OFFERING CIRCULAR

3,000,000 Shares

5.10% Non-Cumulative Preferred Stock, Series E

(stated value $50 per share)

This oÅering circular relates to the oÅer of 3,000,000 shares of the 5.10% Non-Cumulative Preferred Stock, Series E

(the ""Preferred Stock'') of the Federal National Mortgage Association (""Fannie Mae''). The Preferred Stock has a

stated value of $50 per share. Dividends at the rate of 5.10% per year will accrue from and including April 15, 1999. We

will be required to pay dividends quarterly on March 31, June 30, September 30 and December 31 of each year,

commencing June 30, 1999, at the annual rate of $2.55 per share. However, we will be required to pay dividends only

when, as and if declared by our Board of Directors 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 in certain speciÑed ways. However, we will have the right to repurchase

shares of the Preferred Stock before a holder transfers the shares if the transfer would require us to pay increased

dividends on the transferred shares due to the enactment of a current federal budget proposal relating to the dividendsreceived deduction. If we are not given that right, the dividend will not be increased.

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 15, 2004, 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 $50.00 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).

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

Voting Rights; Amendments.''

The Preferred Stock has not been listed on any stock exchange.

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 us.

Price to Underwriting Proceeds to

Public(1) Discount(2) Fannie Mae(1)(3)

Per Share ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $50.00 $.50 $49.50

Total ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $150,000,000 $1,500,000 $148,500,000

(1) Plus accrued dividends, if any, from April 15, 1999.

(2) We have agreed to indemnify the Underwriter against certain liabilities. See ""Underwriting.''

(3) Before deducting expenses payable by us estimated at $100,000.

The Preferred Stock is oÅered by the Underwriter, subject to prior sale, when, as and if issued to and accepted by it

and subject to certain other conditions. The Underwriter reserves the right to withdraw, cancel or modify the oÅer and to

reject orders in whole or in part. It is expected that delivery of the Preferred Stock will be made in New York, New York,

on or about April 15, 1999 against payment in immediately available funds.

Bear, Stearns & Co. Inc.

April 8, 1999
The shares of Preferred Stock are exempt from the registration requirements of the

Securities Act of 1933 and are ""exempted securities'' within the meaning of the Securities

Exchange Act of 1934. Accordingly, we have not Ñled a registration statement with the

U.S. Securities and Exchange Commission. Neither the U.S. Securities and Exchange

Commission 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 into whose

possession this OÅering Circular comes are required by us and the Underwriter to inform

themselves about and to observe any such restrictions.

DOCUMENTS INCORPORATED BY REFERENCE

This OÅering Circular should be read only in conjunction with our Information Statement dated

March 31, 1999 (the ""Information Statement''), which is attached as Appendix B and incorporated

herein by this reference. This OÅering Circular, together with the Information Statement and any

documents incorporated herein by reference, are referred to as the ""OÅering Circular.'' Any Information Statement, supplement to it, or proxy statement published by us subsequent to the date of this

OÅering Circular and prior to the termination of the oÅering of the Preferred Stock shall be deemed to

be incorporated herein by this reference. 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.

AVAILABLE INFORMATION

You can obtain copies of any or all documents incorporated in this OÅering Circular by reference

without charge from the OÇce of Investor Relations, Fannie Mae, 3900 Wisconsin Avenue N.W.,

Washington, D.C. 20016 (telephone: (202) 752-7115). You can read the Information Statement,

proxy statements and other information concerning us at the oÇces of the New York Stock Exchange,

the Chicago Stock Exchange and the PaciÑc Exchange.

Because we are not subject to the periodic reporting requirements of the Securities Exchange Act

of 1934, we do not Ñle reports or other information with the U.S. Securities and Exchange

Commission.

2
SUMMARY OF THE OFFERING

This summary highlights information contained elsewhere 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 and Ñnancial data appearing elsewhere in this OÅering

Circular, the Information Statement and the CertiÑcate of Designation (as deÑned under ""Description

of Preferred Stock'').

The OÅering

Issuer ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Fannie Mae.

Securities OÅered ÏÏÏÏÏÏÏÏÏÏ 3,000,000 shares of 5.10% Non-Cumulative Preferred Stock,

Series E, no par value, stated value and liquidation preference of

$50.00 per share.

Dividends ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Non-cumulative, quarterly cash dividends at the rate of 5.10% per

year will accrue from and including April 15, 1999. We will be

required to pay dividends quarterly on March 31, June 30,

September 30 and December 31 of each year, commencing

June 30, 1999, at the annual rate of $2.55 per share. However, we

will be required to pay dividends only when, as and if declared by

our Board of Directors 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 in certain speciÑed ways. However, we

will have the right to repurchase shares of the Preferred Stock

before a holder transfers the shares if the transfer would require

us to pay increased dividends on the transferred shares due to the

enactment of a current federal budget proposal relating to the

dividends-received deduction. If we are not given that right, the

dividend will not be increased. See ""Description of the Preferred

StockÌDividendsÌChanges in the Dividends-Received

Deduction.''

Preferences ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 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.

Optional RedemptionÏÏÏÏÏÏÏ On or after April 15, 2004, 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 $50.00 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). Holders of Preferred Stock will have no right

to require redemption of Preferred Stock. We also will have a Ñrst

right to purchase shares of Preferred Stock upon the occurrence

of certain events as described under ""Description of Preferred

StockÌDividendsÌChanges in the Dividends-Received DeductionÌDebt Financed Purchases.''

Liquidation Rights ÏÏÏÏÏÏÏÏÏ Upon any dissolution, liquidation or winding up of Fannie Mae,

record holders of the outstanding shares of Preferred Stock will

be entitled to receive, out of our assets available for distribution to

3
stockholders, before any payment or distribution is made on our

common stock (or any other junior stock), $50.00 per share plus an

amount equal to the dividend for the then-current quarterly dividend period accrued to but excluding the date of the liquidation

payment (whether or not declared, but without accumulation of any

dividends for prior dividend periods).

Voting Rights ÏÏÏÏÏÏÏÏÏÏÏÏÏÏ None, except as to certain amendments relating to the terms of the

Preferred Stock.

Preemptive and Conversion

RightsÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ None.

Use of Proceeds ÏÏÏÏÏÏÏÏÏÏÏÏ To be added to our working capital and used for general corporate

purposes, and may be used to repurchase our common stock.

Listing ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ The Preferred Stock has not been listed on any stock exchange.

Summary Selected Financial Data

(Unaudited)

(Dollars in millions)

December 31,

1998 1997 1996 1995 1994

Balance Sheet Data:

Mortgage portfolio, net ÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $415,223 $316,316 $286,259 $252,588 $220,525

Total assets ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 485,014 391,673 351,041 316,550 272,508

Total liabilities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 469,561 377,880 338,268 305,591 262,967

Stockholders' equityÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 15,453 13,793 12,773 10,959 9,541

Capital(1) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 16,244 14,575 13,520 11,703 10,367

Year Ended December 31,

1998 1997 1996 1995 1994

Income Statement Data:

Net interest income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 4,110 $ 3,949 $ 3,592 $ 3,047 $ 2,823

Guaranty fees ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 1,229 1,274 1,196 1,086 1,083

Fee and other income, net ÏÏÏÏÏÏÏÏÏÏÏ 275 125 86 93 143

Special contribution ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Ì Ì Ì (350) Ì

Net incomeÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 3,418 3,056 2,725 2,144 2,132

Year Ended December 31,

1998 1997 1996 1995 1994

Other Data:

Average net interest marginÏÏÏÏÏÏÏÏÏÏ 1.03% 1.17% 1.18% 1.16% 1.24%

Ratio of earnings to combined Ñxed

charges and preferred stock

dividends(2) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 1.18:1 1.19:1 1.19:1 1.17:1 1.22:1

Mortgage purchases ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $188,448 $ 70,465 $ 68,618 $ 56,598 $ 62,389

MBS issued ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 326,148 149,429 149,869 110,456 130,622

MBS outstanding at year end(3) ÏÏÏÏÏ 834,518 709,582 650,780 582,959 530,343

(1) Stockholders' equity plus general allowance for losses.

(2) ""Earnings'' consists of (i) income before federal income taxes and extraordinary item and (ii) Ñxed charges. ""Fixed

charges'' represents interest expense. There was no preferred stock outstanding in 1995 and 1994.

(3) Includes $197 billion, $130 billion, $103 billion, $70 billion, and $44 billion of MBS in portfolio at December 31, 1998,

1997, 1996, 1995, and 1994, respectively.

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 the Information

Statement. 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.

We provide funds to the mortgage market by purchasing mortgage loans from lenders, thereby

replenishing their funds for additional lending. We acquire funds to purchase these loans 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.

We also issue 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, we oÅer various services to lenders and others for a fee. These services include issuing

certain types of MBS and providing technology services for originating and underwriting loans. See

""Business'' in the Information Statement.

Our principal oÇce is located at 3900 Wisconsin Avenue, N.W., Washington, D.C. 20016

(telephone: (202) 752-7000).

USE OF PROCEEDS

The net proceeds from the sale of the Preferred Stock (as deÑned under ""Description of Preferred

Stock'') will be added to our working capital and used for general corporate purposes and may be used

to repurchase our common stock.

We anticipate that additional Ñnancing, including Ñnancing through various types of equity and

debt securities, will be required from time to time. The amount and nature of our Ñnancing activities

are dependent 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 purchased by us, and

general market conditions.

5
CAPITALIZATION

The following table sets forth the capitalization of Fannie Mae as of December 31, 1998, and as

adjusted to give eÅect to the issuance of the Preferred Stock oÅered by this OÅering Circular (before

giving eÅect to the payment of estimated oÅering expenses and underwriting discount): 

Actual

Average Average Outstanding at As

Maturity Cost(1) December 31, 1998 Adjusted

(Dollars in millions)

Debentures, notes, and bonds, net:

Due within one year:

Short-term notes ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 3 mos. 5.18% $136,400 $136,400

Global debt ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 8 mos. 5.30 2,986 2,986

Debentures ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 6 mos. 7.54 7,594 7,594

Medium-term notes(2) ÏÏÏÏÏÏÏÏÏÏÏÏ 6 mos. 5.41 57,977 57,977

Other(3) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Ì 5.23 456 456

Total due within one year ÏÏÏÏÏÏ 205,413 205,413

Due after one year:

Global debt ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 6 yrs. 3 mos. 5.87 64,723 64,723

Debentures ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 5 yrs. 3 mos. 7.40 20,516 20,516

Medium-term notes(2) ÏÏÏÏÏÏÏÏÏÏÏÏ 5 yrs. 9 mos. 6.21 165,993 165,993

Other ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 17 yrs. 7.98 3,646 3,646

Total due after one year ÏÏÏÏÏÏÏ 254,878 254,878

Total debentures, notes, and bondsÏÏÏÏÏÏ $460,291 $460,291

Stockholders' equity:

Preferred stock, $50.00 stated value,

100,000,000 shares authorizedÌ

26,000,000 shares issued

Series A, 7,500,000 shares issuedÏÏÏÏ $ 375 $ 375

Series B, 7,500,000 shares issuedÏÏÏÏ 375 375

Series C, 5,000,000 shares issuedÏÏÏÏ 250 250

Series D, 3,000,000 shares issued ÏÏÏ 150 150

Series E, 3,000,000 shares issuedÏÏÏÏ Ì 150

Common stock, $.525 stated value, no

maximum authorizationÌ1,129 million

shares issued ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 593 593

Additional paid-in capital ÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 1,533 1,533

Retained earnings ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 15,689 15,689

Accumulated other comprehensive

income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (13) (13)

18,952 19,102

Less treasury stock, at costÌ104 million

shares(4)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 3,499 3,499

Total stockholders' equity ÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 15,453 $ 15,603

(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) Medium-term notes may have maturities of one day or longer.

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

(4) Does not reÖect any repurchases of our common stock that may be made using proceeds from the

sale of the Preferred Stock, Series E. See ""Use of Proceeds.''

We frequently issue debentures, notes and other debt obligations. The amount of debentures,

notes, and other debt obligations outstanding on any date subsequent to December 31, 1998 may diÅer

from that shown in the table above.

6
SELECTED FINANCIAL INFORMATION

The following selected Ñnancial data for the years 1994 through 1998 (which data are not covered

by the independent auditors' report) have been summarized or derived from the audited Ñnancial

statements and other Ñnancial information. These data should be read in conjunction with the

audited Ñnancial statements and notes to the Ñnancial statements.

(Dollars in millions, except per common share amounts)

1998 1997 1996 1995 1994 Income Statement Data for the year ended December 31:

Interest income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 29,995 $ 26,378 $ 23,772 $ 21,071 $ 17,347

Interest expense ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (25,885) (22,429) (20,180) (18,024) (14,524)

Net interest income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 4,110 3,949 3,592 3,047 2,823

Guaranty fees ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 1,229 1,274 1,196 1,086 1,083

Fee and other income, net ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 275 125 86 93 143

Credit-related expenses ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (261) (375) (409) (335) (378)

Administrative expenses ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (708) (636) (560) (546) (525)

Special contribution ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Ì Ì Ì (350) Ì

Income before federal income taxes and

extraordinary item ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 4,645 4,337 3,905 2,995 3,146

Provision for federal income taxes ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (1,201) (1,269) (1,151) (840) (1,005)

Income before extraordinary item ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 3,444 3,068 2,754 2,155 2,141

Extraordinary itemÌloss on early extinguishment

of debt, net of tax eÅect ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (26) (12) (29) (11) (9)

Net incomeÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 3,418 $ 3,056 $ 2,725 $ 2,144 $ 2,132

Preferred stock dividends ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (66) (65) (42) Ì Ì

Net income available to common shareholders ÏÏÏÏÏÏÏÏÏÏÏÏ $ 3,352 $ 2,991 $ 2,683 $ 2,144 $ 2,132

Basic earnings per common share(1):

Earnings before extraordinary item ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 3.28 $ 2.87 $ 2.53 $ 1.98 $ 1.96

Extraordinary itemÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (.02) (.02) (.03) (.01) (.01)

Net earnings ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 3.26 $ 2.85 $ 2.50 $ 1.97 $ 1.95

Diluted earnings per common share(1):

Earnings before extraordinary item ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 3.26 $ 2.84 $ 2.51 $ 1.96 $ 1.95

Extraordinary itemÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (.03) (.01) (.03) (.01) (.01)

Net earnings ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 3.23 $ 2.83 $ 2.48 $ 1.95 $ 1.94

Cash dividends per common share ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ .96 $ .84 $ .76 $ .68 $ .60

Balance Sheet Data at December 31:

Mortgage portfolio, net ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $415,223 $316,316 $286,259 $252,588 $220,525

Investments ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 58,515 64,596 56,606 57,273 46,335

Total assets ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 485,014 391,673 351,041 316,550 272,508

Borrowings:

Due within one yearÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 205,413 175,400 159,900 146,153 112,602

Due after one year ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 254,878 194,374 171,370 153,021 144,628

Total liabilities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 469,561 377,880 338,268 305,591 262,967

Stockholders' equityÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 15,453 13,793 12,773 10,959 9,541

Capital(2) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 16,244 14,575 13,520 11,703 10,367

Other Data for the year ended December 31:

Average net interest marginÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 1.03% 1.17% 1.18% 1.16% 1.24%

Return on average common equityÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 25.2 24.6 24.1 20.9 24.3

Dividend payout ratio ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 29.5 29.4 30.4 34.6 30.8

Average eÅective guaranty fee rate ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ .202 .227 .224 .220 .225

Credit loss ratio ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ .027 .041 .053 .050 .057

Ratio of earnings to combined Ñxed charges

and preferred stock dividends(3) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 1.18:1 1.19:1 1.19:1 1.17:1 1.22:1

Mortgage purchases ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $188,448 $ 70,465 $ 68,618 $ 56,598 $ 62,389

MBS issued ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 326,148 149,429 149,869 110,456 130,622

MBS outstanding at year-end(4) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 834,518 709,582 650,780 582,959 530,343

Weighted-average diluted common shares outstanding, in

millions ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 1,037 1,056 1,080 1,098 1,098

(1) Earnings per common share amounts in 1996, 1995, and 1994 have been restated to comply with Financial Accounting

Standard No. 128, Earnings per Share.

(2) Stockholders' equity plus general allowance for losses.

(3) ""Earnings'' consists of (i) income before federal income taxes and extraordinary item and (ii) Ñxed charges. ""Fixed

charges'' represents interest expense. There was no preferred stock outstanding in 1995 and 1994.

(4) Includes $197 billion, $130 billion, $103 billion, $70 billion, and $44 billion of MBS in portfolio at December 31, 1998,

1997, 1996, 1995, and 1994, respectively.

7
GOVERNMENT REGULATION AND CHARTER ACT

We are a federally chartered and stockholder-owned corporation organized and existing under the

Charter Act (12 U.S.C. Û 1716 et seq.) whose 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.

Fannie Mae originally was incorporated in 1938 pursuant to Title III of the National Housing Act

as a wholly owned government corporation and in 1954, under a revised Title III called the Federal

National Mortgage Association Charter Act, became a mixed-ownership corporate instrumentality of

the United States. From 1950 to 1968, Fannie Mae operated in the Housing and Home Finance

Agency, which was succeeded by the Department of Housing and Urban Development (""HUD'').

Pursuant to amendments to the Charter Act enacted in the Housing and Urban Development Act of

1968 (the ""1968 Act''), the then Federal National Mortgage Association was divided into two separate

institutions, the present Fannie Mae and the Government National Mortgage Association, a wholly

owned corporate instrumentality of the United States within HUD, which carried on certain special

Ñnancing assistance and management and liquidation functions. Under the 1968 Act, Fannie Mae was

constituted as a federally chartered corporation and the entire equity interest in Fannie Mae became

stockholder-owned.

Although the 1968 Act eliminated all federal ownership interest in Fannie Mae, it did not

terminate government regulation of Fannie Mae. Under the Charter Act, approval of the Secretary of

the Treasury is required for our issuance of debt obligations and MBS. In addition, the Federal

Housing Enterprises Financial Safety and Soundness Act of 1992 (the ""1992 Act'') established an

independent OÇce of Federal Housing Enterprise Oversight (""OFHEO'') within HUD under the

management of a Director (the ""Director'') who is responsible for ensuring that we are adequately

capitalized and operating safely in accordance with the 1992 Act. The 1992 Act established minimum

capital, risk-based capital and critical capital levels for Fannie Mae and required the Director to

establish, by regulation, a risk-based capital test to be used to determine the amount of total capital we

must have to exceed the risk-based capital level from time to time. OFHEO issued a Ñnal rule (the

""Rule'') in 1996 related to the minimum capital levels for Fannie Mae and Federal Home Loan

Mortgage Corporation (""Freddie Mac'') that sets forth how minimum capital requirements for both

entities are to be calculated, reported and classiÑed on a quarterly basis. The Rule, which Ñnalized an

original proposal dated June 1995, formalized the interim capital standards applied by OFHEO, with

which we have been in compliance since their inception. See also ""Management's Discussion and

Analysis of Financial Condition and Results of OperationsÌBalance Sheet AnalysisÌRegulatory

Capital Requirements'' in the Information Statement.

In 1996, OFHEO released for comment part one (""Part I'') of the proposed regulations to

establish the risk-based capital test. Part I speciÑes that ""benchmark loss experience'' will be

combined with other yet to be determined assumptions and applied each quarter to our book of

business to establish credit losses under the risk-based capital standard for Fannie Mae. Part I also

speciÑes the house price index that OFHEO will use in connection with the risk-based capital

standard. We submitted comments to OFHEO in October 1996 stating that several aspects of the

initial proposal require adjustments or amendment, because it does not accurately capture our credit

history and derives credit loss rates that are signiÑcantly worse than any reasonable representation of

Fannie Mae's and Freddie Mac's loss experience. On March 26, 1999, after inter-agency review and

comment on a proposed second part of the risk-based capital regulation (""Part II''), OFHEO sent

Part II to Congress for review. Shortly after the 15-day period for Congressional review, OFHEO is

8
expected to publish Part II for public review and comment over at least a 120-day period. Part II will

specify, among other matters, remaining aspects of the test and how the test will be used to determine

Fannie Mae's and Freddie Mac's risk-based capital requirements. The summary accompanying Part II

noted that if Part II had been in eÅect as of June 30, 1997, our required risk-based capital would have

been $17.73 billion, as compared with $14.05 billion in actual capital at that time. OFHEO also noted

that there were a variety of means, such as hedging, that we could have used to reduce required riskbased capital to the level of our actual capital. We have not yet thoroughly reviewed Part II but expect

to comment extensively on the proposal, which could change before it is Ñnally issued. The 1992 Act

provides that the Ñnal regulations will be enforceable one year after issuance. Our management is

conÑdent that we will be able to meet any reasonable Ñnal test.

If we fail to meet one or more of the capital standards under the 1992 Act, the Director is required

to take certain remedial measures and may take others, depending on the standards we fail to meet.

The Director's enforcement powers include the power to impose temporary and Ñnal cease-and-desist

orders and civil penalties on us and on our directors or executive oÇcers. If the Director 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 held or securitized by us has

decreased signiÑcantly, the Director is authorized to treat us as not meeting one of the capital

standards that we otherwise meet. In addition, we are required to submit a capital restoration plan if

we fail to meet any of the capital standards. If the Director does not approve the plan or determines

that we have failed to make reasonable eÅorts to comply with the plan, then the Director may treat us

as not meeting one of the capital standards that we otherwise meet. Also, if we fail to meet or are

treated by the Director as not meeting one of the capital standards and the Director has reasonable

cause to believe that we or any of our executive oÇcers or directors are engaging in or about to engage

in any conduct that threatens to result in a signiÑcant depletion of our core capital, then the Director

is authorized to commence proceedings pursuant to which, after a hearing, the Director could issue a

cease-and-desist order prohibiting such conduct. The Director could issue such an order without a

hearing, which would be eÅective until completion of the cease-and-desist proceedings, if the Director

determined that the conduct in question was likely to cause a signiÑcant depletion of core capital.

Prior approval of the Director is required for us to pay a dividend if the dividend would decrease our

capital below risk-based capital or minimum capital levels established under the 1992 Act. The

Director is authorized to levy, pursuant to annual Congressional appropriations, annual assessments

on Fannie Mae and Freddie Mac to cover reasonable expenses of OFHEO.

The 1992 Act also gives the Director the authority to conduct annually an on-site examination of

Fannie Mae for purposes of ensuring our Ñnancial safety and soundness. In addition, we are required

to submit annual and quarterly reports of our Ñnancial condition and operations to the Director.

Moreover, the Charter Act, as amended by the 1992 Act, authorizes the General Accounting OÇce

(""GAO'') to audit our programs, activities, receipts, expenditures and Ñnancial transactions. We also

are required to submit an annual report to the House and Senate Banking Committees and the

Secretary of HUD regarding our performance in meeting housing goals relating to the purchase of

mortgages on housing for low- and moderate-income families, mortgages on rental and owneroccupied housing for low-income families in low-income areas or for very-low-income families, and

mortgages on housing located in rural or other underserved areas.

Under the 1992 Act, the Secretary of HUD retains general regulatory authority to promulgate

rules and regulations to carry out the purposes of the Charter Act, excluding authority over matters

granted exclusively to the Director in the 1992 Act. The Secretary of HUD also must approve any new

conventional mortgage program that is signiÑcantly diÅerent from those approved or engaged in prior

to the 1992 Act. The Secretary of HUD is required to approve any new program unless it is not

authorized by the Charter Act or the Secretary of HUD Ñnds that the new program is not in the public

interest. However, until one year after the Ñnal regulations establishing the risk-based capital test are

in eÅect, the Secretary of HUD must disapprove a new program if the Director determines that the

9
program would risk signiÑcant deterioration of our Ñnancial condition. The Secretary of HUD has

adopted regulations related to the program approval requirement.

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

common stock, and the remaining Ñve members are appointed by the President of the United States.

The appointed directors must include one person from the home building industry, one person from

the mortgage lending industry, and one person from the real estate industry. Under the 1992 Act, one

appointed director also must be from an organization that has represented consumer or community

interests for not less than two years or a person who has demonstrated a career commitment to the

provision of housing for low-income households. Any member of the Board of Directors who is

appointed by the President of the United States may be removed by the President for good cause.

In addition to placing us under federal regulation, the Charter Act also grants to us certain privileges.

For instance, securities issued by us are deemed to be ""exempt securities'' under laws administered by the

U.S. Securities and Exchange Commission (""SEC'') to the same extent as securities that are obligations

of, or guaranteed as to principal and interest by, the United States. We are not required to file registration

statements with respect to our securities or periodic reports with the SEC.

The Secretary of the Treasury of the United States has discretionary authority to 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 of the United States is obligated to Ñnance our operations or to assist us in any other

manner.

We are exempt from all taxation by any state or by any county, municipality, or local taxing

authority except for real property taxes. We are not exempt from payment of federal corporate income

taxes. Also, we may conduct our business without regard to any qualiÑcations or similar statute in any

state of the United States or the District of Columbia.

The Federal Reserve Banks are authorized to act as depositaries, custodians, and Ñscal agents for

us, for its own account, or as Ñduciary.

DESCRIPTION OF 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. On March 1, 1996, we issued

7,500,000 shares of 6.41% Non-Cumulative Preferred Stock, Series A (stated value $50 per share)

(the ""Preferred Stock, Series A''); on April 12, 1996, we issued 7,500,000 shares of 6.50% NonCumulative, Preferred Stock, Series B (stated value $50 per share) (the ""Preferred Stock, Series B'');

on September 20, 1996, we issued 5,000,000 shares of 6.45% Non-Cumulative Preferred Stock,

Series C (stated value $50 per share) (the ""Preferred Stock, Series C''); and on September 30, 1998,

we issued 3,000,000 shares of 5.25% Non-Cumulative Preferred Stock, Series D (stated value $50 per

share) (the ""Preferred Stock, Series D'').

The terms of the Preferred Stock, Series E (the ""Preferred Stock'') will be established by a

CertiÑcate of Designation of Terms of 5.10% Non-Cumulative Preferred Stock, Series E (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 A to this OÅering Circular. The following

is a brief description of the terms of the Preferred Stock which does not purport to be complete and is

subject to and qualiÑed by reference to the CertiÑcate of Designation.

General

We will have the right to create and issue additional shares of the Preferred Stock and to create

and issue additional classes or series of stock ranking, as to dividends, liquidation or otherwise, prior

10
to, on a parity with or junior to the Preferred Stock without the consent of holders of the Preferred

Stock. As of the date of this OÅering Circular, the shares of Preferred Stock, Series A; Preferred

Stock, Series B; Preferred Stock, Series C; and Preferred Stock, Series D were the only shares of

Fannie Mae preferred stock outstanding. The Preferred Stock will rank on a parity, as to the payment

of dividends and the distribution of assets upon dissolution, liquidation or winding up of Fannie Mae,

with the Preferred Stock, Series A; the Preferred Stock, Series B; the Preferred Stock, Series C; and

the Preferred Stock, Series D.

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, will be fully paid and

nonassessable.

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

have no preemptive rights.

First Chicago Trust Company of New York, a division of EquiServe, will be the transfer agent,

dividend disbursing agent and registrar for shares 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 us.

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, in its sole discretion out of

funds legally available therefor, non-cumulative, quarterly cash dividends. Dividends will accrue from

and including April 15, 1999 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, 1999, at the

annual rate of $2.55 per share (without taking into account any adjustments as described below under

""Ì Changes in the Dividends-Received Deduction''). Dividends on the Preferred Stock will be

payable to the Holders on the relevant record date Ñxed by the Board of Directors, or a duly

authorized committee, 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 15, 1999 to but excluding June 30, 1999, will be $.53125 per share. Thereafter, 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, dividends (if declared) on the Preferred Stock will be paid on

the succeeding business day, without interest. A ""Business Day'' shall mean 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. Dividends payable on the 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 and the actual number of days elapsed in any period of less than one month. Dividends

payable on the Preferred Stock for each full dividend period will be computed by dividing the per

annum dividend rate by four.

