) .45 percent of outstanding MBS; and (c) .45 percent of

other oÅ-balance sheet obligations, which may be adjusted by the Director of OFHEO under certain circumstances

(See 12 CFR 1750.4 for existing adjustments made by the Director of OFHEO).

(3) The sum of (a) core capital and (b) the total allowance for loan losses and guaranty liability, less (c) the speciÑc loss

allowance. SpeciÑc loss allowances totaled $19 million and $13 million at December 31, 2002 and 2001, respectively.

(4) The sum of (a) 1.25 percent of on-balance sheet assets; (b) .25 percent of outstanding MBS; and (c) .25 percent of

other oÅ-balance sheet obligations, which may be adjusted by the Director of OFHEO under certain circumstances.

(5) These amounts do not reÖect the reclassiÑcation from our ""Allowance for loan losses'' to a ""Guaranty liability for

MBS'' the amount associated with the guaranty obligation for MBS that we own that occurred in 2002. See Note 1 to

the notes to the Ñnancial statements, Summary of SigniÑcant Accounting Policies Ì Allowance for Loan Losses and

Guaranty Liability for MBS. The reclassiÑcation will not have a material eÅect on these amounts.

The 1992 Act also established our risk-based capital requirements, and it required OFHEO to adopt

regulations establishing a risk-based capital test. OFHEO published regulations under the 1992 Act in

September 2001, as amended on March 15, 2002, establishing a risk-based capital test to determine the

amount of total capital we must hold under the risk-based capital standard on a quarterly basis. OFHEO

implemented the risk-based capital standard on September 13, 2002. At December 31, 2002, our risk-based

capital requirement was $17.4 billion. Our total capital was $28.9 billion at year-end 2002, $11.4 billion higher

than the risk-based capital requirement.

PERFORMANCE OUTLOOK

We expect Fannie Mae's core business earnings to continue to increase in 2003, although at a growth rate

below the above-average trend rates of 2002 and 2001. We project that our net interest margin will move lower

in 2003 as the beneÑts from the actions we took during 2002 and 2001 to lower our debt costs begin to

diminish. We anticipate some increase in our eÅective average guaranty fee rates because of recent pricing

trends. We also believe that while credit expenses may move higher in 2003, they will remain at historically

low levels. Should economic conditions deteriorate, we believe our book of business is well-positioned to

perform better than in prior slowdowns because of improved loan underwriting through Desktop Underwriter,

lower loan-to-value ratios, more third-party credit enhancements, and superior credit loss mitigation eÅorts.

Our administrative expense growth rate should decline in 2003 but remain above historical levels as we

complete our core infrastructure project and begin to expense stock-based compensation. See ""MD&AÌ

Forward Looking Information.''

100
NEW ACCOUNTING STANDARDS

Accounting for Stock Compensation

We elected to adopt the expense recognition provisions of Financial Accounting Standard No. 123

(""FAS 123''), Accounting for Stock-Based Compensation, eÅective January 1, 2003. In accordance with

FAS 123, we will recognize the fair value of stock-based compensation at grant date over the service period of

the employee as an administrative expense in our income statement. We have elected to apply this change in

accounting prospectively to all awards granted on January 1, 2003 and thereafter. We will continue to account

for stock-based compensation awarded prior to January 1, 2003 under Accounting Principles Board Opinion

No. 25, Accounting for Stock Issued to Employees (""APB 25''). We estimate that the impact of adopting the

expense recognition provisions of FAS 123 will result in additional expense of approximately $28 million in

2003.

Guarantor's Accounting and Disclosure Requirements for Guarantees

In November 2002, FASB issued Interpretation No. 45, Guarantor's Accounting and Disclosure

Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Other (""FIN 45''). FIN 45

will primarily apply to guaranteed MBS issued to investors other than Fannie Mae on or after January 1, 2003

by Fannie Mae as trustee, and it will require that we recognize the fair value of our guarantee on MBS as an

asset and the fair value of our guaranty obligations as a liability. Under FIN 45, we will amortize our guaranty

asset and liability amounts equally over the estimated life of the loans underlying the MBS as an adjustment to

guaranty fee income. There will be no eÅect on Fannie Mae's guaranty fee income or stockholders' equity

from adopting this accounting rule because the guaranty asset and liability will be equal under FIN 45.

Special Purpose Entities (""SPEs'')

In January 2003, the FASB issued FASB Interpretation No. 46, Consolidation of Variable Interest

Entities (""FIN 46''). FIN 46 provides guidance on when a company should include in its Ñnancial statements

the assets, liabilities and activities of a variable interest entity (""VIE''). Under FIN 46, a variable interest

entity must be consolidated by a company if that company is subject to a majority of the risk of loss from the

variable interest entity's activities or entitled to receive a majority of the entity's residual returns or both. We

have not identiÑed any current Fannie Mae arrangements that meet the VIE consolidation criteria of FIN 46.

Therefore, we do not believe that FIN 46 will have a material impact on Fannie Mae. Our oÅ-balance sheet

MBS activities are outside the scope of FIN 46 because we conduct those activities through trusts that are

qualifying SPEs. Our investments in low-income housing tax credit partnerships are also outside the scope of

FIN 46 because they do not meet the deÑnition of variable interest entities.

101
Item 7A. Quantitative and Qualitative Disclosures About Market Risk

Quantitative and qualitative disclosure about market risk is set forth on pages 61 to 72 of this Form 10-K

under the caption ""Management's Discussion and Analysis of Financial Condition and Results of Operations''.

102
Item 8. Financial Statements and Supplementary Data

Page

Financial Statements:

Statements of Income for the years ended December 31, 2002, 2001 and 2000 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 104

Balance Sheets as of December 31, 2002 and 2001 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 105

Statements of Changes in Stockholders' Equity for the years ended December 31, 2002, 2001 and

2000 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 106

Statements of Cash Flows for the years ended December 31, 2002, 2001 and 2000 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 107

Notes to Financial StatementsÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 108

Independent Auditors' Report ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 146

Report of ManagementÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 147

Supplemental Schedules:

Quarterly Results of Operations (unaudited) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 148

Financial and Statistical Summary (unaudited) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 149

103
FANNIE MAE

STATEMENTS OF INCOME

Year Ended December 31,

2002 2001 2000

(Dollars and shares in millions,

except per common share

amounts)

Interest income:

Mortgage portfolioÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $49,265 $46,478 $39,403

Nonmortgage investments and cash equivalents ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 1,588 2,692 3,378

Total interest income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 50,853 49,170 42,781

Interest expense:

Short-term debt ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2,978 5,897 4,204

Long-term debt ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 37,309 35,183 32,903

Total interest expense ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 40,287 41,080 37,107

Net interest income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 10,566 8,090 5,674

Other income:

Guaranty fee incomeÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 1,816 1,482 1,351

Fee and other income (expense), net ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 232 151 (44)

Total other income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2,048 1,633 1,307

Other expenses (income):

Provision for losses ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 128 94 122

Foreclosed property income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (36) (16) (28)

Administrative expenses ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 1,219 1,017 905

Special contribution ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Ì 300 Ì

Purchased options expense ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 4,545 37 Ì

Debt extinguishments, net ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 710 524 (49)

Total other expenses (income) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 6,566 1,956 950

Income before federal income taxes and cumulative eÅect of change in accounting

principle ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 6,048 7,767 6,031

Provision for federal income taxesÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 1,429 2,041 1,583

Income before cumulative eÅect of change in accounting principle ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 4,619 5,726 4,448

Cumulative eÅect of change in accounting principle, net of tax eÅect ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Ì 168 Ì

Net income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 4,619 $ 5,894 $ 4,448

Preferred stock dividends ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 99 138 121

Net income available to common stockholders ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 4,520 $ 5,756 $ 4,327

Basic earnings per common share:

Earnings before cumulative eÅect of change in accounting principle ÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 4.56 $ 5.58 $ 4.31

Cumulative eÅect of change in accounting principle ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Ì .17 Ì

Net earningsÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 4.56 $ 5.75 $ 4.31

Diluted earnings per common share:

Earnings before cumulative eÅect of change in accounting principle ÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 4.53 $ 5.55 $ 4.29

Cumulative eÅect of change in accounting principle ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Ì .17 Ì

Net earningsÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 4.53 $ 5.72 $ 4.29

Cash dividends per common share ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 1.32 $ 1.20 $ 1.12

Weighted-average common shares outstanding:

Basic ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 992 1,000 1,003

Diluted ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 997 1,006 1,009

See Notes to Financial Statements.

104
FANNIE MAE

BALANCE SHEETS

December 31,

2002 2001

(Dollars in millions,

except share stated

values)

Assets

Mortgage portfolio:

Mortgage-related securities:

Held-to-maturity ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $437,932 $509,155

Available-for-saleÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 173,706 32,900

Total ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 611,638 542,055

Loans held-for-investment ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 185,652 165,917

Allowance for loan losses ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (79) (48)

Unamortized premiums (discounts) and deferred price adjustments, net ÏÏÏÏ 337 (2,640)

Loans held-for-sale ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 145 40

Mortgage portfolio, net ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 797,693 705,324

Nonmortgage investments:

Held-to-maturity ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 23,050 38,671

Available-for-saleÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 36,794 35,883

Cash and cash equivalents ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 1,710 1,518

Accrued interest receivableÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 4,915 4,705

Acquired property and foreclosure claims, net ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 1,033 684

Derivatives in gain positions ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 3,666 954

OtherÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 18,654 12,209

Total assetsÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $887,515 $799,948

Liabilities and Stockholders' Equity

Liabilities:

Debentures, notes and bonds, net:

Senior debt:

Due within one year ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $382,412 $343,492

Due after one yearÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 458,600 413,582

Subordinated debt:

Due after one yearÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 9,970 6,393

Total ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 850,982 763,467

Accrued interest payableÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 8,379 8,529

Derivatives in loss positions ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 5,697 5,069

Guaranty liability for MBSÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 729 755

OtherÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 5,440 4,010

Total liabilities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 871,227 781,830

Stockholders' Equity:

Preferred stock, $50 stated value, 100 million shares authorized Ì 53.6 million shares

issued and outstanding in 2002 and 46 million shares issued and outstanding in 2001 2,678 2,303

Common stock, $.525 stated value, $1.32 of dividends per share paid in 2002 and

$1.20 of dividends per share paid in 2001, no maximum authorization Ì

1,129 million shares issued ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 593 593

Additional paid-in capital ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 1,839 1,651

Retained earnings ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 29,385 26,175

Accumulated other comprehensive loss ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (11,792) (7,065)

22,703 23,657

Less: Treasury stock, at cost, 140 million shares in 2002 and 132 million shares in

2001ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 6,415 5,539

Total stockholders' equity ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 16,288 18,118

Total liabilities and stockholders' equity ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $887,515 $799,948

See Notes to Financial Statements.

105
FANNIE MAE

STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY

Accumulated

Net Common Additional Other Total

Shares Preferred Common Paid-In Retained Comprehensive Treasury Stockholders'

Outstanding Stock Stock Capital Earnings (Loss) Income Stock Equity

(Dollars and shares in millions)

Balance, January 1, 2000 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 1,019 $1,300 $593 $1,585 $18,417 $ (246) $(4,020) $17,629

Comprehensive income:

Net income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Ì Ì Ì Ì 4,448 Ì Ì 4,448

Other comprehensive income, net of tax

eÅect:

Unrealized gains on available-for-sale

securitiesÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Ì Ì Ì Ì Ì 256 Ì 256

Total comprehensive income ÏÏÏÏÏÏÏÏÏÏÏ 4,704

Dividends ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Ì Ì Ì Ì (1,246) Ì Ì (1,246)

Shares repurchased ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (25) Ì Ì Ì Ì Ì (1,406) (1,406)

Preferred stock issued ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Ì 978 Ì (10) Ì Ì Ì 968

Treasury stock issued for stock options and

beneÑt plans ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 5 Ì Ì 13 Ì Ì 176 189

Balance, December 31, 2000 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 999 2,278 593 1,588 21,619 10 (5,250) 20,838

Comprehensive income:

Net income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Ì Ì Ì Ì 5,894 Ì Ì 5,894

Other comprehensive income, net of tax

eÅect:

Transition adjustment from the

adoption of FAS 133. ÏÏÏÏÏÏÏÏÏÏÏÏÏ Ì Ì Ì Ì Ì (3,972) Ì (3,972)

Unrealized gain on securities

transferred to available-for-sale ÏÏÏÏÏ Ì Ì Ì Ì Ì 86 Ì 86

Net cash Öow hedging losses ÏÏÏÏÏÏÏÏÏ Ì Ì Ì Ì Ì (3,387) Ì (3,387)

Unrealized gains on available-for-sale

securitiesÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Ì Ì Ì Ì Ì 198 Ì 198

Total comprehensive loss ÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (1,181)

Dividends ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Ì Ì Ì Ì (1,338) Ì Ì (1,338)

Shares repurchased ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (6) Ì Ì Ì Ì Ì (464) (464)

Preferred stock issued ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Ì 400 Ì (4) Ì Ì Ì 396

Preferred stock redeemed ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Ì (375) Ì Ì Ì Ì Ì (375)

Treasury stock issued for stock options and

beneÑt plans ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 4 Ì Ì 67 Ì Ì 175 242

Balance, December 31, 2001 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 997 2,303 593 1,651 26,175 (7,065) (5,539) 18,118

Comprehensive income:

Net income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Ì Ì Ì Ì 4,619 Ì Ì 4,619

Other comprehensive income, net of tax

eÅect:

Net cash Öow hedging losses ÏÏÏÏÏÏÏÏÏ Ì Ì Ì Ì Ì (8,892) Ì (8,892)

ReclassiÑcation of securities from heldto-maturity to available-for-sale

under FAS 115. ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Ì Ì Ì Ì Ì 3,539 Ì 3,539

Unrealized gains on available-for-sale

securitiesÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Ì Ì Ì Ì Ì 626 Ì 626

Total comprehensive loss ÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (108)

Dividends ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Ì Ì Ì Ì (1,409) Ì Ì (1,409)

Shares repurchased ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (15) Ì Ì Ì Ì Ì (1,167) (1,167)

Preferred stock issued ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Ì 1,000 Ì (9) Ì Ì Ì 991

Preferred stock redeemed ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Ì (625) Ì Ì Ì Ì Ì (625)

Treasury stock issued for stock options and

beneÑt plans ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 3 Ì Ì 61 Ì Ì 127 188

Treasury stock issued for special

contribution ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 4 Ì Ì 136 Ì Ì 164 300

Balance, December 31, 2002 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 989 $2,678 $593 $1,839 $29,385 $(11,792) $(6,415) $16,288

See Notes to Financial Statements.

106
FANNIE MAE

STATEMENTS OF CASH FLOWS

Year Ended December 31,

2002 2001 2000

(Dollars in millions)

Cash Öows from operating activities:

Net income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 4,619 $ 5,894 $ 4,448

Adjustments to reconcile net income to net cash provided by (used in)

operating activities:

Amortization of discount/premium and deferred price adjustments ÏÏÏÏ 5,801 11,045 10,278

Provision for losses ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 128 94 122

Loss (gain) on debt extinguishmentsÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 710 524 (49)

Cumulative eÅect of change in accounting principle, net of taxÏÏÏÏÏÏÏÏ Ì (168) Ì

Purchased options expense ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 4,545 37 Ì

Deferred income taxes ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (1,626) (190) 161

Other decreases, netÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (2,039) (2,904) (659)

Net cash provided by operating activities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 12,138 14,332 14,301

Cash Öows from investing activities:

Mortgage portfolio purchases ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (373,169) (270,609) (153,837)

Proceeds from sales from mortgage portfolio ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 9,691 8,967 10,599

Mortgage portfolio principal repayments ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 274,941 164,408 56,568

Net proceeds from disposition of foreclosed properties ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2,281 1,827 1,962

Purchases of held-to-maturity nonmortgage investmentsÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (1,819,326) (1,359,614) (1,184,924)

Maturities of held-to-maturity nonmortgage investments ÏÏÏÏÏÏÏÏÏÏÏÏÏ 1,823,915 1,343,328 1,173,546

Purchases of available-for-sale nonmortgage investments ÏÏÏÏÏÏÏÏÏÏÏÏÏ (54,534) (78,632) (13,610)

Maturities of available-for-sale nonmortgage investments ÏÏÏÏÏÏÏÏÏÏÏÏÏ 58,617 68,269 1,190

Proceeds from sales of available-for-sale nonmortgage investments ÏÏÏÏÏ 6,158 7,193 8,995

Net cash used in investing activities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (71,426) (114,863) (99,511)

Cash Öows from Ñnancing activities:

Proceeds from issuance of long-term debtÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 238,252 249,454 110,298

Payments to redeem long-term debt ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (175,809) (196,610) (49,769)

Proceeds from issuance of short-term debt ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 1,631,404 1,746,381 1,130,698

Payments to redeem short-term debtÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (1,620,644) (1,690,806) (1,104,694)

Proceeds from zero-coupon swap callsÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 478 203 Ì

Net payments to purchase or settle hedge instruments ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (12,119) (5,569) (1,245)

Net payments from stock activities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (2,082) (1,621) (1,560)

Net cash provided by Ñnancing activities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 59,480 101,432 83,728

Net increase (decrease) in cash and cash equivalentsÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 192 901 (1,482)

Cash and cash equivalents at beginning of year ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 1,518 617 2,099

Cash and cash equivalents at end of year ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 1,710 $ 1,518 $ 617

Supplemental disclosures of cash Öow information:

Cash paid during the year for:

Interest ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 40,401 $ 40,361 $ 34,863

Income taxesÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 3,032 2,088 1,595

See Notes to Financial Statements.

107
FANNIE MAE

NOTES TO FINANCIAL STATEMENTS

1. Summary of SigniÑcant Accounting Policies

Fannie Mae is a federally chartered and stockholder-owned corporation operating in the residential

mortgage Ñnance industry.

We prepare our Ñnancial statements in conformity with accounting principles generally accepted in the

United States of America. These principles require us to make estimates and assumptions that aÅect the

reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the

Ñnancial statements, and the reported amounts of revenues and expenses during the reporting period. Actual

results could diÅer from those estimates. We have reclassiÑed certain amounts in prior years' Ñnancial

statements to conform to the current presentation.

Principles of Consolidation

We regularly invest in qualiÑed low-income housing tax credit partnerships as a limited partner. In

accordance with American Institute of CertiÑed Public Accountants (AICPA) Statement of Position 78-9,

Accounting for Investments in Real Estate Ventures, we typically do not consolidate these partnerships

because we are a limited partner and do not have voting rights or control the activities of these partnerships.