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. No dividend (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 other stock ranking junior to the Preferred Stock as to the payment of

dividends and the distribution of assets upon dissolution, liquidation or winding up of Fannie Mae)

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

Fannie Mae ranking, as to the payment of dividends, junior to the Preferred Stock) 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. When dividends are not paid in full upon the Preferred Stock

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

11
dividends with the Preferred Stock, all dividends declared upon shares of Preferred Stock and all such

other stock of Fannie Mae 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 adjustments in the

amount of dividends payable as described below under "" ÌChanges in the Dividends-Received

Deduction,'' but without accumulation of unpaid dividends for prior dividend periods) and such other

stock bear to each other.

Dividends on the Preferred Stock will not be cumulative. If a dividend is not declared and paid on

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

so long as no dividend (other than those referred to in the preceding paragraph) is declared or paid on

our common stock (or any other stock of Fannie Mae ranking, as to the payment of dividends, junior

to the Preferred Stock) for the then-current quarterly dividend period.

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

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

other stock of Fannie Mae 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 any default exists in the payment of dividends on any

outstanding class or series of stock of Fannie Mae ranking prior to the Preferred Stock with respect to

the payment of dividends. At the time of issuance of the Preferred Stock, no class or series of stock of

Fannie Mae ranking prior to the Preferred Stock with respect to the payment of dividends will exist.

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

dividends.

Changes in the Dividends-Received Deduction

The following paragraphs describe the circumstances in which the dividends payable in respect of

the Preferred Stock will be adjusted as a result of changes in the Internal Revenue Code of 1986, as

amended (the ""Code''), relating to the dividends-received deduction. Unless the context otherwise

requires, references to dividends in this OÅering Circular will mean dividends as adjusted pursuant to

the following paragraphs. Our calculation of the dividends payable as so adjusted shall be Ñnal and not

subject to review.

See also ""United States TaxationÌDividendsÌRecent Proposals'' for a discussion of certain

proposals that may aÅect the dividends-received deduction.

The Dividends-Received Percentage. If, prior to 18 months after the date of the original issuance

of the Preferred Stock, one or more amendments to the Code are enacted that 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 payable described above under ""Dividends'' (before adjust12
ment) 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 the 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 (or as described under ""ÌDebt Financed Purchases'' below), 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 authorization 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. That opinion 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, if any such amendment to the Code is enacted after the dividend

payable on a Dividend Payment Date has been declared, 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 (x) the product of the dividend paid by us 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 (y) 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 or, if the Preferred Stock is called for redemption prior to such record date, to Holders of

Preferred Stock on the applicable redemption date, as the case may be, in addition to any other

amounts payable on such 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) or, if the Preferred Stock is called for redemption prior to such record date, to Holders of

Preferred Stock on the applicable redemption date, as the case may be. Retroactive Dividends will

equal the excess of (x) 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

(y) 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 authorization 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.

13
Notwithstanding the foregoing, no adjustment in the dividends payable by us shall be made, and

no Post Declaration Date Dividends or Retroactive Dividends shall be payable by us, in respect of the

enactment of any amendment to the Code that reduces the Dividends-Received Percentage and occurs

18 months or more after the date of original issuance of the Preferred Stock.

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.

Debt Financed Purchases. Under existing law, a corporate shareholder's dividends-received

deduction is reduced if the dividend is received with respect to ""portfolio stock'' that is ""debt

Ñnanced.'' Currently, ""portfolio stock'' is considered ""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. A proposal in the budget plan released by the

Clinton Administration on February 1, 1999 (the ""Budget Proposal'') would modify the rules

governing the reduction in the 70-percent dividends-received deduction in respect of a corporate

shareholder's investment in ""portfolio stock'' that is ""debt Ñnanced.''

Under the Budget Proposal, the percentage of portfolio stock considered to be debt Ñnanced, and

thus the percentage reduction in the dividends-received deduction, would equal the sum of (1) the

percentage of stock directly Ñnanced by indebtedness and (2) the percentage of remaining stock

""indirectly'' Ñnanced by indebtedness. The percentage of portfolio stock that is indirectly Ñnanced by

indebtedness would be determined by using a pro-rata allocation similar to the one used in section

264(f) of the Code, under which interest expense is allocated pro rata among the taxpayer's assets.

This proposal would be eÅective for portfolio stock acquired on or after the date of enactment. It is

possible that the eÅective date of this proposal could be amended to make the proposal, if enacted,

applicable to preferred stock acquired before the date of enactment.

If, prior to 18 months after the date of the original issuance of the Preferred Stock, the Budget

Proposal is enacted in substantially the form proposed (as determined by us in our sole discretion)

and would (1) require a percentage reduction in a Holder's dividends-received deduction to the extent

the Holder's investment in Preferred Stock was indirectly Ñnanced by indebtedness (determined using

a pro rata allocation similar to that which is used in section 264(f) of the Code) and (2) be eÅective

for Preferred Stock acquired on or after the eÅective date of the Budget Proposal's changes to the

Code, certain adjustments may be made in respect of dividends payable by Fannie Mae as described

below. However no adjustment shall be made unless prior to a Holder's acquisition of aÅected shares,

Fannie Mae has been given the right to purchase those shares upon reasonable terms and at a fair

market price, the determination of which shall be within Fannie Mae's sole discretion. The adjustment

to dividends payable described in the following paragraph will be made only on shares of Preferred

Stock that a Holder acquires on or after the eÅective date of such changes to the Code, and only if we

were given the right to purchase those shares prior to such Holder's acquisition of the shares. There

will be no adjustment to dividends payable on shares that a Holder acquires prior to the eÅective date

of the changes to the Code.

If a Holder acquires shares of Preferred Stock under the circumstances described in the preceding

paragraph, dividends will accrue on such shares at an adjusted rate from and including the date the

Holder acquires such shares. The dividends payable on the transferred shares of Preferred Stock for

the period beginning on the date of transfer shall be equal to (x) the amount of the dividend that

would be payable for such period on such shares if the shares were not entitled to adjustment

multiplied by (y) 1.08485 (the ""Sale Factor''), rounded to the nearest cent (with one-half cent

rounded upwards). Notwithstanding the foregoing provisions, if, with respect to any amendments to

the Code described in the preceding paragraph, we receive either an unqualiÑed opinion of a nationally

recognized independent tax counsel selected by us or a private letter ruling or similar form of

authorization from the IRS to the eÅect that such amendments do not apply to a dividend payable on

14
the Preferred Stock, then such amendments will not result in the adjustment described above with

respect to such dividend. The opinion shall be based upon the legislation amending the Code or upon a

published pronouncement of the IRS addressing such legislation.

Notwithstanding the foregoing, if a Holder acquires shares of Preferred Stock under the

circumstances described in the two preceding paragraphs but after the dividend payable on a Dividend

Payment Date has been declared, the amount of the dividend payable on such Dividend Payment Date

will not be increased; instead, additional dividends (the ""Second Post Declaration Date Dividends''),

equal to the excess, if any, of (x) the dividend that would have been paid if the adjustment called for

by the previous paragraph had been made over (y) 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 or, if the Preferred Stock is called for redemption prior to

such record date, to Holders of Preferred Stock on the applicable redemption date, as the case may be,

in addition to any other amounts payable on such date.

Notwithstanding the foregoing, no adjustment in the dividends payable by us shall be made, and

no Second Post Declaration Date Dividends shall be payable by us, in respect of the enactment of the

Budget Proposal 18 months or more after the date of original issuance of the Preferred Stock.

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

and/or Second Post Declaration Date Dividends are to be paid with respect to certain shares of

Preferred Stock, we will give notice of each such adjustment and, if applicable, any Second Post

Declaration Date Dividends to the applicable Holders of such Preferred Stock.

Optional Redemption

The Preferred Stock is not subject to any mandatory redemption, sinking fund or other similar

provisions. On or after April 15, 2004, 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 $50.00 per share plus an amount equal to the dividend (whether or not declared) for the thencurrent quarterly dividend period accrued to but excluding the date of redemption, including any

adjustments in the amount of dividends as described under ""DividendsÌChanges in the DividendsReceived Deduction'' above, 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 our Board of

Directors, or a duly authorized committee, in its sole discretion deems equitable.

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

prior to the date Ñxed by the Board of Directors, or a duly authorized committee, for 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 the Holder, the redemption price, the redemption date and the place at which the

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

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.''

Holders of Preferred Stock will have no right to require redemption of Preferred Stock.

If we have given notice of redemption as described above, from and after the redemption date,

dividends on the Preferred Stock called for redemption will cease to accrue and the Preferred Stock

called for redemption will no longer be deemed outstanding, and all rights of the Holders as registered

holders of the Preferred Stock will cease.

15
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 dissolution, liquidation or winding up, the

Holders of the outstanding shares of the Preferred Stock will be entitled to receive 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 other stock of Fannie Mae ranking, as to the

distribution of assets upon dissolution, liquidation or winding up of Fannie Mae, junior to the

Preferred Stock), the amount of $50.00 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 the amount of dividends as described under ""Ì

Changes in the Dividends-Received Deduction'' above, but without accumulation of unpaid dividends

on the Preferred Stock for prior dividend periods. 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

dissolution, liquidation or winding up of Fannie Mae, on a parity with the Preferred Stock, the assets

will be distributed to the Holders of Preferred Stock and holders of the other stock pro rata, based on

the full respective preferential amounts to which they are entitled, including any adjustments in the

amount of dividends as described under ""DividendsÌChanges in the Dividends-Received Deduction''

above, but without accumulation of unpaid dividends on the Preferred Stock for prior dividend

periods. 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, the Holders of Preferred Stock will not be

entitled to any further participation in any distribution of our assets.

Notwithstanding the foregoing, Holders of 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 our stock ranking, as to the distribution of assets upon dissolution, liquidation or

winding up of Fannie Mae, prior to the Preferred Stock have been paid all amounts to which these

classes or series are entitled. At the time of issuance of the Preferred Stock, no class or series of stock

ranking prior to the Preferred Stock with respect to the distribution of assets upon dissolution,

liquidation or winding up of Fannie Mae will exist.

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 or the merger, consolidation or combination of any other corporation 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 dividends if, as and when declared by our Board

of Directors, or a duly authorized committee. However, certain provisions of the 1992 Act may operate

to restrict the ability of our Board of Directors to declare dividends in certain circumstances. The 1992

Act established minimum capital, risk-based capital, and critical capital levels for Fannie Mae, and

required the Director of OFHEO to establish, by regulation, a risk-based capital test to be used to

determine the amount of total capital we must have to exceed the risk-based capital level from time to

time. (See ""Government Regulation and Charter Act'' in this OÅering Circular and the Information

Statement for the current status of the required regulations.) 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 established under the 1992 Act and the dividend

payment would not decrease our base capital below such level.

One year after Ñnal regulations establishing the risk-based capital test take eÅect, we may pay a

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

minimum capital levels and the dividend payment would not decrease our total capital below the risk16
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 also ""Government Regulation and Charter Act'' in this OÅering Circular and in the

Information Statement, and ""Management's Discussion and Analysis of Financial Condition and

Results of OperationsÌBalance Sheet AnalysisÌRegulatory Capital Requirements'' in the Information Statement regarding the capital standards applicable to us.

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 will have the right to amend, alter,

supplement or repeal any terms of the Preferred Stock (1) to cure any ambiguity, or to cure, correct or

supplement any defective provision contained in the CertiÑcate of Designation or (2) 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; provided, however, that

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,

will not be deemed to materially and adversely aÅect the interests of the Holders of Preferred Stock.

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.

Absence of Trading Market

We have not applied for listing of the Preferred Stock on any stock exchange and we do not expect

an active trading market to develop with respect to the Preferred Stock. Accordingly, the ability of a

Holder to dispose of the Preferred Stock may be limited.

LEGALITY OF INVESTMENT

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

accounts without regard to limitations generally applicable to investment securities. The Preferred

Stock would be subject to a 100% risk weighting for federal 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 federal

capital adequacy purposes.

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,

17
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 Fannie Mae. 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-of-assets limits. The regulatory authorities that administer the

legal provisions referred to above generally reserve discretion as to 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 are not generally exempt from taxation by the United

States or other U.S. or non-U.S. taxing jurisdictions.

In the opinion of Arnold & Porter, our special tax counsel, the following discussion correctly

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

beneÑcial owners (""Owners'') of the Preferred Stock. This discussion does not address the U.S.

federal income tax treatment of Owners that are not U.S. Persons. This discussion is based on the

Code, 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 the tax consequences

described herein.

This summary discusses only preferred stock held as a capital asset (within the meaning of

section 1221 of the Code). 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 Owners subject to special rules, such as dealers in securities, certain Ñnancial institutions

and certain securities traders. 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.

18
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

United States person has the authority to control all substantial decisions of the trust.

Dividends

Current Law

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 or 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, such

dividend will be treated Ñrst as a return of capital (rather than as ordinary income) and will be applied

against and reduce the Owner's adjusted tax basis in that share of Preferred Stock. The amount of any

such dividend in excess of the Owner'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 Owners 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 an Owner

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 with respect to that dividend. If the dividend is attributable to a period or

periods aggregating more than 366 days, the dividend received deduction will be available only if the

Owner 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 for 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.

Recent Proposals

On February 1, 1999, the Clinton Administration released a budget plan that includes certain tax

proposals that may aÅect Owners of Preferred Stock. Under one of the proposals, the 70-percent

dividends-received deduction generally available to corporate shareholders, as discussed above under

""Current Law,'' would be eliminated for dividends on ""nonqualiÑed preferred stock'' issued on or after

the date of enactment. The Preferred Stock would not be aÅected by this proposal as it is currently

drafted.

Another proposal in the Clinton Administration's budget plan would modify the rules governing

the reduction in the 70-percent dividends-received deduction in respect of a corporate shareholder's

investment in ""portfolio stock'' that is ""debt Ñnanced.'' Under the proposal, the percentage of

19
portfolio stock considered to be debt Ñnanced, and thus the percentage reduction in the dividendsreceived deduction, would equal the sum of (1) the percentage of stock directly Ñnanced by

indebtedness and (2) the percentage of remaining stock ""indirectly'' Ñnanced by indebtedness. The

percentage of portfolio stock that is indirectly Ñnanced by indebtedness would be determined by using

a pro rata allocation similar to the one used in section 264(f) of the Code, under which interest

expense is allocated pro rata among the taxpayer's assets. This proposal would be eÅective for

portfolio stock acquired on or after the date of enactment. It is possible that the eÅective date of this

proposal could be amended to make the proposal, if enacted, applicable to preferred stock acquired

before the date of enactment. If this proposal is enacted and reduces the dividends-received deduction

applicable to the Preferred Stock, the amount of dividends payable per share of Preferred Stock may

be adjusted to the extent discussed above under ""Description of Preferred Stock Ì Dividends Ì

Changes in the Dividends-Received Deduction Ì Debt Financed Purchases.'' 

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 of cash

received 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 Owners vary depending on each

Owner's income and holding period for the Preferred Stock. Owners 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 Owner 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 Owner 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 Owner must take into account not

only the Preferred Stock and other stock of Fannie Mae that it owns directly, but also the Preferred

Stock and other stock in Fannie Mae that it constructively owns within the meaning of section 318 of

the Code. Because of the complex nature of these rules, each Owner 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 held of record by U.S. persons other than

corporations and other exempt holders are required to be reported to the IRS.

Backup withholding of U.S. federal income tax at a rate of 31 percent may apply to payments

made with respect to shares of Preferred Stock, as well as payments of proceeds from the sale of shares

of Preferred Stock, to holders or Owners that are not ""exempt recipients'' and that fail to provide

certain identifying information (such as the taxpayer identiÑcation number of the holder or Owner) in

the manner required. Individuals generally are not exempt recipients, whereas corporations and

certain other entities generally are exempt recipients.

The U.S. federal tax discussion set forth above is included for general information only

and may not be applicable depending upon an Owner's particular situation. Each Owner

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.

20
UNDERWRITING

Subject to the terms and conditions set forth in the underwriting agreement (the ""Underwriting

Agreement''), we have agreed to sell to Bear, Stearns & Co. Inc. (the ""Underwriter''), and the

Underwriter has agreed to purchase, 3,000,000 shares of Preferred Stock. 

In the Underwriting Agreement, the Underwriter has agreed, subject to the terms and conditions

set forth therein, to purchase all the Preferred Stock oÅered by this OÅering Circular if any is

purchased.

The Underwriter has advised us that the Underwriter proposes initially to oÅer the Preferred

Stock to the public at the price set forth on the cover page of this OÅering Circular.

Prior to this oÅering, there has been no public market for the Preferred Stock. The Preferred

Stock has not been listed on any stock exchange.

In the Underwriting Agreement, we and the Underwriter have agreed to indemnify each other

against and contribute toward certain liabilities.

The Underwriter and certain of its aÇliates engage in transactions with and perform services for

us in the ordinary course of business.

The Underwriter 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 Underwriter makes 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 Underwriter is not required to engage in any of these transactions. When so doing, the

Underwriter acts on its own behalf and not as our representative. Any such transactions, if

commenced, may be discontinued at any time.

VALIDITY OF THE PREFERRED STOCK

The validity of the Preferred Stock will be passed upon for us by Wilmer, Cutler & Pickering,

Washington, D.C., and for the Underwriter by Sullivan & Cromwell, Washington, D.C. Certain

U.S. federal income tax matters will be passed upon for us by Arnold & Porter, Washington, D.C.

21
APPENDIX A

CERTIFICATE OF DESIGNATION OF TERMS OF

5.10% NON-CUMULATIVE PREFERRED STOCK, SERIES E

1. Designation, Par Value and Number of Shares.

The designation of the series of preferred stock of the Federal National Mortgage Association

(the ""Corporation'') created by this resolution shall be ""5.10% Non-Cumulative Preferred Stock,

Series E'' (the ""Series E Preferred Stock''), and the number of shares constituting the Series E

Preferred Stock is Three Million (3,000,000). Shares of Series E Preferred Stock will have no par

value and a stated value and liquidation preference of $50 per share. The Board of Directors of the

Corporation, or a duly authorized committee thereof, in its sole discretion, may increase the number of

shares of Series E Preferred Stock and may reduce the number of shares of Series E Preferred Stock,

provided such reduction is not below the number of shares of Series E Preferred Stock then

outstanding.

2. Dividends.

(a) Holders of record of Series E 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 the

Corporation, 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 15,

1999, 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, 1999, at the annual rate of $2.55 per share or

5.10% of the stated value and liquidation preference of $50 per share (without taking into account any

adjustments referred to in paragraphs (b)and (c) of this Section 2). Dividends on the Series E

Preferred Stock will be payable to the Holders as they appear on the books and records of the

Corporation 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 15, 1999 to but excluding June 30, 1999, will be $.53125 per share. Thereafter, the

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

preceding Dividend Payment Date to but excluding such Dividend Payment Date. If a Dividend

Payment Date is not a Business Day, dividends (if declared) on the Series E Preferred Stock will be

paid on the succeeding Business Day, without interest. A ""Business Day'' shall mean 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. Dividends payable on the Series E 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 and the actual number of days elapsed in any period of less than

one month. Dividends payable on the Series E Preferred Stock for each full dividend period will be

computed by dividing the per annum dividend rate by four.

(b)(i) If, prior to 18 months after the date of original issuance of the Series E Preferred Stock,

one or more amendments to the Internal Revenue Code of 1986, as amended (the ""Code''), are

enacted that reduce the percentage of the dividends-received deduction applicable to the Series E

Preferred Stock (a ""Dividends-Received Reduction Amendment'') as speciÑed in section 243(a)(1)

of the Code or any successor provision thereto (the ""Dividends-Received Percentage''), the adjustments set forth in this paragraph (b) shall be made in respect of the dividends payable by the

Corporation.

(ii) Subject to subclauses (v) and (vi) of this paragraph (b), the amount of each dividend

payable (if declared) per share of Series E Preferred Stock for dividend payments made on or after

the eÅective date of a Dividends-Received Reduction Amendment will be adjusted by multiplying the

amount of the dividend payable pursuant to paragraph (a) of this Section 2 (before adjustment) by a

A-1
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 the 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 E Preferred Stock as set forth in section 243(a)(1) of the Code or any

successor provision thereto, will give rise to an adjustment.

(iii) Notwithstanding the foregoing and subject to subclauses (v) and (vi) of this paragraph (b),

if any Dividends-Received Reduction Amendment is enacted after the dividend payable on a Dividend

Payment Date has been declared, 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 (x) the product of the dividend paid by the Corporation on such Divided

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

(y) the dividend paid by the Corporation on such Dividend Payment Date, will be payable (if

declared) to Holders on the record date applicable to the next succeeding Dividend Payment Date or,

if the Series E Preferred Stock is called for redemption prior to such record date, to Holders on the

applicable redemption date, as the case may be, in addition to any other amounts payable on such

date.

(iv) Subject to subclauses (v) and (vi) of this paragraph (b), if any Dividends-Received

Reduction Amendment is enacted and the reduction in the Dividends-Received Percentage retroactively applies to a Dividend Payment Date as to which the Corporation previously paid dividends on

the Series E Preferred Stock (each, an ""AÅected Dividend Payment Date''), the Corporation 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) or, if the

Series E Preferred Stock is called for redemption prior to such record date, to Holders on the

applicable redemption date, as the case may be, in an amount equal to the excess of (x) the product of

the dividend paid by the Corporation 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 (y) the sum of the

dividend paid by the Corporation on each AÅected Dividend Payment Date. The Corporation will only

make one payment of Retroactive Dividends for any such amendment. Notwithstanding the foregoing

provisions, if, with respect to any such amendment, the Corporation receives either an unqualiÑed

opinion of nationally recognized independent tax counsel selected by the Corporation or a private

letter ruling or similar form of authorization 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 E 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.

(v) Notwithstanding the foregoing provisions, if, with respect to any Dividends-Received Reduction Amendment, the Corporation receives either an unqualiÑed opinion (which opinion shall be

based on the Dividends-Received Reduction Amendment or upon a published pronouncement of the

IRS addressing such legislation) of nationally recognized independent tax counsel selected by the

Corporation or a private letter ruling or similar form of authorization from the Internal Revenue

Service (the ""IRS'') to the eÅect that such an amendment does not apply to a dividend payable on the

Series E Preferred Stock, then such amendment will not result in the adjustment provided for

A-2
pursuant to the DRD Formula with respect to such dividend. Unless the context otherwise requires,

references to dividends herein will mean dividends as adjusted by the DRD Formula. The Corporation's calculation of the dividends payable as so adjusted shall be Ñnal and not subject to review.

(vi) Notwithstanding the foregoing, no adjustment in the dividends payable by the Corporation

shall be made, and no Post Declaration Date Dividends or Retroactive Dividends shall be payable by

the Corporation, in respect of the enactment of any Dividends-Received Reduction Amendment

occurring 18 months or more after the date of original issuance of the Series E Preferred Stock.

(vii) In the event that the amount of dividends payable per share of Series E Preferred Stock is

adjusted pursuant to the DRD Formula and/or Post Declaration Date Dividends or Retroactive

Dividends are to be paid, the Corporation 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 E Preferred Stock.

(c)(i) If one or more amendments to the Code (the ""Debt Financed Purchase Amendments'')

are enacted in substantially the form that was proposed by the President of the United States in a

budget plan released on February 1, 1999 (the determination of which shall be in the Corporation's

sole discretion) and that (1) would deny a percentage of a corporation's dividends-received deduction

attributable to the percentage of Series E Preferred Stock that is indirectly Ñnanced by indebtedness

(including using a pro-rata allocation of interest expense similar to the one used in section 264(f) of

the Code) and (2) would be eÅective for Series E Preferred Stock acquired on or after the eÅective

date of such changes to the Code, the adjustments set forth in this paragraph (c) (the ""Debt Financed

Purchase Adjustments'') shall be made in respect of dividends payable by the Corporation; provided,

however, that no Debt Financed Purchase Adjustments shall be made unless the Corporation has been

oÅered the right to purchase the aÅected shares of Series E Preferred Stock pursuant to subclause (vi)

of this paragraph (c).

(ii) Subject to subclauses (iv) through (vi) of this paragraph (c), upon any transfer of shares of

Series E Preferred Stock that closes on or after the eÅective date of the Debt Financed Purchase

Amendments, the dividends payable on the transferred shares of Series E Preferred Stock for the

period beginning on the date of transfer shall be equal to (1) the amount of the dividend that would be

payable for such period on such shares if the shares were not entitled to adjustment multiplied by

(2) 1.08485 (the ""Sale Factor''), rounded to the nearest cent (with one-half cent rounded upwards).

(iii) Notwithstanding the foregoing, if a Debt Financed Purchase Adjustment is required after

the dividend payable on a Dividend Payment Date has been declared, the amount of the dividend

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

""Second Post Declaration Date Dividends''), equal to the excess, if any, of (x) the amount of the

dividend that would have been payable if the adjustment described in subclause (ii) of this

paragraph (c) had been made over (y) the dividend paid by the Corporation on such Dividend

Payment Date, will be payable (if declared) to the Holders of the aÅected shares of Series E Preferred

Stock on the record date applicable to the next succeeding Dividend Payment Date or, if the Series E

Preferred Stock is called for redemption prior to such record date, to Holders of the aÅected shares of

Series E Preferred Stock on the applicable redemption date, as the case may be, in addition to any

other amounts payable on such date.

(iv) Notwithstanding the foregoing provisions, if, with respect to the Debt Financed Purchase

Amendments, the Corporation receives either an unqualiÑed opinion (which shall be based upon the

Debt Financed Purchase Amendments or upon a published pronouncement of the IRS addressing such

amendments) of a nationally recognized independent tax counsel selected by the Corporation or a

private letter ruling or similar form of authorization from the IRS to the eÅect that such amendments

do not apply to a dividend payable on the Series E Preferred Stock, then such amendments will not

result in a Debt Financed Purchase Adjustment.

(v) Notwithstanding the foregoing, no adjustment in the dividends payable by the Corporation

shall be made, and no Second Post Declaration Date Dividends shall be payable by the Corporation, in

respect of the enactment of any Debt Financed Purchase Amendment occurring 18 months or more

after the date of original issuance of the Series E Preferred Stock.

A-3
(vi) No Debt Financed Purchase Adjustment shall be made, or Second Post Declaration Date

Dividends paid, to any Holder of shares of Series E Preferred Stock unless, after the date of enactment

of the Debt Financed Purchase Amendment and prior to any transfer to the Holder that gives rise to

the rights to such adjustment, the Corporation is oÅered the right to purchase such shares upon

reasonable terms and at a fair market price (which determination shall be in the sole discretion of the

Corporation). If the Corporation has not notiÑed the Holder of its intent to exercise such right in

writing within three trading days of receipt of written notice from the Holder, the Corporation will be

deemed to have declined to exercise such right.

(vii) If a Debt Financed Purchase Adjustment is made, or Second Post Declaration Date

Dividends are to be paid, with respect to certain shares of Series E Preferred Stock, the Corporation

will give notice of each such occurrence to the applicable Holders of such shares of Series E Preferred

Stock.

(d) 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 the Corporation or any other stock

of the Corporation ranking, as to the payment of dividends and the distribution of assets upon

dissolution, liquidation or winding up of the Corporation, junior to the Series E Preferred Stock) may

be declared or paid or set apart for payment on the Corporation's common stock (or on any other

stock of the Corporation ranking, as to the payment of dividends, junior to the Series E Preferred

Stock) unless dividends have been declared and paid or set apart (or ordered to be set apart) on the

Series E 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 E 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 E Preferred Stock in respect of

any prior dividend period. If the full dividend on the Series E Preferred Stock is not paid for any

quarterly dividend period, the Holders of Series E 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 the

Corporation's common stock (or any other stock of the Corporation ranking, as to the payment of

dividends, junior to the Series E Preferred Stock) for such dividend period.

(e) The Board of Directors of the Corporation, or a duly authorized committee thereof, may, in

its discretion, choose to pay dividends on the Series E Preferred Stock without the payment of any

dividends on the Corporation's common stock (or any other stock of the Corporation ranking, as to

the payment of dividends, junior to the Series E Preferred Stock).