We account for these non-consolidated investments using the equity method of accounting. Under the equity

method of accounting, we record the amount of our investment as an asset on our balance sheet. We recognize

our share of partnership income or losses in the income statement line item ""Fee and other income, net'' with

an oÅset to the investment account on our balance sheet. Partnership losses reduce the size of our asset and

partnership income increases our asset. We account for any cash received from these partnerships as a return

of investment and reduce the asset balance. These limited partnership investments are qualiÑed aÅordable

housing projects that are eligible for tax credits. We record these tax credits as a reduction in our provision for

federal income taxes in the income statement when received. We regularly evaluate these investments for

impairment. If there is other-than-temporary impairment in the value of these investments, we recognize the

decline in value as an expense in ""Fee and other income, net.'' If an investment grade third party guarantees

the return on these investments, we account for the investments using the eÅective yield method according to

Emerging Issues Task Force Issue No. 94-1, Accounting for Tax BeneÑts Resulting from Investments in

AÅordable Housing Projects. Under this method, we recognize tax credits as they are allocated to us and

amortize the initial cost of the investment to provide a level yield over the period we are allocated tax credits.

We recognize both the tax credits and the amortization of the investment, net of taxes, in the provision for

federal income taxes.

We also sponsor trusts that facilitate the issuance of Fannie Mae mortgage-backed securities (MBS).

MBS include real estate mortgage investment conduits (REMICs). In this capacity, we serve as trustee for

the creation and issuance of these MBS. To create MBS, lenders transfer loans to us and we immediately

transfer these loans into a trust and deliver certiÑcates to the lender or other purchaser. These certiÑcates

represent beneÑcial interests in the loans underlying the MBS that are held in trust. The trust pays us to

guarantee the timely payment of scheduled principal and interest on MBS to investors. To create REMICs,

investors transfer loans, MBS, or mortgage-related securities to us and we immediately transfer them into a

trust and deliver certiÑcates to the investor. These REMIC certiÑcates represent beneÑcial interests in the

underlying collateral held in trust by us.

The loans underlying MBS and the collateral underlying REMICs are not our assets, and we do not

reÖect them on our balance sheet unless our portfolio investment business buys them. In accordance with

Financial Accounting Standard No. 140, Accounting for Transfers and Servicing of Financial Assets and

Extinguishments of Debt (FAS 140), we do not consolidate the trusts used to issue MBS because these trusts

meet the deÑnition of a qualifying special purpose entity. We recognize a guaranty liability for estimated losses

on our guaranty obligation in accordance with Financial Accounting Standard No. 5, Accounting for

108
FANNIE MAE

NOTES TO FINANCIAL STATEMENTS Ì (Continued)

Contingencies (FAS 5). For more information on the accounting for our guaranty, refer to the sections in this

footnote entitled ""Guaranteed Mortgage-Related Securities,'' ""Mortgage-Related Securities,'' and ""Allowance for Loan Losses and Guaranty Liability for MBS.''

Mortgage Portfolio

Loans

Loans are mortgage loans. We classify mortgages that we have the original intent at the time of purchase

to hold for investment purposes as ""held-for-investment.'' We measure these assets at their unpaid principal

balance (UPB) adjusted for unamortized purchase discount or premium and other deferred price adjustments.

We classify mortgages that we intend to sell as ""held-for-sale.'' We measure mortgages held-for-sale at the

lower of cost or market, determined on a portfolio basis, with any unrealized losses included in current period

earnings.

In accordance with Financial Accounting Standard No. 91, Accounting for Nonrefundable Fees and

Costs Associated with Originating or Acquiring Loans and Initial Direct Costs of Leases (FAS 91), we use

actual principal prepayment experience and estimate future principal prepayments to calculate the constant

eÅective yield necessary to apply the interest method in the amortization of purchase discount or premium and

other deferred price adjustments. We aggregate loans by similar characteristics such as loan type, acquisition

date, interest rate, and maturity to evaluate prepayments. We use historical prepayment data and expected

prepayment performance under varying interest rate scenarios to estimate future prepayments.

We do not accrue interest income on nonperforming loans. We classify conventional single-family and

multifamily loans as nonperforming and reverse previously accrued interest against current period income

when the loan is 90 days or more delinquent and we estimate the interest to be uncollectible. We return loans

to accrual status when the borrower is less than 90 days delinquent because the probability of default is low

and management believes collections of future payments are reasonably assured.

Pursuant to our guaranty obligation, we are required to purchase at par a loan underlying MBS pools

when the borrower has not made a payment for 24 consecutive months. We have the option under the terms of

the trust indenture to purchase the loan out of the pool after the borrower has missed their fourth consecutive

payment. We usually purchase the loan out of the pool after the fourth consecutive missed payment. When the

loan is purchased out of the pool, we record the loan at its approximate fair value. When estimating fair value,

we take into account the underlying real-estate collateral, estimated costs to sell, and estimated receipts from

third-party credit enhancements.

Mortgage-Related Securities

We classify mortgage-related securities that we have the ability and positive intent to hold to maturity as

""held-to-maturity.'' We measure these assets at their unpaid principal balance adjusted for unamortized

purchase discount or premium and other deferred price adjustments. We classify mortgage-related securities

that we intend to hold for an undetermined period, but not necessarily to maturity, as ""available-for-sale.'' We

measure available-for-sale mortgage-related securities at fair value with any valuation adjustments reported as

a component of accumulated other comprehensive income (AOCI), net of deferred taxes, in stockholders'

equity. We use the speciÑc identiÑcation method for determining cost in computing realized gains or losses on

these assets. Realized gains or losses from the sale of these investments are recognized through the ""Fee and

other income, net'' line item on the income statement. We classify and account for these investments as either

held-to-maturity or available-for-sale, according to Financial Accounting Standard No. 115, Accounting for

Certain Investments in Debt and Equity Securities (FAS 115).

We record impairment for mortgage-related securities held in our mortgage portfolio by determining

whether an other-than-temporary decline in fair value below a security's amortized cost basis has occurred. If

109
FANNIE MAE

NOTES TO FINANCIAL STATEMENTS Ì (Continued)

such a decline has occurred, the cost basis of the security is written down to fair value and is accounted for as a

realized loss through the ""Fee and other income, net'' line item on the income statement. The new cost basis is

not changed for subsequent recoveries in fair value.

We also provide a guaranty liability on mortgage-related securities held in the mortgage portfolio that are

guaranteed by Fannie Mae because we have the risk of loss of individual loans underlying these securities. See

""Summary of SigniÑcant Accounting Policies Ì Allowance for Loan Losses and Guaranty Liability for

MBS'' for further discussion.

In accordance with FAS 91, we use actual principal prepayment experience and estimate future principal

prepayments to calculate the constant eÅective yield necessary to apply the interest method in the

amortization of purchase discount or premium and other deferred price adjustments. We aggregate mortgagerelated securities by similar characteristics such as loan type, acquisition date, interest rate, and maturity to

evaluate prepayments. We use historical prepayment data and expected prepayment performance under

varying interest rate scenarios to estimate future prepayments.

Nonmortgage Investments

Nonmortgage investments consist of our liquid investment portfolio (LIP) and other investments. We

classify and account for these investments as either held-to-maturity or available-for-sale, according to

FAS 115. We measure held-to-maturity securities at historical cost, adjusted for unamortized discount or

premium. We measure available-for-sale securities at fair value as of the balance sheet date, with any

valuation adjustments reported as a component of AOCI, net of deferred taxes, in stockholders' equity. We

use the speciÑc identiÑcation method for determining a security's cost basis in computing realized gain or loss.

We accrue interest income unless the collection of interest income is considered doubtful. If collection of

interest is doubtful, we recognize interest income on a cash basis. We regularly evaluate these investments for

impairment. If there is other-than-temporary impairment in the value of these investments, we recognize the

decline in value as an expense in ""Fee and other income, net.''

Guaranteed Mortgage-Related Securities

We charge a guaranty fee in return for guaranteeing the timely payment of scheduled principal and

interest on MBS and other mortgage-related securities to investors. We accrue and collect guaranty fees

monthly based on a Ñxed rate multiplied by the outstanding balance of the guaranteed MBS and other

mortgage-related securities. We apply the eÅective yield method of accounting and amortize any upfront

guaranty fee price adjustments over the estimated life of the loans underlying the MBS and other mortgagerelated securities. For MBS and other mortgage-related securities not held in our mortgage portfolio, we

record the guaranty fee in ""Guaranty fee income.'' For MBS and other mortgage-related securities held in our

mortgage portfolio, we record the guaranty fee in ""Interest income.''

In November 2002, the Financial Accounting Standards Board (FASB) issued Interpretation No. 45:

Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of

Indebtedness of Others. We are required to provide disclosures about guarantees beginning with our

December 31, 2002 Ñnancial statements. The disclosures are located in Footnote 14, ""Financial Instruments

with OÅ-Balance-Sheet Risk.'' The new interpretation also will require us to recognize the fair value of our

MBS guaranty fee and other guaranty fees as assets and the fair value of our MBS guaranty obligation and

other guaranty obligations as liabilities for MBS and other guarantees issued by us to investors other than

Fannie Mae on or after January 1, 2003. Under this interpretation, we will record an asset representing the fair

value of the guaranty along with a liability of equal value. We will amortize the asset and the liability over the

estimated life of the loans underlying the MBS or other guarantees as an adjustment to guaranty fee income.

However, because the asset and liability will be equal and the amortization rates will be the same, there will be

no net eÅect on guaranty fee income or stockholders' equity.

110
FANNIE MAE

NOTES TO FINANCIAL STATEMENTS Ì (Continued)

Allowance for Loan Losses and Guaranty Liability for MBS

We have an allowance for loan losses for loans in the mortgage portfolio (excluding loans held-for-sale).

The allowance for loan losses is included in the balance sheet under ""Mortgage portfolio, net.'' We also have a

guaranty liability for loans underlying MBS held by us or other investors, which is included in the balance

sheet under ""Guaranty liability for MBS.''

The allowance for loan losses and the guaranty liability for MBS represent our estimate of probable credit

losses arising from loans and loans underlying Fannie Mae MBS we own as well as MBS we guarantee for

others as of the balance sheet date. We perform regular, ongoing reviews to identify probable losses. We

monitor delinquency, default, loss rates, and other portfolio risk characteristics. These risk characteristics

include geographic concentration, loan-to-value ratio, mortgage product type, and loan age.

We increase the allowance for loan losses and the guaranty liability for MBS by recording a provision for

losses in the income statement. Charge-oÅs reduce the allowance or guaranty liability and loan recoveries

increase the allowance or guaranty liability. We consider current delinquency levels, historical loss experience,

current economic conditions, and mortgage characteristics when evaluating the adequacy of our allowance and

guaranty liability.

We determine the adequacy of the allowance and guaranty liability for single-family assets by evaluating

risk characteristics such as product type, original loan-to-value ratio, and loan age. We estimate defaults for

each risk characteristic based on historical experience and apply a historical severity to each risk category, in

accordance with FAS 5. In addition, we apply Financial Accounting Standard No. 114, Accounting by

Creditors for Impairment of a Loan (FAS 114), to determine the amount of impairment on speciÑc loans that

have been restructured. We charge-oÅ single-family loans when we foreclose on the loans.

We divide multifamily's allowance and guaranty liability into two parts: loans that are impaired and loans

that are not impaired. A loan is impaired when, based on current information and events, it is probable we will

be unable to collect all amounts due according to the contractual terms of the loan agreement. We apply

FAS 114 to determine the amount of impairment on speciÑc loans that are not performing according to

contractual terms. We apply FAS 5 to loans that are not individually assessed for impairment and set up an

allowance for loan losses or guaranty liability for probable losses as of the balance sheet date. We individually

rate loans and segment them into the main risk categories that we use to monitor the multifamily portfolio.

We then apply historical default rates and a corresponding severity to the loans in each segment.

In 2002, we reclassiÑed from our ""Allowance for loan losses'' to ""Guaranty liability for MBS'' the

amount associated with the guaranty obligation for MBS that we own. The guaranty liability for MBS

associated with MBS guaranteed for others has historically been included in the caption ""Other liabilities'' on

the balance sheet. The balance sheet line item ""Guaranty liability for MBS'' now includes the liability

associated with MBS on the balance sheet and MBS guaranteed for others. Prior period balances have been

restated to reÖect this reclassiÑcation.

We previously recorded gains from the sale of foreclosed properties and related mortgage insurance

claims against our allowance for loan losses and guaranty liability as a recovery of charge-oÅs. During 2002,

we reclassiÑed these gains to ""Foreclosed property income''. Additionally, the AICPA rescinded Statement of

Position 92-3, Accounting for Foreclosed Assets (SOP 92-3), during the fourth quarter of 2002. Under

SOP 92-3, we recorded selling costs related to the disposition of foreclosed properties in our income statement

under ""Foreclosed property income''. We now include selling costs in our initial charge-oÅ estimate. All prior

periods have been reclassiÑed to conform to the current year presentation. The reclassiÑed amounts result in

equal and oÅsetting changes to our ""Provision for losses'' and ""Foreclosed property income'' line items within

111
FANNIE MAE

NOTES TO FINANCIAL STATEMENTS Ì (Continued)

our previously reported income statements. These reclassiÑcations have no impact on previously reported net

income, total credit-related expenses, or the balance of the allowance for losses.

Acquired Property

We measure foreclosed assets at fair value, less estimated cost to sell, at the time of foreclosure. Fair

value is determined based on the estimated net proceeds the company will receive from the disposition of the

foreclosed asset. We charge subsequent changes in the collateral's fair value as well as foreclosure, holding,

and disposition costs, directly to earnings through foreclosed property income.

We account for and classify deeds in lieu of foreclosure similar to foreclosures. Our accounting for

preforeclosure sales of properties by the borrower is slightly diÅerent because we do not have title to the

underlying properties. In a preforeclosure situation, the loan remains in the mortgage-related security or our

mortgage portfolio until the borrower sells the property. At that point, we reduce the carrying amount of the

mortgage loan and create a receivable for the sale proceeds in the amount of the sales price. We classify the

receivable for the sale proceeds as part of ""Acquired property and foreclosure claims, net'' on the balance

sheet. If there is any remaining investment in the mortgage loan, we charge oÅ the mortgage loan against the

allowance for loan losses or guaranty liability for MBS. If the sale proceeds exceed the mortgage loan balance,

we record it in ""Foreclosed property income'' on the income statement.

Derivative Instruments and Hedging Activities

On January 1, 2001, we adopted Financial Accounting Standard No. 133, Accounting for Derivative

Instruments and Hedging Activities (FAS 133), as amended by Financial Accounting Standard No. 138,

Accounting for Certain Derivative Instruments and Certain Hedging Activities. Under FAS 133, we recognize

all derivatives as either assets or liabilities on the balance sheet at their fair value. Subject to certain qualifying

conditions, we may designate a derivative as either a hedge of the cash Öows of a variable-rate instrument or

anticipated transaction (cash Öow hedge) or a hedge of the fair value of a Ñxed-rate instrument (fair value

hedge). For a derivative qualifying as a cash Öow hedge, we report fair value gains or losses in a separate

component of AOCI, net of deferred taxes, in stockholders' equity to the extent the hedge is eÅective. We

recognize these fair value gains or losses in earnings during the period(s) in which the hedged item aÅects

earnings. For a derivative qualifying as a fair value hedge, we report fair value gains or losses on the derivative

in earnings along with fair value gains or losses on the hedged item attributable to the risk being hedged. For a

derivative not qualifying as a hedge, or components of a derivative that are excluded from any hedge

eÅectiveness assessment, we report fair value gains and losses in earnings.

If a derivative no longer qualiÑes as a cash Öow or fair value hedge, we discontinue hedge accounting

prospectively. We continue to carry the derivative on the balance sheet at fair value and record fair value gains

and losses in earnings until the derivative is settled. For discontinued cash Öow hedges, we recognize the gains

or losses previously deferred in AOCI in earnings in the same period(s) that the hedged item aÅects earnings.

For discontinued fair value hedges, we no longer adjust the carrying amount of the hedged asset or liability for

changes in its fair value. We then amortize previous fair value adjustments to the carrying amount of the

hedged item to earnings over the remaining life of the hedged item using the eÅective yield method.

Our adoption of FAS 133 on January 1, 2001, resulted in a cumulative after-tax increase in income of

$168 million and an after-tax reduction in AOCI of $3.9 billion. In addition, we reclassiÑed investment

securities and MBS with an amortized cost of approximately $20 billion from held-to-maturity to availablefor-sale upon the adoption of FAS 133. At the time of this noncash transfer, we had gross unrealized gains and

losses of $164 million and $32 million, respectively, on these securities.

112
FANNIE MAE

NOTES TO FINANCIAL STATEMENTS Ì (Continued)

We reÖect payments to purchase and terminate derivatives used as hedges of our debt as ""net payments

to purchase or settle hedge instruments'' in our cash Öow statement. We classify these payments as Ñnancing

activities because we use these derivatives as hedges of our funding costs.

During the fourth quarter of 2002, we reÑned our methodology for estimating the initial time value of

interest rate caps at the date of purchase and prospectively adopted a preferred method that resulted in a

$282 million pre-tax reduction in purchased options expense and increased our diluted earnings per share for

2002 by $.18. Under our previous valuation method, we treated the entire premium paid on purchased ""at-themoney'' caps as time value with no allocation to intrinsic value. Our new methodology allocates the initial

purchase price to reÖect the value of individual caplets, some of which are above the strike rate of the cap,

which results in a higher intrinsic value and corresponding lower time value at the date of purchase. This

approach is more consistent with our estimation of time value subsequent to the initial purchase date. This

change does not aÅect the total expense that will be recorded in our income statement over the life of our caps.

Cash and Cash Equivalents

We consider highly liquid investment instruments with an original maturity of three months or less to be

cash equivalents. We record cash equivalents at cost. Cost is representative of fair value for these instruments

because changes in short-term interest rates should have a minimal impact on the fair value of securities that

have an original term of three months or less.

Administrative Expenses

Administrative expenses include those costs we incur to run our daily operations. A signiÑcant component

of administrative expenses is compensation expense, which totaled $683 million in 2002, $602 million in 2001,

and $541 million in 2000.

Debt Extinguishments

During the second quarter of 2002, we adopted Financial Accounting Standard No. 145, Rescission of

FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections

(FAS 145). This standard eliminates the extraordinary treatment of gains and losses on debt and related

interest rate swaps for us because the early extinguishment of debt is an ordinary and frequent part of our

business. We reclassiÑed all prior periods to conform to the new classiÑcation.

Income Taxes

We establish deferred federal income tax assets and liabilities for temporary diÅerences between Ñnancial

and taxable income. We measure these deferred amounts using the current marginal statutory tax rate. We

generally recognize investment and other tax credits when we record these items on the tax return.

Comprehensive Income

Comprehensive income is the change in equity, on a net of tax basis, resulting from transactions and other

events and circumstances from nonowner sources during a period. It includes all changes in equity during a

period, except those resulting from investments by owners and distributions to owners.

Special Contribution

We made a commitment during the fourth quarter of 2001 to contribute $300 million of Fannie Mae

common stock to the Fannie Mae Foundation. The Fannie Mae Foundation creates aÅordable homeownership and housing opportunities through innovative partnerships and initiatives that build healthy, vibrant

communities across the United States. It is a separate, private nonproÑt organization that is not consolidated

113
FANNIE MAE

NOTES TO FINANCIAL STATEMENTS Ì (Continued)

by Fannie Mae, but is supported solely by Fannie Mae. Fannie Mae acquired the shares through open market

purchases and contributed the shares to the Foundation in the Ñrst quarter of 2002.