(f) No full dividends shall be declared or paid or set apart for payment on any stock of the

Corporation ranking, as to the payment of dividends, on a parity with the Series E Preferred Stock for

any period unless full dividends have been declared and paid or set apart for payment on the Series E

Preferred Stock for the then-current quarterly dividend period. When dividends are not paid in full

upon the Series E Preferred Stock and all other classes or series of stock of the Corporation, if any,

ranking, as to the payment of dividends, on a parity with the Series E Preferred Stock, all dividends

declared upon shares of Series E Preferred Stock and all such other stock of the Corporation will be

declared pro rata so that the amount of dividends declared per share of Series E 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 E Preferred Stock (including any adjustments in dividends payable pursuant to Sections 2(b) and 2(c) but without accumulation of unpaid dividends on the Series E Preferred Stock for

prior dividend periods) and such other stock bear to each other.

(g) No dividends may be declared or paid or set apart for payment on any shares of Series E

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 the Corporation ranking, as to the payment of dividends,

prior to the Series E Preferred Stock.

(h) Holders of Series E 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.

A-4
3. Optional Redemption.

(a) On or after April 15, 2004, the Corporation, at its option, may redeem the Series E 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 $50.00 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

redemption, including any adjustments in dividends payable pursuant to Sections 2(b) and 2(c) but

without accumulation of unpaid dividends on the Series E Preferred Stock for prior dividend periods.

If less than all of the outstanding shares of Series E Preferred Stock are to be redeemed, the

Corporation 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 the Corporation, or a duly authorized committee thereof, in its sole discretion deems

equitable.

(b) In the event the Corporation shall redeem any or all of the Series E Preferred Stock as

aforesaid, the Corporation will give notice of any such redemption to Holders of Series E Preferred

Stock not less than 30 days prior to the date Ñxed by the Board of Directors of the Corporation, or

duly authorized committee thereof, for such redemption. Each such notice will state: (1) the number

of shares of Series E Preferred Stock to be redeemed and, if fewer than all of the shares of Series E

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 E Preferred Stock must be presented upon such redemption. Failure to give notice, or any defect in the notice, to any Holder of Series E Preferred Stock shall

not aÅect the validity of the proceedings for the redemption of shares of any other Holder of Series E

Preferred Stock being redeemed.

(c) Notice having been given as herein provided, from and after the redemption date, dividends

on the Series E Preferred Stock called for redemption shall cease to accrue and such Series E

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 E Preferred Stock will cease. Upon

surrender in accordance with said notice of the certiÑcate(s) representing shares of Series E Preferred

Stock so redeemed (properly endorsed or assigned for transfer, if the Board of Directors of the

Corporation, or a duly authorized committee thereof, shall so require and the notice shall so state),

such shares shall be redeemed by the Corporation at the redemption price aforesaid. Any shares of

Series E 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 E Preferred Stock will not be subject to any mandatory redemption, sinking fund

or other similar provisions. In addition, Holders of Series E Preferred Stock will have no right to

require redemption of any shares of Series E Preferred Stock.

4. Liquidation Rights.

(a) Upon any voluntary or involuntary dissolution, liquidation or winding up of the Corporation,

after payment or provision for the liabilities of the Corporation and the expenses of such dissolution,

liquidation or winding up, the Holders of outstanding shares of the Series E Preferred Stock will be

entitled to receive out of the assets of the Corporation or proceeds thereof available for distribution to

stockholders, before any payment or distribution of assets is made to holders of the Corporation's

common stock (or any other stock of the Corporation ranking, as to the distribution of assets upon

dissolution, liquidation or winding up of the Corporation, junior to the Series E Preferred Stock), the

amount of $50.00 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 pursuant to Sections 2(b) and 2(c) but without

accumulation of unpaid dividends on the Series E Preferred Stock for prior dividend periods.

A-5
(b) If the assets of the Corporation available for distribution in such event are insuÇcient to pay

in full the aggregate amount payable to Holders of Series E Preferred Stock and holders of all other

classes or series of stock of the Corporation, if any, ranking, as to the distribution of assets upon

dissolution, liquidation or winding up of the Corporation, on a parity with the Series E Preferred

Stock, the assets will be distributed to the Holders of Series E 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 pursuant to Sections 2(b) and 2(c) but without

accumulation of unpaid dividends on the Series E Preferred Stock for prior dividend periods.

(c) Notwithstanding the foregoing, Holders of Series E Preferred Stock will not be entitled to be

paid any amount in respect of a dissolution, liquidation or winding up of the Corporation until holders

of any classes or series of stock of the Corporation ranking, as to the distribution of assets upon

dissolution, liquidation or winding up of the Corporation, prior to the Series E 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 the Corporation, nor the merger,

consolidation or combination of the Corporation into or with any other corporation or the merger,

consolidation or combination of any other corporation into or with the Corporation, 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 the Corporation to which they are entitled pursuant to paragraphs (a), (b) and (c) of

this Section 4, the Holders of Series E Preferred Stock will not be entitled to any further participation

in any distribution of assets by the Corporation.

5. No Conversion or Exchange Rights.

The Holders of shares of Series E 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 the Corporation.

6. No Pre-emptive Rights.

No Holder of Series E 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,

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 E Preferred Stock will not be entitled to any

voting rights, either general or special.

(b) Without the consent of the Holders of Series E Preferred Stock, the Corporation will have

the right to amend, alter, supplement or repeal any terms of the Series E Preferred Stock (i) to cure

any ambiguity, or to cure, correct or supplement any defective provision contained in this CertiÑcate

of Designation or (ii) to make any other provision with respect to matters or questions arising with

respect to the Series E 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 E Preferred Stock; provided, however, that any increase in the amount of authorized

or issued Series E 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 the Corporation, whether ranking prior to, on a

parity with or junior to the Series E Preferred Stock, as to the payment of dividends or the

distribution of assets upon dissolution, liquidation or winding up of the Corporation, or otherwise, will

not be deemed to materially and adversely aÅect the interests of the Holders of Series E Preferred

Stock.

A-6
(c) Except as set forth in paragraph (b) of this Section 7, the terms of the Series E 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 E 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 E Preferred

Stock shall vote separately as a class. On matters requiring their consent, Holders of Series E

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

the Corporation, 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 shares of the Series E Preferred Stock are listed at the time.

8. Additional Classes or Series of Stock.

The Board of Directors of the Corporation, 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 the Corporation, 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 E Preferred

Stock as to the payment of dividends or the distribution of assets upon dissolution, liquidation or

winding up of the Corporation, or otherwise.

9. Priority.

For purposes of this CertiÑcate of Designation, any stock of any class or series of the Corporation

shall be deemed to rank:

(a) Prior to the shares of Series E Preferred Stock, either as to the payment of dividends or the

distribution of assets upon dissolution, liquidation or winding up of the Corporation, 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 the Corporation, as the case may be, in preference or priority

to the Holders of shares of Series E Preferred Stock.

(b) On a parity with shares of Series E Preferred Stock, either as to the payment of dividends or

the distribution of assets upon dissolution, liquidation or winding up of the Corporation, 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 E 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 the Corporation, 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 E Preferred Stock.

(c) Junior to shares of Series E Preferred Stock, either as to the payment of dividends or the

distribution of assets upon dissolution, liquidation or winding up of the Corporation, if such class shall

be common stock of the Corporation or if the Holders of shares of Series E Preferred Stock shall be

entitled to the receipt of dividends or of amounts distributable upon dissolution, liquidation or

winding up of the Corporation, as the case may be, in preference or priority over the holders of such

class or series.

(d) The shares of Preferred Stock of the Corporation designated ""6.41% Non-Cumulative

Preferred Stock, Series A'' (the ""Series A Preferred Stock''), ""6.50% Non-Cumulative Preferred

Stock, Series B'' (the ""Series B Preferred Stock''), ""6.45% Non-Cumulative Preferred Stock,

Series C'' (""the Series C Preferred Stock'') and ""5.25% Non-Cumulative Preferred Stock, Series D''

(the ""Series D Preferred Stock'') shall be deemed to rank on a parity with shares of Series E

Preferred Stock as to the payment of dividends and the distribution of assets upon dissolution,

liquidation or winding up of the Corporation. Accordingly, the holders of record of Series A Preferred

Stock, the holders of record of Series B Preferred Stock, the holders of record of Series C Preferred

A-7
Stock, the holders of record of Series D Preferred Stock and the Holders of Series E Preferred Stock

shall be entitled to the receipt of dividends and of amounts distributable upon dissolution, liquidation

or winding up of the Corporation, 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.

The Corporation hereby appoints First Chicago Trust Company of New York, a division of

EquiServe, as its initial transfer agent, dividend disbursing agent and registrar for the Series E

Preferred Stock. The Corporation may at any time designate an additional or substitute transfer

agent, dividend disbursing agent and registrar for the Series E 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 E Preferred Stock by the Corporation shall be made by Ñrst-class

mail, postage prepaid, to the addresses of such Holders as they appear on the books and records of the

Corporation. 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 the

Corporation's judgment, to give notice by mail, then such notiÑcation may be made, in the

Corporation'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 the

Corporation.

With respect to any right to purchase shares of the Series E Preferred Stock aÅorded the

Corporation under Section 2(c)(vi) hereof, a Holder must submit notice via facsimile transmission of

the terms and price of the oÅer to each of the following persons at the Corporation:

Facsimile number: (202) 752-5980

Attention: Executive Vice President and Chief Financial OÇcer

Facsimile number: (202) 752-4948

Attention: General Counsel

Facsimile number: (202) 752-0410

Attention: Vice President - Corporate Finance

The notice also must contain the name, title, address, telephone number and facsimile transmission number of an authorized representative of the Holder to whom the Corporation should respond.

RECEIPT AND ACCEPTANCE OF A SHARE OR SHARES OF THE SERIES E PREFERRED STOCK BY OR ON BEHALF OF A HOLDER SHALL CONSTITUTE THE UNCONDITIONAL ACCEPTANCE BY SUCH HOLDER (AND ALL OTHERS HAVING BENEFICIAL

OWNERSHIP OF SUCH SHARE OR SHARES) OF ALL OF THE TERMS AND PROVISIONS

OF THIS CERTIFICATE OF DESIGNATION. NO SIGNATURE OR OTHER FURTHER MANIFESTATION OF ASSENT TO THE TERMS AND PROVISIONS OF THIS CERTIFICATE OF

DESIGNATION SHALL BE NECESSARY FOR ITS OPERATION OR EFFECT AS BETWEEN

THE CORPORATION AND THE HOLDER (AND ALL SUCH OTHERS).

A-8
APPENDIX B

Information Statement

This Information Statement describes the business and operations of the Federal National

Mortgage Association (""Fannie Mae'' or the ""Corporation'') as of March 31, 1999 and its Ñnancial

condition as of December 31, 1998.

In connection with oÅerings of securities, Fannie Mae distributes OÅering Circulars, Prospectuses, or other oÅering documents that describe securities oÅered, their selling arrangements and

other information. Although typically incorporated by reference into such selling documents, the

Information Statement does not oÅer any securities for sale. Any incorporation of this Information

Statement by reference includes all supplements hereto. You may obtain copies of Fannie Mae's

current Information Statement, any supplements thereto and other available information from the

oÇce listed on page 2.

This Information Statement contains Fannie Mae's audited Ñnancial statements for the year

ended December 31, 1998. Fannie Mae updates its Information Statement quarterly.

Fannie Mae is a federally chartered corporation. Its principal oÇce is located at 3900 Wisconsin

Avenue, NW, Washington, DC 20016 (202/752-7000). Its Internal Revenue Service employer

identiÑcation number is 52-0883107.

Fannie Mae's securities are not required to be registered under the Securities Act of 1933. At the

close of business on February 28, 1999, approximately 1,027 million shares of Fannie Mae's common

stock (without par value) were outstanding.

The delivery of this Information Statement at any time shall not under any circumstances create an implication that there has been no change in the aÅairs of Fannie Mae

since the date hereof or that the information contained herein is correct as of any time

subsequent to its date.

March 31, 1999

B-1
TABLE OF CONTENTS

Caption Page

Documents Incorporated by Reference ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ B-2

Available Information ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ B-2

Business ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ B-3

General ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ B-3

Mortgage Loan Portfolio ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ B-3

Mortgage-Backed SecuritiesÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ B-7

AÅordable Housing Initiatives and Goals ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ B-8

Delinquencies and REO ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ B-9

Fee-Based ServicesÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ B-9

CompetitionÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ B-9

Facilities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ B-11

Employees ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ B-11

Government Regulation and Charter Act ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ B-12

Legal ProceedingsÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ B-14

Common Stock ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ B-15

Forward-Looking InformationÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ B-16

Selected Financial Information: 1994-1998 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ B-18

Management's Discussion and Analysis of Financial Condition and Results of OperationsÏÏÏ B-19

Index to Financial Statements ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ B-44

Management ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ B-78

AccountantsÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ B-82

DOCUMENTS INCORPORATED BY REFERENCE

Fannie Mae's Proxy Statement for the 1998 Annual Meeting of Shareholders is incorporated by

reference herein under ""ManagementÌAdditional Information.'' Any later proxy statement published by Fannie Mae prior to the publication of a new Information Statement is incorporated herein

by this reference. Fannie Mae will supplement this Information Statement to reÖect its quarterly

Ñnancial results and other events and information as Fannie Mae determines. References to the

""Information Statement'' include any documents incorporated herein by reference and any applicable

amendments or supplements hereto. If Fannie Mae modiÑes or updates information in the Information Statement in a later supplement or in a document incorporated by reference in this Information

Statement, the information as modiÑed or updated replaces the information initially reported by

Fannie Mae in this Information Statement.

AVAILABLE INFORMATION

Fannie Mae periodically makes available statistical information on its mortgage purchase and

mortgage-backed securities volumes as well as other relevant information about Fannie Mae. You may

obtain copies of this Information Statement, any supplements relating hereto, as well as Fannie Mae's

annual and quarterly reports to stockholders, the Federal National Mortgage Association Charter Act,

Fannie Mae's bylaws and other information regarding Fannie Mae without charge from the OÇce of

Investor Relations, Fannie Mae, 3900 Wisconsin Avenue, NW, Washington, DC 20016 (telephone: (202/752-7115)). This Information Statement also is available from Fannie Mae by accessing

the Corporation's World Wide Web site at http://www.fannniemae.com. You may inspect reports and

other information concerning Fannie Mae at the oÇces of the New York Stock Exchange, the Chicago

Stock Exchange and the PaciÑc Stock Exchange. Fannie Mae does not Ñle reports or other

information with the Securities and Exchange Commission.

B-2
BUSINESS

General

Fannie Mae is a federally chartered and stockholder-owned corporation, and is the largest

investor in home mortgage loans in the United States. Fannie Mae was established in 1938 as a

United States government agency to provide supplemental liquidity to the mortgage market, and was

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 from lenders,

thereby replenishing their funds for additional lending. Fannie Mae acquires funds to purchase these

loans by issuing debt securities to capital market investors, many of whom ordinarily would not invest

in mortgages. In this manner, Fannie Mae is able to expand the total amount of funds available for

housing.

Fannie Mae also issues Mortgage-Backed Securities (""MBS''), receiving guaranty fees for its

guarantee of timely payment of principal and interest on MBS certiÑcates. Fannie Mae issues MBS

primarily in exchange for pools of mortgage loans from lenders. The issuance of MBS enables Fannie

Mae to further its 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 providing technology services for originating and underwriting loans.

For information regarding Fannie Mae's mortgage loan, MBS and other activities in 1998, see

""Management's Discussion and Analysis of Financial Condition and Results of Operations.''

In this document, both whole loans and participation interests in loans are referred to as ""loans,''

""mortgage loans'' and ""mortgages.'' (Fannie Mae purchases participation interests that range from

50 to 99 percent.) The term ""mortgage'' also is used to refer to the security instrument securing a

loan rather than the loan itself, and when so used also refers to a deed of trust. Mortgage loans

secured by four or fewer dwelling units are referred to as ""single-family'' mortgage loans, and mortgage

loans secured by more than four dwelling units are referred to as ""multifamily'' mortgage loans.

Mortgage Loan Portfolio

Mortgage Loans Purchased

Fannie Mae purchases primarily single-family, conventional (i.e., not federally insured or

guaranteed), Ñxed- or adjustable-rate (""ARMs''), Ñrst mortgage loans, but it also purchases other

types of residential mortgage loans for its loan portfolio, including mortgage loans insured by the

Federal Housing Administration (""FHA''), mortgage loans guaranteed by the Department of Veterans AÅairs (""VA''), mortgage loans guaranteed by the Rural Housing Service, multifamily mortgage

loans and second mortgage loans (i.e., loans secured by second liens). The Corporation's purchases

have a variety of maturities. Fannie Mae's purchases of ARMs, Ñxed-rate loans with intermediate

terms of 20 years or less, and second mortgage loans are designed to provide a secondary market for a

variety of loans that may be attractive to homeowners.

The composition of Fannie Mae's loan portfolio at the end of each of the last Ñve years is shown

in the table in ""Portfolio Composition.'' The composition of its purchases during the last three years

is shown in ""Management's Discussion and Analysis of Financial Condition and Results of OperationsÌBalance Sheet AnalysisÌMortgage Portfolio.'' Of the single-family and multifamily mortgage

loans that the Corporation purchased in 1998, including mortgage-backed securities, approximately

77 percent (measured by unpaid principal balance (""UPB'')) were from investment banking

companies, 8 percent were from mortgage banking companies, 6 percent were from commercial and

mutual savings banks, 4 percent were from savings and loan associations and 5 percent were from

B-3
other institutions. All of Fannie Mae's mortgage loan purchases from investment banking companies

were through purchases of mortgage-backed securities.

Principal Balance Limits. Maximum principal balance limits apply to Fannie Mae's mortgage

loan purchases. For 1998, Fannie Mae could not purchase conventional mortgage loans on single-family dwellings if the loan's original principal balance exceeded $227,150, except for loans secured

by properties in Alaska, Hawaii and the Virgin Islands. Higher principal balance limits apply to loans

secured by properties in those areas or secured by two- to four-family dwelling units. The maximum

principal balance limits applicable to conventional mortgage loans secured by one- to four-family

dwellings can be adjusted by Fannie Mae annually based on the national average price of a

single-family dwelling as surveyed by the Federal Housing Finance Board. In January 1999, Fannie

Mae increased its maximum principal balance limit to $240,000.

Prior to last year, maximum principal balance limits also applied to Fannie Mae's purchases of

conventional multifamily mortgage loans. These limits were removed by the VA-HUD Ñscal year 1999

appropriations bill.

Mortgage loans insured by the FHA or guaranteed by the Rural Housing Service are subject to

statutory maximum amount limitations. Fannie Mae will not purchase VA-guaranteed mortgage

loans that have principal amounts in excess of amounts that Fannie Mae speciÑes from time to time.

Fixed-Rate/Adjustable-Rate. Substantially all Ñxed-rate mortgage loans purchased by Fannie

Mae provide for level monthly installments of principal and interest. Some of these loans (1 percent

of the single-family portfolio at December 31, 1998) have balloon payments due 5, 7 or 10 years after

origination, but with monthly payments based on longer (in many cases 30-year) amortization

schedules. Many 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.

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. Substantially all ARMs

also provide for monthly installments of principal and/or interest with the total amount of monthly

installments adjusted (up or down) after the interest rate on the loan is adjusted because of changes in

the applicable index. Fannie Mae currently purchases ARMs only if the ARMs have a cap on the

amount the interest rate may change over the life of the loan. A substantial number of the ARMs

purchased by the Corporation provide the mortgagor with the option, at speciÑed times or during

speciÑed periods of time, to convert the ARM to a Ñxed-rate mortgage loan with payment of a small

fee.

Fannie Mae also purchases certain ARMs, called reverse mortgages, that provide for monthly

installments of principal to be paid to the borrower. Over the life of the loan, interest and certain

other fees accrue on the balance of the payments made to the borrower. Fannie Mae currently

purchases reverse mortgages only if the reverse mortgages are subject to a cap on the amount the

interest rate may change over the life of the loan. Generally, the loan is due when the borrower no

longer occupies the property.

Maturity. Fannie Mae currently purchases conventional, single-family Ñxed- and adjustable-rate

mortgage loans with original maturities of up to 30 years and 40 years, respectively. Only a small

portion of such ARMs purchased have maturities of more than 30 years. The multifamily mortgage

loans that Fannie Mae currently purchases for its portfolio generally are conventional Ñxed-rate loans

that have maturities of up to 30 years.

Repayments

Substantially all of the single-family mortgage loans in Fannie Mae's portfolio are prepayable by

the borrower without penalty. Therefore, Fannie Mae bears the risk that prepayments may increase

B-4
when interest rates decline signiÑcantly or as a result of other factors. Fannie Mae manages this risk

as described in ""Management's Discussion and Analysis of Financial Condition and Results of

OperationsÌRisk ManagementÌInterest Rate Risk Management.'' Most multifamily loans in

Fannie Mae's portfolio provide for a prepayment premium that is calculated under a formula that is

intended to protect Fannie Mae from loss of yield on its investment in the mortgage loan being

prepaid.

Portfolio Composition

The following table shows the composition of Fannie Mae's mortgage loan portfolio and the

weighted-average yield (net of servicing) on the mortgage loan portfolio. The table includes mortgage

loans that back MBS held in Fannie Mae's mortgage loan portfolio.

Mortgage Loan Portfolio Composition

(Dollars in millions)

December 31,

1998 1997 1996 1995 1994

Single-family:

Government insured or guaranteed ÏÏÏÏÏÏÏÏÏÏ $ 21,805 $ 19,478 $ 15,912 $ 13,102 $ 11,659

Conventional:

Long-term, Ñxed-rate ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 297,106 211,541 177,070 140,466 109,079

Intermediate-term, Ñxed-rate ÏÏÏÏÏÏÏÏÏÏÏ 71,560 61,571 66,284 68,752 68,166

Adjustable-rate ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 11,873 11,373 12,783 15,108 16,718

Second ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 206 268 323 423 536

Multifamily ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 11,965 12,447 14,680 15,660 15,899

Total UPBÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 414,515 $316,678 $287,052 $253,511 $222,057

Yield ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 7.12% 7.60% 7.69% 7.80% 7.80%

Commitments

Fannie Mae issues commitments to purchase, during the term of the commitment, a speciÑed

dollar amount of mortgage loans. Fannie Mae purchases mortgage loans through standard product

commitments with posted yields and through negotiated commitments.

Fannie Mae purchases most of its mortgage loans pursuant to mandatory delivery portfolio

commitments. Under such commitments, lenders are obligated to sell loans to the Corporation at the

commitment yield. Mandatory delivery commitments are available for standard product and

negotiated transactions. If a lender is not able to deliver the mortgage loans required under a

mandatory delivery commitment during its term, the lender may buy back the commitment at any

time during the commitment term for a fee.

Fannie Mae issues master commitments to lenders to facilitate the delivery of mortgages into

MBS pools or portfolio. In order to deliver under a master commitment, a lender must either deliver

mortgages in exchange for MBS or enter into a mandatory delivery portfolio commitment with the

yield established upon execution of the portfolio commitment.

Fannie Mae also issues to lenders negotiated standby commitments that commit Fannie Mae to

purchase a designated dollar amount of single-family mortgage loans from the lenders if they convert

their standby commitments to mandatory delivery portfolio commitments. Standby commitments do

not obligate the lenders to sell the loans to Fannie Mae; they are obligated to do so only after such

commitments are converted to mandatory delivery portfolio commitments. The yield on the mortgage

loans is established at the time of the conversion in the case of standby commitments. See

""Management's Discussion and Analysis of Financial Condition and Results of OperationsÌBalance

Sheet AnalysisÌLiquidity and Capital Resources.''

B-5
Underwriting Guidelines

Fannie Mae has established certain underwriting guidelines for purchases of conventional

mortgage loans to help reduce the risk of loss from mortgagor defaults. These guidelines are designed

to assess the creditworthiness of the mortgagor, as well as the value of the mortgaged property relative

to the amount of the mortgage loan. Fannie Mae, in its discretion, accepts deviations from the

guidelines. Fannie Mae also reviews and changes its guidelines from time to time. As part of its

aÅordable housing initiatives, Fannie Mae continues to introduce new underwriting criteria that could

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, Fannie Mae is

continuing its underwriting experiments involving alternative methods of assessing the creditworthiness of potential borrowers, among other factors. See ""AÅordable Housing Initiatives and Goals.''

Fannie Mae generally relies on lender representations to ensure that the mortgage loans it

purchases conform to its underwriting guidelines. Fannie Mae also performs 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, the Corporation

can demand that the lender repurchase the loan.

In each of the last three years, Fannie Mae enhanced Desktop Underwriter», its automated

underwriting system, to assist lenders in meeting its underwriting standards. Desktop Underwriter is

designed to help lenders process mortgage applications in a more eÇcient and accurate manner and to

apply Fannie Mae's underwriting criteria consistently and objectively, and in a more customized

manner, to all prospective borrowers. If Desktop Underwriter provides an ""approve'' recommendation

to a loan application, the Corporation waives certain representations as long as the loan is originated

in accordance with the information that was submitted to Desktop Underwriter.

Fannie Mae generally requires that the UPB of each conventional single-family Ñrst mortgage

loan it purchases not be greater than 80 percent of the value of the mortgaged property unless at least

the excess over the 80 percent level is insured by a mortgage insurance company acceptable to Fannie

Mae. If mortgage insurance is required initially, Fannie Mae requires it to be maintained as long as

the UPB is greater than 80 percent of the original value (or of the appraised value as determined by a

subsequent appraisal). Fannie Mae does not require mortgage insurance on conventional single-family loans with LTV ratios greater than 80 percent if the mortgage loan seller provides other

acceptable credit enhancement. Fannie Mae bears the risk that in some cases parties assuming credit

enhancement obligations may be unable to meet their contractual obligations to the Corporation.

Fannie Mae regularly monitors this risk and follows speciÑc criteria in evaluating and accepting credit

enhancement arrangements in order to minimize its exposure to credit loss.

Fannie Mae has required credit enhancement for a majority of the mortgage loans in its

multifamily loan portfolio. See ""Management's Discussion and Analysis of Financial Condition and

Results of OperationsÌRisk ManagementÌCredit Risk ManagementÌMultifamily.''

Servicing

Fannie Mae does not service mortgage loans, except for government-insured multifamily loans,

for which the primary servicing functions are performed by a major servicing entity under a

subservicing arrangement. However, Fannie Mae generally manages and markets properties acquired

through foreclosure. Fannie Mae mortgage loans held in portfolio or backing MBS can be serviced

only by a servicer approved by the Corporation, and must be serviced subject to the Corporation's

guidelines. Lenders who sell single-family mortgage loans and conventional multifamily loans to

Fannie Mae often are such servicers. Servicing includes the collection and remittance of principal and

interest payments, administration of escrow accounts, evaluation of transfers of ownership interests,

responding to requests for partial releases of security, granting of easements, handling proceeds from

casualty losses, negotiating problem loan workouts and, if necessary, processing of foreclosures. In the

case of multifamily loans, servicing also includes performing property inspections, evaluating the

B-6
Ñnancial condition of owners, and administering various types of agreements (including agreements

regarding replacement reserves, completion/repair, and operations and maintenance). Fannie Mae

compensates servicers by permitting them to retain a speciÑed portion of each interest payment on a

serviced mortgage loan. Fannie Mae reserves the right to remove servicing responsibility from a

lender.

Mortgage-Backed Securities

MBS are mortgage pass-through trust certiÑcates issued and guaranteed by Fannie Mae that

represent beneÑcial interests in pools of mortgage loans or other MBS. Fannie Mae serves as trustee

for each trust.

MBS are backed by loans from one of three sources: a single lender, multiple lenders, or the

Corporation's portfolio. Single-lender MBS generally are issued through lender swap transactions in

which a lender exchanges pools of mortgage loans for MBS. Multiple-lender MBS allow several

lenders to pool mortgage loans together and, in return, receive MBS representing a proportionate

share of a larger pool (called Fannie Majors»). MBS may back other securities, including Fannie

Megas» (""Megas''), Stripped MBS (""SMBS''), real estate mortgage investment conduit securities

(""REMICs''), and other mortgage securities utilizing a ""grantor trust'' structure.

MBS are not assets of Fannie Mae, except when acquired for investment purposes, nor are MBS

recorded as liabilities. The Corporation, however, is liable under its guarantee to make timely

payments to investors of principal and interest on the mortgage loans in the pools, even if Fannie Mae

has not received payments of principal or interest on the mortgage loans in the underlying pools.

MBS enable the Corporation to further its statutory purpose of increasing the liquidity of residential

mortgage loans and create a source of guaranty fee income to Fannie Mae without assuming any debt

reÑnancing risk on the underlying pooled mortgages. Because Fannie Mae guarantees the timely

payment of principal and interest, it assumes the ultimate credit risk of borrowers' defaults on all

mortgage loans underlying MBS, as well as for portfolio mortgage loans. See ""Management's

Discussion and Analysis of Financial Condition and Results of OperationsÌRisk ManagementÌ

Credit Risk Management.''

Fannie Mae issues MBS backed by single-family or multifamily Ñrst or second mortgage loans,

with Ñxed or adjustable rates. Generally, the mortgage loans are either conventional mortgage loans,

or FHA-, VA- or Rural Housing Service-guaranteed mortgage loans. The conventional mortgage loans

are subject to the maximum principal balance limits applicable to Fannie Mae's purchases as described

under ""Mortgage Loan PortfolioÌMortgage Loans PurchasedÌPrincipal Balance Limits.'' The

mortgage loans also are subject to the same underwriting guidelines as those for mortgage loans

purchased for portfolio as described under ""Mortgage Loan PortfolioÌUnderwriting Guidelines.''

The substantial majority of Fannie Mae's MBS outstanding represents beneÑcial interests in

conventional Ñxed-rate Ñrst mortgage loans on single-family dwellings.

Fannie Mae issues and guarantees several forms of MBS, including Fannie Majors, that involve

only a single class of certiÑcates with each investor receiving a portion of the payments of principal

and interest on the underlying mortgage loans equal to its undivided interest in the pool. With these

standard MBS, an investor has an undivided interest in a pool of underlying mortgage loans that

generally are provided either by one lender or by Fannie Mae out of the Corporation's mortgage loan

portfolio. Megas represent undivided interests in a pool of MBS, REMIC tranches, or Government

National Mortgage Association (""Ginnie Mae'') guaranteed pass-through certiÑcates (""Ginnie Mae

certiÑcates'') of the same type. In addition, Fannie Mae issues and guarantees MBS in the form of

single-class ""grantor trust'' securities representing an undivided interest in a pool of MBS, Ginnie

Mae certiÑcates, other mortgage-backed securities, or mortgage loans.

Fannie Mae also issues and guarantees MBS that involve more than one class of certiÑcates and,

therefore, require special allocations of cash Öows. SMBS are issued in series, with one or more

classes, each of which is entitled to diÅerent cash Öows and may represent (a) an undivided interest

B-7
solely in the principal payments, (b) an undivided interest solely in the interest payments or

(c) diÅerent percentage interests in principal and interest payments, to be made on a pool of mortgage

loans, MBS, REMICs, other SMBS and/or Ginnie Mae certiÑcates. REMICs represent beneÑcial

interests in a trust having multiple classes of certiÑcates entitled to diÅerent cash Öows from the

underlying mortgage loans, MBS, SMBS, Ginnie Mae certiÑcates and/or certiÑcates from other

REMICs. Pursuant to its guaranty of REMICs and SMBS, Fannie Mae is obligated to make timely

distribution of required installments of principal and/or interest and, in the case of REMICs, to

distribute the principal balance in full by a speciÑed date, whether or not suÇcient funds are available

in the related REMIC trust (Fannie Mae has issued a limited amount of subordinated REMIC classes

that are not guaranteed by the Corporation).

Fannie Mae receives guaranty fees for a signiÑcant portion of its MBS (principally its standard

MBS and Fannie Majors). Such fees are paid monthly until the underlying mortgage loans have been

repaid or otherwise liquidated from the pool (generally as a result of delinquency or prepayment).

The aggregate amount of guaranty fees received by Fannie Mae depends upon the amount of MBS

outstanding and on the guaranty fee rate. The amount of MBS outstanding is inÖuenced by the rates

at which the underlying mortgage loans are repaid or liquidated due to foreclosure, and by the rate at

which Fannie Mae issues new MBS. In general, when the level of interest rates declines signiÑcantly

below the interest rates on loans underlying MBS, the rate of prepayments is likely to increase;

conversely, when interest rates rise above the interest rates on loans underlying MBS, the rate of

prepayments is likely to slow down. In addition to interest rate changes, the rate of principal

prepayments is inÖuenced by a variety of economic, demographic and other factors. Fannie Mae also

generally receives one-time fees for swapping SMBS, REMICs, Megas, and grantor trust securities for

MBS, mortgage loans, Ginnie Mae certiÑcates, SMBS, REMIC certiÑcates, or other mortgage-backed

securities.

In many instances, the lender or lenders that originated the loans in an MBS pool created from

Fannie Mae's portfolio or the lender or lenders that exchanged the loans for the MBS (in the case of a

""swap'' transaction) initially service the loans. Fannie Mae, however, reserves the right to remove the

servicing responsibility from a lender at any time if it considers such removal to be in the best interest

of MBS certiÑcate holders. In such event, Fannie Mae Ñnds a replacement lender that will service the

loans. Generally, Fannie Mae ultimately is responsible to MBS holders for the administration and

servicing of mortgage loans underlying MBS, including the collection and receipt of payments from

lenders, and the remittance of distributions and certain reports to holders of MBS certiÑcates.

AÅordable Housing Initiatives and Goals

In 1994, Fannie Mae announced that, for the seven years from 1994 through the year 2000, the

Corporation would commit $1 trillion to help Ñnance over 10 million homes for families and

communities most in need (the ""Trillion Dollar Commitment''). As part of the Trillion Dollar

Commitment announcement, Fannie Mae laid out 11 initiatives targeting speciÑc areas of the

mortgage Ñnance system for improvement. (In early 1996, the Fannie Mae Foundation undertook

three of the initiatives.) By the end of 1998, Fannie Mae was able to report the following progress

with respect to each of the eleven initiatives (including progress on the three Foundation initiatives

that have been supported by the Corporation): (i) established 33 Partnership OÇces around the

country (initiative: Fannie Mae Partnership OÇces); (ii) integrated research on credit scoring and

loan performance with Fannie Mae's automated underwriting, oÅering lenders a tool that allows them

to use the most Öexible loan criteria to extend full consideration for each borrower's unique credit

proÑle (initiative: Underwriting Flexibilities); (iii) issued $9.4 billion of total commitments to speciÑc

underwriting experiments intended to lower barriers to homeownership (initiative: Underwriting

Experiments); (iv) addressed emerging markets with products designed to meet home improvement

renovation Ñnancing needs and targeted those most in need with products designed for seniors,

disabled people and their families, and Native Americans (initiative: Innovations for Change);

(v) originated $40.3 billion in multifamily Ñnancing (initiative: Multifamily Housing Finance);

B-8
(vi) identiÑed potential savings of approximately $800 per mortgage related to the origination costs of

mortgages through the use of Fannie Mae technology (initiative: Technology to Reduce Costs);

(vii) approved more than $50 million of investments in community development Ñnancial institutions

and provided Ñnancing to more than 1.4 million minority borrowers (initiative: Fighting Discrimination); (viii) together with 29 for-proÑt, nonproÑt and governmental organizations, created the

American Homeowner Education and Counseling Institute, an independent nonproÑt organization

committed to increased professionalism in homeowner counseling and to identifying more eÅective

ways to Ñnance home buyer education (initiative: HomePath Initiative); (ix) exceeded its original

commitment to increase giving to the Fannie Mae Foundation (initiative: Increased Foundation

Giving); (x) handled over 6.6 million consumers' requests for homeownership information (initiative:

Opening Doors for Every American campaignÌFannie Mae Foundation initiative); and (xi) provided

nearly 1.7 million immigrants with home-buying information, using multilingual media and community organizations supportive of immigrants (initiative: New Americans CampaignÌFannie Mae

Foundation initiative).

Under the Federal Housing Enterprises Financial Safety and Soundness Act of 1992 (the ""1992

Act''), Fannie Mae has certain goals to promote aÅordable housing for moderate-, low- and very

low-income families and to serve the housing needs of those in underserved areas. In 1998, Fannie

Mae exceeded the applicable goals. See ""Management's Discussion and Analysis of Financial

Condition and Results of OperationsÌHousing Goals.''

Delinquencies and REO

When a mortgage loan for which Fannie Mae bears the default risk is liquidated through

foreclosure, the Corporation generally acquires the underlying property (such real estate owned is

called ""REO'') and holds it for sale. The level of delinquencies and number of REO are aÅected by

economic conditions, loss mitigation eÅorts (which include contacting delinquent borrowers to oÅer a

preforeclosure sale, loan modiÑcation, or other options), and a variety of other factors. Fannie Mae

manages the risk of delinquencies and REO as described in ""Management's Discussion and Analysis

of Financial Condition and Results of OperationsÌRisk ManagementÌCredit Risk Management.''

Fee-Based Services

Fannie Mae oÅers certain services to lenders and other customers in return for a fee. These

include issuing REMICs, SMBS, Fannie Megas, and grantor trust securities, technology services for

originating and underwriting loans, and the facilitation of securities transactions.

Fannie Mae receives fee income from dealers in exchange for creating and issuing REMICs,

SMBS, grantor trust securities, and Megas. In addition to issuing these securities, Fannie Mae is

responsible for all tax reporting and administration costs associated with these securities.

Fannie Mae also receives fee income in return for providing technology related services such as

Desktop Underwriter, Desktop Originator», Desktop Trader», and other on-line services. These

services provide lenders the ability to underwrite mortgage loans electronically, communicate with

third-party originators, access Fannie Mae loan pricing schedules, and enter into sale commitments

with the Corporation on a real-time basis.

Fannie Mae also simultaneously purchases and sells MBS and certain other mortgage-related

securities, such as Ginnie Mae certiÑcates, with the intention of earning a spread on such trades or as

a service to customers. In addition, Fannie Mae receives fee income through other activities, such as

repurchase transactions, and by providing other investment alternatives for customers.

Competition

Fannie Mae competes, within the limits prescribed by its Charter Act, for the purchase of

mortgage loans for portfolio and the issuance of mortgage-backed securities in the secondary mortgage

market. For single-family products, Fannie Mae competes primarily with the Federal Home Loan

Mortgage Corporation (""Freddie Mac''), another government-sponsored enterprise also regulated by

the Department of Housing and Urban Development (""HUD'') and the OÇce of Federal Housing

B-9
Enterprise Oversight (""OFHEO'') with a mission and authority that is virtually identical to that of

Fannie Mae. Fannie Mae competes to a lesser extent with savings and loan associations, savings

banks, commercial banks, other government-sponsored entities, and other companies that purchase

for their own portfolio or pool single-family mortgage loans for sale to investors as whole loans or

mortgage-backed securities. A number of Federal Home Loan Banks (""FHLBs'') are participating in

a pilot program, which was expanded in 1998, for the Ñnancing and servicing of single-family mortgage

loans. Given the pace of the pilot's development, the FHLBs are not currently signiÑcant competitors.

Fannie Mae competes with the FHA insurance program, a HUD program, for the business of

guaranteeing the credit performance of mortgage loans and, due to the eligibility of such FHA-insured

loans for securitization by Ginnie Mae, with Ginnie Mae as well.

In 1999, Fannie Mae is limited to purchasing and guaranteeing the credit performance of

mortgage loans with a maximum principal balance of $240,000 (or more depending upon geographical

area and number of dwelling units). The Ñscal year 1999 federal budget increased the maximum

principal balance for loans eligible for the FHA insurance program to 48 percent from 38 percent of

Fannie Mae's loan limits. The loan limit for FHA-insured loans in high cost areas was increased from

75 percent, and now can be as high as 87 percent of Fannie Mae's limits. The higher FHA limits may

result in increased competition for Fannie Mae's guaranty business. (For additional information on

the maximum principal balances for loans purchased by the Corporation, see ""Mortgage Loan

PortfolioÌMortgage Loans PurchasedÌPrincipal Balance Limits.'')

In the case of multifamily products, Fannie Mae generally competes with government housing

programs, with insurance companies, and with the same kinds of entities as in the case of single-family

products. Competition for multifamily mortgage loans is intense from certain entities typically

sponsored by investment banks which purchase such loans and pool them for sale to investors in the

commercial mortgage-backed securities market. Such entities are referred to as ""conduits,'' and their

role in the multifamily mortgage market increased signiÑcantly in 1997. In 1998, conduits continued

to be a strong source of competition, but with the disruption in the Ñxed-income capital market in the

latter part of the year, they became less of a factor due to decreased loan originations. However,

Fannie Mae expects that they will provide increased competition as market conditions stabilize. Prior

to 1999, under the Charter Act, maximum principal balance limits also applied to Fannie Mae's

purchase of conventional multifamily mortgage loans. The Ñscal year 1999 federal budget removed the

limitations on the size of multifamily mortgage loans that Fannie Mae has authority to purchase.

Notwithstanding the change, Fannie Mae currently intends to continue to comply with prior

limitations in most cases.

Fannie Mae's market share of loans purchased for cash or swapped for MBS 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 other market participants that compete with the

Corporation.

Fannie Mae competes 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 Fannie Mae, Freddie Mac, and other

market participants.

Competition is particularly intense for multifamily mortgage loans eligible for government

subsidies, which have low-income rent and occupancy restrictions. As a prerequisite to expansion or

merger plans, commercial banks must fund such loans to meet certain obligations under the

Community Reinvestment Act, and they often are willing to do so at or below their own cost of funds.

Fannie Mae competes for these same investment opportunities to meet its housing goals.

Competition also is a consideration in connection with the issuance of Fannie Mae's debt

securities. Fannie Mae competes with Freddie Mac, the FHLB system, the Student Loan Marketing

Association, and other government-sponsored entities for funds raised through the issuance of

B-10
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 Fannie Mae's 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 raised through the issuance of certain types of unsecured debt may be adversely aÅected by

regulatory initiatives that tend to reduce investments by certain depository institutions in unsecured

debt with greater than normal volatility or interest-rate sensitivity.

Under the 1992 Act, the Secretary of HUD must approve any new Fannie Mae or Freddie Mac

program that is signiÑcantly diÅerent from those approved or engaged in prior to that Act's

enactment. The ability of Fannie Mae and Freddie Mac to compete with other competitors possibly

could be aÅected by this requirement. See ""Government Regulation and Charter Act.''

Facilities

Fannie Mae owns its principal oÇce, which is located at 3900 Wisconsin Avenue, NW, Washington, DC, an oÇce at 3939 Wisconsin Avenue, NW, Washington, DC, and two facilities in Herndon,

Virginia. These owned facilities total 620,000 square feet. In addition, Fannie Mae leases approximately 379,000 square feet of oÇce space at 4000 Wisconsin Avenue, NW, which is adjacent to the

Corporation's principal oÇce, and approximately 64,000 square feet of oÇce space at 2115 Wisconsin

Avenue, NW. The present lease for 4000 Wisconsin Avenue expires in 2003, but the Corporation has

options to extend the lease for up to 15 additional years, in 5-year increments. The lease for

2115 Wisconsin expires in 2002. Fannie Mae also maintains regional oÇces in leased premises in

Pasadena, California; Atlanta, Georgia; Chicago, Illinois; Philadelphia, Pennsylvania; and Dallas,

Texas. The regional oÇces negotiate mortgage loan and MBS business with lenders, assist in

supervising the servicing of the Corporation's mortgage loan portfolio by lenders, assist in supervising

or managing the handling and disposition of REO, and provide training to the staÅs of lenders. In

addition to the regional oÇces, Fannie Mae has opened 33 ""Fannie Mae Partnership OÇces'' to date

in leased premises around the country which will work with cities, rural areas and other underserved

communities. Fannie Mae also plans to establish 11 additional Partnership OÇces in 1999. There

currently are Fannie Mae Partnership OÇces in Birmingham, Alabama; Phoenix, Arizona; Los Angeles, California; Denver, Colorado; Hartford, Connecticut; Washington, D.C.; Miami, Florida; Orlando,

Florida; Atlanta, Georgia; Chicago, Illinois; Des Moines, Iowa; Kansas City, Kansas; New Orleans,

Louisiana; Baltimore, Maryland; Boston, Massachusetts; Detroit, Michigan; St. Paul, Minnesota;

Jackson, Mississippi; St. Louis, Missouri; Lincoln, Nebraska; Las Vegas, Nevada; Albuquerque,

New Mexico; BuÅalo, New York; New York, New York; Charlotte, North Carolina; Oklahoma City,

Oklahoma; Cleveland, Ohio; Columbus, Ohio; Portland, Oregon; Houston, Texas; San Antonio, Texas

(two oÇces, one of which is responsible for border region issues); and Seattle, Washington.

Employees

At December 31, 1998, Fannie Mae employed approximately 3,800 full-time personnel.

B-11
GOVERNMENT REGULATION AND CHARTER ACT

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

under the Charter Act (12 U.S.C. Û 1716 et seq.) whose 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.

Fannie Mae originally was incorporated in 1938 pursuant to Title III of the National Housing Act

as a wholly owned government corporation and in 1954, under a revised Title III called the Federal

National Mortgage Association Charter Act, became a mixed-ownership corporate instrumentality of

the United States. From 1950 to 1968, it operated in the Housing and Home Finance Agency, which

was succeeded by HUD. Pursuant to amendments to the Charter Act enacted in the Housing and

Urban Development Act of 1968 (the ""1968 Act''), the then Federal National Mortgage Association

was divided into two separate institutions, the present Corporation and the Government National

Mortgage Association, a wholly owned corporate instrumentality of the United States within HUD,

which carried on certain special Ñnancing assistance and management and liquidation functions.

Under the 1968 Act, Fannie Mae was constituted as a federally chartered corporation and the entire

equity interest in Fannie Mae became stockholder-owned.

Although the 1968 Act eliminated all federal ownership interest in Fannie Mae, it did not

terminate government regulation of the Corporation. Under the Charter Act, approval of the

Secretary of the Treasury is required for Fannie Mae's issuance of its debt obligations and MBS. In

addition, the 1992 Act established OFHEO, an independent oÇce within HUD under the management

of a Director (the ""Director'') who is responsible for ensuring that the Corporation is adequately

capitalized and operating safely in accordance with the 1992 Act. The 1992 Act established minimum

capital, risk-based capital, and critical capital requirements for Fannie Mae and required the Director

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

the Corporation must have to exceed the risk-based capital level from time to time. OFHEO issued a

Ñnal rule (the ""Rule'') in 1996 related to the minimum capital levels for Fannie Mae and Freddie Mac

that sets forth how minimum capital requirements for both entities are to be calculated, reported, and

classiÑed on a quarterly basis. The Rule, which Ñnalized an original proposal dated June 1995,

formalized the interim capital standards applied by OFHEO, with which Fannie Mae has been in

compliance since their inception. See also ""Management's Discussion and Analysis of Financial

Condition and Results of OperationsÌBalance Sheet AnalysisÌRegulatory Capital Requirements.''

In 1996, OFHEO also released for comment part one (""Part I'') of the proposed regulations to

establish the risk-based capital test. Part I speciÑes that ""benchmark loss experience'' will be

combined with other yet to be determined assumptions and applied each quarter to Fannie Mae's book

of business to establish credit losses under the risk-based capital standard for the Corporation. Part I

also speciÑes the house price index that OFHEO will use in connection with the risk-based capital

standard. Fannie Mae submitted comments to OFHEO in October 1996 stating that several aspects of

the initial proposal require adjustments or amendment, because it does not accurately capture Fannie

Mae's credit history and derives credit loss rates that are signiÑcantly worse than any reasonable

representation of Fannie Mae's and Freddie Mac's loss experience. On March 26, 1999, after interagency review and comment on a proposed second part of the risk-based capital regulation

(""Part II''), OFHEO sent Part II to Congress for review. Shortly after the 15-day period for

Congressional review, OFHEO is expected to publish Part II for public review and comment over at

least a 120-day period. Part II will specify, among other matters, remaining aspects of the test and

B-12
how the test will be used to determine Fannie Mae's and Freddie Mac's risk-based capital requirements. The summary accompanying Part II noted that if Part II had been in eÅect as of June 30, 1997,

Fannie Mae's required risk-based capital would have been $17.73 billion, as compared with $14.05 billion in actual capital at that time. OFHEO also noted that there were a variety of means, such as

hedging, that Fannie Mae could have used to reduce required risk-based capital to the level of its

actual capital. Fannie Mae has not yet thoroughly reviewed Part II but expects to comment

extensively on the proposal, which could change before it is Ñnally issued. The 1992 Act provides that

the Ñnal regulations will be enforceable one year after issuance. Management is conÑdent that Fannie

Mae will be able to meet any reasonable Ñnal test.

If Fannie Mae fails to meet one or more of the capital standards under the 1992 Act, the Director

is required to take certain remedial measures and may take others, depending on the standards the

Corporation fails to meet. The Director's enforcement powers include the power to impose temporary

and Ñnal cease-and-desist orders and civil penalties on the Corporation and on directors or executive

oÇcers of the Corporation. If the Director determines that Fannie Mae is 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 held or securitized by the Corporation has decreased signiÑcantly, the

Director is authorized to treat the Corporation as not meeting one of the capital standards that it

otherwise meets. In addition, Fannie Mae is required to submit a capital restoration plan if it fails to

meet any of the capital standards. If the Director does not approve the plan or determines that Fannie

Mae has failed to make reasonable eÅorts to comply with the plan, then the Director may treat the

Corporation as not meeting one of the capital standards that it otherwise meets. Also, if Fannie Mae

fails to meet or is treated by the Director as not meeting one of the capital standards and the Director

has reasonable cause to believe that the Corporation or any executive oÇcer or director of the

Corporation is engaging in or about to engage in any conduct that threatens to result in a signiÑcant

depletion of the Corporation's core capital, then the Director is authorized to commence proceedings

pursuant to which, after a hearing, the Director could issue a cease and desist order prohibiting such

conduct. The Director could issue such an order without a hearing, which would be eÅective until

completion of the cease-and-desist proceedings, if the Director determined that the conduct in

question was likely to cause a signiÑcant depletion of core capital. Prior approval of the Director is

required for Fannie Mae to pay a dividend if the dividend would decrease the Corporation's capital

below risk-based capital or minimum capital levels established under the 1992 Act. See ""Common

Stock.'' The Director is authorized to levy, pursuant to annual Congressional appropriations, annual

assessments on Fannie Mae and Freddie Mac to cover reasonable expenses of OFHEO.

The 1992 Act also gives the Director the authority to conduct on-site examinations of Fannie Mae

for purposes of ensuring the Corporation's Ñnancial safety and soundness. In addition, Fannie Mae is

required to submit annual and quarterly reports of the Ñnancial condition and operations of the

Corporation to the Director. Moreover, the Charter Act, as amended by the 1992 Act, authorizes the

General Accounting OÇce to audit the programs, activities, receipts, expenditures and Ñnancial

transactions of the Corporation. Fannie Mae also is required to submit an annual report to the House

and Senate Banking Committees and the Secretary of HUD regarding the Corporation's performance

in meeting housing goals relating to the purchase of mortgages on housing for low- and moderateincome families, mortgages on rental and owner-occupied housing for low-income families in lowincome areas or for very-low-income families, and mortgages on housing located in rural or other

underserved areas.

Under the 1992 Act, the Secretary of HUD retains general regulatory authority to promulgate

rules and regulations to carry out the purposes of the Charter Act, excluding authority over matters

granted exclusively to the Director in the 1992 Act. The Secretary of HUD also must approve any new

conventional mortgage program that is signiÑcantly diÅerent from those approved or engaged in prior

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

the Charter Act of the Corporation or the Secretary Ñnds that it is not in the public interest.

However, until one year after the Ñnal regulations establishing the risk-based capital test are in eÅect,

the Secretary must disapprove a new program if the Director determines that the program would risk

B-13
signiÑcant deterioration of the Ñnancial condition of Fannie Mae. The Secretary has adopted

regulations related to the program approval requirement.

Thirteen members of Fannie Mae's eighteen-member Board of Directors are elected by the

holders of the Corporation's common stock, and the remaining Ñve members are appointed by the

President of the United States. The appointed directors must include one person from the home

building industry, one person from the mortgage lending industry, and one person from the real estate

industry. Under the 1992 Act, one appointed director also must be from an organization that has

represented consumer or community interests for not less than two years or a person who has

demonstrated a career commitment to the provision of housing for low-income households. 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.

In addition to placing Fannie Mae under federal regulation, the Charter Act also grants to the

Corporation certain privileges. For instance, securities issued by Fannie Mae are deemed to be

""exempt securities'' under laws administered by the Securities and Exchange Commission (""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 Fannie Mae's securities are not Ñled with the

SEC. The Corporation also is not required to Ñle periodic reports with the SEC.

The Secretary of the Treasury of the United States has discretionary authority to 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 Fannie Mae's transition from government ownership in 1968. Neither the

United States nor any agency thereof is obligated to Ñnance Fannie Mae's operations or to assist the

Corporation in any other manner.

Fannie Mae is exempt from all taxation by any state or by any county, municipality, or local

taxing authority except for real property taxes. Fannie Mae is not exempt from payment of federal

corporate income taxes. Also, Fannie Mae may conduct its business without regard to any

qualiÑcations or similar statute in any state of the United States or the District of Columbia.

The Federal Reserve Banks are authorized to act as depositaries, custodians, and Ñscal agents for

Fannie Mae, for its own account, or as Ñduciary.

LEGAL PROCEEDINGS

In the ordinary course of business, Fannie Mae is involved in legal proceedings that arise in

connection with properties acquired by the Corporation, either through foreclosure on properties

securing delinquent mortgage loans owned by the Corporation or by receiving deeds to such properties

in lieu of foreclosure. For example, claims related to possible tort liability and compliance with

applicable environmental requirements arise from time to time, primarily in the case of single-family

REO.

Fannie Mae is a party to legal proceedings from time to time arising from its relationships with its

seller/servicers. Disputes with lenders concerning their loan origination or servicing obligations to

Fannie Mae, or disputes concerning termination by Fannie Mae (for any of a variety of reasons) of a

lender's authority to do business with the Corporation as a seller and/or servicer, can result in

litigation. Also, loan servicing issues have resulted from time to time in claims against Fannie Mae

brought as putative class actions for borrowers.

Fannie Mae also is a party to legal proceedings from time to time arising from other aspects of its

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 Fannie Mae, management believes that their outcome will not have a material adverse

eÅect on the Corporation's Ñnancial condition or results of operations.

B-14
COMMON STOCK

Section 303(a) of the Charter Act provides that Fannie Mae shall have common stock, without

par value. The common stock is vested with all voting rights. Each share of common stock is entitled

to one vote at all elections of directors and on all other matters presented for common stockholder

vote. The holders of the common stock elect thirteen directors, and the President of the United States

appoints the remaining Ñve directors. The Charter Act, Fannie Mae's governing instrument, cannot

be amended by the stockholders, but only by an Act of Congress.

Fannie Mae also is authorized by the Charter Act to have preferred stock on such terms and

conditions as the Board of Directors of the Corporation may prescribe. No common stockholder

approval is required to issue preferred stock. Fannie Mae issued $1 billion of non-cumulative preferred

stock in 1996 and $150 million in 1998 that is redeemable at the Corporation's option beginning in

2001 and 1999, respectively. Holders of these preferred stock issues are entitled to receive noncumulative, quarterly dividends when, and if, declared by Fannie Mae's Board of Directors. Payment of

dividends on preferred stock is not mandatory, but has priority over payment of dividends on common

stock. After the speciÑed period, preferred stock is redeemable at its stated value at the option of

Fannie Mae. See ""Notes to Financial StatementsÌNote 12'' for additional information on preferred

stock.