Stock-Based Compensation

At December 31, 2002, we had Ñve stock-based compensation or beneÑts programs that we describe in

Footnote 8, Stock-Based Compensation Plans. Financial Accounting Standard No. 123, Accounting for StockBased Compensation (FAS 123), gives companies the option of either recording an expense for all stock

compensation awards based on the fair value at grant date or continuing to follow Accounting Principles Board

Opinion No. 25 (APB 25). Companies that follow APB 25 must disclose, in a footnote, pro forma net income

and earnings per share as if they had adopted the expense recognition provisions of FAS 123. Prior to January

2003, we elected to apply APB 25 and related interpretations in accounting for our plans. As a result of

applying APB 25, we did not recognize compensation expense for nonqualiÑed stock options and the

Employee Stock Purchase Plan. We have elected to change our accounting for stock-based compensation and

will record expense for all future stock compensation awards at fair value at grant date under FAS 123

beginning on January 1, 2003. We estimate that the impact of adopting the expense recognition provisions of

FAS 123 will result in additional expense of approximately $28 million in 2003.

In accordance with the disclosure requirements of Financial Accounting Standard No. 148, Accounting

for Stock-Based Compensation Ì Transition and Disclosure (FAS 148), the following table summarizes our

net income available to common stockholders and reported basic and diluted earnings per common share for

the years 2000-2002 under APB 25, as well as proforma net income available to common stockholders and

basic and diluted earnings per common share if we had recognized compensation expense according to

FAS 123.

2002 2001 2000

(Dollars in millions,

except per share amounts)

Net income available to common stockholders, as reportedÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $4,520 $5,756 $4,327

Plus: Stock-based employee compensation expense recorded under APB 25, net of related

tax eÅects ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 25 27 31

Less: Stock-based employee compensation expense determined under fair value based

method, net of related tax eÅects ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (105) (96) (80)

Pro forma net income available to common stockholders ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $4,440 $5,687 $4,278

Earnings per share:

Basic Ì as reportedÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 4.56 $ 5.75 $ 4.31

Basic Ì pro formaÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 4.47 5.69 4.26

Diluted Ì as reported ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 4.53 5.72 4.29

Diluted Ì pro forma ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 4.45 5.65 4.24

We determined the fair value of our stock-based compensation using a Black-Scholes pricing model. The

following table summarizes the major assumptions used in the model.

2002 2001 2000

Risk-free rate(1)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 3.235-4.995% 3.885-5.155% 5.085-6.815%

Volatility ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 31-33% 33-34% 29-34%

Dividend(2)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $1.32 $1.20 $1.12

Average expected life ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 6 yrs. 5 yrs. 5 yrs.

(1) The synthetic 6-year zero-coupon U.S. Treasury strip yield formed by interpolating between the 5-year and 7-year

zero-coupon U.S. Treasury strip yields in 2002.

(2) Dividend rate on common stock at date of grant. Dividend rate assumed to remain constant over the option life.

114
FANNIE MAE

NOTES TO FINANCIAL STATEMENTS Ì (Continued)

2. Mortgage Portfolio, Net(1)

The mortgage portfolio, net is composed of whole loans and securities backed by loans. The following

presents the composition of these two components at December 31,

2002 2001

(Dollars in

millions) Mortgages

Single-family:

Government insured or guaranteed ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 5,458 $ 5,070

Conventional:

Long-term, Ñxed-rate ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 103,220 96,417

Intermediate-term, Ñxed-rate(2) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 54,503 43,522

Adjustable-rateÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 9,045 10,410

Total conventional single-family ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 166,768 150,349

Total single-familyÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 172,226 155,419

Multifamily:

Government insured or guaranteed ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 1,353 1,551

Conventional ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 12,218 8,987

Total multifamily ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 13,571 10,538

Unamortized premium (discount) and deferred price adjustments ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 337 (2,640)

Allowance for loan losses(3) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (79) (48)

Total mortgages ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $186,055 $163,269

Mortgage-related securities

Single-family:

Government insured or guaranteed ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 33,293 $ 37,111

Conventional:

Long-term, Ñxed-rate ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 510,435 456,046

Intermediate-term, Ñxed-rate(2) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 39,409 25,890

Adjustable-rateÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 13,946 10,355

Total conventional single-family ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 563,790 492,291

Total single-familyÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 597,083 529,402

Multifamily:

Government insured or guaranteed ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 7,370 6,481

Conventional ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 7,050 5,636

Total multifamily ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 14,420 12,117

Unamortized premium ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 135 536

Total mortgage-related securities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $611,638 $542,055

Mortgage portfolio, net

Single-family:

Government insured or guaranteed ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 38,751 $ 42,181

Conventional:

Long-term, Ñxed-rate ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 613,655 552,463

Intermediate-term, Ñxed-rate(2) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 93,912 69,412

Adjustable-rateÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 22,991 20,765

Total conventional single-family ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 730,558 642,640

Total single-familyÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 769,309 684,821

Multifamily:

Government insured or guaranteed ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 8,723 8,032

Conventional ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 19,268 14,623

Total multifamily ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 27,991 22,655

Total mortgage portfolio ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 797,300 707,476

Unamortized premium (discount) and deferred price adjustments, net ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 472 (2,104)

Allowance for loan losses(3) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (79) (48)

Mortgage portfolio, net ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $797,693 $705,324

(1) Data represents unpaid principal balance adjusted to include mark-to-market gains and losses on available-for-sale securities.

(2) Intermediate-term, Ñxed-rate consists of portfolio loans with contractual maturities at purchase equal to or less than 20 years and

MBS and mortgage-related securities held in portfolio with maturities of 15 years or less at issue date.

(3) Allowance for loan losses does not apply to loans held-for-sale of $145 million and $40 million at December 31, 2002 and 2001,

respectively.

115
FANNIE MAE

NOTES TO FINANCIAL STATEMENTS Ì (Continued)

Nonaccrual loans totaled $5.5 billion and $3.7 billion at December 31, 2002 and 2001, respectively.

Accruing loans past 90 days due totaled $673 million and $565 million at December 31, 2002 and 2001,

respectively.

At December 31, 2002 and 2001, the balance of whole loans held for sale was $145 million and

$40 million, respectively. There were no gross realized gains or losses on sales of whole loans held for sale in

2002, 2001, or 2000.

Within the mortgage portfolio are MBS and other mortgage-related securities that we classify as either

held-to-maturity or available-for-sale. Below is a table of the securities held in each of these categories along

with their gross unrealized gains and losses and total fair value for the years ending 2002 and 2001.

December 31, 2002

Gross Gross

Amortized Unrealized Unrealized Fair

Cost(1) Gains Losses Value

(Dollars in millions)

Held-to-maturity:

MBS(2)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $286,422 $11,173 $ (1) $297,594

REMICs and Stripped MBS ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 110,423 4,339 (87) 114,675

Other mortgage-related securities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 41,087 2,813 (45) 43,855

TotalÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $437,932 $18,325 $(133) $456,124

Available-for-sale:

MBS(2)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $116,081 $ 5,425 $ (1) $121,505

REMICs and Stripped MBS ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 33,763 678 (369) 34,072

Other mortgage-related securities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 17,358 782 (11) 18,129

TotalÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $167,202 $ 6,885 $(381) $173,706

December 31, 2001

Gross Gross

Amortized Unrealized Unrealized Fair

Cost(1) Gains Losses Value

(Dollars in millions)

Held-to-maturity:

MBS(2)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $333,896 $ 3,536 $ (54) $337,378

REMICs and Stripped MBS ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 127,675 2,432 (579) 129,528

Other mortgage-related securities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 47,584 1,411 (87) 48,908

TotalÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $509,155 $ 7,379 $(720) $515,814

Available-for-sale:

MBS(2)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 9,119 $ 105 $ (27) $ 9,197

REMICs and Stripped MBS ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 1,083 211 (240) 1,054

Other mortgage-related securities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 22,236 425 (12) 22,649

TotalÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 32,438 $ 741 $(279) $ 32,900

(1) Amortized cost includes unamortized premiums, discounts, and deferred price adjustments.

(2) Excludes REMICs and Stripped MBS.

116
FANNIE MAE

NOTES TO FINANCIAL STATEMENTS Ì (Continued)

On September 13, 2002, concurrent with the new risk-based capital rule issued by our regulator, OÇce of

Federal Housing Enterprise Oversight (OFHEO), we reclassiÑed $124 billion of securities in our mortgage

portfolio from held-to-maturity to available-for-sale. Prior to September 13, 2002, Fannie Mae was not subject

to a risk-based capital standard. OFHEO implemented the risk-based standard on that date and this standard

applied to all assets held by Fannie Mae. FAS 115 speciÑcally identiÑes ""a signiÑcant increase in the risk

weights of debt securities used for regulatory risk-based capital purposes'' as a change in circumstance under

which a company may reclassify securities from held-to-maturity to available-for-sale without calling into

question the intent to hold other securities to maturity in the future. At the time of this noncash transfer, these

securities had gross unrealized gains and losses of $5.364 billion and $53 million, respectively.

Total gross realized gains and losses on sales of MBS and other mortgage-related securities in 2002 were

$78 million and $21 million, respectively. Total net realized losses on sales of MBS and other mortgagerelated securities were $13 million in 2001 and $21 million in 2000.

REMICs and Stripped MBS

Included in the table above are REMICs backed by MBS and whole loans and Stripped MBS (SMBS)

backed by MBS. REMICs represent a beneÑcial interest in a trust having multiple classes of securities. The

securities of each class entitle investors to cash Öows structured diÅerently from the payments on the

underlying assets. SMBS are created by ""stripping'' or separating the principal and interest payments from the

underlying pool of mortgages into two classes of securities, with each receiving a diÅerent proportion of the

principal and interest payments. REMICs and SMBS do not subject us to additional credit risk if we already

guarantee the underlying MBS. REMICs and SMBS generally have diÅerent interest rate risk than MBS. To

estimate fair values for these securities, we use a stochastic simulation to model future interest rates and

discount factors over a large number of scenarios. The simulation calibrates the distribution of interest rates to

the current market yield curve and reÖects current option adjusted spreads in its discount factors. To model

prepayments, we use our proprietary prepayment models to develop an estimated prepayment level for each

point in time along each scenario.

Retained Interests

In some cases, we create REMICs using assets from our mortgage portfolio and retain an interest in the

REMICs. In these instances, we measure our retained interests by allocating the carrying amount of the assets

we retained based on their fair value at the transfer date relative to the assets we sold. We are a passive

investor with regard to the transferred assets, as our continuing involvement is limited to guaranteeing some of

the assets underlying these REMICs.

The entire principal balance of REMICs outstanding at December 31, 2002 and December 31, 2001 was

$55.6 billion and $21.0 billion, respectively. For the years ended December 31, 2002 and December 31, 2001,

we recognized a $25.4 million net gain and a $24.4 million net loss, respectively, on the portion of assets we

sold at the time of securitization, which totaled $3.7 billion and $2.2 billion, respectively. Cash proceeds

received from the sale of these assets totaled $3.7 billion and $2.2 billion for the years ended December 31,

2002 and December 31, 2001, respectively. Because these REMIC securities are backed by guaranteed MBS,

the cash Öows from purchases of delinquent loans or foreclosed loans is immaterial. We did not sell any of our

retained interests in either 2002 or 2001. Therefore, we did not incur any gains or losses on sales of retained

interests for the years then ended. At December 31, 2002 and 2001, the book value of our retained interests

was $41.9 billion and $18.9 billion, respectively. These securities are backed by MBS guaranteed by Fannie

Mae. As a result, the delinquency and credit loss information associated with these REMIC securities is

immaterial because all principal and interest is passed through to the REMIC regardless of how the

underlying MBS perform.

117
FANNIE MAE

NOTES TO FINANCIAL STATEMENTS Ì (Continued)

Our retained interests are essentially investments of principal in mortgages because there is only a small

amount of original premium or discount associated with our investment. As a result, we classify our retained

interests as held-to-maturity because they cannot be prepaid or settled in such a way that we would not

recover substantially all of our investment. Our retained interests give us the right to receive repayment of the

principal we have invested, and the borrowers' obligations are secured by the Ñnanced properties.

We use an option-adjusted spread (OAS) approach to measure the fair value of our retained interests,

which is the same approach used to measure the fair value for MBS held in our portfolio. The OAS is the

incremental spread over our debt rates after taking into account the variability of mortgage cash Öows due to

the embedded prepayment option. Our proprietary interest rate and prepayment models are key assumptions

used in this valuation approach. The OAS approach starts with quoted market prices for a set of benchmark

securities that are a representative sample of our portfolio holdings. We use our interest rate model in a

stochastic simulation to generate a large number of scenarios. Our prepayment model provides estimated

prepayment speeds to determine the cash Öows for each time period in each scenario. After the interest rates

(including discount factors) and cash Öows are generated, the model solves for the OAS associated with the

market price of each benchmark security. These option-adjusted spreads are mapped to similar securities,

including our retained interests, and the stochastic simulation process is repeated, this time including the

appropriate OAS as part of the discount rate to calculate the fair value of each security.

At December 31, 2002 and 2001, the fair value of our retained interests was $42.7 billion and

$18.6 billion, respectively, with a weighted-average life of 3.7 years and 7.3 years, respectively. The key

assumptions used in measuring the fair value of retained interests at the time of securitization are as follows:

2002 2001

Weighted-average life ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 6.0 years 6.0 years

Average lifetime CPR prepayment speed assumption ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 16.1% 15.8%

Average discount rate assumption ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 5.2 5.2

To quantify the sensitivity of the fair values of these retained interests to changes in valuation

assumptions, we adjust the parameters of the prepayment model in order to change prepayment speeds and

directly change the discount factors. Changes in prepayment speeds are speciÑed as the eÅect on the constant

prepayment rate (CPR) over the Ñrst 12 months. This is typically the time period where immediate changes

in prepayments will have the most signiÑcant eÅect on fair value. Changes in discount rate would incorporate

both the debt rate and the OAS.

These sensitivities are hypothetical and should be used with caution. The eÅect of a variation in one of

these assumptions on the fair value of our retained interests is calculated without changing any other

assumptions. Changing one assumption could result in variation in another assumption, which may increase or

decrease the corresponding sensitivities. These sensitivities only measure changes in the fair value of our

retained interests and do not incorporate oÅsetting changes in the values of associated debt funding the

retained interests. At December 31, 2002 and 2001, we modiÑed the following assumptions to quantify the

118
FANNIE MAE

NOTES TO FINANCIAL STATEMENTS Ì (Continued)

impact of immediate 5 percent, 10 percent, and 15 percent adverse changes in these assumptions on the fair

value of our retained interests.

2002 2001

(Dollars in millions)

Prepayment speed assumptions:

Impact on year-end fair value from 5 percent adverse change in 12 month CPR prepayment

speed ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ (68) $ (24)

Impact on year-end fair value from 10 percent adverse change in 12 month CPR

prepayment speedÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (131) (48)

Impact on year-end fair value from 15 percent adverse change in 12 month CPR

prepayment speedÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (203) (73)

Average 12 month CPR prepayment speed assumption ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 49.2% 9.5%

Discount rate assumptions:

Impact on year-end fair value from 5 percent adverse change ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ (358) $(307)

Impact on year-end fair value from 10 percent adverse change ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (711) (609)

Impact on year-end fair value from 15 percent adverse change ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (1,049) (898)

Average discount rate assumption ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 3.3% 6.4%

3. Allowance for Loan Losses and Guaranty Liability for MBS

We maintain a separate allowance for loan losses for our mortgage portfolio as well as a guaranty liability

for our guaranty of MBS. Changes for the years 2000 through 2002 are summarized below.

2002 2001 2000

(Dollars in millions)

Allowance for loan losses:(1)

Beginning balance ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 48 $ 51 $ 56

Provision ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 44 7 9

Charge-oÅs(2) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (13) (10) (14)

Ending balance ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 79 $ 48 $ 51

Guaranty liability for MBS(1):

Beginning balance ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 755 $755 $ 745

Provision ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 84 87 113

Charge-oÅs ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (110) (87) (103)

Ending balance ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 729 $755 $ 755

Combined allowance for loan losses and guaranty liability for MBS(3):

Beginning balance ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 803 $806 $ 801

Provision ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 128 94 122

Charge-oÅs(2) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (123) (97) (117)

Ending balance ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 808 $803 $ 806

(1) In 2002, we reclassiÑed from our ""Allowance for loan losses'' to a ""Guaranty liability for MBS'' the amount

associated with the guaranty obligation for MBS that we own. Prior period balances, the provision for losses, and

charge-oÅ amounts have been restated to reÖect this reclassiÑcation.

(2) Charge-oÅs exclude $1 million in 2002 on charge-oÅs related to foreclosed Federal Housing Administration loans

that are reported in the balance sheet under ""Acquired property and foreclosure claims, net.''

(3) The total excludes $2 million at year-end 2002 and $3 million at the end of 2001 and 2000, related to foreclosed

Federal Housing Administration loans that are reported in the balance sheet under ""Acquired property and

foreclosure claims, net.''

119
FANNIE MAE

NOTES TO FINANCIAL STATEMENTS Ì (Continued)

The following table summarizes the UPB of impaired loans and corresponding speciÑc loss allowances for

the years 2000 through 2002. The majority of our impaired and restructured loans are multifamily loans.

Single-family loans that have not been restructured are exempt from FAS 114 because they are considered to

be a group of homogeneous loans that are collectively evaluated for impairment. A loan is impaired when it is

probable that all contractual principal and interest payments will not be collected as scheduled in the loan

agreement based on current information and events. In the event of impairment, we compare the UPB of

impaired and restructured loans with the fair value of the underlying collateral to measure any impairment and

provide a speciÑc allowance for estimated losses.

2002 2001 2000

(Dollars in millions)

UPB of impaired loans ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $314 $320 $186

UPB of impaired loans with speciÑc loss allowanceÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 137 213 67

SpeciÑc loss allowance on impaired and restructured loans ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 17 13 2

UPB of impaired loans without speciÑc loss allowance ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 177 107 119

Average UPB of impaired loans(1) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 285 204 210

Estimated interest income recognized while loans were impaired ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 7 8 3

(1) Averages have been calculated on a monthly average basis.

4. Nonmortgage Investments

We classify securities in the LIP and other investments as either available-for-sale or held-to-maturity.

We have presented below a schedule of available-for-sale nonmortgage investments at December 31, 2002 and

2001.

2002

Gross Gross

Amortized Unrealized Unrealized Fair

Cost Gains Losses Value

(Dollars in millions)

Available-for-sale:

Asset-backed securities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $22,281 $ 98 $ (68) $22,311

Floating-rate notes(1) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 11,754 10 (29) 11,735

Corporate bonds ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 1,149 42 Ì 1,191

Taxable auction notes ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 949 Ì Ì 949

Auction rate preferred stock ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 112 Ì (4) 108

Commercial paper ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 100 Ì Ì 100

Other ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 400 Ì Ì 400

TotalÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $36,745 $150 $(101) $36,794

2001

Gross Gross

Amortized Unrealized Unrealized Fair

Cost Gains Losses Value

(Dollars in millions)

Available-for-sale:

Asset-backed securities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $14,876 $21 $(25) $14,872

Floating-rate notes(1) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 12,114 12 (45) 12,081

Commercial paper ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 8,879 1 Ì 8,880

Other ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 50 Ì Ì 50

TotalÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $35,919 $34 $(70) $35,883

(1) As of December 31, 2002 and 2001, 100 percent of Öoating-rate notes repriced at intervals of 90 days or less.