The Charter Act contains no limitation on the amount of stock that may be issued, except that if

Fannie Mae fails to meet certain minimum capital standards, the Director could require that the

Director approve the Corporation's issuance of stock or securities convertible into stock. At

February 28, 1999, there were outstanding approximately 1,027 million shares of common stock,

which were held by approximately 25,000 stockholders of record. Based on the number of requests for

proxies and quarterly reports, Fannie Mae estimates that on February 28, 1999 there were approximately 340,000 additional stockholders who held shares through banks, brokers and nominees.

Holders of the common 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 riskbased capital, minimum capital and critical capital requirements for Fannie Mae, and required the

Director of OFHEO to establish, by regulation, a risk-based capital test to be used to determine the

amount of total capital Fannie Mae must have to exceed the risk-based capital level from time to time.

As discussed in ""Government Regulation and Charter Act,'' the Director of OFHEO publicly released

Part I of the proposed risk-based capital regulations in 1996, and it is expected that Part II of the

proposed risk-based capital regulations will be published for public review and comment shortly. 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 of OHFEO if Fannie Mae meets the minimum

capital level established under the 1992 Act and the dividend payment would not decrease the

Corporation's base 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 Fannie Mae meets both the risk-based capital and

minimum capital levels and the dividend payment would not decrease the Corporation's total capital

below the risk-based capital level or its core capital below the minimum capital level. If Fannie Mae

meets either the risk-based capital standard or the minimum capital standard, it may make a dividend

payment without obtaining the approval of the Director only if the dividend payment would not cause

Fannie Mae to fail to meet another capital standard. At any time when Fannie Mae does not meet the

risk-based capital standard but meets the minimum capital standard, Fannie Mae is prohibited from

making a dividend payment that would cause the Corporation to fail to meet the minimum capital

standard. If Fannie Mae meets neither the risk-based capital standard nor the minimum capital

standard but does meet the critical capital standard established under the 1992 Act, it may make a

dividend payment only if the Corporation would not fail to meet the critical capital standard as a

B-15
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 Fannie Mae to submit a report to the

Director regarding any capital distribution (including any dividend) declared by Fannie Mae before

the Corporation makes the distribution. See ""Government Regulation and Charter Act'' and

""Management's Discussion and Analysis of Financial Condition and Results of OperationsÌBalance

Sheet AnalysisÌRegulatory Capital Requirements'' regarding the capital standards applicable to

Fannie Mae.

The payment of dividends on common stock also is subject to the payment of dividends on any

preferred stock outstanding. Accordingly, no cash dividend may be declared or paid or set apart for

payment on common stock unless cash dividends have been declared and paid or set apart (or ordered

to be set apart) on preferred stock outstanding for the then-current dividend period.

Dividends on common stock have been declared and paid for each quarter during Fannie Mae's

two most recent Ñscal years. See ""Quarterly Results of Operations'' on pages 73-74 for quarterly

dividends paid on common stock during 1998 and 1997.

In the event of liquidation of Fannie Mae, holders of common stock are entitled to share ratably,

in accordance with their holdings, in the remaining assets of Fannie Mae after payment of all liabilities

of the Corporation and amounts payable to the holders of preferred stock.

The common stock has no conversion or pre-emptive rights or redemption or sinking fund

provisions. The outstanding shares of common stock are fully paid and nonassessable. There is no

prohibition against the purchase by Fannie Mae of its own common stock, holding such common stock

in its treasury, and reselling such stock.

This description is summarized from the Charter Act, the 1992 Act, the bylaws and certain

resolutions of the Board of Directors and stockholders of Fannie Mae. This description does not

purport to be complete, and is qualiÑed in its entirety by reference to the Charter Act, the 1992 Act,

the bylaws of Fannie Mae, and such resolutions. Copies of the Charter Act, the bylaws of Fannie Mae,

and any applicable resolutions may be obtained from Fannie Mae.

Fannie Mae's common stock is publicly traded on the New York, PaciÑc and Chicago stock

exchanges and is identiÑed by the ticker symbol ""FNM.'' The transfer agent and registrar for the

common stock is First Chicago Trust Company of New York, 525 Washington Boulevard, Jersey City,

New Jersey 07310.

The following table shows, for the periods indicated, the high and low prices per share of Fannie

Mae's common stock on the New York Stock Exchange Composite Transactions as reported in the

Bloomberg Financial Markets service.

Quarterly Common Stock Data

1998 1997

Quarter High Low High Low

1st ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $66.38 $56.06 $43.75 $36.13

2nd ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 67.19 55.75 47.63 36.13

3rdÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 68.31 55.56 49.44 41.13

4thÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 76.19 49.56 57.31 44.69

The closing price of Fannie Mae's common stock on March 30, 1999, as so reported, was $70.19.

FORWARD-LOOKING INFORMATION

From time to time, Fannie Mae may make forward-looking statements relating to matters such as

the Corporation's anticipated Ñnancial performance, business prospects, future business plans,

Ñnancial condition or other matters. For example, ""Management's Discussion and Analysis of

Financial Condition and Results of Operations'' includes forward-looking statements, which are

statements therein that are not historical facts or explanations of historical data. The words

B-16
""believes,'' ""anticipates,'' ""expects,'' and similar expressions generally identify forward-looking

statements.

Forward-looking statements reÖect management's expectations based on various assumptions

and management's estimates of trends and economic factors in the markets in which Fannie Mae is

active, as well as Fannie Mae's business plans. As such, forward-looking statements are subject to

risks and uncertainties, and Fannie Mae's actual results may diÅer (possibly signiÑcantly) from those

indicated in such statements. Among the factors that may aÅect the performance, development or

results of Fannie Mae's 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

Fannie Mae's 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, Fannie Mae's funding

opportunities, or Fannie Mae's net interest margins;

‚ signiÑcant changes in employment rates, housing price appreciation, or other factors

aÅecting delinquency or foreclosure levels and credit losses;

‚ signiÑcant changes in Fannie Mae's policies or strategies, such as its underwriting

requirements or its interest rate risk management, credit loss mitigation, or investment

strategies;

‚ regulatory or legislative changes aÅecting Fannie Mae, its competitors, or the markets in

which the Corporation is active, including changes in taxes or capital requirements

applicable to Fannie Mae or its activities (see ""Government Regulation and Charter Act,''

and ""Management's Discussion and Analysis of Financial Condition and Results of

OperationsÌBalance Sheet AnalysisÌRegulatory Capital Requirements'' regarding certain matters currently being considered by regulators, legislators or the Administration);

‚ competitive developments in the markets for mortgage loan purchases and for the sale of

mortgage-backed 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 Fannie Mae's expenses, and the

costs (and eÅects) of legal or administrative proceedings (see ""Legal Proceedings'') or

changes in accounting policies or practices;

‚ operational, legal, or other issues related to the Year 2000 (see ""Management's Discussion

and Analysis of Financial Condition and Results of Operations Ì Risk Management Ì

Operational Risk Management'');

‚ signiÑcant changes in general economic conditions, or the monetary or Ñscal policy of the

United States; and

‚ unanticipated, substantial changes in interest rates. While Fannie Mae has achieved 44

consecutive quarters of record operating earnings despite major Öuctuations in interest

rates during this period and employs a variety of interest rate risk management techniques,

it is possible that sudden, severe swings in interest rates could have at least a short-term

signiÑcant eÅect on Fannie Mae's results.

Fannie Mae does not undertake to update any forward-looking statement herein or that may be

made from time to time on behalf of the Corporation.

B-17
SELECTED FINANCIAL INFORMATION: 1994-1998

The following selected Ñnancial data for the years 1994 through 1998 (which data are not covered

by the independent auditors' report) have been summarized or derived from the audited Ñnancial

statements and other Ñnancial information. These data should be read in conjunction with the

audited Ñnancial statements and notes to the Ñnancial statements.

(Dollars in millions, except per common share amounts)

1998 1997 1996 1995 1994 Income Statement Data for the year ended December 31:

Interest income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 29,995 $ 26,378 $ 23,772 $ 21,071 $ 17,347

Interest expense ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (25,885) (22,429) (20,180) (18,024) (14,524)

Net interest income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 4,110 3,949 3,592 3,047 2,823

Guaranty fees ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 1,229 1,274 1,196 1,086 1,083

Fee and other income, net ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 275 125 86 93 143

Credit-related expenses ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (261) (375) (409) (335) (378)

Administrative expenses ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (708) (636) (560) (546) (525)

Special Contribution ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Ì Ì Ì (350) Ì

Income before federal income taxes and

extraordinary item ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 4,645 4,337 3,905 2,995 3,146

Provision for federal income taxes ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (1,201) (1,269) (1,151) (840) (1,005)

Income before extraordinary item ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 3,444 3,068 2,754 2,155 2,141

Extraordinary itemÌloss on early extinguishment

of debt, net of tax eÅect ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (26) (12) (29) (11) (9)

Net incomeÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 3,418 $ 3,056 $ 2,725 $ 2,144 $ 2,132

Preferred stock dividends ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (66) (65) (42) Ì Ì

Net income available to common shareholders ÏÏÏÏÏÏÏÏÏÏÏÏ $ 3,352 $ 2,991 $ 2,683 $ 2,144 $ 2,132

Basic earnings per common share(1):

Earnings before extraordinary item ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 3.28 $ 2.87 $ 2.53 $ 1.98 $ 1.96

Extraordinary itemÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (.02) (.02) (.03) (.01) (.01)

Net earnings ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 3.26 $ 2.85 $ 2.50 $ 1.97 $ 1.95

Diluted earnings per common share(1):

Earnings before extraordinary item ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 3.26 $ 2.84 $ 2.51 $ 1.96 $ 1.95

Extraordinary itemÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (.03) (.01) (.03) (.01) (.01)

Net earnings ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 3.23 $ 2.83 $ 2.48 $ 1.95 $ 1.94

Cash dividends per common share ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ .96 $ .84 $ .76 $ .68 $ .60

Balance Sheet Data at December 31:

Mortgage portfolio, net ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $415,223 $316,316 $286,259 $252,588 $220,525

Investments ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 58,515 64,596 56,606 57,273 46,335

Total assets ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 485,014 391,673 351,041 316,550 272,508

Borrowings:

Due within one yearÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 205,413 175,400 159,900 146,153 112,602

Due after one year ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 254,878 194,374 171,370 153,021 144,628

Total liabilities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 469,561 377,880 338,268 305,591 262,967

Stockholders' equityÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 15,453 13,793 12,773 10,959 9,541

Capital(2) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 16,244 14,575 13,520 11,703 10,367

Other Data for the year ended December 31:

Average net interest marginÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 1.03% 1.17% 1.18% 1.16% 1.24%

Return on average common equityÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 25.2 24.6 24.1 20.9 24.3

Dividend payout ratio ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 29.5 29.4 30.4 34.6 30.8

Average eÅective guaranty fee rate ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ .202 .227 .224 .220 .225

Credit loss ratio ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ .027 .041 .053 .050 .057

Ratio of earnings to combined Ñxed charges

and preferred stock dividends(3) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 1.18:1 1.19:1 1.19:1 1.17:1 1.22:1

Mortgage purchases ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $188,448 $ 70,465 $ 68,618 $ 56,598 $ 62,389

MBS issued ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 326,148 149,429 149,869 110,456 130,622

MBS outstanding at year-end(4) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 834,518 709,582 650,780 582,959 530,343

Weighted-average diluted common shares outstanding, in

millions ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 1,037 1,056 1,080 1,098 1,098

(1) Earnings per common share amounts in 1996, 1995, and 1994 have been restated to comply with Financial Accounting

Standard No. 128, Earnings per Share.

(2) Stockholders' equity plus general allowance for losses.

(3) ""Earnings'' consists of (i) income before federal income taxes and extraordinary item and (ii) Ñxed charges. ""Fixed

charges'' represents interest expense. There was no preferred stock outstanding in 1995 and 1994.

(4) Includes $197 billion, $130 billion, $103 billion, $70 billion, and $44 billion of MBS in portfolio at December 31, 1998,

1997, 1996, 1995, and 1994, respectively.

B-18
MANAGEMENT'S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS

This discussion highlights signiÑcant factors inÖuencing Fannie Mae's Ñnancial condition and

results of operations. It should be read in conjunction with the Ñnancial statements and related notes.

This discussion (and other sections of this Information Statement) includes certain forward-looking

statements based on management's estimates of trends and economic factors in markets in which

Fannie Mae is active, as well as the corporation's business plans. In light of securities law developments, including the ""safe harbor'' provisions of the Private Securities Litigation Reform Act of 1995,

Fannie Mae notes that such forward-looking statements are subject to risks and uncertainties.

Accordingly, the corporation's actual results may diÅer from those set forth in such statements.

SigniÑcant changes in economic conditions; regulatory or legislative changes aÅecting Fannie Mae, its

competitors, or the markets in which it is active; or changes in other factors may cause future results to

vary from those expected by Fannie Mae. The ""Forward-Looking Information'' section in Fannie

Mae's Information Statement discusses certain factors that may cause such diÅerences to occur.

Overview

Fannie Mae extended its string of record earnings in 1998 to 12 years, with diluted earnings per

common share increasing to $3.23 per share, or 14 percent, compared with $2.83 in 1997. Net income

increased $362 million to $3.418 billion in 1998, compared with $3.056 billion for 1997. Fannie Mae's

1998 double-digit earnings growth was principally due to a record volume of mortgage purchases and

Fannie Mae mortgage-backed securities issues, increased fee and other income, strengthened credit

performance, and continued eÅective management of interest rate risk. The 31 percent increase in the

portfolio was the product of a number of factors, including a sustained period of lower interest rates

that resulted in record mortgage originations, as well as wide mortgage-to-debt spreads that, in part,

stemmed from a period of exceptional market turbulence in the second half of the year.

In 1998, Fannie Mae initiated a new funding product called Benchmark NotesSM. Benchmark

Notes are large issues of noncallable debt securities designed to provide liquidity and performance to

investors while reducing Fannie Mae's cost of debt. Benchmark Notes have served to consolidate

much of Fannie Mae's noncallable long-term debt issuances from a large number of small, unscheduled

issues to a smaller number of larger, regular, more liquid issues. Fannie Mae anticipates that the

liquidity of the Benchmark Notes, combined with Fannie Mae's outstanding credit quality, will cause

Benchmark Notes to be viewed by many investors as a liquid investment alternative to U.S.

Treasuries. During 1998, Fannie Mae issued $42 billion of Benchmark Notes.

Fannie Mae's credit risk management continued to excel during 1998. The decline in

credit-related expenses was a result of the combined beneÑcial eÅects of an improved housing market,

particularly in California; a signiÑcant degree of risk sharing on higher-risk loans; and continued

success in loss mitigation activities. The credit loss ratioÌcredit losses as a percentage of the average

unpaid principal balance of total mortgages in portfolio and Fannie Mae MBS outstandingÌdeclined

to .027 percent in 1998 from .041 percent in 1997.

Fannie Mae's core capital grew 12 percent, to $15.5 billion at December 31, 1998. Fannie Mae also

repurchased $1.1 billion of common stock during the year. Core capital exceeded applicable regulatory

capital standards by $131 million at December 31, 1998.

The remainder of Management's Discussion and Analysis includes detailed information on

Fannie Mae's results of operations, risk management, balance sheet analysis, mortgage-backed

securities, and housing goals, as well as a new accounting standard.

B-19
Results of Operations

Net Interest Income

Net interest income increased $161 million to $4.110 billion in 1998, compared with $3.949 billion

in 1997. The 4 percent increase was a result of a $53 billion, or 18 percent, increase in the average

mortgage portfolio balance, which was partially oÅset by a 14 basis point decrease in the average net

interest margin. The decline in the average net interest margin stemmed from an increase in the

reÑnancing of high-coupon mortgages; the recording, during the fourth quarter of 1998, of additional

amortization of premiums on mortgages held in portfolio ; an increase in tax-advantaged investments,

which generally have lower investment yields; and the repurchase of common shares. The additional

amortization recorded in the fourth quarter reÖects management's estimate of the eÅects of the

decline in interest rates and the high level of 1998 reÑnancing activity on the unamortized premium

and discount balances associated with the net mortgage portfolio. The repurchase of common shares

reduces the net interest margin, as such share repurchases are funded through the issuance of debt,

but has a positive eÅect on earnings per common share. For 1999, management expects that net

interest income will increase due to continued growth in the average net mortgage portfolio and a more

stable net interest margin.

Net interest income excludes interest receivable on nonperforming loans. Conventional single-family and multifamily loans are classiÑed as nonperforming and previously accrued interest is

removed from income when the collection of interest payments is deemed less than probable.

Guaranty Fee Income

Guaranty fees compensate Fannie Mae for its guarantee of the timely payment of principal and

interest to MBS investors and for the assumption of credit risk on loans underlying MBS. Guaranty

fees on Fannie Mae MBS held in portfolio are included in interest income. Guaranty fee income

decreased 4 percent, or $45 million, from $1.274 billion in 1997 to $1.229 billion in 1998. The decrease

in guaranty fee income primarily resulted from a decrease of .025 percentage points in the average

eÅective guaranty fee rate, which was partially oÅset by a $48 billion, or 9 percent, increase in average

net MBS outstanding. The decline in the average eÅective guaranty fee rate was due to several factors,

including recording additional amortization of prepaid or deferred guaranty fees in the fourth quarter

of 1998, reÖecting management's estimate of the eÅects of the decline in interest rates and reÑnance

activity on such fees; growth in the number of loans swapped for MBS for which the default risk is

shared by a third party; and competitive pricing in the market. For 1999, management expects that

guaranty fee income will increase as a result of continued growth in average net MBS outstanding.

The table below presents guaranty fee income as a percentage of the average balance of MBS

outstanding, net of MBS held in portfolio, in 1998, 1997, and 1996.

Guaranty Fee Data

1998 1997 1996

(Dollars in millions)

Guaranty fee income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 1,229 $ 1,274 $ 1,196

Average balance of net MBS outstanding ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 609,513 561,079 534,553

EÅective guaranty fee rateÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ .202% .227% .224%

Additional information on Fannie Mae's MBS and guaranty fees is presented under ""Mortgage-Backed Securities'' below.

B-20
Fee and Other Income

Fee and other income is composed of multifamily fees, structured transaction fees, and technology

fees, as well as other miscellaneous items, and is net of operating losses from certain tax-advantaged

investments. Fee and other income increased 120 percent, or $150 million, to $275 million in 1998,

compared with $125 million in 1997. The increase was primarily due to increases in technology fees,

multifamily fees, and other fees. The increase in technology fees was driven by record usage of Fannie

Mae's Desktop Underwriter» and Desktop Originator» systems. Additional information on structured

transactions is presented under ""Mortgage-Backed Securities.'' For 1999, management expects that

fee and other income will be somewhat lower than in 1998.

Credit-Related Expenses

Credit-related expenses, which include the provision for losses and foreclosed property expenses,

decreased $114 million to $261 million in 1998, compared with $375 million in 1997. The credit loss

ratio fell to 2.7 basis points in 1998 from 4.1 basis points in 1997. The decrease in credit-related

expenses was driven by a signiÑcant reduction in the provision for losses as compared with 1997. In

1998, Fannie Mae recorded a negative loss provision of $50 million, compared with a $100 million loss

provision recorded in 1997. Contributing to the decrease in credit-related expenses was a reduction in

the number of foreclosed properties. A stronger national housing market (especially in California), a

signiÑcant degree of risk sharing on higher-risk loans, and continued loss mitigation eÅorts contributed to the reduction in the provision for losses and the number of foreclosed properties.

Management anticipates that credit-related expenses will continue to decline in 1999 in spite of

continued growth in the mortgage portfolio and MBS outstanding. In 1999, Fannie Mae expects to

continue to beneÑt from a healthy national housing market and the Corporation's loss mitigation

eÅorts.

Administrative Expenses

Administrative expenses grew 11 percent to $708 million in 1998, compared with $636 million in

1997. The ratio of Fannie Mae's administrative expenses to the average net mortgage portfolio plus

average net MBS outstanding was .074 percent in both 1998 and 1997. The ratio of administrative

expenses to revenues (net interest income, guaranty fees, and fee and other income) was 12.6 percent

in 1998 and 11.9 percent in 1997. The increase in administrative expenses resulted primarily from

higher technology equipment costs and compensation costs, which included eÅorts to make Fannie

Mae's computer systems Year 2000 compliant and the eÅect of a higher common share price on

certain Fannie Mae stock-based compensation plans. Compensation expense was $453 million in

1998, compared with $394 million in 1997. Additional information concerning the Year 2000 issue is

presented under ""Risk Management.''

Income Taxes

The provision for federal income taxes, net of the tax beneÑt from extraordinary losses, was

$1.187 billion in 1998, compared with $1.262 billion in 1997. The eÅective federal income tax rate was

26 percent in 1998, compared with 29 percent in 1997. The reduction in federal income tax expense

and the eÅective federal income tax rate for 1998 reÖect the recording of additional low-income

housing tax credits in the fourth quarter of 1998. The additional tax credits were a result of the

Corporation using improved systems and information to reÑne the timing of the recognition of the tax

beneÑts associated with investments qualifying for low-income housing tax credits. Management

expects the eÅective federal income tax rate to increase slightly in 1999.

Extraordinary Loss

Extraordinary loss is recognized when debt or certain interest rate swaps are repurchased or

called. The repurchase and call of debt and the call of certain interest rate swaps are part of Fannie

B-21
Mae's interest rate risk management strategy, and are designed to favorably aÅect Fannie Mae's

future cost of funds. For 1998, as a result of these transactions, Fannie Mae recognized net

extraordinary losses of $40 million ($26 million after tax), compared with $19 million ($12 million

after tax) in 1997.

During 1998, the amount of long-term debt called or repurchased plus the notional amount of

interest rate swaps called totaled $77 billion, with a weighted-average cost of 6.71 percent. The

comparable amount in 1997 was $31 billion, with a weighted-average cost of 7.22 percent.

Risk Management

Fannie Mae is subject to three major areas of risk: interest rate risk, credit risk, and operational

risk. Active management of these risks is an essential part of Fannie Mae's operations and a key

determinant of its ability to maintain steady earnings growth. The following discussion highlights

Fannie Mae's various strategies to diversify and mitigate these three risks.

Interest Rate Risk Management

Fannie Mae is exposed to interest rate risk because changes in interest rates may aÅect mortgage

portfolio cash Öows in a way that will adversely impact earnings or long-term value. Fannie Mae's

management of interest rate risk involves analyses and actions that position the corporation to meet

its objective of consistent earnings growth in a wide range of interest rate environments. Fannie Mae's

interest rate risk is concentrated primarily in the mortgage portfolio, where exposure to changes in

interest rates is managed to achieve stable earnings growth and an acceptable return on equity over

time. Central elements of Fannie Mae's approach to managing interest rate risk include: (1) investing

in assets and issuing liabilities that perform similarly in diÅerent interest rate environments, (2)

assessing the sensitivity of portfolio proÑtability and risk to changes in interest rates, and (3) taking

rebalancing actions in the context of a well-deÑned risk management process.

The Ñrst element of interest rate risk management is the funding of mortgage assets with

liabilities that have similar durations or average cash Öow patterns through time. To achieve the

desired liability durations, Fannie Mae issues debt across a broad spectrum of maturities. Because the

durations of mortgage assets change as interest rates change, callable debt with similar duration

characteristics is frequently issued. The duration of callable debt, like that of a mortgage asset,

shortens when interest rates decrease and lengthens when interest rates increase. Fannie Mae also

utilizes oÅ-balance-sheet derivative Ñnancial instruments, including interest rate swaps and other

derivative instruments with embedded interest rate options, to achieve its desired liability structure

and to better match the prepayment risk of the mortgage portfolio. A high degree of diversiÑcation of

the interest rate option characteristics embedded in the assets and liabilities of the portfolio also

serves to reduce interest rate risk.

Because the assets and the liabilities in Fannie Mae's mortgage portfolio are not perfectly

matched, the portfolio's projected performance changes with movements in interest rates. Accordingly, the second element of interest rate risk management involves regularly assessing the portfolio's

risk using a diverse set of analyses and measures, including net interest income simulations, duration

gap analysis, portfolio value analysis, and stress testing. Portfolio net interest income is projected for a

wide range of interest rate environments, including speciÑc rising and falling interest rate paths, and

interest rate simulations based on historical interest rate volatility. These analyses generally include

assumptions about new business activity to provide a more realistic assessment of possible portfolio

performance. Duration gap and portfolio value analyses are used to provide information on the

interest rate sensitivity of the existing portfolio only (assuming no new business.) The portfolio

duration gapÌthe diÅerence between the durations of portfolio assets and liabilitiesÌsummarizes for

management the extent to which asset and liability estimated cash Öows are matched, on average,

through time. Management regularly monitors the portfolio's duration gap under current market

conditions and for a series of hypothetical interest rate scenarios. In addition, management tracks the

B-22
portfolio's long-term value and potential changes in value for a broad range of potential interest rate

scenarios. Information about interest rate risk is also obtained by means of Ñnancial performance

simulations in which highly stressful interest rate scenarios are assumed.

Management monitors interest rate risk not only by using a diverse set of risk measures, but also

by evaluating the sensitivity of those measures to changes in assumptions about future business

conditions and Ñnancial market relationships. Fannie Mae's practice of employing a variety of risk

measures and assumptions proved especially useful during the high level of Ñnancial market volatility

experienced in 1998. Risk measures and assumptions are regularly reevaluated, and modeling tools are

enhanced as management believes appropriate.

The third element of Fannie Mae's interest rate risk management is a framework that facilitates

the communication and attainment of corporate objectives. 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 relative to these. Senior management is responsible for ensuring that the

appropriate long-term strategies are in place to achieve the goals and objectives. Short-term strategies

are formulated in weekly meetings of senior mortgage portfolio management, based on recent Ñnancial

market information and the portfolio's standing relative to long-term objectives. Management

establishes reference points for the key performance measures that are used to signal material changes

in risk and to assist in determining whether adjustments in portfolio strategy are required to achieve

long-term objectives. These measures and reference points are reported regularly to the Board of

Directors. Comparing the performance measures with the reference points helps management make

decisions about the necessity or desirability of portfolio rebalancing.

Fannie Mae's performance in 1998 is evidence of management's ability to meet its interest rate

risk objectives. During the year, long-term interest rates dropped to their lowest levels in over

30 years. In the quarter ending September 30, 1998, interest rates dropped by the largest amount in

any three-month period in nine years. Consequently, the mortgage portfolio's duration gap moved

somewhat outside Fannie Mae's established reference points and reached its lowest point in early

October. Portfolio rebalancing and the subsequent rise in long-term interest rates resulted in the

duration gap returning to a level within management's target reference range by year-end.

At December 31, 1998, the duration gap of Fannie Mae's mortgage portfolio was a negative three

months. A negative duration gap results when the duration of mortgage assets is shorter than the

duration of the related liabilities, and generally indicates that the existing portfolio's long-term

earnings stream is more vulnerable to a declining interest rate environment. At the end of 1998, the

projected net interest income of the mortgage portfolio over the next one to two years was also

somewhat more exposed to declining interest rates than to rising interest rates. Actual portfolio net

interest income performance may diÅer from projections because of speciÑc interest rate movements,

changing business conditions, and management actions.

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. The following table

presents Fannie Mae's estimated net asset value as of December 31, 1998, and two projections of the

value 12 months later assuming hypothetical changes in interest rates over the 12-month period.

These interest rate movements represent the most extreme changes in rates that would be expected

over this period within a 95 percent conÑdence interval, based on historical interest rate volatility.

The interest rate changes include an increase in long-term U.S. Treasury yields of approximately 175

basis points and a decrease of approximately 125 basis points from December 31, 1998 levels.

B-23
Interest Rate Sensitivity of Net Asset Value

Percentage of

NetDecember 31, 1998

Asset Value Net Asset Value

(Dollars in billions)

December 31, 1998 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $14.9 Ì

Assuming a 175 basis point increaseÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 15.5 104%

Assuming a 125 basis point decrease ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 13.0 87

The net asset value of Fannie Mae as of December 31, 1998, as presented in the above table, is the

same as that disclosed in Note 15 to the Financial Statements, ""Disclosures of Fair Value of Financial

Instruments,'' and includes the values of all portfolio business, as well as the guaranty fee business.

The projected net asset values were derived in a manner consistent with the estimation procedures

used in determining the December 31, 1998 net asset value.

As the table indicates, the net asset value of Fannie Mae's existing book of business is projected to

increase if interest rates were to rise 175 basis points over the next year, and decline if interest rates

were to fall 125 basis points over the next year. These sensitivities reÖect the generally greater

exposure of the company's existing book of business to declining interest rates at the end of 1998.

These fair value estimates represent valuations for the company's existing business only, and do

not take into account the value of the company as a going concern, which would include the value of

future business opportunities. For example, in a declining interest rate environment, the projected

faster runoÅ of the company's guaranty fee business would lower the net asset value of the company's

existing business. In the same environment, however, it is likely that new business opportunities would

result in faster growth of the total guaranty fee book outstanding. Similarly, in a declining rate

environment there are likely to be increased opportunities for portfolio growth and wider portfolio

purchase spreads.

Additional information on interest rate risk management is presented under ""Balance Sheet

AnalysisÌFinancing Activities.''

Credit Risk Management

Fannie Mae's primary exposure to credit risk results from the possibility that it will not recover

amounts due from borrowers. Management's overall objective in managing credit risk is to minimize

losses by applying prudent underwriting guidelines and loan servicing requirements. Furthermore,

Fannie Mae and its servicers use analytical models to apply credit risk analysis throughout the life of a

loan.

Fannie Mae is also subject to the credit risk that counterparties to its transactions may be unable

to meet their contractual obligations. Additional information on this credit risk exposure is presented

under ""Balance Sheet AnalysisÌFinancing Activities'' and in the Notes to Financial Statements,

""OÅ-Balance-Sheet Credit Risk'' and ""Concentrations of Credit Risk.'' The discussion that follows

addresses the major elements of credit risk management as they pertain to conventional single-family

and multifamily mortgage loans.

Single-Family

Fannie Mae manages its single-family mortgage credit risk by focusing on two phases: loan

underwriting and loan servicing. If these are not managed eÅectively, the likelihood of credit loss

increases.

In the Ñrst phase, loan underwriting, the corporation manages credit risk through its eÅorts to

develop sound underwriting policies and to ensure that loans sold to Fannie Mae meet the corporation's credit quality criteria.

B-24
Desktop Underwriter, Fannie Mae's automated underwriting model, was designed to help lenders

process mortgage applications more eÇciently, accurately, and consistently. It provides beneÑts to

lenders, borrowers, and Fannie Mae by consistently and objectively applying the corporation's

underwriting standards to all prospective borrowers, as well as customizing Fannie Mae's underwriting

standards to a loan's unique combination of credit risk factors. Use of Desktop Underwriter

signiÑcantly increased in 1998. Desktop Underwriter was used by nearly 800 lenders and was

processing, on average, 22 percent of the loans that were delivered to Fannie Mae in 1998 versus 9

percent in 1997. By December 1998, 26 percent of loans delivered to Fannie Mae were processed

through Desktop Underwriter. Management expects Desktop Underwriter usage to continue to

increase in 1999.

In the second phase of credit risk management, loan servicing, Fannie Mae manages the risk of

credit loss by requiring its servicers to follow guidelines for servicing a loan owned or securitized by

Fannie Mae. The guidelines help ensure that loans are serviced consistently and eÇciently.

An important element in loan servicing is the servicer's responsibility to carry out loss mitigation

activities. A major component of loss mitigation is early intervention in a delinquency. To help keep

borrowers in their homes or reduce the costs incurred when a loan goes through the foreclosure

process, borrowers are contacted early in the delinquency to determine whether their delinquency

might be resolved through a repayment plan, temporary forbearance, or modiÑcation of terms. If

repayment plans, forbearance, or modiÑcation are not appropriate, the loan servicer may attempt to

arrange a preforeclosure sale. The beneÑts of a preforeclosure sale include avoidance of the costs of

foreclosure and a tendency for the property to sell at a better price because the home is usually

occupied. If a preforeclosure sale is not possible, Fannie Mae's goal is to handle the foreclosure process

expeditiously in order to minimize the amount of time the Corporation retains a nonearning asset.

In 1998, Fannie Mae expanded on two initiatives introduced in 1997 that it believes will

contribute to reducing future credit losses. The Ñrst initiative, Risk ProÑlerTM, is a default prediction

model that assists servicers in loss mitigation activities. Risk ProÑler predicts the likelihood that a

loan will go into default by using updated borrower credit data, current property values, and loan

characteristics, all of which are strong predictors of credit risk. Currently, servicers are using Risk

ProÑler to evaluate more than seven million loans on a quarterly basis, which represents approximately 75 percent of the loans in Fannie Mae's book of business. Servicers have been able to integrate

the results from Risk ProÑler into their loss mitigation activities to prioritize their eÅorts on the

high-risk loans if they become delinquent. As a result of servicers using Risk ProÑler, in 1998 Fannie

Mae experienced an increase in the number of loan workouts as compared with 1997, and management

expects this trend to continue as the use of Risk ProÑler expands.

The second initiative involves placing Fannie Mae employees, or servicing consultants, on-site

with certain servicers to facilitate loss mitigation eÅorts. The servicing consultants work with

servicers to improve the default management process and increase the number of loss mitigation

workouts. At the end of 1998, Fannie Mae had servicing consultants working on-site periodically with

nearly all of its major servicers. Servicing consultants also provide value-added beneÑts to the servicer,

including working with the servicer to improve operational processes and implement best practices. As

a result of this initiative, Fannie Mae has experienced an increased Öow of information between itself

and its servicers, which has led to greater eÇciencies in the servicers' loss mitigation activities, a

strengthened relationship between Fannie Mae and its servicers, and a reduction in credit losses.

Desktop Underwriter and Risk ProÑler are part of Fannie Mae's strategy to increase homeownership opportunities by providing a broad array of desktop products that enable lenders to process and

manage all of their business more eÇciently. Management expects to continue investing in research

and technology to provide lenders and Fannie Mae with additional quantitative information for

evaluating and managing credit risk while expanding homeownership opportunities.

In addition to Fannie Mae's continuing loss mitigation eÅorts, a much stronger California

economy, a healthy national housing market, and the increased payments from mortgage insurance

B-25
were key factors in the continued improvement of credit performance in 1998. To illustrate the

company's improvement in California, at December 31, 1998, 20 percent of Fannie Mae's total book of

business was located in California, while 35 percent of Fannie Mae's properties acquired due to

foreclosure during the year were from California. The comparable amounts in 1997 were 20 percent

and 45 percent, respectively. Moreover, 40 percent of total credit-related losses came from California

loans in 1998, compared with 61 percent in 1997. The improved California economy has contributed

to reductions in the number of foreclosures and serious delinquencies, while strong home price

appreciation has resulted in a lower loss per case experienced on foreclosures.

As shown in the table below, single-family credit-related losses declined by 28 percent, or

$96 million, in 1998, compared with 1997. The decrease in credit-related losses was attributable to net

recoveries experienced in 1998 compared with net charge-oÅs experienced in 1997, slightly oÅset by an

increase in foreclosed property expenses. The average loss per foreclosed property decreased to $9,400

in 1998 from $12,800 in 1997, and single-family foreclosed property acquisitions decreased to 20,703

in 1998, compared with 22,222 in 1997.

Single-Family Credit-Related Losses

Year Ended December 31,

1998 1997 1996

(Dollars in millions)

(Recoveries) Charge-oÅs, net ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $(57) $ 66 $191

Foreclosed property expensesÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 306 279 216

Credit-related losses ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $249 $345 $407

Credit loss ratio ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ .027% .042% .053%

With the improvement in the California economy and a healthy national housing market, Fannie

Mae expects to continue to experience a reduction in its total credit-related losses in 1999.

Fannie Mae's single-family credit loss ratio declined to .027 percent in 1998, compared with

.042 percent in 1997. Management expects the 1999 credit loss ratio to be somewhat lower than the

1998 level.

The total number of single-family properties owned by Fannie Mae at December 31, 1998, was

8,576, compared with 9,481 at December 31, 1997. These properties had net carrying amounts of

$730 million and $735 million at December 31, 1998 and 1997, respectively.

In evaluating expected future credit performance, management analyzes the risk proÑle of the

conventional single-family loans in Fannie Mae's mortgage portfolio and underlying MBS. The loanto-value (""LTV'') ratio is an important factor in credit performance because the amount of equity a

borrower has in a home has proven to be highly predictive of both the incidence and the severity of

default. Fannie Mae utilizes an increasing array of credit-risk-sharing partnerships to manage credit

risk. For instance, Fannie Mae oÅsets its potential risk of loss by, among other strategies, requiring or

purchasing mortgage insurance, or structuring other credit protection on loans with LTV ratios over

80 percent and certain loans with lower LTV ratios.

Fannie Mae experienced record volumes in 1998 as a result of the attractive market conditions

throughout much of the year. The lower interest rate environment subjected a greater proportion of

Fannie Mae's book of business to reÑnancing, which in turn resulted in a large percentage of new

business consisting of reÑnanced Ñxed-rate mortgages. ReÑnanced loans typically have higher credit

quality because they usually involve loans with lower LTV ratios and often convert higher-risk,

adjustable-rate loans into lower-risk, Ñxed-rate loans. Accordingly, management believes that the

higher credit quality loans added to Fannie Mae's portfolio in 1998 will contribute to improved credit

performance in the future.

B-26
Experience has shown that loan age is also a major factor aÅecting delinquency rates and that the

incidence of default for a group of mortgage loans peaks in the third through Ñfth years after

origination. Unless real estate values decline signiÑcantly, loans outstanding after Ñve years tend to

have lower default rates because borrowers have a history of being able to make their payments and

most likely have built up additional equity in their properties. Between 1992 and 1994, Fannie Mae

acquired a signiÑcant portion of the loans in its portfolio and underlying MBS outstanding (30 percent of total outstanding UPB at December 31, 1998). These loans are now largely past their peak

default years.

Product mix also inÖuences potential future credit losses because the credit risks associated with

each product type vary. Adjustable-rate mortgages generally have a higher incidence of default than

long-term, Ñxed-rate mortgages, while intermediate-term, Ñxed-rate mortgages tend to have a lower

incidence of default than long-term, Ñxed-rate mortgages.

The following table presents data, by percentage of UPB, on conventional mortgage loans

outstanding in the Corporation's own portfolio or underlying MBS issued at December 31, 1998 and

1997 by product distribution, original LTV ratio, and current LTV ratio. In addition, the table

presents data by product distribution and original LTV ratio for conventional loans purchased for the

corporation's portfolio or underlying MBS in the years 1998, 1997, and 1996. Current LTV ratios are

derived by adjusting the value of a property by the estimated change in the price of the home since the

mortgage was originated and by comparing this adjusted value with the current UPB of the mortgage

at December 31, 1998 and 1997.

B-27
Distribution of Single-Family Loans

by Product Type and Loan-to-Value Ratio

Outstanding at

December 31, Percentage of Business Volumes

1998 1997 1998 1997 1996

Product:

Long-term, Ñxed-rate ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 69% 64% 77% 72% 70%

Intermediate-term, Ñxed-rate(1) ÏÏÏÏÏÏÏ 24 26 19 17 22

Adjustable-rate ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 7 10 4 11 8

TotalÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 100% 100% 100% 100% 100%

Original loan-to-value ratio:

Greater than 90% ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 12% 13% 10% 16% 16%

81% to 90% ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 15 17 12 17 18

71% to 80% ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 40 38 43 40 38

61% to 70% ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 15 14 16 13 13

Less than 61% ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 18 18 19 14 15

TotalÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 100% 100% 100% 100% 100%

Average original loan-to-value ratio ÏÏÏÏÏÏ 74% 74% 74% 76% 76%

Current loan-to-value ratio:

Greater than 90% ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2% 2%

81% to 90% ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 9 13

71% to 80% ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 24 22

61% to 70% ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 23 22

Less than 61% ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 42 41

TotalÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 100% 100%

Average current loan-to-value ratioÏÏÏÏÏÏÏ 61% 62%

Average loan amount ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $85,800 $80,800 $112,800 $99,900 $99,900

(Maximum $227,150 in 1998)

(1) Contractual maturities of 20 years or less at purchase for portfolio loans and 15 years or less

at issue date for MBS issuances.

The following table summarizes conventional single-family serious delinquency rates by region as

of December 31, 1998, 1997, and 1996. Single-family serious delinquency rates are based on the

number of conventional loans in portfolio or underlying MBS for which Fannie Mae has primary risk

of loss and that are delinquent 90 days or more or are in the process of foreclosure.

Single-Family Serious Delinquency Rates

December 31,

1998 1997 1996

Northeast ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ .83% .89% .87%

Southeast ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ .57 .59 .51

Midwest ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ .41 .40 .33

Southwest ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ .46 .45 .40

West ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ .61 .71 .74

Total ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ .58% .62% .58%

B-28
Multifamily

There are two primary risks involved in the underwriting and management of income-producing

multifamily properties: (1) that underlying property cash Öows will be insuÇcient to service the debt

over the life of the loan and (2) that proceeds from the sale or reÑnancing of a property will be

insuÇcient to repay the loan at maturity.

Fannie Mae manages the credit risk on its multifamily loan portfolio in several ways. First, the

Corporation maintains rigorous loan-underwriting guidelines coupled with extensive real estate due

diligence examinations for loan acquisitions. Because multifamily loans are primarily cash Öow

dependent and much larger than single-family loans, management monitors the ongoing performance

of individual loans by requiring servicers to submit periodic operating information and property

condition reviews. This information, combined with other loan risk characteristics, is used to evaluate

the credit quality of the portfolio, identify potential problem loans, and initiate appropriate loss

mitigation activities.

During the last two years, Fannie Mae has strengthened its credit risk management of multifamily

assets by creating a dedicated portfolio monitoring team and expanding the quality control function.

The activities of these groups include detailed quarterly portfolio loss reviews, identiÑcation and

monitoring of borrower and geographic concentration risks, lender assessments, counterparty risk

analyses, and enhanced reviews of large transactions.

Fannie Mae also manages its credit risk exposure through various forms of credit enhancement.

For the majority of multifamily loans, Fannie Mae has shared risk arrangements with lenders, full or

partial recourse to lenders or third parties for loan losses (which may be secured by letters of credit,

investment agreements, or pledged collateral), or government mortgage insurance. The following table

presents the risk proÑle, by UPB, of multifamily loans in the Corporation's portfolio or underlying

MBS at December 31, 1998, 1997, and 1996.

Multifamily Risk ProÑle

December 31,

1998 1997 1996

Fannie Mae riskÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 11% 14% 15%

Shared risk(1) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 52 48 44

Recourse(2) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 37 38 41

TotalÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 100% 100% 100%

(1) Includes loans where the lender initially bears losses of up to 5 percent of UPB and shares

any remaining losses with Fannie Mae.

(2) Includes loans not included in ""shared risk'' that have government mortgage insurance, or

full or partial recourse to lenders or third parties.

As a result of strong underwriting standards and quality control processes, continued improvements in the multifamily rental market, declining interest rates, and continued emphasis on early loss

mitigation eÅorts, the level of serious delinquencies for multifamily loans has declined signiÑcantly

over the past several years.

Multifamily serious delinquencies at December 31, 1998, 1997, and 1996 were .29 percent,

.37 percent, and .68 percent, respectively. Multifamily serious delinquencies are those loans for which

Fannie Mae has primary risk of loss (including those with shared risk) and that are delinquent two

months or more. Multifamily delinquency percentages are based on the UPB of such loans in portfolio

and underlying MBS.

B-29
Multifamily foreclosed property acquisitions where Fannie Mae has the primary risk of loss

totaled 12 properties and 28 properties during 1998 and 1997, respectively. At December 31, 1998 and

1997, the corporation held 9 primary risk foreclosed properties with an aggregate carrying value of

$12 million and 14 such properties with an aggregate carrying value of $17 million, respectively.

Credit-related losses and the ratio of credit-related losses to average UPB outstanding for

multifamily loans in portfolio or underlying MBS are summarized in the following table.

Multifamily Credit-Related Losses

Year Ended December 31,

1998 1997 1996

(Dollars in millions)

Charge-oÅs, net ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 8 $ 11 $ 19

Foreclosed property expense (income), net ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 5 (4) (3)

Credit-related losses ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 13 $ 7 $ 16

Credit loss ratio ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ .036% .020% .054%

In 1998, multifamily credit-related losses increased as a result of higher foreclosed property

expenses, primarily property preservation costs. Despite increased business, credit-related losses have

remained relatively low over the past three years primarily because of aggressive management of

delinquent multifamily assets and a healthy multifamily rental market. Management anticipates that

these losses will increase somewhat in 1999.

Allowance for Losses

In evaluating the risk of loss on portfolio loans and MBS outstanding, management considers

current delinquency levels, historical loss experience, current economic conditions, geographic concentrations, and other pertinent factors. The allowance for losses is established by recording an expense

for the provision for losses. It is subsequently reduced through charge-oÅs on foreclosed properties

and is increased through recoveries on foreclosed properties. Changes in the allowance for losses for

the years 1994 through 1998 are presented in the following table.

B-30
Allowance for Losses

Total

(Dollars in millions)

Balance, January 1, 1994 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 841

Provision ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 155

Net foreclosure losses charged oÅÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (169)

Balance, December 31, 1994 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 827

Provision ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 140

Net foreclosure losses charged oÅÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (172)

Balance, December 31, 1995 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 795

Provision ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 195

Net foreclosure losses charged oÅÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (210)

Balance, December 31, 1996 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 780

Provision ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 100

Net foreclosure losses charged oÅÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (77)

Balance, December 31, 1997 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 803

Provision ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (50)

Net recoveries ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 49

Balance, December 31, 1998 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 802

Operational Risk Management

Operational risk is the risk of potential loss due to a breakdown in established controls and

procedures, examples of which include circumvention of internal controls, fraud, human error, and

systems malfunction or failure. Fannie Mae has established extensive policies and procedures to

decrease the potential likelihood of such occurrences. Fannie Mae's Internal Audit Department tests

the adequacy of and adherence to internal controls and established policies and procedures. Financial

system data are regularly reconciled to source documents to ensure the accuracy of Ñnancial system

outputs. Additionally, Fannie Mae has a comprehensive disaster recovery plan that is designed to

allow critical operations to be restored with minimal interruption in the event of a natural disaster.

The use of Ñnancial forecast models is another potential operational risk. To mitigate the risk

associated with the use of Ñnancial models, Fannie Mae regularly reconciles forecasted results to

actual results and makes adjustments to the models for diÅerences aÅecting future periods.

The major operational risk faced by Fannie Mae is its Year 2000 system compliance issue. Fannie

Mae has been actively addressing the Year 2000 issues that may result from computer programs that

currently use two digits instead of four digits to identify the year in a date Ñeld. If these issues are not

resolved, Fannie Mae's information technology (""IT'') and non-IT systems (such as facilities

management systems) or those of its business partners may make incorrect calculations or fail.

Because this issue creates signiÑcant operational risks, Fannie Mae has undertaken a major eÅort to

identify and modify its internal systems so that they are Year 2000 compliant. In addition, Fannie

Mae is coordinating with its business partners to assess whether their systems will be operational in

the Year 2000. However, due to the pervasive and complex nature of the risks associated with Year

2000, there can be no assurance that Fannie Mae will identify all the risks or undertake all actions

necessary to prevent a material adverse impact on the Corporation's business or results of operations.

Risks Associated with the Year 2000

The business of Fannie Mae is highly dependent on the smooth interaction of numerous internal

and external (non-Fannie Mae) computer systems, and, as such, the Year 2000 issue poses signiÑcant

operational risks to Fannie Mae. Fannie Mae is focusing on four types of Year 2000 risks: disruptions

B-31
and/or inaccuracies in decision support systems and business processing; disruptions from third-party

Year 2000 noncompliance; disruptions from Year 2000 noncompliance of funds and securities wiring

and clearing systems, including the Federal Reserve Bank; and disruptions in the telecommunications

and utilities industries and economic environment outside of Fannie Mae's control. These risks may

result in interruptions or delays in Fannie Mae's daily processing relating to MBS issuance, mortgage

purchases, Ñnancial reporting, calculation of securities payments, and other matters. Such results

could lead to loss of revenue, loss of investor conÑdence, and possible litigation against the

Corporation. Fannie Mae cannot determine the likelihood or severity of such events.

In addition, the level of economic and market activities may be temporarily reduced as market

participants assess the eÅectiveness of the global and domestic markets' Year 2000 readiness in the

period before and subsequent to the Year 2000 date change. Such an event also could result in a

reduction of Fannie Mae's business activities. Fannie Mae cannot predict the likelihood of such a

reduction or estimate the impact such a reduction would have on its business.

Project Organization

Oversight of Fannie Mae's Year 2000 eÅort is structured in three tiers. First, a core Year 2000

project team representing the technology and business areas of Fannie Mae shares primary accountability for the overall Year 2000 eÅort. Second, a steering committee chaired by the President of Fannie

Mae meets monthly to review progress and resolve corporate-wide issues. Third, Fannie Mae's Board

of Directors interacts with the Year 2000 project team on a regular basis to monitor project status.

Fannie Mae has developed a comprehensive approach to the Year 2000 issue that includes

preventative eÅorts and contingency planning to address the risks discussed above. Fannie Mae has

divided its Year 2000 project into three areas of concentration: internal compliance, external

compliance, and business continuity planning. Internal compliance is designed to address the systems

and applications (internally developed and third-party vendor packages) used by Fannie Mae

employees. It also extends to Fannie Mae-developed applications that are used by third parties.

External compliance is designed to address Fannie Mae applications with external interfaces and other

electronic linkages between Fannie Mae and its business partners. Business continuity planning

includes developing contingency plans for Fannie Mae's business operations.

Internal Compliance

Internal compliance involves four phases: (1) an inventory, assessment, and planning phase;

(2) a repair phase; (3) a validation phase; and (4) an enterprise testing phase. Also included in

internal compliance is MORNET»/MORNETPlus» software compliance and facilities management

readiness.

The inventory, assessment, and planning phase Ñrst identiÑed existing business applications and

systems used internally (developed internally or purchased from third-party vendors) and technology

infrastructure components that are sensitive to the date change. The second step in this phase

assessed the Year 2000 readiness of each identiÑed application, system, or infrastructure component.

Finally, a timeline for necessary repair was planned. Fannie Mae has completed the inventory,

assessment, and planning phase.

The repair phase modiÑed the code in an existing system or application that is not Year 2000

compliant or, where necessary, replaced the existing system, application, or infrastructure component

with one that is designed to be Year 2000 compliant. The repair phase Ñrst addressed mission-critical

systems necessary for Fannie Mae to conduct its day-to-day operations and then proceeded to

non-mission-critical systems. Fannie Mae has completed the necessary repairs on all identiÑed

mission-critical and non-mission-critical systems.

The validation phase tests systems and applications individually to ensure that they are Year

2000 compliant. Fannie Mae's validation test environment is designed to mirror its production

B-32
environment and to test each system by simulating key business events in the Year 2000. At

December 31, 1998, Fannie Mae completed 100 percent of the testing of all systems identiÑed as

mission critical. Testing on identiÑed non-mission-critical systems is expected to be completed by the

second quarter of 1999. At December 31, 1998, Fannie Mae completed 90 percent of non-mission

critical testing.

After the validation phase is completed for all systems, Fannie Mae will use enterprise testing to

further assess whether Fannie Mae will be able to operate under normal business circumstances in the

Year 2000. Fannie Mae expects to use enterprise testing to simultaneously test both internal interfaces

among Fannie Mae's systems and external interfaces with certain of Fannie Mae's major business

partners using simulated Year 2000 business events. Fannie Mae expects to begin enterprise testing in

the second quarter of 1999 and to complete enterprise testing early in the fourth quarter of 1999,

followed by a suspension of discretionary changes to Fannie Mae's production environment through

January 2000.

Fannie Mae's internal compliance eÅort also involves eÅorts to make the software provided to its

customers Year 2000 ready. Most of Fannie Mae's lenders use MORNET and MORNETPlus software

applications to communicate with Fannie Mae. Fannie Mae released 100 percent of its Year

2000-ready versions of these applications to subscribers in 1998.

Fannie Mae's facilities, building security, and building control systems are also likely to be

aÅected by the Year 2000 date change. Providers of Fannie Mae's facilities management services have

been asked to submit Year 2000 certiÑcations. Fannie Mae has received certiÑcations from its

facilities management service providers and, on that basis, believes that Fannie Mae's facilities,

building security, and building control systems will be Year 2000 compliant by the second quarter of

1999.

External Compliance

External compliance focuses on business partners and, in particular, on those with which Fannie

Mae exchanges electronic information. These business partners include lenders that sell loans to or

service loans for Fannie Mae, securities dealers, clearing agencies, securities depositories, data

vendors, and the Federal Reserve Bank. Fannie Mae's approach to the Year 2000 issue includes

measures intended to protect against the risk that its operations could be materially aÅected by its

business partners' failure to ensure Year 2000 readiness. These preventative measures include on-site

assessments of major lenders, evaluation of service providers, testing with the Federal Reserve Bank,

and participation in the Mortgage Bankers Association's (""MBA's'') industry test.

Fannie Mae's Year 2000 project team has developed a methodology to evaluate the Year 2000

readiness of its servicers. This includes on-site meetings with each of Fannie Mae's top-tier servicers

to determine their respective Year 2000 readiness. Fannie Mae has completed this assessment. Fannie

Mae expects to complete the assessment of the readiness of its smaller lenders by the second quarter of

1999. Fannie Mae is one of the premier sponsors of the Year 2000 Inter-System Readiness Test

sponsored by the MBA, which was developed to assist servicers and other mortgage industry

participants in evaluating their Year 2000 readiness. Fannie Mae has mandated that its servicers

validate certain critical business functions using the MBA test by March 31, 1999.

Fannie Mae's day-to-day operations are highly dependent on the smooth interaction between

Fannie Mae and its service providers. Fannie Mae's service providers are involved in certain missioncritical activities, including the securities clearing and depository functions. They also provide services

related to Fannie Mae's capital markets transactions. Accordingly, Fannie Mae's Year 2000 eÅorts

include assessing the readiness of these service providers. Fannie Mae is currently testing with its

major external service providers, with the degree of testing commensurate with the perceived level of

business risk.

B-33
Fannie Mae's operations are also highly dependent on the Federal Reserve Bank for handling

book-entry securities and the wiring of funds and securities. During 1998, Fannie Mae completed

extensive testing with the Federal Reserve Bank. Additionally, Fannie Mae established the Washington, DC, Year 2000 Usergroup, a forum for industry participants to share best practices regarding

Year 2000 awareness and readiness.

The steps outlined above are intended to evaluate Fannie Mae's external business partners' Year

2000 readiness. However, Fannie Mae cannot predict the Year 2000 compliance of these external

entities. In the event that these entities are not Year 2000 compliant, Fannie Mae's ability to purchase

mortgage loans and to issue, transfer, and make periodic payments on its debt, mortgage, and other

securities may be adversely aÅected.

Business Continuity Planning

The third area of concentration is business continuity planning. Fannie Mae has completed its

business continuity plan and will continue to reÑne it throughout 1999. The business continuity plan

identiÑes the most likely and worst-case scenarios, prioritizes the risks associated with each scenario,

and addresses how Fannie Mae intends to handle such a scenario.

Fannie Mae's business continuity plan includes the addition of alternate suppliers, including

multiple telephone service providers, vendors, servicers, and trading partners, as necessary, to permit

business operations to continue and to minimize possible disruptions if key business partners have

signiÑcant Year 2000 problems. Fannie Mae's plan also includes several measures designed to ensure

adequate liquidity in the event of Year 2000 problems aÅecting the Ñnancial markets. Additional

measures include backup systems, manual processes, or changes in business practices. Fannie Mae

expects to be prepared to move functions from noncompliant partners to companies that are Year

2000 compliant, if necessary. Fannie Mae intends to test key aspects of its business continuity plan

during 1999.