120
FANNIE MAE

NOTES TO FINANCIAL STATEMENTS Ì (Continued)

Total gross realized gains on nonmortgage investments that were classiÑed as available-for-sale was

$4.5 million in 2002, $9.9 million in 2001, and $6.6 million in 2000. Total gross realized losses on nonmortgage

investments that were classiÑed as available-for-sale was $1.7 million in 2002, $6.1 million in 2001, and

$4.3 million in 2000.

On September 13, 2002, concurrent with the new risk-based capital rule issued by our regulator,

OFHEO, we reclassiÑed securities in our LIP that had an amortized cost of $11.0 billion and a fair value of

$11.2 billion from held-to-maturity to available-for-sale. Prior to September 13, 2002, Fannie Mae was not

subject to a risk-based capital standard. OFHEO implemented the risk-based standard on that date and this

standard applied to all assets held by Fannie Mae. FAS 115 speciÑcally identiÑes ""a signiÑcant increase in the

risk weights of debt securities used for regulatory risk-based capital purposes'' as a change in circumstance

under which a company may reclassify securities from held-to-maturity to available-for-sale without calling

into question the intent to hold other securities to maturity in the future. At the time of this noncash transfer,

these securities had gross unrealized gains and losses of $139 million and $6 million, respectively. We have

presented below a schedule of held-to-maturity nonmortgage investments at December 31, 2002 and 2001.

2002

Gross Gross

Amortized Unrealized Unrealized Fair

Cost Gains Losses Value

(Dollars in millions)

Held-to-maturity:

Repurchase agreements ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $20,732 $Ì $Ì $20,732

Eurodollar time deposits ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 1,398 Ì Ì 1,398

Auction rate preferred stock ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 402 Ì Ì 402

Federal funds ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 150 Ì Ì 150

Commercial paper ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 100 Ì Ì 100

Other ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 268 1 Ì 269

TotalÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $23,050 $ 1 $Ì $23,051

2001

Gross Gross

Amortized Unrealized Unrealized Fair

Cost Gains Losses Value

(Dollars in millions)

Held-to-maturity:

Repurchase agreements ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 9,380 $ Ì $Ì $ 9,380

Eurodollar time deposits ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 11,185 Ì Ì 11,185

Auction rate preferred stock ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2,127 Ì Ì 2,127

Federal funds ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 4,904 Ì Ì 4,904

Commercial paper ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2,844 1 Ì 2,845

Asset-backed securities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 6,065 89 (1) 6,153

Other ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2,166 73 Ì 2,239

TotalÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $38,671 $163 $(1) $38,833

121
FANNIE MAE

NOTES TO FINANCIAL STATEMENTS Ì (Continued)

The following table shows the amortized cost, fair value, and yield of nonmortgage investments by

investment classiÑcation and remaining maturity as well as the amortized cost, fair value, and yield of our

asset-backed securities at December 31, 2002 and 2001.

2002 2001

Amortized Fair Amortized Fair

Cost Value Yield Cost Value Yield

(Dollars in millions)

Available-for-sale:

Due within one year ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 8,844 $ 8,851 2.31% $10,863 $10,863 2.18%

Due after one year through Ñve years ÏÏÏÏÏÏÏÏÏÏÏÏÏ 5,620 5,632 2.42 10,180 10,148 2.49

Due after Ñve through ten years ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Ì Ì Ì Ì Ì Ì

Due after ten years ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Ì Ì Ì Ì Ì Ì

14,464 14,483 2.35 21,043 21,011 2.33

Held-to-maturity:

Due within one year ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 23,016 23,017 1.76 31,327 31,347 2.49

Due after one year through Ñve years ÏÏÏÏÏÏÏÏÏÏÏÏÏ 34 34 6.21 1,279 1,333 7.11

Due after Ñve through ten years ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Ì Ì Ì Ì Ì Ì

Due after ten years ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Ì Ì Ì Ì Ì Ì

23,050 23,051 1.76 32,606 32,680 2.68

Asset-backed securities(1) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 22,281 22,311 2.22 20,941 21,025 3.07

Total ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $59,795 $59,845 2.08% $74,590 $74,716 2.69%

(1) Contractual maturity of asset-backed securities is not a reliable indicator of their expected life because borrowers

generally have the right to repay their obligations at any time.

5. Debentures, Notes, and Bonds, Net

Borrowings Due Within One Year

Below is a summary of borrowings due within one year at December 31, 2002 and 2001, net of

unamortized discount and premium.

2002

Maximum Outstanding at Average Outstanding Outstanding December 31, During Year at Any

Amount Cost(1) Amount Cost(1) Month-end

(Dollars in millions)

Short-term notes ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $290,091 1.55% $252,857 1.98% $290,091

Other short-term debt ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 12,522 1.33 18,512 1.70 28,126

Current portion of borrowings due after one year(2):

Universal Standard Debt ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 41,681 2.25

Universal Benchmark Debt ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 37,376 4.89

Universal Retail DebtÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 73 9.52

Other ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 669 3.24

Total due within one year ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $382,412 1.95%

122
FANNIE MAE

NOTES TO FINANCIAL STATEMENTS Ì (Continued)

2001

Maximum Outstanding at Average Outstanding Outstanding December 31, During Year at Any

Amount Cost(1) Amount Cost(1) Month-end

(Dollars in millions)

Short-term notes ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $256,905 2.58% $247,060 4.31% $265,953

Other short-term debt ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 29,891 1.96 31,479 4.40 43,811

Current portion of borrowings due after one year(2):

Universal Standard Debt ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 34,413 3.67

Universal Benchmark Debt ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 21,987 5.31

Universal Retail DebtÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Ì Ì

Other ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 296 4.96

Total due within one year ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $343,492 2.81%

(1) Represents weighted-average cost, which includes the amortization of discounts, premiums, issuance costs, hedging

results, and the eÅects of currency and debt swaps. Averages have been calculated on a monthly average basis.

(2) Information on average amount and cost of debt outstanding during the year and maximum amount outstanding at

any month-end is not meaningful. See ""Borrowings Due After One Year'' for additional information.

Amounts payable for federal funds purchased and securities sold under agreements to repurchase were

$9.1 billion and $6.0 billion at December 31, 2002 and 2001, respectively, and are included in the above table

under the heading ""Other short-term debt.'' These amounts include both secured and unsecured debt.

123
FANNIE MAE

NOTES TO FINANCIAL STATEMENTS Ì (Continued)

Borrowings Due After One Year

Below is a summary of borrowings due after one year at December 31, 2002 and 2001, net of unamortized

discount and premium.

2002 2001

Maturity Amount Average Amount Average

Date Outstanding Cost(1) Outstanding Cost(1)

(Dollars in millions)

Senior debt:

Universal Benchmark Debt, net of $796 of deferred

costs for 2002 ($886 for 2001) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2002-2030 $282,972 5.49% $246,458 5.88%

Universal Standard Debt, net of $311 of deferred

costs for 2002 ($325 for 2001) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2002-2038 152,656 4.31 156,495 4.84

Universal Retail Debt, net of $97 of deferred costs

for 2002 ($62 for 2001) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2002-2027 10,556 6.10 7,098 5.87

Long-term other, net of $5,809 of deferred costs for

2002 ($6,998 for 2001) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2002-2032 3,681 7.71 3,383 7.23

449,865 5.12 413,434 5.50

Subordinated debt:

Universal Benchmark Debt, net of $43 of deferred

costs for 2002 ($10 for 2001) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2002-2012 8,457 5.58 4,990 5.78

Universal Standard Debt, net of $7 of deferred costs

for 2002 ($7 for 2001) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2002-2019 244 9.31 243 9.31

Long-term other, net of $5,481 of deferred costs for

2002 ($5,655 for 2001) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2002-2019 1,269 10.01 1,160 9.97

9,970 6.23 6,393 6.67

Total senior and subordinated debtÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 459,835 5.14% 419,827 5.52%

Fair value adjustment for FAS 133(2) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 8,889 1,423

Adjustment for foreign currency translationÏÏÏÏÏÏÏÏÏÏÏ (154) (1,275)

Total due after one yearÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $468,570 $419,975

(1) Represents weighted-average cost, which includes the amortization of discounts, premiums, issuance costs, hedging

results, and the eÅects of currency and debt swaps. Averages have been calculated on a monthly average basis.

(2) Represents change in the fair value of hedged debt in fair value hedges.

We consolidated our outstanding debt agreements for various funding programs into one comprehensive

oÅering document, the Universal Debt Facility. This supersedes and replaces the Global Debt Facility,

Medium-Term Notes, Short-Term Notes, and Debenture Programs.

Debentures, notes, and bonds at December 31, 2002 included $178 billion of callable debt. We can

redeem this debt at our option any time on or after a speciÑed date in whole or in part. At December 31, 2002,

our debentures, notes, and bonds were not subject to mandatory redemptions tied to certain indices or rates

after an initial nonredemption period.

We have summarized in the following table the amounts, call periods, and maturity dates for our optionembedded Ñnancial instruments at December 31, 2002. These instruments include callable debt, callable

swaps, and receive-Ñxed swaptions (excluding $9.9 billion of callable debt that was swapped to variable-rate

124
FANNIE MAE

NOTES TO FINANCIAL STATEMENTS Ì (Continued)

debt) as well as the notional amount of pay-Ñxed swaptions and caps. We also include universal debt that is

redeemable at our option in the table.

Call Year ofAmount Average

Date Maturity Outstanding Cost(1)

(Dollars in millions)

Callable debt, callable swaps and receive-Ñxed swaptions: Currently callable 2004-2020 $ 664 5.08%

2003 2003-2031 192,419 4.82

2004 2004-2022 75,191 5.95

2005 2007-2030 25,831 6.05

2006 2010-2031 22,384 6.25

2007 2011-2032 16,733 6.36

2008 and later 2012-2030 16,611 6.76

349,833 5.41%

Pay-Ñxed swaptions ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 129,225

Caps ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 122,393

Total option-embedded Ñnancial instruments ÏÏÏÏÏÏÏÏÏÏÏÏÏ $601,451

(1) Averages have been calculated on a monthly average basis.

Listed below are the principal amounts of total debt payable as of December 31, 2002, for the years 2004-

2008, assuming we pay oÅ callable debt at maturity and we redeem callable debt at the initial call date.

Assuming Callable Debt

Total Debt by Year Redeemed at Initial

of Maturity(1) Call Date(1)

(Dollars in millions)

2004 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $105,232 $96,020

2005 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 71,453 46,892

2006 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 47,415 29,235

2007 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 67,326 43,317

2008 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 21,160 15,020

(1) Includes $9.9 billion of callable debt that was swapped to variable-rate debt.

We repurchased or called $182 billion of debt and swaps with an average cost of 5.36 percent in 2002,

$183 billion of debt and swaps with an average cost of 6.23 percent in 2001, and $18 billion of debt and swaps

with an average cost of 7.10 percent in 2000. We recorded losses of $710 million in 2002, losses of $524 million

in 2001, and gains of $49 million in 2000 on our debt extinguishments.

As part of our voluntary safety and soundness initiatives, we began issuing Subordinated Benchmark

Notes in the Ñrst quarter of 2001 on a periodic basis to create a new, liquid class of Ñxed-income assets for

investors. We issued subordinated debt totaling $3.5 billion and $5.0 billion during 2002 and 2001,

respectively. Outstanding Subordinated Benchmark Notes totaled $8.5 billion at December 31, 2002 versus

$5.0 billion at the end of 2001. The total subordinated debt balance at December 31, 2002 and December 31,

2001 includes other subordinated debt issuances that preceded this initiative.

Pursuant to Fannie Mae's Charter Act, the Secretary of the Treasury has the authority to approve Fannie

Mae's issuance of debt obligations.

125
FANNIE MAE

NOTES TO FINANCIAL STATEMENTS Ì (Continued)

6. Income Taxes

The components of our federal income tax provision for the years ended December 31, 2002, 2001, and

2000 were as follows:

2002 2001 2000

(Dollars in millions)

Current ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 3,055 $2,231 $1,422

Deferred ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (1,626) (190) 161

1,429 2,041 1,583

Tax expense of cumulative eÅect of change in accounting principleÏÏÏÏÏÏÏÏÏÏÏ Ì 90 Ì

Net federal income tax provisionÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 1,429 $2,131 $1,583

The table above does not reÖect the tax eÅects of unrealized gains and losses on available-for-sale

securities and derivatives. We record the unrealized gains and losses on these items in AOCI, net of deferred

taxes. The tax expense associated with these items was a tax beneÑt of $2.5 billion in 2002 and $3.8 billion in

2001, and a tax expense of $6 million in 2000.

The tax eÅects of temporary diÅerences between Ñnancial income and taxable income that gave rise to

signiÑcant portions of the deferred tax assets and deferred tax liabilities at December 31, 2002 and 2001

consisted of the following:

2002 2001

(Dollars in

millions)

Deferred tax assets:

Derivatives in loss positions, net ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 9,423 $3,679

Outstanding MBS and REMIC fees ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 1,337 915

Allowance for loan losses and guaranty liability for MBSÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 325 314

Other items, net ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 160 143

Deferred tax assets ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 11,245 5,051

Deferred tax liabilities:

Unrealized gains on available-for-sale securitiesÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2,401 158

Debt-related expenses ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 446 536

BeneÑts from tax-advantaged investmentsÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 214 125

Purchase discount and deferred fees ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 42 356

Other items, net ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 89 57

Deferred tax liabilities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 3,192 1,232

Net deferred tax asset ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 8,053 $3,819

We anticipate it is more likely than not that the results of future operations will generate suÇcient taxable

income to realize the entire balance of deferred tax assets.

126
FANNIE MAE

NOTES TO FINANCIAL STATEMENTS Ì (Continued)

Our eÅective tax rates diÅered from statutory federal tax rates for the years ended December 31, 2002,

2001, and 2000 as follows:

2002 2001 2000

Statutory corporate tax rate ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 35% 35% 35%

Tax-exempt interest and dividends received deductions ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (5) (4) (5)

Equity investments in aÅordable housing projects ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (6) (4) (4)

EÅective tax rateÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 24% 27% 26%

We are exempt from state and local taxes, except for real estate taxes.

7. Earnings per Common Share

The following table sets forth the computation of basic and diluted earnings per common share.

Year Ended December 31,

2002 2001 2000

Basic Diluted Basic Diluted Basic Diluted

(Dollars and shares in millions, except per share amounts)

Net income before cumulative eÅect of change in

accounting principle ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $4,619 $4,619 $5,726 $5,726 $4,448 $4,448

Cumulative eÅect of change in accounting principle ÏÏÏÏÏÏ Ì Ì 168 168 Ì Ì

Preferred stock dividendÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (99) (99) (138) (138) (121) (121)

Net income available to common stockholders ÏÏÏÏÏÏÏÏÏÏÏ $4,520 $4,520 $5,756 $5,756 $4,327 $4,327

Weighted average common shares ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 992 992 1,000 1,000 1,003 1,003

Dilutive potential common shares(1) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Ì 5 Ì 6 Ì 6

Average number of common shares outstanding used to

calculate earnings per common share ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 992 997 1,000 1,006 1,003 1,009

Earnings per common share before cumulative eÅect of

change in accounting principle ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 4.56 $ 4.53 $ 5.58 $ 5.55 $ 4.31 $ 4.29

Cumulative eÅect of change in accounting principle ÏÏÏÏÏÏ Ì Ì .17 .17 Ì Ì

Net earnings per common share ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 4.56 $ 4.53 $ 5.75 $ 5.72 $ 4.31 $ 4.29

(1) Dilutive potential common shares consist primarily of the dilutive eÅect from employee stock options and other stock

compensation plans.

For additional disclosures regarding our stock compensation plans and outstanding preferred stock, refer

to Notes 8 and 12, respectively.

8. Stock-Based Compensation Plans

Employee Stock Purchase Plan

We have an Employee Stock Purchase Plan that allows us to issue up to 41 million shares of common

stock to qualiÑed employees at a price equal to 85 percent of the fair market value of the stock on the grant

date. This plan meets the deÑnition of a noncompensatory plan under APB 25; therefore, we did not recognize

any compensation expense for grants under the plan. Employees have the option of either receiving cash or

shares through a Cashless Exercise Program or purchasing shares directly. In 2002, we granted each qualiÑed

employee, excluding certain oÇcers and other highly compensated employees, the right to purchase up to

310 shares of common stock at $68.46 per share in January 2003. Under the 2002 oÅering, qualiÑed employees

127
FANNIE MAE

NOTES TO FINANCIAL STATEMENTS Ì (Continued)

purchased 5,580 shares at $68.46 per share, compared with purchasing 1,274,396 common shares at $66.00 per

share under the 2001 oÅering.

Employee Stock Ownership Plan

We have an Employee Stock Ownership Plan (ESOP) for qualiÑed employees who are regularly

scheduled to work at least 1,000 hours in a calendar year. Participation is not open to participants in the

Executive Pension Plan. We may contribute to the ESOP each year an amount based on achievement of

deÑned corporate earnings goals, not to exceed 4 percent of the aggregate eligible salary for all participants.

The Board of Directors determines the contribution percentage annually. We may contribute either shares of

Fannie Mae common stock or cash to purchase Fannie Mae common stock. Such contributions are recorded

as a current period expense. Unless employees elect to receive cash, ESOP dividends are automatically

reinvested in Fannie Mae stock within the ESOP. Dividends are accrued four times a year and paid, pursuant

to employees' elections, once a year in February for the four previous quarters. ESOP shares are included as

outstanding for purposes of our EPS calculations. Vested beneÑts are based on years of service. Eligible

employees are 100 percent vested in their ESOP accounts either upon attainment of age 65 or more than Ñve

years of service. Employees who are at least 55 years of age, and have at least 10 years of participation in the

ESOP, may qualify to diversify vested ESOP shares into the same types of funds available under the

Retirement Savings Plan without losing the tax deferred status of the value of the ESOP. Expense recorded in

2002, 2001, and 2000 in connection with the ESOP was $7.6 million, $6.5 million, and $6.0 million,

respectively. At December 31, 2002, 2001, and 2000, allocated shares held by the ESOP were 1,450,973

common shares, 1,396,610 common shares, and 1,358,486 common shares, respectively, and committed-tobe-released shares held by the ESOP were 115,127 common shares, 80,459 common shares, and 66,495

common shares, respectively. At December 31, 2002, 2001, and 2000, the ESOP shares held in suspense were

2,105 common shares, 729 common shares, and 7,684 common shares, respectively. The fair value of

unearned ESOP shares was $1.4 million, $1.7 million, and $1.8 million at December 31, 2002, 2001, and 2000,

respectively.