Costs

Fannie Mae's Year 2000 project is proceeding as scheduled and budgeted. The estimated total cost

to Fannie Mae is expected to be between $60 million and $65 million for the project, which began in

early 1997 and runs through the year 2000. Approximately $38 million has been spent on the project

from its inception through December 31, 1998.

Balance Sheet Analysis

This section discusses Fannie Mae's mortgage portfolio and other investments as well as related

Ñnancing activities. A discussion of liquidity and capital resources and regulatory capital requirements

is also included.

Mortgage Portfolio

At December 31, 1998, the net mortgage portfolio totaled $415 billion, compared with $316 billion

at December 31, 1997. The increase in the net mortgage portfolio was due primarily to the increased

availability of mortgage products in the secondary market resulting from the prolonged period of lower

interest rates; record Ñxed-rate mortgage originations; and wide mortgage-to-debt spreads stemming

from the period of exceptional market turbulence in the fall of 1998. The volume of mortgage

purchases in 1999 will depend on Ñnancial and mortgage market conditions over the course of the

year.

The yield on the net mortgage portfolio was 7.12 percent at December 31, 1998, compared with

7.60 percent at December 31, 1997. The yield on the net mortgage portfolio averaged 7.38 percent in

1998, compared with 7.67 percent in 1997. The decline in both the ending yield and average yield for

B-34
the year was due largely to the lower interest rate environment that existed in 1998, which resulted in

the reÑnancing of many mortgages with high interest rates.

The following table summarizes mortgage purchases, sales, and repayments for the years 1996

through 1998.

Mortgage Portfolio Activity

Purchases Sales Repayments(1)

1998 1997 1996 1998 1997 1996 1998 1997 1996

(Dollars in millions)

Single-family:

Government insured or

guaranteedÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 6,016 $ 5,539 $ 4,461 $ Ì $ Ì $ Ì $ 3,729 $ 1,973 $ 1,650

Conventional:

Long-term, Ñxed-rate ÏÏÏÏÏÏÏÏ 147,615 55,925 54,021 1,383 563 105 60,718 20,995 17,554

Intermediate-term, fixed-rate ÏÏ 28,703 6,001 8,139 1 26 44 18,713 10,688 10,564

Adjustable-rateÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 3,507 1,977 706 Ì 476 Ì 2,965 2,807 2,789

Second ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 22 29 17 Ì Ì Ì 84 84 117

Total single-family ÏÏÏÏÏÏ 185,863 69,471 67,344 1,384 1,065 149 86,209 36,547 32,674

Multifamily ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2,585 994 1,274 409 23 Ì 2,658 3,204 2,254

TotalÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $188,448 $70,465 $68,618 $1,793 $1,088 $149 $88,867 $39,751 $34,928

Average net yield ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 6.61% 7.40% 7.57% 7.66% 7.70% 7.81%

Repayments as a percentage of

average mortgage portfolio ÏÏÏÏÏ 25.0% 13.2% 12.9%

(1) Includes mortgage loan prepayments, scheduled amortization, and foreclosures.

Investments

Fannie Mae maintains an investment portfolio consisting of high-quality, short-term nonmortgage investments, such as federal funds, commercial paper, repurchase agreements, asset-backed

securities, and other investments. The objectives of the investment portfolio are to serve as a source of

liquidity and to provide a return on the excess capital of Fannie Mae. As of December 31, 1998, the

balance in Fannie Mae's investment portfolio was $59 billion, compared with $65 billion at December 31, 1997. The decline in the investment portfolio was a result of Fannie Mae utilizing its excess

capital, during the period of exceptional market turbulence in the fall of 1998, to signiÑcantly increase

its purchases of mortgage loans in support of the market. The weighted-average interest rate earned

on investment securities was 5.76 percent for 1998 and 5.82 percent for 1997.

Additional information on these investments is presented in Note 4 to the Financial Statements,

""Investments.''

Financing Activities

The following table sets forth the amount and average cost of debt issued and repaid in 1998,

1997, and 1996, and of debt outstanding at the end of each year. The average cost of debt outstanding

at December 31, 1998 was 6.10 percent, compared with 6.46 percent at December 31, 1997. The

average cost of debt outstanding at December 31, 1998 declined because of lower interest rates during

1998 and the call and refunding of higher-cost debt. The weighted-average maturity of eÅective longterm, Ñxed-rate debt outstanding at December 31, 1998 and 1997 was 68 months and 66 months,

respectively.

B-35
Short-Term and Long-Term Debt Activity

1998 1997 1996

(Dollars in millions)

Issued during the year:

Short-term(1):

Amount ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $695,495 $755,281 $635,595

Average cost ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 5.42% 5.53% 5.36%

Long-term(1):

Amount ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $147,430 $ 86,325 $ 80,302

Average cost ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 5.81% 6.37% 6.17%

Repaid during the year:

Short-term(1):

Amount ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $657,308 $738,552 $636,768

Average cost ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 5.51% 5.49% 5.41%

Long-term(1):

Amount ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 94,728 $ 63,690 $ 46,937

Average cost ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 6.40% 6.65% 6.93%

Outstanding at year-end:

Due within one year:

Net amountÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $205,413 $175,400 $159,900

Average cost(2) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 5.33% 5.76% 5.66%

Due after one year:

Net amountÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $254,878 $194,374 $171,370

Average cost(2) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 6.25% 6.67% 6.66%

Total debt:

Net amountÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $460,291 $369,774 $331,270

Average cost(2) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 6.10% 6.46% 6.49%

(1) ""Short-term'' refers to the face amount of debt issued with an original term of one year or

less. ""Long-term'' is the face amount of debt issued with an original term greater than one

year.

(2) Average cost includes the amortization of premiums, discounts, issuance costs, hedging

results, and the eÅects of currency, debt and interest rate swaps.

In 1998, Fannie Mae initiated a new funding product called Benchmark Notes. Benchmark Notes

are large issues of noncallable debt securities designed to provide liquidity and performance to

investors while reducing Fannie Mae's cost of debt. Benchmark Notes have served to consolidate

much of Fannie Mae's long-term debt issuances from a large number of small, unscheduled issues to a

smaller number of larger, regular, more liquid issues. During 1998, Fannie Mae issued $42 billion of

Benchmark Notes with maturities ranging from 3 years to 10 years.

As described under ""Risk ManagementÌInterest Rate Risk Management,'' matching the duration of mortgage assets with the duration of liabilities funding those assets is accomplished through

the use of varied debt maturities and embedded option characteristics, as well as the use of oÅbalance-sheet Ñnancial instruments, primarily interest rate swaps, caps, and swaptions.

The following table presents option-embedded debt instruments as a percentage of mortgage

purchases and the net mortgage portfolio. Option-embedded debt instruments include derivative

Ñnancial instruments.

B-36
Option-Embedded Debt Instruments

1998 1997 1996

(Dollars in billions)

Issued during the year ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $113 $ 36 $ 44

Percentage of total mortgage purchases ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 60% 51% 64%

Outstanding at year-end ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $174 $139 $130

Percentage of total net mortgage portfolio ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 42% 44% 45%

The decline in the percentage of option-embedded debt instruments to 42 percent at December 31, 1998 from 44 percent at December 31, 1997 was primarily attributable to the large amount of

debt called in 1998.

Derivative Ñnancial instruments increase the Öexibility of Fannie Mae's funding alternatives by

providing the speciÑc cash Öows or characteristics that the portfolio requires but that might not be as

readily available or cost-eÅective if obtained in the standard debt market. Fannie Mae does not

speculate using derivatives and does not engage in derivatives trading. Fannie Mae primarily uses four

types of derivative instruments: (1) generic swaps, which involve the exchange of Ñxed and variable

interest payments based on contractual notional principal amounts, and which may include callable

swaps (which give the counterparties or, in some cases, Fannie Mae the right to terminate the interest

rate swap agreement before its stated maturity); (2) basis swaps, whereby the Corporation exchanges

variable payments that have maturities similar to the underlying debt but rates based on diÅerent

indices; (3) swaptions, which provide Fannie Mae with the option to enter into a swap at a future

date, thereby mirroring the economic eÅect of callable debt; and (4) interest rate caps, which

eÅectively cap the interest rate on a variable-rate debt instrument in exchange for a premium.

The following table summarizes Fannie Mae's derivative activity for the years ended December 31, 1998 and 1997, together with the expected maturities and weighted-average interest rates to be

received and paid on these derivative instruments.

Derivative Activity and Maturity Data

Pay Generic-Pay Variable/ Fixed/Receive Variable Swaps(1) Receive

Pay Receive Fixed Basis Caps and

Notional(2) Rate(3) Rate(3) Swaps Swaps Swaptions Total

(Dollars in millions)

Balance on January 1, 1997 ÏÏÏÏÏÏÏÏ $100,111 6.73% 5.59% $15,624 $40,078 $ Ì $155,813

Additions ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 12,557 6.56 5.71 24,685 15,234 Ì 52,476

Maturities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 15,955 6.36 5.69 10,656 32,929 Ì 59,540

Balance on December 31, 1997ÏÏÏÏÏÏ 96,713 6.77 5.82 29,653 22,383 Ì 148,749

Additions ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 23,725 5.31 5.28 20,448 10,931 27,165 82,269

Maturities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 24,424 6.25 5.72 20,631 16,395 Ì 61,450

Balance on December 31, 1998. ÏÏÏÏÏ $ 96,014 6.53% 5.30% $29,470 $16,919 $27,165 $169,568

Future Maturities (4)

1999 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 5,450 6.64% 4.89% $16,325 $15,120 $ 250 $ 37,145

2000 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 14,648 5.18 5.19 3,275 1,200 5,500 24,623

2001 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 9,800 6.22 5.28 2,892 Ì 4,750 17,442

2002 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 4,950 6.28 5.36 400 79 7,000 12,429

2003 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 4,376 5.96 5.35 1,000 200 7,365 12,941

Thereafter ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 56,790 6.98 5.36 5,578 320 2,300 64,988

$ 96,014 6.53% 5.30% $29,470 $16,919 $27,165 $169,568

(1) Included in the notional amounts are callable swaps of $26 billion, and $23 billion with

weighted-average pay rates of 4.93 percent, and 6.58 percent, and weighted-average receive

B-37
rates of 5.44 percent, and 5.89 percent at December 31, 1998, and December 31, 1997,

respectively.

(2) The notional value only indicates the amount on which swap payments are being calculated

and does not represent the amount at risk of loss.

(3) The weighted-average interest rate payable and receivable is as of the date indicated. The

interest rates of the swaps may be Öoating-rate, so these rates may change as prevailing

interest rates change.

(4) Based on stated maturities. Assumes that variable interest rates remain constant at December 31, 1998 levels.

Fannie Mae's interest rate swaps had a weighted-average term of 68 months and 72 months at

December 31, 1998 and 1997, respectively. Long-term debt outstanding, including the eÅect of swaps

but excluding eÅective variable-rate debt (i.e., long-term debt that reprices within one year), totaled

$352 billion at December 31, 1998, and $294 billion at December 31, 1997. Interest rate swaps

eÅectively lengthened the Ñnal maturity of Fannie Mae's liabilities by 13 months at December 31,

1998, and 18 months at December 31, 1997.

The primary risk posed by Fannie Mae's derivative instruments is credit risk, or the risk that a

counterparty will fail to meet its contractual obligations on a transaction, thereby causing Fannie Mae

to have to replace the derivative instrument at market prices. Fannie Mae manages this risk by dealing

only with experienced counterparties with high credit quality, diversifying its derivative instruments

across many counterparties, and entering into interest rate swaps under master agreements that

require counterparties to post collateral if Fannie Mae is exposed to credit loss exceeding an agreedupon threshold. In addition, master agreements provide for netting of certain amounts payable by

each party. Fannie Mae regularly monitors the exposures on its derivative instruments by determining

the market value of positions via dealer quotes and internal pricing models. Fannie Mae held

$72 million of collateral for derivative instruments at December 31, 1998.

Fannie Mae's oÅ-balance-sheet exposure on derivative instruments (taking into account master

agreements that allow for netting of payments) was $46 million at December 31, 1998, compared with

$26 million at December 31, 1997.

Fannie Mae also hedges against Öuctuations in interest rates on planned debt issuances using

derivative instruments that simulate the short sale of U.S. Treasury securities, through interest rate

swaps, and through deferred rate-setting agreements. Gains and losses on these instruments are

deferred and reÖected as basis adjustments to the cost of the debt when issued. The hedging of

anticipated debt issuances enables Fannie Mae to maintain an orderly and cost-eÅective debt issuance

schedule and to make daily loan purchase commitments without signiÑcantly increasing its interest

rate risk exposure.

Additional information on interest rate swaps and other oÅ-balance-sheet Ñnancial instruments

are presented in Notes 13 and 15 to the Financial Statements, ""OÅ-Balance-Sheet Credit Risk'' and

""Disclosures of Fair Value of Financial Instruments.''

Liquidity and Capital Resources

Fannie Mae's statutory mission requires that it provide ongoing assistance to the secondary

market for mortgage loans. Fannie Mae therefore must raise funds continually to support its mortgage

purchase activity. The capital markets traditionally have treated Fannie Mae's obligations as ""federal

agency'' debt. As a result, even though the U.S. government does not guarantee Fannie Mae's debt,

Fannie Mae has had ready access to funding at relatively favorable spreads.

Fannie Mae's primary sources of cash are issuances of debt obligations, mortgage loan repayments, interest income, and MBS guaranty fees. In addition, at December 31, 1998, Fannie Mae had

cash and cash equivalents and short-term investments totaling $59 billion, compared with $67 billion

B-38
at December 31, 1997. Primary uses of cash include the purchase of mortgages and other securities,

repayment of debt, interest payments, administrative expenses, and taxes.

At December 31, 1998, Fannie Mae had mandatory delivery commitments and lender-option

commitments outstanding to purchase $11 billion and $2 billion of mortgage loans, respectively,

compared with $4 billion and $2 billion, respectively, outstanding at December 31, 1997.

Fannie Mae's capital base (stockholders' equity plus general allowance for losses) grew to

$16.2 billion at December 31, 1998, compared with $14.6 billion at the end of 1997. At year-end 1998,

there were 1.025 billion shares of common stock outstanding. In January 1999, the Board of Directors

approved a quarterly dividend rate for 1999 of $.27 per common share, and dividends of $.80125 per

Series A preferred share, $.81250 per Series B preferred share, $.80625 per Series C preferred share,

and $.65625 per Series D preferred share for the period December 31, 1998, up to but excluding

March 31, 1999. In 1998, the quarterly dividend rate was $.24 per common share.

During the third quarter of 1998, Fannie Mae issued 3 million shares of 5.25 percent noncumulative preferred stock, Series D, with a stated value of $50 per share. In addition, in October 1998, the

Board of Directors authorized the issuance of up to $850 million in preferred stock by January 1, 2001.

During 1998, Fannie Mae continued implementing its capital restructuring program, approved by the

Board of Directors in December 1995, by repurchasing 17 million shares of common stock. The shares

were repurchased pursuant to the Board's approval for the repurchase of up to an additional six

percent of outstanding common shares as of December 27, 1995 (adjusted for a stock split), to oÅset

the dilutive eÅect of common shares issued or expected to be issued in conjunction with various stock

compensation plans, and to use the $150 million proceeds from the Series D preferred stock oÅering.

In 1997, Fannie Mae repurchased 31 million shares of common stock to oÅset the eÅect of shares

issued in conjunction with various stock compensation plans and toward the aforementioned capital

restructuring program.

Fannie Mae assesses the adequacy of its capital using an internally developed stress test

methodology. The stress test model calculates the amount of capital required under diÅerent economic

scenarios. By using this model, Fannie Mae can estimate the amount of capital needed to carry out the

company's mission during times of economic distress. At December 31, 1998, Fannie Mae's capital

was suÇcient under all tested scenarios. As discussed below, a regulatory capital standard based on a

stress test is being developed.

Regulatory Capital Requirements

Fannie Mae is subject to capital adequacy and risk-based standards established by the 1992 Act.

The capital adequacy standards require that Fannie Mae's core capital equal or exceed a minimum

capital standard and a critical capital standard. The following table shows Fannie Mae's core capital

compared with the requirements.

Capital Requirements

December 31,

1998 1997

(Dollars in millions)

Core capital(1) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $15,465 $13,793

Required minimum capital(2) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 15,334 12,703

Required critical capital(3) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 7,863 6,528

Excess of core capital over minimum capital ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 131 $ 1,090

(1) The sum of (a) the par value of outstanding common stock; (b) the par value of outstanding

noncumulative perpetual preferred stock; (c) paid-in capital; and (d) retained earnings.

B-39
(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, except as adjusted by the Director

of OFHEO.

(3) 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, except as adjusted by the Director

of OFHEO.

The Director of OFHEO also is developing a risk-based standard consistent with the parameters

speciÑed in the 1992 Act. The risk-based standard includes credit and interest rate risk components

along with an additional amount of required capital for management and operations risk. To meet that

standard, Fannie Mae must hold total capital equal to the amount necessary to meet the combined

occurrence of highly stressful credit and interest rate conditions over a ten-year period, plus an

additional 30 percent of this amount for management and operations risk.

The Director of OFHEO publicly released Part I of the proposed risk-based capital regulations in

1996. Part I creates benchmarks for credit testing and speciÑes the housing price index that will be

used in connection with this standard. After interagency review and comment, OFHEO recently sent

Part II of the proposed risk-based capital regulations to Congress for review and comment. After the

Congressional review period, OFHEO is expected to publish Part II for public review and comment.

Part II will specify the remaining credit risk criteria and the interest rate risk criteria. The 1992 Act

provides that the Ñnal regulations will be enforceable one year after issuance. Management is

conÑdent that Fannie Mae will be able to meet any reasonable stress test. See ""Government

Regulation and Charter Act.''

Mortgage-Backed Securities

MBS outstanding grew to $835 billion at December 31, 1998, compared with $710 billion at

December 31, 1997. MBS are backed by loans from a single lender, from multiple lenders, or from

Fannie Mae's mortgage loan portfolio. Single-lender MBS are issued through lender swap transactions

whereby a lender exchanges pools of mortgage loans for MBS. Multiple-lender MBS allow several

lenders to pool mortgage loans and receive, in return, MBS (called Fannie Majors») representing a

proportionate share of a larger pool. In some instances, Fannie Mae buys loans and at the same time

enters into a forward sale commitment. These loans are designated as held for sale and sold from the

portfolio as MBS.

MBS are not assets of Fannie Mae, except when acquired for investment purposes, nor are they

recorded as liabilities. However, Fannie Mae is liable under its guarantee to make timely payment of

principal and interest to investors. The issuance of MBS creates guaranty fee income for Fannie Mae.

Sellers of pools of mortgage loans may retain or transfer to one or more third parties the primary

default risk on loans constituting the MBS pools, or they may elect to transfer this credit risk to

Fannie Mae. The guaranty fee paid by the lender varies, depending on the risk proÑle of the loans

securitized as well as the level of credit risk assumed by Fannie Mae. Fannie Mae, however, assumes

the ultimate risk of loss on all MBS.

The table below summarizes MBS issued and outstanding for the years ended December 31, 1998,

1997, and 1996. The increase in the total amount of MBS issued compared with prior periods was due

to several factors including a sustained period of lower interest rates that resulted in record mortgage

originations and increased reÑnance activity. The increase in the percentage of total MBS issued in

the lender or shared risk category in 1998, compared with 1997, was primarily a result of increases in

deals in which the default risk is shared with a third party.

B-40
MBS Risk Distribution

Issued(1) Outstanding(1)

Lender Lender

or or

Shared Fannie Mae Shared Fannie Mae

Risk Risk Total Risk(2) Risk Total(3)

(Dollars in millions)

1998 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $90,694 $235,454 $326,148 $160,223 $674,295 $834,518

1997 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 35,740 113,689 149,429 94,262 615,320 709,582

1996 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 13,389 136,480 149,869 70,642 580,138 650,780

(1) Based on primary default risk category. MBS outstanding includes MBS that have been

pooled to back Fannie Megas, SMBS, or REMICs.

(2) Included in lender risk are $123 billion, $57 billion, and $31 billion at December 31, 1998,

1997, and 1996, respectively, on which the lender or a third party had agreed to bear default

risk limited to a certain portion or percentage of the loans delivered and, in some cases, on

which the lender had pledged collateral to secure that obligation.

(3) Included are $197 billion, $130 billion, and $103 billion at December 31, 1998, 1997, and

1996, respectively, of MBS in Fannie Mae's portfolio.

Fannie Mae issues REMICs backed by MBS, SMBS, Ginnie Mae mortgage-backed securities,

other REMIC securities, or whole loans. REMICs provide an additional source of fee income that does

not subject the Corporation to added credit risk, except for REMICs backed by whole loans. In 1998,

REMIC issuances were $76 billion, compared with $75 billion in 1997. The outstanding balance of

REMICs at December 31, 1998 was $311 billion, compared with $329 billion at December 31, 1997.

Housing Goals

The 1992 Act gives the Secretary of HUD authority to establish low- and moderate-income,

underserved areas, and special aÅordable housing goals for Fannie Mae. In December 1995, the

Secretary of HUD issued Ñnal regulations setting the housing goals for 1996 through 1999. Under the

Ñnal regulation, the Corporation's goal for 1997 through 1999 in low- and moderate-income housing is

42 percent of Fannie Mae's conventional mortgage business. The geographic goal for 1997 through

1999, based on underserved census tracts in metropolitan statistical areas and counties in rural areas,

is 24 percent of Fannie Mae's conventional mortgage business. The special aÅordable housing goal,

which serves very low-income families and low-income families in low-income areas, is 14 percent of

Fannie Mae's single-family conventional mortgage business and multifamily business for the years

1996 through 1999. Under this goal, Fannie Mae also must include mortgage purchases of multifamily

units totaling no less than $1.3 billion (.8 percent of Fannie Mae's 1994 total dollar volume of such

mortgage purchases). All of these goals are measured as a percentage of dwelling units Ñnanced.

Fannie Mae exceeded its low- and moderate-income housing goal in 1998 and 1997, with

44 percent and 45 percent, respectively, of its conventional mortgage business counting toward this

goal. In 1998, Fannie Mae exceeded its geographic goal, with over 26 percent of its conventional

mortgage business counting toward this goal. Fannie Mae exceeded the 1997 geographic goal, with

29 percent of the conventional mortgage business serving families in underserved areas. In addition, in

1998 Fannie Mae exceeded its special aÅordable housing goal, with over 15 percent of the conventional

single-family and multifamily business counting toward this goal and with $3.6 billion of multifamily

business meeting the $1.3 billion multifamily requirement. In 1997, Fannie Mae exceeded the special

aÅordable housing goal, with 19 percent of single-family and multifamily business counting toward

this goal and with special aÅordable multifamily purchases of $3.2 billion.

Fannie Mae has built a solid foundation in aÅordable housing through signiÑcant community

outreach eÅorts, products directed at certain disadvantaged groups, and the introduction of products

B-41
with targeted underwriting Öexibilities, including an initiative to purchase loans with lower down

payments to help low-income households aÅord homes. In 1994, Fannie Mae announced a commitment to increase outreach and access to mortgage credit under our Trillion Dollar Commitment to

serve 10 million households by the end of the year 2000. Through the end of 1998, Fannie Mae has

Ñnanced $700 billion under this commitment, serving 8.3 million households. This targeted housing

Ñnance serves families with incomes below the median for their areas, minorities and new immigrants,

families who live in central cities and distressed communities, and people with special housing needs.

With this announcement, Fannie Mae pledged to provide the innovation and leadership necessary to

transform the housing Ñnance industry into one without arbitrary barriers to individuals and families

who have been shut out of the dream of homeownership or have not had ready access to decent, safe

rental housing.

New Accounting Standard

In the second quarter of 1998, the Financial Accounting Standards Board issued Financial

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

Activities, which is eÅective for Fannie Mae on January 1, 2000. FAS 133 requires that all derivatives

be recognized either as assets or liabilities on the balance sheet at fair value. Subject to certain

qualifying conditions, a derivative may be designated as either a hedge of the fair value of a Ñxed-rate

instrument (fair value hedge) or as a hedge of the cash Öows of a variable-rate instrument or

anticipated transaction (cash Öow hedge). For a derivative qualifying as a fair value hedge, fair value

gains or losses would be reported in earnings along with oÅsetting fair value gains or losses

attributable to the risk being hedged. For derivatives qualifying as a cash Öow hedge, fair value gains

or losses associated with the risk being hedged would be reported in a separate component of

stockholders' equity (other comprehensive income) and then recognized in earnings in the period(s)

in which the hedged item aÅects income. For a derivative instrument not qualifying as a hedge, fair

value gains and losses would be reported in earnings. Management currently is evaluating the impact

that this standard will have on its internal operations. If Fannie Mae continues with its current

business strategies, this standard will not have a signiÑcant eÅect on net income, although it is likely

to have a material eÅect on the ""other comprehensive income'' component of stockholders' equity.

Comparison of 1997 with 1996

The following discussion and analysis provides a comparison of Fannie Mae's results of operations for the years ended December 31, 1997 and 1996.

Results of Operations

Net income increased to $3.056 billion in 1997 from $2.725 billion in 1996, and earnings per

common share were $2.83, up from $2.48 in 1996.

Net interest income increased $357 million to $3.949 billion in 1997, as a result of a $30 billion, or

11 percent, increase in the average mortgage portfolio balance, which was partially oÅset by a 1 basis

point decrease in the average net interest margin.

Guaranty fee income increased $78 million to $1.274 billion in 1997, compared with $1.196 billion

in 1996. The increase in guaranty fee income resulted from a $27 billion increase in average net Fannie

Mae MBS outstanding coupled with an increase of .3 basis points in the average eÅective guaranty fee

rate.

Fee and other income increased $39 million to $125 million in 1997, compared with $86 million in

1996. The 45 percent increase was due largely to increases in income from structured transaction fees,

multifamily fees, and special transaction fees.

Credit-related expenses decreased $34 million to $375 million in 1997 from $409 million in 1996.

The decrease in credit-related expenses was driven by a reduction in the provision for losses, reÖecting

B-42
a lower average loss per foreclosed property in 1997. The lower average loss per foreclosed property

resulted from a stronger national housing market, increased payments from mortgage insurance, and

continued loss mitigation eÅorts.

Administrative expenses grew $76 million, or 14 percent, to $636 million in 1997, compared with

$560 million in 1996. The increase in administrative expenses resulted primarily from additional

investments in systems development, which included eÅorts to make Fannie Mae's computer systems

Year 2000 compliant, expenses associated with restructuring the corporation's regional oÇces, and the

eÅect of a higher common share price on Fannie Mae's stock-based compensation plans. Compensation expense was $394 million in 1997, compared with $344 million in 1996.

The provision for federal income taxes, net of the tax beneÑt from extraordinary losses, was

$1.262 billion in 1997, compared with $1.135 billion in 1996. The eÅective federal income tax rate was

29 percent for both periods.

During 1997, the amount of long-term debt called or repurchased and the notional principal

amount of interest rate swaps called was $31 billion, with a weighted-average cost of 7.22 percent. The

comparable amount in 1996 was $26 billion, with a weighted-average cost of 7.09 percent. As a result

of repurchase and call activity, Fannie Mae recognized net extraordinary losses of $19 million

($12 million after tax) in 1997, compared with $45 million ($29 million after tax) in 1996. The

repurchase or call of high-coupon debt favorably aÅects Fannie Mae's future cost of funds.

B-43
FANNIE MAE

INDEX TO FINANCIAL STATEMENTS

Page

Independent Auditors' Report ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏB-45

Statements of Income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏB-46

Balance SheetsÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏB-47

Statements of Changes in Stockholders' Equity ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏB-48

Statements of Cash FlowsÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏB-49

Notes to Financial StatementsÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏB-50

Quarterly Results of Operations (unaudited)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏB-74

Net Interest Income and Average Balances (unaudited) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏB-76

Rate/Volume Analysis (unaudited) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏB-77

B-44
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, 1998 and

1997, 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, 1998. 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 generally accepted auditing standards. 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, 1998 and 1997, and the results of its

operations and its cash Öows for each of the years in the three-year period ended December 31, 1998,

in conformity with generally accepted accounting principles.