Performance Shares

Fannie Mae's Stock Compensation Plan of 1993 authorizes eligible employees to receive performance

awards. We generally issue awards with a performance period that can range from three to Ñve years. The

performance shares become actual awards only if we attain our goals set for the award period. At the end of

the award period, we pay out common stock in either two or three installments over a period not longer than

three years. For the 2003-2005, 2002-2004, and 2001-2003 performance periods, there were 466,216 common

shares, 505,588 common shares, and 449,520 common shares, respectively, from outstanding contingent

grants.

NonqualiÑed Stock Options

Fannie Mae may grant stock options to eligible employees and nonmanagement members of the Board of

Directors. Employees cannot generally exercise them until at least one year after the grant date. Nonmanagement directors can exercise them on the grant date. The stock options generally expire ten years from the grant

date for both groups. The exercise price of the common stock covered by each option is equal to the fair value

of the stock on the date we grant the option. Thus, we have not recorded compensation expense for grants

under this plan under APB 25.

Under the Stock Compensation Plan of 1993, our Board of Directors approved the EPS Challenge

Option Grant in January 2000 for all regular full-time and part-time employees. At that time, all employees,

other than management group employees, received an option grant of 350 shares at a price of $62.50 per share,

the fair market value of the stock on the grant date. Management group employees received option grants

128
FANNIE MAE

NOTES TO FINANCIAL STATEMENTS Ì (Continued)

equivalent to a percentage of their November 1999 stock grants. We tied vesting for options granted to the

achievement of a core business diluted earnings per share (EPS) goal of $6.46 by the end of 2003. Core

business earnings is a non-GAAP performance measure developed by management that ratably allocates the

cost of purchased options over the period they are held instead of recognizing unrealized gains and losses on

purchased options in earnings. Core business diluted EPS reÖects net income less the after-tax unrealized gain

or loss on purchased options plus the after-tax purchased options amortization expense. If our core business

diluted EPS for 2003 is $6.46 or greater, then 100 percent of the EPS Challenge options will vest in January

2004. If we do not reach a core business diluted EPS of $6.46 by the end of 2003, we delay vesting one year

and then vesting begins at a rate of 25 percent per year. The Board of Directors has discretion to oÅset future

option grants or other forms of compensation if the core business diluted EPS goal is not reached. These

options expire January 18, 2010.

The following table summarizes our nonqualiÑed stock option activity for the years 2000-2002.

2002 2001 2000

Weighted- Weighted- Weighted- Weighted- Weighted- WeightedAverage Average Average Average Average Average

Exercise Fair Value Exercise Fair Value Exercise Fair Value

Options Price at Grant Date Options Price at Grant Date Options Price at Grant Date

(Options in thousands)

Balance, January 1, ÏÏ 26,234 $57.06 $19.22 25,310 $50.86 $16.90 22,349 $40.90 $12.81

Granted ÏÏÏÏÏÏÏÏÏÏÏÏ 865 78.38 26.23 4,173 80.37 28.07 7,741 66.79 24.11

ExercisedÏÏÏÏÏÏÏÏÏÏÏ (1,484) 29.58 9.37 (2,611) 31.92 9.90 (4,003) 23.88 7.31

Forfeited ÏÏÏÏÏÏÏÏÏÏÏ (484) 70.61 24.47 (638) 66.93 23.12 (777) 61.98 20.42

Balance,

December 31, ÏÏÏÏÏ 25,131 $59.16 $22.76 26,234 $57.05 $19.22 25,310 $50.86 $16.90

Options vested,

December 31, ÏÏÏÏÏ 15,619 $51.48 $16.71 13,919 $44.10 $13.92 13,551 $36.83 $11.36

The following table summarizes information about our nonqualiÑed stock options outstanding at

December 31, 2002.

Options Outstanding

Weighted-Average Options Exercisable

Number ofRemaining Weighted-Average Number ofWeighted-Average

Range of Exercise Prices Options(1) Contractual Life Exercise Price Options(1) Exercise Price

$18.00 Ó $35.00 ÏÏÏÏÏÏÏÏÏÏÏ 4,444 1.5 yrs. $22.96 4,444 $22.96

35.01 Ó 53.00 ÏÏÏÏÏÏÏÏÏÏÏ 4,010 4.6 46.14 3,827 45.82

53.01 Ó 70.00 ÏÏÏÏÏÏÏÏÏÏÏ 6,717 6.5 64.06 3,140 66.48

70.01 Ó 87.00 ÏÏÏÏÏÏÏÏÏÏÏ 9,960 8.1 77.25 4,208 75.56

TotalÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 25,131 6.1 yrs. $59.16 15,619 $51.48

(1) Options in thousands.

Restricted Stock

In 2002, we awarded, issued, and placed in escrow 85,927 shares of restricted stock under the Stock

Compensation Plan of 1993 (117,447 shares in 2001). We released 106,062 shares in 2002 as awards vested

(105,560 shares in 2001).

129
FANNIE MAE

NOTES TO FINANCIAL STATEMENTS Ì (Continued)

Options Available for Future Issuance

At December 31, 2002, 4,727,809 and 11,569,275 shares remained available for grant under the

Employee Stock Purchase Plan and the Stock Compensation Plan of 1993, respectively. The Stock

Compensation Plan of 1993 expires in May 2003, at which time we will ask shareholders to approve a new

plan.

9. Employee Retirement BeneÑts

Retirement Savings Plan

All regular employees of Fannie Mae scheduled to work 1,000 hours or more in a calendar year are

eligible to participate in our Retirement Savings Plan, which includes a 401(k) option. In 2002, employees

could contribute up to the lower of 25 percent of their base salary or the current annual dollar cap established

and revised annually by the Internal Revenue Service. Fannie Mae matches employee contributions up to

3 percent of base salary in cash. Under the plan, employees may allocate investment balances to a variety of

investment options. As of December 31, 2002, there was no option to invest directly in stock of Fannie Mae.

Expense recorded in 2002, 2001, and 2000 in connection with the Retirement Savings Plan was $10.8 million,

$9.3 million, and $8.5 million, respectively.

Postretirement BeneÑt Plans

All regular employees of Fannie Mae scheduled to work 1,000 hours or more in a calendar year are

covered by a noncontributory corporate retirement plan or by the contributory Civil Service Retirement Law.

BeneÑts payable under the corporate plan are based on years of service and compensation using the average

pay during the 36 consecutive highest-paid months of the last 120 months of employment. Our policy is to

contribute an amount no less than the minimum required employer contribution under the Employee

Retirement Income Security Act of 1974. We contribute to the corporate plan in cash based on beneÑts

attributed to employees' service to date and compensation expected to be paid in the future. A contribution of

$41 million was made to the corporate plan in 2002. Corporate plan assets consist primarily of listed stocks,

Ñxed-income securities, and other liquid assets. Plan assets do not directly include any shares of Fannie Mae

stock.

At December 31, 2002 and 2001, the projected beneÑt obligations for services rendered were $391 million

and $319 million, respectively, while the plan assets were $234 million and $237 million, respectively. At

December 31, 2002 and 2001, the pension liability (included on the balance sheet under ""Other liabilities'')

was $51 million and $65 million, respectively. Net periodic pension costs were $27 million, $14 million, and

$5 million for the years ended December 31, 2002, 2001, and 2000, respectively. We use the straight-line

method of amortization for prior service costs.

The assumptions we used to determine the net periodic pension costs and projected beneÑt obligations

were as follows:

2002 2001 2000

Discount rate used to determine pension expenseÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 7.25% 7.75% 8.00%

Discount rate used to determine projected beneÑt obligation at year-end ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 6.75 7.25 7.75

Average rate of increase in future compensation levels ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 6.50 6.50 6.50

Expected long-term weighted average return on plan assets ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 8.50 9.50 9.00

Fannie Mae also has an Executive Pension Plan, Supplemental Pension Plan, and a bonus-based

Supplemental Pension Plan, which supplement the beneÑts payable under the retirement plan. We fund

accrued beneÑts under the Executive Pension Plan through a Rabbi trust. We accrue estimated beneÑts under

the supplementary plans as an expense over the period of employment.

130
FANNIE MAE

NOTES TO FINANCIAL STATEMENTS Ì (Continued)

We sponsor a post-retirement Health Care Plan that covers substantially all full-time employees. The

plan pays stated percentages of most necessary medical expenses incurred by retirees, after subtracting

payments by Medicare or other providers and after meeting a stated deductible. Participants become eligible

for the subsidized beneÑts as follows: (1) for employees hired prior to January 1, 1998, if they retire from

Fannie Mae after reaching age 55 with Ñve or more years of service; or (2) for employees hired January 1,

1998, or later, if they retire from Fannie Mae after reaching age 55 with ten or more years of service.

Employees hired January 1, 1998 or later who retire with less than ten years of service may purchase coverage

by paying the full premium. The plan is contributory, with retiree contributions adjusted annually. We charge

the expected cost of these beneÑts to expense during the years that the employees render service and we pay

all beneÑts out of our general assets. We base cost-sharing percentages on length of service with Fannie Mae,

eligibility for and date of retirement, and a deÑned dollar beneÑt cap.

Our accrued post-retirement health care cost liability for the years ended December 31, 2002 and 2001

was $65 million and $52 million, respectively. The net post-retirement health care costs were $15 million,

$9 million, and $8 million for the years ended December 31, 2002, 2001, and 2000, respectively. In

determining the net post-retirement health care cost for 2002, we assumed a 13.50 percent annual rate of

increase in the per capita cost of covered health care claims with the rate decreasing over the next Ñve years to

4.50 percent and remaining at that level thereafter. In determining the net post-retirement health care cost for

2001, we assumed a 4.75 percent annual rate of increase in the per capita cost of covered health care claims

with the rate decreasing gradually over the next year to 4.50 percent and remaining at that level thereafter. In

determining the net post-retirement health care cost for 2000, we assumed a 5.00 percent annual rate of

increase in the per capita cost of covered health care claims with the rate decreasing gradually over the next

two years to 4.50 percent and remaining at that level thereafter. The health care cost trend rate assumption has

a signiÑcant eÅect on the amounts reported. To illustrate, increasing the assumed health care cost trend rates

by one percentage point in each year would increase the accumulated post-retirement beneÑt obligation as of

December 31, 2002 by $5 million and the aggregate of the service and interest cost components of net postretirement health care cost for the year by $1 million. Decreasing the assumed health care cost trend rates by

one percentage point in each year would decrease the accumulated post-retirement beneÑt obligation as of

December 31, 2002 by $12 million and the aggregate of the service and interest cost components of net postretirement health care cost for the year by $2 million.

The weighted-average discount rates we used to determine the health care cost and the year-end

accumulated post-retirement beneÑt obligation were 6.75 percent at December 31, 2002, 7.25 percent at

December 31, 2001, and 7.75 percent at December 31, 2000.

10. Line of Business Reporting

We have two lines of business that generate revenue. These business lines also focus on managing our key

business risks. We measure the results of our lines of business based on core business earnings. We evaluate

the results of our business lines as though each were a stand-alone business. Hence, we allocate certain income

and expenses to each line of business for purposes of business segment reporting. We eliminate certain intersegment allocations in our consolidated core business earnings results.

Portfolio Investment Business: The Portfolio Investment business has two principal components: a

mortgage investment portfolio and a liquid investment portfolio. The mortgage investment portfolio purchases

mortgage loans, mortgage-related securities, and other investments from lenders, securities dealers, and other

market participants. The LIP serves as an alternative source of funds to meet our cash Öow needs by investing

in high quality, short-term and medium-term investments that provide an ongoing supply of funds that can be

used as necessary for liquidity or reinvestment, or readily marketable, high credit quality securities that can be

sold to raise cash. We fund the purchase of the assets in our Portfolio Investment business by issuing debt in

the global capital markets. The Portfolio Investment business generates proÑts by ensuring that the interest

131
FANNIE MAE

NOTES TO FINANCIAL STATEMENTS Ì (Continued)

income from the mortgages, MBS, mortgage-related securities, and liquid investments we purchase is greater

than our borrowing costs. A primary measure of proÑtability for the Portfolio Investment business is our net

interest margin. Our net interest margin reÖects the diÅerence between taxable-equivalent income on our

mortgage assets and non-mortgage investments and our borrowing expense, divided by average interest earning

assets.

Our Portfolio Investment business focuses on managing Fannie Mae's interest rate risk. Interest rate risk

is the risk that changes in interest rates could change cash Öows on our mortgage assets and debt in a way that

adversely aÅects Fannie Mae's earnings or long-term value.

Credit Guaranty Business: Our Credit Guaranty business has primary responsibility for managing all of

our mortgage credit risk. Credit risk is the risk of loss to future earnings and future cash Öows that may result

from the failure of a borrower or counterparty to fulÑll their contractual obligation to Fannie Mae. The Credit

Guaranty business primarily generates income from guaranty fees for guaranteeing the timely payment of

scheduled principal and interest on mortgage-related securities we guarantee that are not owned by the

Portfolio Investment business. The primary source of income for the Credit Guaranty business is the

diÅerence between the guaranty fees earned and the costs of providing this service. Income is also allocated to

the Credit Guaranty business for the following activities:

‚ Managing the credit risk on mortgage-related assets held by the Portfolio Investment business.

‚ Providing capital to the Portfolio Investment business.

‚ Temporarily investing principal and interest payments on loans underlying MBS prior to remittance to

investors.

Our Credit Guaranty business manages Fannie Mae's mortgage credit risk by managing the proÑle and

quality of mortgages in the mortgage credit book of business, using credit enhancements to reduce our losses,

assessing the sensitivity of credit losses to changes in economic conditions, and aggressively managing problem

assets to mitigate losses.

We assign actual direct revenues and expenses among our two lines of business. We use estimates to

apportion overhead and other corporate items. For example, we allocate administrative expenses as direct

expenses for the line of business. If we cannot allocate expenses to a particular business, we base the allocation

on revenues, proÑts, or volumes as applicable. We allocate capital to the lines of business through an

assessment of the interest rate risk and credit risk associated with each business.

Core Business Earnings: The diÅerence between core business earnings and reported net income relates

to the FAS 133 accounting treatment for purchased options. Core business earnings does not exclude any

other accounting eÅects related to the application of FAS 133 or any other non-FAS 133 related adjustments.

The guaranty fee income that we allocate to the Credit Guaranty business for managing the credit risk on

mortgage-related assets held by the Portfolio Investment business is oÅset by a corresponding guaranty fee

expense allocation to the Portfolio Investment business in our line of business results. Thus, there is no

reconciling adjustment between our total line of business guaranty fee income and our reported guaranty fee

income. We allocate transaction fees received for structuring and facilitating securities transactions for our

customers primarily to our Portfolio Investment business. We allocate technology-related fees received for

providing Desktop Underwriter and other on-line services and fees received for providing credit enhancement

alternatives to our customers primarily to our Credit Guaranty business.

132
FANNIE MAE

NOTES TO FINANCIAL STATEMENTS Ì (Continued)

The following table shows our line of business results for the years ended December 31, 2002, 2001, and

2000, and reconciles total core business earnings to reported GAAP results.

2002(a)

Reconciling

Total Core Items Related

Portfolio Credit Business to Purchased Reported

Investment Guaranty Earnings Options Results

Dollars in millions

Net interest income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 9,869 $ 697 $10,566 $ Ì $10,566

Purchased options amortization expense ÏÏÏÏÏÏÏÏÏÏÏÏ (1,814) Ì (1,814) 1,814 (c) Ì

Core net interest income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 8,055 697 8,752 1,814 10,566

Guaranty fee income (expense) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (1,374) 3,190 1,816 Ì 1,816

Fee and other income (expense), net ÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 348 (116) 232 Ì 232

Credit-related expenses(b) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Ì (92) (92) Ì (92)

Administrative expenses ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (357) (862) (1,219) Ì (1,219)

Purchased options expense under FAS 133ÏÏÏÏÏÏÏÏÏÏ Ì Ì Ì (4,545)(d) (4,545)

Debt extinguishments, net ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (710) Ì (710) Ì (710)

Income before federal income taxesÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 5,962 2,817 8,779 (2,731) 6,048

Provision for federal income taxes ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (1,747) (638) (2,385) 956 (f) (1,429)

Net income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 4,215 $2,179 $ 6,394 $(1,775) $ 4,619

2001(a)

Reconciling

Total Core Items Related

Portfolio Credit Business to Purchased Reported

Investment Guaranty Earnings Options Results

Dollars in millions

Net interest income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 7,369 $ 721 $ 8,090 $ Ì $ 8,090

Purchased options amortization expense ÏÏÏÏÏÏÏÏÏÏÏÏ (590) Ì (590) 590 (c) Ì

Core net interest income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 6,779 721 7,500 590 8,090

Guaranty fee income (expense) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (1,109) 2,591 1,482 Ì 1,482

Fee and other income (expense), net ÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 211 (60) 151 Ì 151

Credit-related expenses(b) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Ì (78) (78) Ì (78)

Administrative expenses ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (302) (715) (1,017) Ì (1,017)

Special contribution ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (192) (108) (300) Ì (300)

Purchased options expense under FAS 133ÏÏÏÏÏÏÏÏÏÏ Ì Ì Ì (37)(d) (37)

Debt extinguishments, net ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (524) Ì (524) Ì (524)

Income before federal income taxes and eÅect of

accounting change ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 4,863 2,351 7,214 553 7,767

Cumulative eÅect of accounting change ÏÏÏÏÏÏÏÏÏÏÏÏ Ì Ì Ì 168 (e) 168

Provision for federal income taxes ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (1,374) (473) (1,847) (194)(f) (2,041)

Net income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 3,489 $1,878 $ 5,367 $ 527 $ 5,894

133
FANNIE MAE

NOTES TO FINANCIAL STATEMENTS Ì (Continued)

2000

Reconciling

Total Core Items Related

Portfolio Credit Business to Purchased Reported

Investment Guaranty Earnings Options Results

Dollars in millions

Net interest income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 5,055 $ 619 $ 5,674 $Ì $ 5,674

Purchased options amortization expense ÏÏÏÏÏÏÏÏÏÏÏÏ Ì Ì Ì Ì Ì

Core net interest income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 5,055 619 5,674 Ì 5,674

Guaranty fee income (expense) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (1,079) 2,430 1,351 Ì 1,351

Fee and other income (expense), net ÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 27 (71) (44) Ì (44)

Credit-related expenses(b) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Ì (94) (94) Ì (94)

Administrative expenses ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (254) (651) (905) Ì (905)

Debt extinguishments, net ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 49 Ì 49 Ì 49

Income before federal income taxesÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 3,798 2,233 6,031 Ì 6,031

Provision for federal income taxes ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (1,053) (530) (1,583) Ì (1,583)

Net income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 2,745 $1,703 $ 4,448 $Ì $ 4,448

(a) Reported net income for 2002 and 2001 includes the eÅect of FAS 133, which was adopted on January 1, 2001.

(b) Credit-related expenses includes the income statement line items ""Provision for losses'' and ""Foreclosed property

income.''

(c) This amount represents the straight-line amortization of purchased options expense that we allocate to interest

expense over the original expected life of the options. We include this amount in core business earnings instead of

recording the unrealized gains and losses on purchased options to make it consistent with the accounting for the

embedded options in our callable debt and the vast majority of our mortgages.

(d) This amount, which is recorded in our income statement under purchased options expense, represents unrealized

gains and losses on purchased options recorded in accordance with FAS 133. We exclude this amount from our core

business earnings measure because it does not reÖect our strategy to hold options to maturity or exercise date and it is

not our strategy to realize the period-to-period Öuctuations in the value of options.

(e) This non-recurring amount represents the one-time transition recorded upon the adoption of FAS 133 on January 1,

2001. We exclude the transition gain from core business earnings because it relates to unrealized gains on purchased

options that were recorded when we adopted FAS 133.

(f) This amount represents the net federal income tax eÅect of core business earnings adjustments based on the

applicable federal income tax rate of 35 percent.

The Portfolio Investment business represented $869 billion, or 98 percent of total assets, at December 31,

2002 and $785 billion, or 98 percent of total assets, at December 31, 2001.

11. Dividend Restrictions and Regulatory Capital Ratios

Our ability to pay dividends may be subject to certain statutory restrictions. We would need approval by

the Director of OFHEO for any dividend payment that would cause our capital to fall below speciÑed capital

levels. We have exceeded the applicable capital standard since the adoption of these restrictions in 1992;

therefore, we have been making dividend payments without the need for director approval. The capital

adequacy standard requires that our core capital equal or exceed a minimum capital standard and a critical

capital standard.

OFHEO published regulations under the Federal Housing Enterprises Financial Safety and Soundness

Act of 1992 in September 2001, as amended on March 15, 2002, establishing a risk-based capital test to

determine the amount of total capital we must hold under the risk-based capital standard on a quarterly basis.

The risk-based capital standard was implemented by OFHEO on September 13, 2002.

134
FANNIE MAE

NOTES TO FINANCIAL STATEMENTS Ì (Continued)

The following table shows how our capital at December 31, 2002 and 2001 compared with these

requirements.

2002 2001

(Dollars in millions)

Core capital(1)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $28,079 $25,182

Required minimum capital(2)(5) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 27,203 24,182

Excess of core capital over minimum capital(5) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 877 $ 1,000

Total capital(3) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $28,871 $25,976

Required risk-based capital ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 17,434 N/A

Excess of total capital over required risk-based capital ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 11,437 N/A

Required critical capital(4)(5)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $13,880 $12,324

Excess of core capital over required critical capital(5) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 14,199 12,859

(1) The sum of (a) the stated value of common stock; (b) the stated value of outstanding noncumulative perpetual

preferred stock; (c) paid-in capital; and (d) retained earnings, less treasury stock. Core capital excludes accumulated

other comprehensive income (AOCI).

(2) The sum of (a) 2.50 percent of on-balance sheet assets; (b) .45 percent of outstanding MBS; and (c) .45 percent of

other oÅ-balance sheet obligations, which may be adjusted by the Director of OFHEO under certain circumstances

(See 12 CFR 1750.4 for existing adjustments made by the Director of OFHEO).

(3) The sum of (a) core capital and (b) the total allowance for loan losses and guaranty liability, less (c) the speciÑc loss

allowance. SpeciÑc loss allowances totaled $19 million and $13 million for the years ended December 31, 2002 and

December 31, 2001, respectively.

(4) The sum of (a) 1.25 percent of on-balance sheet assets; (b) .25 percent of outstanding MBS; and (c) .25 percent of

other oÅ-balance sheet obligations, which may be adjusted by the Director of OFHEO under certain circumstances.

(5) These amounts do not reÖect the reclassiÑcation from our ""Allowance for loan losses'' to a ""Guaranty liability for

MBS'' the amount associated with the guaranty obligation for MBS that we own that occurred in 2002. See Note 1 to

the notes to the financial statements, Summary of SigniÑcant Accounting Policies Ì Allowance for Loan Losses and

Guaranty Liability for MBS. The reclassiÑcation will not have a material eÅect on these amounts.

Payment of dividends on common stock is subordinate to any payment of dividends on preferred stock

outstanding. Payment of preferred stock dividends is not mandatory.

135
FANNIE MAE

NOTES TO FINANCIAL STATEMENTS Ì (Continued)

12. Preferred Stock

The following table presents preferred stock outstanding as of December 31, 2002.

Shares Issued Stated

and Value Annual Redeemable

Issue Date Outstanding per Share Dividend Rate On or After

Series D ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ September 30, 1998 3,000,000 $50 5.250% September 30, 1999

Series E ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ April 15, 1999 3,000,000 50 5.100 April 15, 2004

Series F ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ March 20, 2000 13,800,000 50 3.540(1) March 31, 2002(3)

Series G ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ August 8, 2000 5,750,000 50 1.830(2) September 30, 2002(3)

Series H ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ April 6, 2001 8,000,000 50 5.810 April 6, 2006

Series IÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ October 28, 2002 6,000,000 50 5.375 October 28, 2007

Series JÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ November 26, 2002 14,000,000 50 3.780(4) November 26, 2004

Total ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 53,550,000

(1) Rate eÅective March 31, 2002. Variable dividend rate that resets every two years thereafter at the Constant Maturity

U.S. Treasury Rate minus .16 percent with a cap of 11 percent per year.

(2) Rate eÅective September 30, 2002. Variable dividend rate that resets every two years thereafter at the Constant

Maturity U.S. Treasury Rate minus .18 percent with a cap of 11 percent per year.

(3) Represents initial call date. Redeemable every two years thereafter.

(4) Initial rate. Variable dividend rate that resets every two years thereafter at the two-year U.S. Dollar Swap Rate plus

1.38 percent with a cap of 8 percent per year.

In general, our preferred stock has no par value, has a stated value and liquidation preference of $50 per

share, and is not convertible into or exchangeable for any of our other stock or obligations. Holders of

preferred stock are entitled to receive noncumulative, quarterly dividends when, and if, declared by our Board

of Directors, but will have no right to require redemption of any shares of preferred stock. Payment of

dividends on preferred stock is not mandatory, but has priority over payment of dividends on common stock.

After a speciÑed period, we have the option to redeem preferred stock at its stated value. All outstanding

preferred stock is nonvoting.

We redeemed all 7.5 million of our outstanding Series B preferred stock on February 28, 2002 and all

5.0 million shares of our outstanding Series C preferred stock on July 31, 2002.

13. Derivative Instruments and Hedging Activities

Fannie Mae issues various types of debt to Ñnance the acquisition of mortgages. We typically use

derivative instruments to hedge against the impact of interest rate movements on our debt costs to preserve

mortgage-to-debt spreads. We do not engage in trading or other speculative usage of derivative instruments.

We principally use interest-rate swaps, basis swaps, swaptions, and caps in our hedging activities. Swaps

provide for the exchange of Ñxed and variable interest payments based on contractual notional principal

amounts. These may include callable swaps, which give counterparties or us the right to terminate interest rate

swaps before their stated maturities. Or, these may include foreign currency swaps, where Fannie Mae and our

counterparties exchange payments in diÅerent types of currencies. Basis swaps provide for the exchange of

variable payments that have maturities similar to hedged debt, but have payments based on diÅerent interest

rate indices. Swaptions give us the option to enter into swaps at a future date, thereby mirroring the economic

eÅect of callable debt. Interest rate caps provide ceilings on the interest rates of variable-rate debt.

We formally document all relationships between hedging instruments and the hedged items, including the

risk management objective and strategy for undertaking various hedge transactions. We link all derivatives to

speciÑc assets and liabilities on the balance sheet or to speciÑc forecasted transactions and designate them as

cash Öow or fair value hedges. We also formally assess, both at the hedge's inception and on an ongoing basis,

136
FANNIE MAE

NOTES TO FINANCIAL STATEMENTS Ì (Continued)

whether the derivatives that we use in hedging transactions are highly eÅective in oÅsetting changes in the

cash Öows or fair values of the hedged items.

The following table reÖects the hedge classiÑcation of the notional balances of derivatives by type that we

held at December 31, 2002 and 2001.

2002 2001

Fair Value Cash Flow Fair Value Cash Flow

Hedges Hedges Total Hedges Hedges Total

(Dollars in millions)

Interest rate swaps:

Pay-Ñxed ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 16,355 $152,157 $168,512 $ 7,063 $206,617 $213,680

Receive-Ñxed and basis ÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 29,636 48,259 77,895 10,989 75,134 86,123

Interest rate capsÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Ì 122,393 122,393 Ì 75,893 75,893

Swaptions:

Pay-Ñxed ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Ì 129,225 129,225 Ì 69,650 69,650

Receive-Ñxed ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 94,750 51,500 146,250 74,400 Ì 74,400

Other(1) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 4,120 8,200 12,320 8,843 4,550 13,393

Total ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $144,861 $511,734 $656,595 $101,295 $431,844 $533,139

(1) Includes foreign currency swaps, forward starting swaps, asset swaps, and other derivatives used to hedge anticipated

debt issues.

We discontinue hedge accounting prospectively when

‚ the derivative is no longer eÅective in oÅsetting changes in the cash Öows or fair value of a hedged

item;

‚ the derivative expires or is sold, terminated, or exercised;

‚ the derivative is de-designated as a hedge instrument because it is unlikely that a forecasted transaction

will occur; or,

‚ designation of the derivative as a hedge instrument is no longer appropriate.

Cash Flow Hedges

Objectives and Context

We employ cash Öow hedges to lock in the interest spread on purchased assets by hedging existing

variable-rate debt and the forecasted issuance of debt through our Benchmark Program. The issuance of shortterm Discount Notes and variable-rate long-term debt during periods of rising interest rates can result in a

mismatch of cash Öows relative to Ñxed-rate mortgage assets. We minimize the risk of mismatched cash Öows

by converting variable-rate interest expense to Ñxed-rate interest expense in order to lock-in our funding costs

and interest spread.

Risk Management Strategies and Policies

We enter into interest rate swaps, swaptions, and caps to hedge the variability of cash Öows resulting from

changes in interest rates. We enter into pay-Ñxed interest rate swaps to protect against an increase in interest

rates by converting the debt's variable rate to a Ñxed rate and to protect against Öuctuations in market prices of

anticipated debt issuances.

We enter into pay-Ñxed interest rate swaps and swaptions as well as interest rate caps to change the

variable-rate cash Öow exposure on our short-term Discount Notes and long-term variable-rate debt to Ñxedrate cash Öows. Under the swap agreements, we eÅectively create Ñxed-rate debt by receiving variable interest

137
FANNIE MAE

NOTES TO FINANCIAL STATEMENTS Ì (Continued)

payments and making Ñxed interest payments. We purchase swaptions that give us the option to enter into a

pay-Ñxed, receive-variable interest rate swap at a future date. Under interest rate cap agreements, we reduce

the variability of cash Öows on our variable-rate debt by purchasing the right to receive cash if interest rates

rise above a speciÑed level.

We continually monitor changes in interest rates and identify interest rate exposures that may adversely

impact expected future cash Öows on our mortgage and debt portfolios. We use analytical techniques,

including cash Öow sensitivity analysis, to estimate the expected impact of changes in interest rates on our

future cash Öows. We did not discontinue any cash Öow hedges during the year because it was no longer

probable that the hedged debt would be issued. We had no open positions for hedging the forecasted issuance

of debt at December 31, 2002.

Financial Statement Impact

Consistent with FAS 133, we record changes in the fair value of derivatives used as cash Öow hedges in

AOCI to the extent they are eÅective hedges. We amortize fair value gains or losses in AOCI into the income

statement and reÖect them as either a reduction or increase in interest expense over the life of the hedged

item. We recognize the income or expense associated with derivative instruments as an adjustment to the

eÅective cost of the hedged debt. We will amortize an estimated $4.7 billion, net of taxes, out of AOCI and

into earnings during the next 12 months. Actual amortization results in 2003 will likely diÅer from the

amortization estimate because actual swap yields during 2003 will change from the swap yield curve

assumptions at December 31, 2002.

The reconciliation below reÖects the change in AOCI, net of taxes, from January 1, 2001 through

December 31, 2002 associated with FAS 133:

FAS 133

Impact

(Dollars in millions) on AOCI

Transition adjustment to adopt FAS 133, January 1, 2001 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ (3,972)

Losses on cash Öow hedges, net ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (5,530)

ReclassiÑcations to earnings, net ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2,143

Balance at December 31, 2001 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (7,359)

Losses on cash Öow hedges, net ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (14,274)

ReclassiÑcations to earnings, net ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 5,382

Balance at December 31, 2002 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $(16,251)

If there is any hedge ineÅectiveness or derivatives do not qualify as cash Öow hedges, we record the

ineÅective portion in the ""Fee and other income, net'' line item on the income statement. We included a pretax loss of $.4 million in 2002 and $3 million in 2001 related to the ineÅective portion of cash Öow hedges in

""Fee and other income, net.''

We include only changes in the intrinsic value of swaptions and interest rate caps in our assessment of

hedge eÅectiveness. Therefore, we exclude changes in the time value of these contracts from the assessment of

hedge eÅectiveness and recognize them in the ""Purchased options expense'' line item on the income

statement. We recorded a pre-tax loss of $2.57 billion in 2002 and $34 million in 2001 in ""Purchased options

expense'' for the change in time value of options designated as cash Öow hedges.

138
FANNIE MAE

NOTES TO FINANCIAL STATEMENTS Ì (Continued)

Fair Value Hedges

Objectives and Context

We employ fair value hedges to preserve our mortgage-to-debt interest spreads when there is a decline in

interest rates by converting Ñxed-rate debt to variable-rate debt. A decline in interest rates increases the risk of

mortgage assets repricing at lower yields while Ñxed-rate debt remains at above-market costs. We limit the

interest rate risk inherent in our Ñxed-rate debt instruments by using fair value hedges to convert Ñxed-rate

debt to variable-rate debt.

Risk Management Strategies and Policies

We enter into various types of derivative instruments, such as receive-Ñxed interest rate swaps and

swaptions, to convert Ñxed-rate debt to Öoating-rate debt and preserve mortgage-to-debt interest spreads when

interest rates decline. Under receive-Ñxed interest rate swaps, we receive Ñxed interest payments and make

variable interest payments, thereby creating Öoating-rate debt. Receive-Ñxed swaptions give us the option to

enter into an interest rate swap at a future date. In this event, we eÅectively create callable debt that reprices

at a lower interest rate because we will receive Ñxed interest payments and make variable interest payments.

Financial Statement Impact

We record changes in the fair value of derivatives used as fair value hedges in the ""Fee and other income,

net'' line item on the income statement along with oÅsetting changes in the fair value of the hedged items

attributable to the risk being hedged. Our fair value hedges produced hedge ineÅectiveness totaling $.2 million

of expense during the year ended December 31, 2002. Our fair value hedges produced no hedge ineÅectiveness

during the year ended December 31, 2001.

We only include changes in the intrinsic value of swaptions in our assessment of hedge effectiveness. We

exclude changes in the time value of receive-fixed swaptions used as fair value hedges from the assessment of

hedge effectiveness and record them in the ""Purchased options expense'' line item on the income statement. For

the years ended December 31, 2002 and 2001, we recorded pre-tax purchased options expense of $1.97 billion

and $3 million, respectively, in the income statement for the change in the time value of these contracts.

Foreign Currency Hedges

Fannie Mae uses derivatives to hedge foreign currency exposure on debt issued in a foreign currency.

Because all of our assets are denominated in U.S. dollars, we enter into currency swaps to eÅectively convert

the foreign currency debt into U.S. dollars. Our foreign denominated debt is not material, representing

.5 percent of total debt outstanding.

14. Financial Instruments with OÅ-Balance-Sheet Risk

We are involved in Ñnancial instrument transactions that create oÅ-balance-sheet risk. We enter into

these transactions to fulÑll our statutory purpose of meeting the Ñnancing needs of the secondary residential

mortgage market and to reduce our own exposure to interest rate Öuctuations. These Ñnancial instruments

include guaranteed MBS and other mortgage-related securities, commitments to purchase mortgage portfolio

assets or to issue and guarantee MBS, and credit enhancements. These instruments involve elements of credit

and interest rate risk in excess of amounts recognized on the balance sheet to varying degrees.

Guaranteed MBS and Mortgage-Related Securities

As guarantor of MBS, we are obligated to disburse scheduled monthly installments of principal and

interest at the certiÑcate rate plus the UPB of any foreclosed mortgage to MBS investors whether or not they

have been received. We are paid a guaranty fee for assuming this credit risk. We also are obligated to disburse

139
FANNIE MAE

NOTES TO FINANCIAL STATEMENTS Ì (Continued)

unscheduled principal payments received from borrowers on MBS. The borrower, lender, or Fannie Mae may

purchase credit enhancements, such as mortgage insurance, to protect against the risk of loss from borrower

default. Occasionally, lenders may elect to remain at risk for the loans underlying MBS through recourse

arrangements. Lenders that keep recourse retain the primary default risk, in whole or in part, in exchange for a

lower guaranty fee. We may also enter into other credit enhancement arrangements. Fannie Mae, however,

bears the ultimate risk of default on MBS. To a much more limited extent, we guarantee the payment of

principal and interest on other mortgage-related securities.

At December 31, 2002, the maximum potential amount of future principal payments we could be

required to make under our guarantee of MBS and other mortgage-related securities was $1.029 trillion. We

have recognized a liability of $471 million at year-end 2002 for these guaranty obligations based on our

estimate of probable credit losses in the loans underlying MBS and other mortgage-related securities as of

December 31, 2002.

In the event we were required to make the maximum amount of future payments under the guarantees,

we would Ñrst pursue recovering these payments by proceeding against the underlying collateral of the loans. If

the value of the collateral was less than the payments made under our guarantees, then we would recover

payments from third-party providers of credit enhancements. In the event that the principal amount of singlefamily loans exceeds the value of the underlying properties, then we have credit enhancements with maximum

coverage totaling $66.1 billion in primary mortgage insurance, $7.0 billion in pool insurance, and $31.5 billion

in full recourse to lenders on single-family loans. If the collateral proceeds for multifamily loans were

insuÇcient, then we have credit enhancements totaling $4.2 billion in recourse to multifamily lenders.

Commitments

We enter into master delivery commitments with lenders on either a mandatory or an optional basis.

Under a mandatory master commitment, a lender must either deliver loans under an MBS contract at a

speciÑed guaranty fee rate or enter into a mandatory portfolio commitment with the yield established upon

executing the portfolio commitment.

We will also accept mandatory or lender-option delivery commitments not issued pursuant to a master

commitment. These commitments may be for purchases for our mortgage portfolio or for issuances of our

MBS. The guaranty fee rate on MBS lender-option commitments is speciÑed in the contract, while the yield

for portfolio lender-option commitments is set at the date of conversion to a mandatory commitment.

We generally hedge the cost of funding future portfolio purchases upon issuance of, or conversion to, a

mandatory commitment. Therefore, we largely mitigate the interest rate risk relating to loans purchased

pursuant to those commitments.

Credit Enhancements

Credit enhancements typically represent credit enhancement and liquidity support for taxable or taxexempt housing bonds issued by state and local governmental entities to Ñnance multifamily housing for lowand moderate-income families and for other obligations related to the Ñnancing. We issue MBS, pledge an

interest in certain mortgages we own, or otherwise provide contractual assurance of payment to a trustee for

the bonds or another party in the transaction. Our direct credit enhancement improves the rating on the bonds,

thus resulting in lower-cost Ñnancing for multifamily housing.

140
FANNIE MAE

NOTES TO FINANCIAL STATEMENTS Ì (Continued)

Credit Exposure for OÅ-Balance-Sheet Financial Instruments

The following table presents the contractual amount of oÅ-balance-sheet Ñnancial instruments at

December 31, 2002 and 2001. Contractual or notional amounts do not necessarily represent the credit risk of

the positions.

2002 2001

(Dollars in

billions)

Contractual amounts:

Outstanding MBS(1) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $1,029 $859

Master commitments:

Mandatory ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 41 24

Optional ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 6 16

Portfolio commitments:

Mandatory ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 85 55

Optional ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 3 2

Other investments ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 3 2

Credit enhancements ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 12 16

(1) Includes MBS and other mortgage-related securities guaranteed by Fannie Mae and held by investors

other than Fannie Mae.

15. Concentrations of Credit Risk

Concentrations of credit risk exist when a number of counterparties engage in similar activities and have

similar economic characteristics that make them susceptible to similar changes in economic conditions that

could aÅect their ability to meet contractual obligations. In our case, these counterparties include singlefamily borrowers, servicers, mortgage insurers, and derivative counterparties.

Regional economic conditions aÅect a borrower's ability to repay and the value of the collateral

underlying a loan. Geographic concentrations increase the susceptibility of our portfolio to changes in credit

risk. Our single-family geographic concentrations have been consistently diversiÑed over the past three years

with our largest exposure to the western region of the U.S. No region or state experienced negative home price

growth. No signiÑcant concentration existed at the state level at December 31, 2002 and 2001 except for

California, where 18 percent of the gross UPB of our conventional single-family mortgage loans in portfolio

and those underlying MBS in portfolio and outstanding MBS was located at both December 31, 2002 and

2001. The following table presents the regional geographic distribution of properties underlying our conventional single-family mortgage loans in portfolio and those underlying MBS in portfolio and outstanding MBS

at December 31, 2002 and 2001. Excluded from this population at December 31, 2002 and 2001 are nonFannie Mae mortgage securities for which geographic information is not available.

Geographic Distribution(1)

Midwest Northeast Southeast Southwest West Total

2002 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 18% 19% 21% 16% 26% 100%

2001 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 19 18 21 16 26 100

(1) Midwest includes IL, IN, IA, MI, MN, NE, ND, OH, SD, WI; Northeast includes CT, DE, ME, MA, NH, NJ, NY,

PA, PR, RI, VT, VI; Southeast includes AL, DC, FL, GA, KY, MD, NC, MS, SC, TN, VA, WV; Southwest includes

AZ, AR, CO, KS, LA, MO, NM, OK, TX, UT; West includes AK, CA, GU, HI, ID, MT, NV, OR, WA, WY.

141
FANNIE MAE

NOTES TO FINANCIAL STATEMENTS Ì (Continued)

To manage credit risk and comply with legal requirements, we require primary mortgage insurance or

other credit enhancement if the current LTV ratio of a single-family conventional mortgage loan is greater

than 80 percent when the loan is delivered to us. We may also require credit enhancement if the original LTV

ratio of a single-family conventional mortgage loan is less than 80 percent when the loan is delivered to us.

The primary credit risk associated with mortgage insurers is that they will fail to fulÑll their obligations to

reimburse us for claims under insurance policies. We were the beneÑciary of primary mortgage insurance

coverage on $316 billion of single-family loans in portfolio or underlying MBS at December 31, 2002 and

$314 billion at December 31, 2001. Seven mortgage insurance companies, all rated AA or higher by Standard

& Poor's, provided approximately 99 percent of the total coverage at the end of 2002 and 2001.

The primary risk associated with mortgage lenders is that they will fail to fulÑll their servicing obligations.

Mortgage servicers collect mortgage and escrow payments from borrowers, pay taxes and insurance costs from

escrow accounts, monitor and report delinquencies, and perform other required activities on our behalf. A

servicing contract breach could result in credit losses for us, or we could incur the cost of Ñnding a

replacement servicer, which could be substantial for loans that require a special servicer. Our ten largest

single-family mortgage servicers serviced 63 percent of our single-family book of business at both year-end

2002 and year-end 2001. Our Ñfteen largest multifamily mortgage servicers serviced 70 percent of our

multifamily book of business at year-end 2002, compared with 67 percent at year-end 2001.

The primary credit exposure we have on a derivative transaction is that a counterparty might default on

payments due, which could result in having to replace the derivative with a diÅerent counterparty at a higher

cost. Over 99 percent of the $657 billion and $533 billion notional amount of our outstanding derivative

transactions were with counterparties rated A or better both by Standard & Poor's (S&P) and Moody's at

December 31, 2002 and 2001, respectively (one counterparty was downgraded below an A rating after the

contract was entered into). Our derivative instruments were diversiÑed among 21 and 23 counterparties at

year-end 2002 and 2001, respectively, to reduce our credit risk concentrations. At December 31, 2002, eight

counterparties with credit ratings of A or better represented approximately 76 percent of the total notional

amount of outstanding derivatives transactions. At December 31, 2001, eight counterparties with credit ratings

of A or better represented approximately 78 percent of the total notional amount of outstanding derivatives

transactions.

Seventy-one percent of our net exposure of $197 million at December 31, 2002 was with six

counterparties rated AA or better by S&P and Aa or better by Moody's. The percentage of our exposure with

these six counterparties ranged from 2 to 23 percent. In comparison, Ñve counterparties rated AA or better by

S&P and Aa or better by Moody's accounted for 83 percent of our net exposure of $110 million at

December 31, 2001. The percentage of our net exposure with counterparties rated AA or better by S&P and

Aa or better by Moody's fell during 2002 because of a change in the relative mix of our derivative products in

response to changes in market conditions that shifted the relative level of activity and exposure between

individual counterparties.

16. Fair Value of Financial Instruments

The basic assumptions used and the estimates disclosed in the Fair Value Balance Sheets represent our

best judgment of appropriate valuation methods. These estimates are based on pertinent information available

to us as of December 31, 2002 and 2001. In certain cases, fair values are not subject to precise quantiÑcation

or veriÑcation and may change as economic and market factors, and our evaluation of those factors, change.

Although we use our best judgment in estimating the fair value of these Ñnancial instruments, there are

inherent limitations in any estimation technique. Therefore, these fair value estimates are not necessarily

indicative of the amounts that we would realize in a market transaction. The accompanying Fair Value

Balance Sheets do not represent an estimate of the overall market value of Fannie Mae as a going concern,

which would take into account future business opportunities.

142
FANNIE MAE

NOTES TO FINANCIAL STATEMENTS Ì (Continued)

Fair Value Balance Sheets

December 31, 2002 December 31, 2001

Carrying Estimated Carrying Estimated

Amount Fair Value Amount Fair Value

(Dollars in millions)

Assets

Mortgage portfolio, net ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $797,693 $826,870 $705,324 $720,174

Nonmortgage investments ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 59,844 59,845 74,554 74,716

Cash and cash equivalents ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 1,710 1,710 1,518 1,518

Other assets ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 24,602 19,316 17,598 13,020

Derivatives in gain positions ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 3,666 3,666 954 954

887,515 911,407 799,948 810,382

OÅ-balance-sheet items:

Guaranty fee income, net(1) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Ì 5,146 Ì 6,451

Mortgage purchase commitments(2) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Ì 1,650 Ì (567)

Total assetsÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $887,515 $918,203 $799,948 $816,266

Liabilities and Net Assets

Liabilities:

Senior debt

Due within one year ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $382,412 $382,453 $343,492 $343,648

Due after one yearÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 458,600 485,297 413,582 427,209

Subordinated debt

Due within one year ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Ì Ì Ì Ì

Due after one yearÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 9,970 12,424 6,393 7,625

850,982 880,174 763,467 778,482

Other liabilities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 14,548 10,202 13,294 10,040

Derivatives in loss positions ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 5,697 5,697 5,069 5,069

Total liabilities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 871,227 896,073 781,830 793,591

Net assets, net of tax eÅect ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 16,288 $ 22,130 $ 18,118 $ 22,675

(1) At December 31, 2002 and 2001, total MBS was $1,538 billion and $1,290 billion, respectively. Refer to Note 14,

""Financial Instruments with OÅ-Balance-Sheet Risk,'' for more information on the nature of this item.

(2) At December 31, 2002 and 2001, the amount of mandatory mortgage purchase commitments was $85 billion and

$55 billion, respectively. Refer to Note 14, ""Financial Instruments with OÅ-Balance-Sheet Risk,'' for more

information on the nature of this item.

See accompanying Notes to Fair Value Balance Sheets.

Notes to Fair Value Balance Sheets

The following discussion summarizes the signiÑcant methodologies and assumptions we used to estimate

the fair values in the accompanying Fair Value Balance Sheets.

Mortgage Portfolio, Net

The fair value calculations of our mortgage portfolio considered such variables as interest rates, credit

quality, and loan collateral. Because an active market does not exist for a portion of mortgage loans in the

portfolio, the portfolio's unsecuritized mortgages were aggregated into pools by product type, coupon, and

maturity and converted into notional MBS. A normal guaranty fee that our securitization business would

143
FANNIE MAE

NOTES TO FINANCIAL STATEMENTS Ì (Continued)

charge for a pool of loans with similar characteristics was subtracted from the weighted-average coupon rate

less servicing fees. We describe the method for estimating this guaranty fee and the credit risk associated with

the mortgage portfolio under ""Guaranty fee income.''

We then employed an option-adjusted spread (OAS) approach to estimate fair values for MBS held in

portfolio and other mortgage-related securities. The OAS approach represents the risk premium or incremental interest spread over some market benchmark rates, typically our debt rates, that is included in a security's

yield to compensate an investor for the uncertain eÅects of embedded prepayment options on mortgages. The

OAS was calculated using quoted market values for selected benchmark securities and provided a generally

applicable return measure that considers the eÅect of prepayment risk and interest rate volatility.

Nonmortgage Investments

We based fair values of our nonmortgage investment portfolio on actual quoted prices or prices quoted for

similar Ñnancial instruments.

Cash and Cash Equivalents

We used the carrying amount of cash and cash equivalents as a reasonable estimate of their fair value.

Other Assets

Other assets include accrued interest receivable, net currency swap receivables, and several other smaller

asset categories. The fair value of other assets, excluding certain deferred items that have no fair value and net

currency swap receivables, approximates their carrying amount. We estimated the fair value of net currency

swap receivables based on either the expected cash Öows or quoted market values of these instruments.

The fair value amount also includes the estimated eÅect on deferred income taxes of providing for federal

income taxes for the diÅerence between net assets at fair value and at cost at the statutory corporate tax rate of

35 percent.

Derivatives

We enter into interest rate swaps, including callable swaps that, in general, extend or adjust the eÅective

maturity of certain debt obligations. Under these swaps, we generally pay a Ñxed rate and receive a Öoating

rate based on a notional amount. We also enter into interest rate swaps that are linked to speciÑc investments

(asset swaps) or speciÑc debt issues (debt swaps). We estimated the fair value of interest rate swaps based on

either the expected cash Öows or quoted market values of these instruments, net of tax. We included the eÅect

of netting under master agreements in determining swap obligations in a gain position or loss position.

In addition, we enter into swaptions and interest rate caps. Under a swaption, we have the option to enter

into a swap, as described above, at a future date. We use interest rate caps to eÅectively manage our interest

expense in a period of rising interest rates by entering into an agreement whereby a counterparty makes

payments to us for interest rates above a speciÑed rate. We estimated the fair values of these derivative

instruments based on either the expected cash Öows or the quoted market values of these instruments, net of

tax.

Guaranty Fee Income

Guaranteed MBS and other mortgage-related securities are not assets owned by us, except when acquired

for investment purposes. We receive a guaranty fee calculated on the outstanding principal balance of the

MBS or other mortgage-related assets held by third-parties. The guaranty fee represents a future income

stream for us. Under generally accepted accounting principles, we recognize this guaranty fee as income over

144
FANNIE MAE

NOTES TO FINANCIAL STATEMENTS Ì (Continued)

the life of the securities. The Fair Value Balance Sheets reÖect the present value of guaranty fees, net of

estimated future administrative costs and credit losses, taking into account estimated prepayments.

We estimated the credit loss exposure attached to the notional amount of guaranteed MBS and other

mortgage-related securities held by third-party investors. We deducted estimated credit losses from the

projected guaranty fee cash Öows to arrive at fair value. We calculated estimated credit losses with an internal

forecasting model based on our actual historical loss experience. We then valued the net guaranty fee cash

Öows with reference to the pricing of similar assets.

Noncallable and Callable Debt

We estimated the fair value of our noncallable debt using quotes for selected Fannie Mae debt securities

with similar terms. We estimated the fair value of callable debt with an OAS model similar to the valuation of

the mortgage portfolio.

Other Liabilities

Other liabilities primarily include accrued interest payable, amounts payable to MBS holders, estimated

losses on guaranteed MBS, net currency swap payables, and several other smaller liability categories. The fair

value of other liabilities often approximates their carrying amount; however, certain deferred liabilities have no

fair value. We included credit loss exposure for guaranteed MBS and other mortgage-related securities as a

component of the net MBS guaranty fee. We estimated the fair value of net currency swap payables based on

the expected cash Öows or quoted market values of these instruments.

Mortgage Purchase Commitments

Mortgage purchase commitments include mandatory commitments to purchase MBS and loans. We

estimated their fair value based on the prices for similar MBS that are being traded in the marketplace.

145
INDEPENDENT AUDITORS' REPORT

To the Board of Directors and Stockholders of Fannie Mae:

We have audited the accompanying balance sheets of Fannie Mae as of December 31, 2002 and 2001,

and the related statements of income, changes in stockholders' equity, and cash Öows for each of the years in

the three-year period ended December 31, 2002. These Ñnancial statements are the responsibility of Fannie

Mae's management. Our responsibility is to express an opinion on these Ñnancial statements based on our

audits.

We conducted our audits in accordance with auditing standards generally accepted in the United States

of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about

whether the Ñnancial statements are free of material misstatement. An audit includes examining, on a test

basis, evidence supporting the amounts and disclosures in the Ñnancial statements. An audit also includes

assessing the accounting principles used and signiÑcant estimates made by management, as well as evaluating

the overall Ñnancial statement presentation. We believe that our audits provide a reasonable basis for our

opinion.

In our opinion, the Ñnancial statements referred to above present fairly, in all material respects, the

Ñnancial position of Fannie Mae as of December 31, 2002 and 2001, and the results of its operations and its

cash Öows for each of the years in the three-year period ended December 31, 2002, in conformity with

accounting principles generally accepted in the United States of America.

As discussed in Note 13 to the Ñnancial statements, Fannie Mae changed its method of accounting for

derivative instruments and hedging activities in 2001 in accordance with the adoption of Financial Accounting

Standard No. 133, Accounting for Derivative Instruments and Hedging Activities.

We also have audited in accordance with auditing standards generally accepted in the United States of

America the supplemental fair value balance sheets of Fannie Mae as of December 31, 2002 and 2001,

included in Note 16 to the Ñnancial statements. As described in Note 16, the supplemental fair value balance

sheets have been prepared by management to present relevant Ñnancial information that is not provided by the

Ñnancial statements and is not intended to be a presentation in conformity with accounting principles generally

accepted in the United States of America. In addition, the supplemental fair value balance sheets do not

purport to present the net realizable, liquidation, or market value of Fannie Mae as a whole. Furthermore,

amounts ultimately realized by Fannie Mae from the disposal of assets may vary signiÑcantly from the fair

values presented. In our opinion, the supplemental fair value balance sheets included in Note 16 present fairly,

in all material respects, the information set forth therein.

/s/ KPMG LLP

Washington, DC

January 14, 2003

146
REPORT OF MANAGEMENT

To The Stockholders Of Fannie Mae:

The management of Fannie Mae is responsible for the preparation, integrity, and fair presentation of the

accompanying Ñnancial statements and other information appearing elsewhere in this report. In our opinion,

the Ñnancial statements have been prepared in conformity with accounting principles generally accepted in the

United States of America appropriate in the circumstances, and the other Ñnancial information in this report is

consistent with such statements. In preparing the Ñnancial statements and in developing the other Ñnancial

information, it has been necessary to make informed judgments and estimates of the eÅects of business events

and transactions. We believe that these judgments and estimates are reasonable, that the Ñnancial information

contained in this report reÖects in all material respects the substance of all business events and transactions to

which the corporation was a party, and that all material uncertainties have been appropriately accounted for or

disclosed.

The management of Fannie Mae is also responsible for maintaining internal control over Ñnancial

reporting that provides reasonable assurance that transactions are executed in accordance with appropriate

authorization, permits preparation of Ñnancial statements in conformity with accounting principles generally

accepted in the United States of America, and establishes accountability for the assets of the corporation.

Internal control over Ñnancial reporting includes controls for the execution, documentation, and recording

of transactions, and an organizational structure that provides an eÅective segregation of duties and responsibilities. Fannie Mae has an internal OÇce of Auditing whose responsibilities include monitoring compliance with

established controls and evaluating the corporation's internal controls over Ñnancial reporting. Organizationally, the internal OÇce of Auditing is independent of the activities it reviews.

Fannie Mae's Ñnancial statements are audited by KPMG LLP, the corporation's independent auditors,

whose audit is performed in accordance with auditing standards generally accepted in the United States of

America. In addition, KPMG LLP obtained an understanding of our internal controls over Ñnancial reporting

and conducted such tests and other auditing procedures as they considered necessary to express the opinion on

the Ñnancial statements in their report that follows.

The Board of Directors of Fannie Mae exercises its oversight of Ñnancial reporting and related controls

through an Audit Committee, which is composed solely of directors who are not oÇcers or employees of the

corporation. The Audit Committee meets with management and the internal OÇce of Auditing periodically to

review the work of each and to evaluate the eÅectiveness with which they discharge their respective

responsibilities. In addition, the committee meets periodically with KPMG LLP, who has free access to the

committee, without management present. The appointment of the independent auditors is made annually by

the Board of Directors subject to ratiÑcation by the stockholders.

Management recognizes that there are inherent limitations in the eÅectiveness of any internal control

environment. However, management believes that, as of December 31, 2002, Fannie Mae's internal control

environment, as described herein, provided reasonable assurance as to the integrity and reliability of the

Ñnancial statements and related Ñnancial information.

/s/ TIMOTHY HOWARD /s/ LEANNE G. SPENCER

Timothy Howard Leanne G. Spencer

Executive Vice President and Senior Vice President and

Chief Financial OÇcer Controller

147
FANNIE MAE

QUARTERLY RESULTS OF OPERATIONS (Unaudited)

The following unaudited results of operations include, in the opinion of management, all adjustments

necessary for a fair presentation of the results of operations for such periods.

2002 Quarter Ended

December September June March

(Dollars in millions,

except per common share amounts)

Net interest income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 3,012 $ 2,591 $2,532 $2,431

Guaranty fee incomeÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 523 463 423 407

Fee and other income (expense), net ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 95 91 42 4

Provision for losses ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (41) (26) (33) (28)

Foreclosed property income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 8 12 9 7

Administrative expenses ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (313) (315) (301) (290)

Purchased options expense ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (1,881) (1,378) (499) (787)

Debt extinguishments, net ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (176) (138) (224) (172)

Income before federal income taxes ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 1,227 1,300 1,949 1,572

Provision for federal income taxesÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (275) (307) (485) (362)

Net income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 952 $ 993 $1,464 $1,210

Preferred stock dividends ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (20) (22) (24) (33)

Net income available to common stockholders ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 932 $ 971 $1,440 $1,177

Diluted earnings per common share ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ .94 $ .98 $ 1.44 $ 1.17

Cash dividends per common share ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ .33 .33 .33 .33

2001 Quarter Ended

December September June March

(Dollars in millions,

except per common share amounts)

Net interest income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 2,404 $ 2,079 $1,900 $1,707

Guaranty fee incomeÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 398 384 357 343

Fee and other income (expense), net ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 51 49 24 27

Provision for losses ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (21) (18) (24) (31)

Foreclosed property income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 5 3 6 2

Administrative expenses ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (251) (273) (254) (239)

Special contribution ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (300) Ì Ì Ì

Purchased options income (expense) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 578 (413) 36 (238)

Debt extinguishments, net ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (91) (207) (142) (84)

Income before federal income taxes and cumulative eÅect of change in

accounting principle ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2,773 1,604 1,903 1,487

Provision for federal income taxesÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (804) (375) (500) (362)

Income before cumulative eÅect of change in accounting principle ÏÏÏÏÏÏÏ 1,969 1,229 1,403 1,125

Cumulative eÅect of change in accounting principle, net of tax eÅect ÏÏÏÏÏ Ì Ì Ì 168

Net income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 1,969 $ 1,229 $1,403 $1,293

Preferred stock dividends ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (35) (35) (35) (33)

Net income available to common stockholders ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 1,934 $ 1,194 $1,368 $1,260

Diluted earnings per common share:

Earnings before cumulative eÅect of change in accounting principle ÏÏÏÏ $ 1.92 $ 1.19 $ 1.36 $ 1.08

Cumulative eÅect of change in accounting principle ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Ì Ì Ì .17

Net earnings ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 1.92 $ 1.19 $ 1.36 $ 1.25

Cash dividends per common share ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ .30 $ .30 $ .30 $ .30

148
FANNIE MAE

FINANCIAL AND STATISTICAL SUMMARY (Unaudited)

For the Year 2002 2001 2000 1999 1998

(Dollars in millions, except per common share amounts)

Summary Statements of Income:

Interest income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 50,853 $ 49,170 $ 42,781 $ 35,495 $ 29,995

Interest expenseÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (40,287) (41,080) (37,107) (30,601) (25,885)

Net interest income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 10,566 8,090 5,674 4,894 4,110

Guaranty fee incomeÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 1,816 1,482 1,351 1,282 1,229

Fee and other income (expense), net ÏÏÏÏÏÏÏÏÏÏ 232 151 (44) 191 275

Provision for losses ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (128) (94) (122) (151) (245)

Foreclosed property income (expense) ÏÏÏÏÏÏÏÏÏ 36 16 28 24 (16)

Administrative expenses ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (1,219) (1,017) (905) (800) (708)

Special contribution ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Ì (300) Ì Ì Ì

Purchased options expense ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (4,545) (37) Ì Ì Ì

Debt extinguishments (loss) gain, net ÏÏÏÏÏÏÏÏÏ (710) (524) 49 (14) (40)

Income before federal income taxes and

cumulative eÅect of change in accounting

principle ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 6,048 7,767 6,031 5,426 4,605

Provision for federal income taxesÏÏÏÏÏÏÏÏÏÏÏÏÏ (1,429) (2,041) (1,583) (1,514) (1,187)

Income before cumulative eÅect of change in

accounting principle ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 4,619 5,726 4,448 3,912 3,418

Cumulative eÅect of change in accounting

principle, net of tax eÅect ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Ì 168 Ì Ì Ì

Net income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 4,619 $ 5,894 $ 4,448 $ 3,912 $ 3,418

Preferred stock dividends ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (99) (138) (121) (78) (66)

Net income available to common stockholders ÏÏ $ 4,520 $ 5,756 $ 4,327 $ 3,834 $ 3,352

Basic earnings per common share:

Earnings before cumulative eÅect of change in

accounting principle ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 4.56 $ 5.58 $ 4.31 $ 3.75 $ 3.26

Cumulative eÅect of change in accounting

principle ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Ì .17 Ì Ì Ì

Net earnings ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 4.56 $ 5.75 $ 4.31 $ 3.75 $ 3.26

Diluted earnings per common share:

Earnings before cumulative eÅect of change in

accounting principle ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 4.53 $ 5.55 $ 4.29 $ 3.72 $ 3.23

Cumulative eÅect of change in accounting

principle ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Ì .17 Ì Ì Ì

Net earnings ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 4.53 $ 5.72 $ 4.29 $ 3.72 $ 3.23

Cash dividends per common share ÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 1.32 $ 1.20 $ 1.12 $ 1.08 $ .96

Mortgages purchased:

Single-family ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 363,149 $ 262,440 $ 149,674 $ 191,642 $185,863

Multifamily ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 7,492 8,144 4,557 3,568 2,585

Total mortgages purchasedÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 370,641 $ 270,584 $ 154,231 $ 195,210 $188,448

Average net yield on mortgages purchased ÏÏÏ 5.92% 6.56% 7.62% 6.88% 6.61%

Debt issued:

Short-term debt ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $1,635,919 $1,756,691 $1,143,131 $1,136,001 $695,495

Long-term debt ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 238,467 249,352 110,215 139,020 147,430

Total ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $1,874,386 $2,006,043 $1,253,346 $1,275,021 $842,925

Average cost of debt issued ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2.21% 3.97% 6.34% 5.33% 5.49%

MBS issues acquired by others ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 478,260 $ 344,739 $ 105,407 $ 174,850 $220,723

149
FANNIE MAE

FINANCIAL AND STATISTICAL SUMMARY (Unaudited)

At December 31,

2002 2001 2000 1999 1998

(Dollars in millions, except per common share amounts)

Summary Balance Sheets:

Mortgage portfolio:

Mortgage-related securities:

Held-to-maturity ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 437,932 $ 509,155 $ 443,872 $ 365,749 $ 250,274

Available-for-sale ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 173,706 32,900 11,434 8,501 9,021

Total ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 611,638 542,055 455,306 374,250 259,295

Loans held-for-investmentÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 185,652 165,917 152,437 149,101 155,774

Allowance for loan losses ÏÏÏÏÏÏÏÏÏÏ (79) (48) (51) (56) (79)

Unamortized premiums (discounts)

and deferred price adjustments, net 337 (2,640) (209) (378) 360

Loans held-for-saleÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 145 40 68 4 5

Mortgage portfolio, net ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 797,693 705,324 607,551 522,921 415,355

Other assets ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 89,822 94,624 67,673 52,387 69,791

Total assets ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 887,515 $ 799,948 $ 675,224 $ 575,308 $ 485,146

Debentures, notes, and bonds, net:

Due within one yearÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 382,412 $ 343,492 $ 280,322 $ 226,582 $ 205,413

Due after one year ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 468,570 419,975 362,360 321,037 254,878

Total debentures, notes, and bonds, netÏÏÏ 850,982 763,467 642,682 547,619 460,291

Guaranty liability for MBS ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 729 755 755 745 720

Other liabilities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 19,516 17,608 10,949 9,315 8,682

Total liabilities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 871,227 781,830 654,386 557,679 469,693

Stockholders' equity ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 16,288 18,118 20,838 17,629 15,453

Total liabilities and stockholders' equity ÏÏÏÏ $ 887,515 $ 799,948 $ 675,224 $ 575,308 $ 485,146

Core capitalÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 28,079 $ 25,182 $ 20,827 $ 17,876 $ 15,465

Excess of core capital over minimum capital ÏÏÏÏ 877 1,000 533 106 131

Excess of core capital over required critical

capital ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 14,199 12,859 10,490 8,748 7,602

Yield on net mortgage portfolio ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 6.45% 6.95% 7.24% 7.08% 7.12%

Yield on total interest earning assets ÏÏÏÏÏÏÏÏÏÏÏ 6.13 6.53 7.21 7.01 6.95

Cost of debt outstanding ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 4.81 5.49 6.47 6.18 6.10

Book value per common share ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 13.76 $ 15.86 $ 18.58 $ 16.02 $ 13.95

Common shares outstanding ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 989 997 999 1,019 1,025

Outstanding MBS ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $1,029,456 $ 858,867 $ 706,684 $ 679,169 $ 637,143

Book of businessÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 1,820,256 1,564,034 1,314,083 1,201,949 1,052,366

150
Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure

There were no changes in or disagreements with our accountants on accounting and Ñnancial disclosure

during the two most recent Ñscal years.

PART III

Item 10. Directors and Executive OÇcers of the Registrant

Information relating to directors and executive oÇcers of Fannie Mae is set forth under Item 5 of the

Form 10 and incorporated by reference herein.

Section 16(a) BeneÑcial Ownership Reporting Compliance

During 2002, no Fannie Mae executive oÇcer or director failed to Ñle any report required by

Section 16(a) with respect to equity securities of Fannie Mae on a timely basis.

Item 11. Executive Compensation

Information on certain transactions with directors and indebtedness of executive oÇcers is set forth under

Item 6 of the Form 10 and incorporated by reference herein.

Item 12. Security Ownership of Certain BeneÑcial Owners and Management and Related Stockholder

Matters

Information about the beneÑcial ownership of Fannie Mae common stock by each Fannie Mae director,

certain executive oÇcers, and by all directors and executive oÇcers as a group is set forth under Item 4 of the

Form 10 and incorporated by reference herein.

The table setting forth information on our compensation plans under which common stock is authorized

for issuance is set forth under Item 9 of the Form 10 and incorporated by reference herein. The material

features of each plan are brieÖy described under Item 6 of the Form 10 and incorporated by reference herein.

Item 13. Certain Relationships and Related Transactions

Information about certain relationships and related transactions is set forth under Item 7 of the Form 10

and incorporated by reference herein.

Item 14. Controls and Procedures

Franklin D. Raines, our Chairman of the Board of Directors and Chief Executive OÇcer, and J. Timothy

Howard, our Executive Vice President and Chief Financial OÇcer, have evaluated Fannie Mae's disclosure

controls and procedures, as deÑned in Rule 13a-14(c), within 90 days of the Ñling date of this Annual Report

and concluded that they have been eÅective. Mr. Raines and Mr. Howard have also indicated that there were

no signiÑcant changes in Fannie Mae's internal controls or in other factors that could signiÑcantly aÅect

internal controls subsequent to the date of their most recent evaluation, including any corrective actions with

regard to signiÑcant deÑciencies and material weaknesses.

151
PART IV

Item 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K

(a) Documents Ñled as part of this report

1. Financial Statements

The Ñnancial statements required to be Ñled as part of this report are contained in Item 8 beginning

on page 103, and included in this report following page 103.

2. Financial Statement Schedules

The financial statement schedule required to be Ñled as part of this report is listed on page 103 and

appears on page 148. All other schedules have been omitted because they are not required or are not

applicable or because the required information is included in the Financial Statements or the Notes.

3. Exhibits

An index to exhibits has been Ñled as part of this Report beginning on page E-1 and is incorporated

herein by reference.

(b) Reports on Form 8-K

Fannie Mae Ñled no reports on Form 8-K during the period covered by this Report.

152
SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the

registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

FEDERAL NATIONAL MORTGAGE ASSOCIATION

Date: March 31, 2003 By: /s/ FRANKLIN D. RAINES

Franklin D. Raines

Chairman and Chief Executive OÇcer

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below

by the following persons on behalf of the registrant and in the capacities and on the dates indicated.

Signature Title Date

/s/ FRANKLIN D. RAINES Chairman of the Board of Directors March 31, 2003

Franklin D. Raines and Chief Executive OÇcer

/s/ J. TIMOTHY HOWARD Executive Vice President and Chief March 31, 2003

Financial OÇcer J. Timothy Howard

/s/ LEANNE G. SPENCER Senior Vice President and Controller March 31, 2003

Leanne G. Spencer

/s/ VICTOR H. ASHE Director March 31, 2003

Victor H. Ashe

/s/ STEPHEN B. ASHLEY Director March 31, 2003

Stephen B. Ashley

/s/ MOLLY H. BORDONARO Director March 31, 2003

Molly H. Bordonaro

/s/ KENNETH M. DUBERSTEIN Director March 31, 2003

Kenneth M. Duberstein

/s/ THOMAS P. GERRITY Director March 31, 2003

Thomas P. Gerrity

/s/ JAMIE S. GORELICK Vice Chair March 31, 2003

Jamie S. Gorelick

/s/ WILLIAM R. HARVEY Director March 31, 2003

William R. Harvey

/s/ MANUEL J. JUSTIZ Director March 31, 2003

Manuel J. Justiz

153
Signature Title Date

/s/ ANN MCLAUGHLIN KOROLOGOS Director March 31, 2003

Ann McLaughlin Korologos

/s/ FREDERIC V. MALEK Director March 31, 2003

Frederic V. Malek

/s/ DONALD B. MARRON Director March 31, 2003

Donald B. Marron

/s/ DANIEL H. MUDD Vice Chairman and Chief March 31, 2003

Daniel H. Mudd Operating OÇcer

/s/ ANNE M. MULCAHY Director March 31, 2003

Anne M. Mulcahy

/s/ JOE K. PICKETT Director March 31, 2003

Joe K. Pickett

/s/ TAYLOR C. SEGUE, III Director March 31, 2003

Taylor C. Segue, III

/s/ H. PATRICK SWYGERT Director March 31, 2003

H. Patrick Swygert

154
CERTIFICATIONS

PURSUANT TO SECURITIES EXCHANGE ACT RULE 13a-14

I, Franklin D. Raines, certify that:

1. I have reviewed this annual report on Form 10-K of Fannie Mae (formally, the Federal National

Mortgage Association);

2. Based on my knowledge, this annual report does not contain any untrue statement of a material

fact or omit to state a material fact necessary to make the statements made, in light of the circumstances

under which such statements were made, not misleading with respect to the period covered by this annual

report;

3. Based on my knowledge, the Ñnancial statements, and other Ñnancial information included in

this annual report, fairly present in all material respects the Ñnancial condition, results of operations and

cash Öows of the registrant as of, and for, the periods presented in this annual report;

4. The registrant's other certifying oÇcers and I are responsible for establishing and maintaining

disclosure controls and procedures (as deÑned in Exchange Act Rules 13a-14 and 15d-14) for the

registrant and have:

(a) designed such disclosure controls and procedures to ensure that material information

relating to the registrant, including its consolidated subsidiaries, is made known to us by others

within those entities, particularly during the period in which this annual report is being prepared;

(b) evaluated the eÅectiveness of the registrant's disclosure controls and procedures as of a

date within 90 days prior to the Ñling date of this annual report (the ""Evaluation Date''); and

(c) presented in this annual report our conclusions abut the eÅectiveness of the disclosure

controls and procedures based on our evaluation as of the Evaluation Date;

5. The registrant's other certifying oÇcers and I have disclosed, based on our most recent

evaluation, to the registrant's auditors and the audit committee of the registrant's board of directors (or

persons performing the equivalent functions):

(a) all signiÑcant deÑciencies in the design or operation of internal controls which could

adversely aÅect the registrant's ability to record, process, summarize and report Ñnancial data and

have identiÑed for the registrant's auditors any material weaknesses in internal controls; and

(b) any fraud, whether or not material, that involves management or other employees who

have a signiÑcant role in the registrant's internal controls; and

6. The registrant's other certifying oÇcers and I have indicated in this annual report whether there

were signiÑcant changes in internal controls or in other factors that could signiÑcantly aÅect internal

controls subsequent to the date of our most recent evaluation, including any corrective actions with regard

to signiÑcant deÑciencies and material weaknesses.

/s/ FRANKLIN D. RAINES

Franklin D. Raines

Chairman of the Board of Directors and

Chief Executive OÇcer

Date: March 31, 2003

155
I, J. Timothy Howard, certify that:

1. I have reviewed this annual report on Form 10-K of Fannie Mae (formally, the Federal National

Mortgage Association);

2. Based on my knowledge, this annual report does not contain any untrue statement of a material

fact or omit to state a material fact necessary to make the statements made, in light of the circumstances

under which such statements were made, not misleading with respect to the period covered by this annual

report;

3. Based on my knowledge, the Ñnancial statements, and other Ñnancial information included in

this annual report, fairly present in all material respects the Ñnancial condition, results of operations and

cash Öows of the registrant as of, and for, the periods presented in this annual report;

4. The registrant's other certifying oÇcers and I are responsible for establishing and maintaining

disclosure controls and procedures (as deÑned in Exchange Act Rules 13a-14 and 15d-14) for the

registrant and have:

(a) designed such disclosure controls and procedures to ensure that material information

relating to the registrant, including its consolidated subsidiaries, is made known to us by others

within those entities, particularly during the period in which this annual report is being prepared;

(b) evaluated the eÅectiveness of the registrant's disclosure controls and procedures as of a

date within 90 days prior to the Ñling date of this annual report (the ""Evaluation Date''); and

(c) presented in this annual report our conclusions abut the eÅectiveness of the disclosure

controls and procedures based on our evaluation as of the Evaluation Date;

5. The registrant's other certifying oÇcers and I have disclosed, based on our most recent

evaluation, to the registrant's auditors and the audit committee of the registrant's board of directors (or

persons performing the equivalent functions):

(a) all signiÑcant deÑciencies in the design or operation of internal controls which could

adversely aÅect the registrant's ability to record, process, summarize and report Ñnancial data and

have identiÑed for the registrant's auditors any material weaknesses in internal controls; and

(b) any fraud, whether or not material, that involves management or other employees who

have a signiÑcant role in the registrant's internal controls; and

6. The registrant's other certifying oÇcers and I have indicated in this annual report whether there

were signiÑcant changes in internal controls or in other factors that could signiÑcantly aÅect internal

controls subsequent to the date of our most recent evaluation, including any corrective actions with regard

to signiÑcant deÑciencies and material weaknesses.

/s/ J. TIMOTHY HOWARD

J. Timothy Howard

Executive Vice President and Chief

Financial OÇcer

Date: March 31, 2003

156
6,000,000 Shares

5.125% Non-Cumulative Preferred Stock, Series L

(stated value $50 per share)

OFFERING CIRCULAR

Lehman Brothers

Goldman, Sachs & Co.

Bear, Stearns & Co. Inc.

Deutsche Bank Securities

Utendahl Capital Partners, L.P.