We also have audited in accordance with generally accepted auditing standards the supplemental

fair value balance sheets of Fannie Mae as of December 31, 1998 and 1997, included in Note 15 to the

Ñnancial statements. As described in Note 15, 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 generally accepted

accounting principles. 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 15

present fairly, in all material respects, the information set forth therein.

KPMG LLP

Washington, DC

January 13, 1999

B-45
FANNIE MAE

STATEMENTS OF INCOME

Year Ended December 31,

1998 1997 1996

(Dollars in millions,

except per common share amounts)

Interest income:

Mortgage portfolio ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $25,676 $22,716 $20,560

Investments and cash equivalentsÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 4,319 3,662 3,212

Total interest incomeÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 29,995 26,378 23,772

Interest expense:

Short-term debt ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 4,809 3,659 3,395

Long-term debt ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 21,076 18,770 16,785

Total interest expense ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 25,885 22,429 20,180

Net interest income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 4,110 3,949 3,592

Other income:

Guaranty feesÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 1,229 1,274 1,196

Fee and other income, net ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 275 125 86

Total other incomeÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 1,504 1,399 1,282

Other expenses:

Provision for losses ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (50) 100 195

Foreclosed property ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 311 275 214

AdministrativeÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 708 636 560

Total other expenses ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 969 1,011 969

Income before federal income taxes and extraordinary item ÏÏÏÏÏÏÏ 4,645 4,337 3,905

Provision for federal income taxes ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 1,201 1,269 1,151

Income before extraordinary itemÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 3,444 3,068 2,754

Extraordinary itemÌloss on early extinguishment of debt (net of

tax eÅect of $14 million in 1998, $7 million in 1997, and

$16 million in 1996) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 26 12 29

Net incomeÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 3,418 $ 3,056 $ 2,725

Preferred stock dividends ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 66 65 42

Net income available to common stockholders ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 3,352 $ 2,991 $ 2,683

Basic earnings per common share (1):

Earnings before extraordinary item ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 3.28 $ 2.87 $ 2.53

Extraordinary itemÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (.02) (.02) (.03)

Net earningsÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 3.26 $ 2.85 $ 2.50

Diluted earnings per common share (1):

Earnings before extraordinary item ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 3.26 $ 2.84 $ 2.51

Extraordinary itemÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (.03) (.01) (.03)

Net earningsÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 3.23 $ 2.83 $ 2.48

Cash dividends ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ .96 $ .84 $ .76

Weighted-average shares outstanding:

Basic ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 1,029 1,049 1,071

DilutedÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 1,037 1,056 1,080

(1) Earnings per share amounts in 1996 have been restated to comply with Financial Accounting

Standard No. 128, Earnings per Share.

See Notes to Financial Statements

B-46
FANNIE MAE

BALANCE SHEETS

Assets

December 31,

1998 1997

(Dollars in millions)

Mortgage portfolio, net ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $415,223 $316,316

Investments:

Held-to-maturity ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 42,299 58,690

Available-for-sale ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 16,216 5,906

Cash and cash equivalents ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 743 2,205

Accrued interest receivable ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 3,453 2,864

Acquired property and foreclosure claims, net ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 827 919

Other ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 6,253 4,773

Total assetsÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $485,014 $391,673

Liabilities and Stockholders' Equity

Liabilities:

Debentures, notes and bonds, net:

Due within one year ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $205,413 $175,400

Due after one yearÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 254,878 194,374

TotalÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 460,291 369,774

Accrued interest payable ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 5,262 4,611

Other ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 4,008 3,495

Total liabilities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 469,561 377,880

Stockholders' Equity:

Preferred stock, $50 stated value, 100 million shares authorizedÌ

23 million shares outstanding in 1998 and 20 million shares

outstanding in 1997 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 1,150 1,000

Common stock, $.525 stated value, no maximum authorizationÌ

1,129 million shares outstanding ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 593 593

Additional paid-in capital ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 1,533 1,495

Retained earnings ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 15,689 13,326

Accumulated other comprehensive income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (13) (1)

18,952 16,413

Less: Treasury stock, at cost, 104 million shares in 1998 and

92 million shares in 1997 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 3,499 2,620

Total stockholders' equity ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 15,453 13,793

Total liabilities and stockholders' equity ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $485,014 $391,673

See Notes to Financial Statements.

B-47
FANNIE MAE

STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY

Number of Accumulated

Common Additional Other Total

Shares Preferred Common Paid-In Retained Comprehensive Treasury Stockholders'

Outstanding Stock Stock Capital Earnings Income Stock Equity

(Dollars and shares in millions)

Balance, January 1, 1996ÏÏÏÏ 1,092 $ Ì $593 $1,389 $ 9,348 $ Ì $ (371) $10,959

Comprehensive Income:

Net income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Ì Ì Ì Ì 2,725 Ì Ì 2,725

Other comprehensive

income:

Unrealized losses on

available-for-sale

securities, net of tax

eÅect ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Ì Ì Ì Ì Ì (1) Ì (1)

Total comprehensive

income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2,724

Dividends ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Ì Ì Ì Ì (858) Ì Ì (858)

Shares repurchasedÏÏÏÏÏÏÏÏÏÏ (48) Ì Ì Ì Ì Ì (1,536) (1,536)

Preferred stock issued ÏÏÏÏÏÏÏ Ì 1,000 Ì (20) Ì Ì Ì 980

Contribution to Foundation ÏÏ 11 Ì Ì 12 Ì Ì 338 350

Treasury stock issued for

stock options and beneÑt

plansÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 6 Ì Ì 70 Ì Ì 84 154

Balance, December 31, 1996 1,061 1,000 593 1,451 11,215 (1) (1,485) 12,773

Comprehensive Income:

Net income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Ì Ì Ì Ì 3,056 Ì Ì 3,056

Other comprehensive

income:

Unrealized losses on

available-for-sale

securities, net of tax

eÅect ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Ì Ì Ì Ì Ì Ì Ì Ì

Total comprehensive

income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 3,056

Dividends ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Ì Ì Ì Ì (945) Ì Ì (945)

Shares repurchasedÏÏÏÏÏÏÏÏÏÏ (31) Ì Ì Ì Ì Ì (1,291) (1,291)

Treasury stock issued for

stock options and beneÑt

plansÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 7 Ì Ì 44 Ì Ì 156 200

Balance, December 31, 1997 1,037 1,000 593 1,495 13,326 (1) (2,620) 13,793

Comprehensive Income:

Net income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Ì Ì Ì Ì 3,418 Ì Ì 3,418

Other comprehensive

income:

Unrealized losses on

available-for-sale

securities, net of tax

eÅect ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Ì Ì Ì Ì Ì (12) Ì (12)

Total comprehensive

income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 3,406

Dividends ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Ì Ì Ì Ì (1,055) Ì Ì (1,055)

Shares repurchasedÏÏÏÏÏÏÏÏÏÏ (17) Ì Ì Ì Ì Ì (1,051) (1,051)

Preferred stock issued ÏÏÏÏÏÏÏ Ì 150 Ì Ì Ì Ì Ì 150

Treasury stock issued for

stock options and beneÑt

plansÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 5 Ì Ì 38 Ì Ì 172 210

Balance, December 31, 1998 1,025 $1,150 $593 $1,533 $15,689 $(13) $(3,499) $15,453

See Notes to Financial Statements

B-48
FANNIE MAE

STATEMENTS OF CASH FLOWS

Year Ended December 31,

1998 1997 1996

(Dollars in millions)

Cash Öows from operating activities:

Net income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 3,418 $ 3,056 $ 2,725

Adjustments to reconcile net income to net cash provided by

operating activities:

Discount amortization on short-term debt ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 5,828 5,012 4,338

Provision for losses ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (50) 100 195

Loss on early extinguishment of debt ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 40 19 45

Other decreases, netÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (1,540) (1,691) (830)

Net cash provided by operating activitiesÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 7,696 6,496 6,473

Cash Öows from investing activities:

Purchases of mortgagesÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (189,721) (70,768) (68,471)

Proceeds from sales of mortgagesÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 1,824 1,082 102

Mortgage principal repaymentsÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 86,918 37,714 32,853

Net proceeds from disposition of foreclosed propertiesÏÏÏÏÏ 2,890 3,085 2,448

Net decrease (increase) in investments ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 6,081 (7,990) 667

Net cash used in investing activities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (92,008) (36,877) (32,401)

Cash Öows from Ñnancing activities:

Proceeds from issuance of long-term debt ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 149,034 86,079 79,189

Payments to redeem long-term debt ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (95,920) (63,716) (46,966)

Proceeds from issuance of short-term debt ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 682,524 737,054 606,427

Payments to redeem short-term debt ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (650,961) (725,584) (610,876)

Net payments from stock activities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (1,827) (2,097) (1,314)

Net cash provided by Ñnancing activities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 82,850 31,736 26,460

Net (decrease) increase in cash and cash equivalentsÏÏÏÏÏÏÏÏ (1,462) 1,355 532

Cash and cash equivalents at beginning of year ÏÏÏÏÏÏÏÏÏÏÏÏÏ 2,205 850 318

Cash and cash equivalents at end of yearÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 743 $ 2,205 $ 850

Supplemental disclosures of cash Öow information:

Cash paid during the year for:

Interest ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 24,415 $ 21,622 $ 19,526

Income taxes ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 555 1,240 1,053

See Notes to Financial Statements

B-49
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.

The accounting and reporting policies of Fannie Mae conform with generally accepted accounting

principles. Certain amounts in prior years' Ñnancial statements have been reclassiÑed to conform with

the current presentation.

The preparation of Ñnancial statements in conformity with generally accepted accounting

principles requires management to make estimates and assumptions that aÅect the reported amounts

of assets and liabilities and 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.

Mortgage Portfolio

Mortgages and mortgage-backed securities that Fannie Mae has the ability and positive intent to

hold to maturity are classiÑed as held-to-maturity and are carried at their unpaid principal balances

(""UPB'') adjusted for unamortized purchase discount or premium and deferred price adjustments.

Mortgage loans held for sale are carried at the lower of cost or fair value, with any unrealized losses

included in current period earnings. Mortgage-backed securities that Fannie Mae intends to hold for

an undetermined period, but not necessarily to maturity, are classiÑed as available-for-sale and are

carried at fair value, with any valuation adjustments reported as a component of other comprehensive

income, net of deferred taxes, in stockholders' equity.

Fannie Mae uses actual principal prepayment experience and estimates of future principal

prepayments in calculating the constant eÅective yield necessary to apply the interest method in the

amortization of deferred price adjustments and purchase discount or premium. In evaluating prepayments, loans are aggregated by similar characteristics (e.g., loan type, acquisition date, and maturity).

Factors used in determining estimates of future prepayments include historical prepayment data and

expected prepayment performance under varying interest rate scenarios.

Interest income is not accrued on nonperforming loans. Conventional single-family and multifamily loans are classiÑed as nonperforming and previously accrued interest is removed from income when

the collection of interest payments is deemed less than probable.

Investments

Nonmortgage investments are classiÑed as either available-for-sale or held-to-maturity. Investments that are classiÑed as available-for-sale are carried at fair value as of the balance sheet date, with

any valuation adjustments reported as a component of other comprehensive income, net of deferred

taxes, in stockholders' equity. Investments that are classiÑed as held-to-maturity are carried at

historical cost, adjusted for unamortized discount or premium. Interest income is recognized on an

accrual basis unless the collection of interest income is considered doubtful, in which case interest

income is recognized on a cash basis.

Guaranteed Mortgage-Backed Securities

Fannie Mae guarantees the timely payment of principal and interest on most Fannie Mae

Mortgage-Backed Securities (""MBS''). These securities represent beneÑcial interests in pools of

mortgages or other mortgage-backed securities held in trust by Fannie Mae. The pools of mortgages or

B-50
FANNIE MAE

NOTES TO FINANCIAL STATEMENTSÌ(Continued)

mortgage-backed securities are not assets of Fannie Mae, except when acquired for investment

purposes, nor are the related outstanding securities liabilities; accordingly, neither are reÖected on the

accompanying balance sheets. Fannie Mae receives monthly guaranty fees for each MBS mortgage

pool based on a percentage of the pool's outstanding balance. Adjustments to the guaranty fee rate

eÅected through an upfront payment at securitization are deferred and amortized into guaranty fee

income over the estimated life of the underlying loans using the interest method. For MBS pools held

in Fannie Mae's portfolio, the guaranty fee is reÖected as interest income.

Allowance for Losses

The allowance for losses is based on an analysis of portfolio loans and MBS outstanding and

provides for known probable losses and losses inherent in the mortgage portfolio and MBS.

Management's analysis considers current delinquency levels, historical loss experience, current

economic conditions, geographic conditions and concentrations, and other pertinent factors. The

allowance for losses is established by recording an expense for the provision for losses. It is

subsequently reduced through charge-oÅs on foreclosed properties and is increased through recoveries

on foreclosed properties. In management's judgement, the allowance for losses is adequate to provide

for expected losses.

Acquired Property

Foreclosed assets are carried at the lower of cost or fair value less estimated costs to sell. Cost is

deÑned as fair value at foreclosure and represents the amount that a willing seller could reasonably

expect from a willing buyer in an arm's-length transaction. The diÅerence between estimated fair

value of the collateral at foreclosure and the carrying amount of the underlying loan is recorded as a

charge-oÅ against the allowance for losses. Foreclosure, holding, and disposition costs are charged

directly to earnings.

Hedging Instruments

Fannie Mae utilizes certain Ñnancial instruments, such as interest rate swaps, swaptions,

derivative instruments that simulate the short sale of Treasury securities, interest rate caps, deferred

rate-setting agreements, and foreign currency swaps to achieve a speciÑc Ñnancing or investment

objective at a desired cost or yield. Fannie Mae does not engage in trading or other speculative use of

these Ñnancial instruments. SpeciÑc criteria must be met for Ñnancial instruments to qualify as a

hedge on either an accrual or a deferred basis. Financial instruments not qualifying as hedges are

marked to market through earnings. Financial instruments used to hedge the anticipated issuance of

debt must maintain a high correlation between the hedging instrument and the item being hedged,

both at inception and throughout the hedge period.

Interest rate swaps are contractual agreements between two parties for the exchange of periodic

payments, generally based on a notional principal amount and agreed-upon Ñxed and variable rates.

Fannie Mae has long-term interest rate swap agreements with various parties to extend the eÅective

maturity of certain short-term debt obligations and to adjust the eÅective maturity of certain longterm debt obligations. Fannie Mae also has interest rate swap agreements that are linked to speciÑc

debt issues (""debt swaps'') or speciÑc investments (""asset swaps''). These swaps achieve a speciÑc

Ñnancing or investment objective at a desired cost or yield. The costs and terms of the speciÑc debt

issues and yield of these speciÑc investments, as presented in the Ñnancial statements, include the

eÅects of these swaps. Interest rate swaps are accounted for on an accrual basis with the net payable or

receivable recognized as an adjustment to interest income or expense on the related assets or

liabilities. Gains or losses on terminated interest rate swaps are deferred and amortized over the

B-51
FANNIE MAE

NOTES TO FINANCIAL STATEMENTSÌ(Continued)

shorter of the remaining life of the hedged items or the term of the original swap. The fair value of the

interest rate swap agreements and changes in these fair values as a result of changes in market interest

rates are not recognized in the Ñnancial statements.

Swaptions are derivative instruments that provide Fannie Mae with the option to enter into an

interest rate swap at a future date, thereby mirroring the economic eÅect of callable debt. Swaptions

are used to hedge planned debt issuances or existing debt instruments. The fair value of the swaptions

and changes in these fair values as a result of changes in market interest rates are not recognized in the

Ñnancial statements.

Derivative instruments that simulate short sales of Treasury securities are used to hedge interest

rate risk on planned debt issuances. Gains and losses that result from the hedge positions are deferred

and recognized as adjustments to debt cost over the life of the hedged debt issuance.

An interest rate cap agreement is entered into with a counterparty to eÅectively cap Fannie Mae's

exposure on a variable-rate debt instrument in a rising interest rate environment. In exchange for the

premium paid for the cap, the counterparty agrees to pay Fannie Mae an amount equal to any interest

on the debt in excess of the agreed-upon rate. Interest rate caps are used to hedge planned debt

issuances. The fair value of the interest rate caps and changes in these fair values as a result of changes

in market interest rates are not recognized in the Ñnancial statements.

Fannie Mae enters into deferred rate-setting agreements when Ñxed-rate debt is issued prior to

the commitment for mortgages that the debt will support. Under these agreements, Fannie Mae is able

to set the eÅective interest rate on the debt based on prevailing market conditions at one or more

future dates. At settlement of all or a portion of a deferred rate-setting agreement, Fannie Mae pays or

receives cash in an amount representing the present value of the interest rate diÅerential between the

Ñxed-rate debt and the prevailing rate. Gains and losses that result from the hedge position are

deferred and recognized as adjustments to debt cost over the life of the debt issuance.

Fannie Mae issues debt securities in which principal, interest, or both are payable in a foreign

currency or are determined by reference to an index that includes one or more foreign currencies.

Concurrently, Fannie Mae enters into currency swaps that convert the proceeds of certain borrowings

into dollars or provide for scheduled exchanges of the currencies to insulate Fannie Mae against

foreign currency exchange risk. Foreign currency swaps are accounted for on an accrual basis with the

net diÅerential received or paid under such swaps recognized as an adjustment to interest income or

expense on the related asset or liability. Foreign currency borrowings and the related net receivables

and payables from currency swaps are translated at the market rates of exchange as of the balance

sheet date.

Cash and Cash Equivalents

Fannie Mae considers highly liquid investment instruments, generally with an original maturity of

three months or less, to be cash equivalents. Cash equivalents are carried at cost, which approximates

fair value.

Income Taxes

Deferred federal income tax assets and liabilities are established for temporary diÅerences

between Ñnancial and taxable income and are measured using the current marginal statutory tax rate.

Investment and other tax credits are generally recognized when recorded on the tax return.

B-52
FANNIE MAE

NOTES TO FINANCIAL STATEMENTSÌ(Continued)

Comprehensive Income

In 1998, Financial Accounting Standard No. 130 (""FAS 130''), Reporting Comprehensive

Income, became eÅective. FAS 130 requires reporting of comprehensive income by its components and

in total in the Ñnancial statements.

Comprehensive income is deÑned as the change in equity of a business enterprise during a period

from transactions and other events and circumstances from nonowner sources. It includes all changes

in equity during a period except those resulting from investments by owners and distributions to

owners.

Fannie Mae adopted the requirements of FAS 130 on January 1, 1998. Presentation of prior year

amounts have been restated to conform with the requirements of FAS 130.

2. Mortgage Portfolio, Net

The mortgage portfolio consisted of the following at December 31, 1998 and 1997.

1998 1997

(Dollars in millions)

Single-family mortgages:

Government insured or guaranteed ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 21,805 $ 19,478

Conventional:

Long-term, Ñxed-rate ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 297,106 211,541

Intermediate-term, Ñxed-rate(1) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 71,560 61,571

Adjustable-rate ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 11,873 11,373

Second ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 206 268

402,550 304,231

Multifamily mortgages:

Government insured ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 3,607 3,360

Conventional ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 8,358 9,087

11,965 12,447

Total unpaid principal balance ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 414,515 316,678

Less:

Unamortized (premium) discount and deferred price adjustments, net ÏÏ (919) 86

Allowance for losses ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 211 276

Net mortgage portfolio ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $415,223 $316,316

(1) Intermediate-term consists of portfolio loans with contractual maturities at purchase equal

to or less than 20 years and MBS held in portfolio with maturities of 15 years or less at issue

date.

Included in the mortgage portfolio are $260 billion and $157 billion of MBS and other mortgagerelated securities at December 31, 1998 and 1997, respectively, with fair values of $264 billion and

$163 billion, respectively. MBS held in portfolio at December 31, 1998 and 1997 included $77 billion

B-53
FANNIE MAE

NOTES TO FINANCIAL STATEMENTSÌ(Continued)

and $35 billion, respectively, of Real Estate Mortgage Investment Conduits (""REMICs'') and

Stripped MBS (""SMBS''). REMICs and SMBS backed by MBS do not subject Fannie Mae to added

credit risk but generally have diÅerent interest rate risks than MBS. At December 31, 1998, these

securities had aggregate gross unrealized losses of $444 million and gross unrealized gains of

$1,122 million. At December 31, 1997, the aggregate gross unrealized losses and gains were $175

million and $796 million, respectively.

Mortgage assets available for sale were $8.9 billion with unrealized gains of $17 million at

December 31, 1998 and $.6 billion with unrealized gains of $1 million at December 31, 1997.

The UPB of multifamily impaired loans at December 31, 1998 was $250 million, of which

$120 million had a speciÑc loss allowance, compared with $351 million and $161 million, respectively,

at December 31, 1997. The average balance of impaired loans during 1998 and 1997 was $310 million

and $438 million, respectively.

Nonperforming loans outstanding totaled $3.2 billion at the end of 1998, compared with

$2.6 billion at the end of 1997. If these nonperforming loans had been fully performing, they would

have contributed an additional $68 million to net interest income in 1998 and $138 million in 1997.

3. Allowance for Losses

Changes in the allowance for the years 1996 through 1998 are summarized below.

Total

(Dollars in millions)

Balance, January 1, 1996 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 795

Provision ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 195

Net foreclosure losses charged oÅÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (210)

Balance, December 31, 1996 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 780

Provision ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 100

Net foreclosure losses charged oÅÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (77)

Balance, December 31, 1997 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 803

Provision ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (50)

Net recoveries ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 49

Balance, December 31, 1998 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 802

At December 31, 1998, $211 million of the allowance for losses is included in the balance sheet

under ""Mortgage portfolio, net,'' which represents the allocation for portfolio loan losses; $588 million

is included in liabilities under ""Other'' for estimated losses on MBS; and the remainder, or $3 million,

which relates to unrecoverable losses on Federal Housing Administration loans, is included in

""Acquired property and foreclosure claims, net.'' The corresponding amounts at December 31, 1997

were $276 million, $523 million, and $4 million, respectively. Included in the allowance for losses at

December 31, 1998, are $10 million of speciÑc allowances for impaired loans, compared with

$21 million at the end of 1997. During 1998, Fannie Mae established $3 million of speciÑc allowances

for these loans, compared with $29 million in 1997.

B-54
FANNIE MAE

NOTES TO FINANCIAL STATEMENTSÌ(Continued)

4. Investments

Presented below are the amortized cost and fair value of nonmortgage investments classiÑed as

held-to-maturity at December 31, 1998 and 1997.

1998 1997

Gross Gross Gross Gross

Amortized Unrealized Unrealized Fair Amortized Unrealized Unrealized Fair

CostGains Losses Value CostGains Losses Value

(Dollars in millions)

Held-to-maturity

investments:

Asset-backed securities ÏÏÏ $12,188 $15 $ Ì $12,203 $13,034 $ 1 $ Ì $13,035

Eurodollar time deposits 5,179 Ì Ì 5,179 12,828 1 Ì 12,829

Commercial paper ÏÏÏÏÏÏÏ 5,155 5 Ì 5,160 11,745 4 Ì 11,749

Repurchase agreements ÏÏ 7,556 Ì Ì 7,556 6,715 Ì Ì 6,715

Federal funds ÏÏÏÏÏÏÏÏÏÏÏ 2,747 Ì Ì 2,747 6,384 Ì Ì 6,384

Auction rate preferred

stock ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 933 Ì Ì 933 1,641 Ì Ì 1,641

Other ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 8,541 22 Ì 8,563 6,343 6 Ì 6,349

Total ÏÏÏÏÏÏÏÏÏÏÏ $42,299 $42 $ Ì $42,341 $58,690 $12 $ Ì $58,702

Presented below are the amortized cost and fair value of nonmortgage investments classiÑed as

available-for-sale at December 31, 1998 and 1997.

1998 1997

Gross Gross Gross Gross

Amortized Unrealized Unrealized Fair Amortized Unrealized Unrealized Fair

CostGains Losses Value CostGains Losses Value

(Dollars in millions)

Available-for-sale

securities:

Asset-backed securities ÏÏ $ 8,831 $Ì $26 $ 8,805 $3,607 $Ì $ 2 $3,605

OtherÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 7,415 Ì 4 7,411 2,301 Ì Ì 2,301

Total ÏÏÏÏÏÏÏÏÏÏÏÏ $16,246 $Ì $30 $16,216 $5,908 $Ì $ 2 $5,906

B-55
FANNIE MAE

NOTES TO FINANCIAL STATEMENTSÌ(Continued)

The following table shows the amortized cost, fair value, and yield of nonmortgage investments at

December 31, 1998 and 1997, by remaining maturity.

1998 1997

Amortized Fair Amortized Fair

CostValue Yield CostValue Yield

(Dollars in millions)

Due within one year ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $28,268 $28,280 5.81% $44,562 $44,567 5.93%

Due after one year through Ñve years ÏÏÏÏ 9,258 9,269 5.66 3,395 3,401 6.13

37,526 37,549 5.77 47,957 47,968 5.95

Asset-backed securities(1)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 21,019 21,008 5.76 16,641 16,640 6.16

Total ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $58,545 $58,557 5.77% $64,598 $64,608 6.00%

(1) Contractual maturity of asset-backed securities is not a reliable indicator of their expected

life because borrowers have the right to repay their obligations at any time.

5. Debentures, Notes, and Bonds, Net

Borrowings Due Within One Year

Borrowings due within one year at December 31, 1998 and 1997 are summarized below. Amounts

are net of unamortized discount and premium.

1998 1997

Outstanding Average Outstanding Average Maximum Maximum at Outstanding at Outstanding Outstanding Outstanding December 31, During Year December 31, During Year at Any at Any

Amount Cost(1) Amount Cost(1) Month-End Amount Cost(1) Amount Cost(1) Month-End

(Dollars in millions)

Short-term notes ÏÏÏ $136,400 5.18% $107,344 5.47% $136,400 $104,964 5.69% $91,535 5.57% $104,964

Other short-term

debt ÏÏÏÏÏÏÏÏÏÏÏÏÏ 38,192 5.25 39,625 5.49 43,601 32,226 5.74 36,874 5.59 41,044

Current portion of

borrowings due

after one year(2):

DebenturesÏÏÏÏÏÏÏ 5,394 8.42 14,300 6.40

Global debt ÏÏÏÏÏÏ 2,986 5.30 Ì Ì

Medium-term

notes ÏÏÏÏÏÏÏÏÏÏ 22,171 5.67 23,629 5.68

OtherÏÏÏÏÏÏÏÏÏÏÏÏ 270 6.09 281 6.50

Total due within

one year ÏÏÏÏÏ $205,413 5.33% $175,400 5.76%

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

issuance costs, hedging results, and the eÅects of currency swaps, debt swaps, swaptions and

interest rate caps.

(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.

B-56
FANNIE MAE

NOTES TO FINANCIAL STATEMENTSÌ(Continued)

Borrowings Due After One Year

Borrowings due after one year consisted of the following at December 31, 1998 and 1997.

1998 1997

Maturity Amount Average Amount Average

Date Outstanding Cost(1) Outstanding Cost(1)

(Dollars in millions)

Medium-term notes, net of $380 of

discount for 1998 ($299 for 1997) ÏÏ 1999-2028 $165,993 6.21% $135,453 6.48%

Benchmark notes, net of $113 of

discount for 1998ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2001-2008 42,137 5.63 Ì Ì

Other global debt, net of $495 of

discount for 1998 ($28 for 1997) ÏÏ 1999-2038 22,586 6.32 21,752 6.47

Debentures, net of $54 of discount for

1998 ($99 for 1997) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 1999-2022 20,516 7.40 35,170 7.36

Zero coupon securities and

subordinated capital debentures,

net of $13,687 of discount for 1998

($12,612 for 1997) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 1999-2019 4,037 7.89 2,671 8.96

Long-term other, net of $43 of

discount for 1998 ($47 for 1997) ÏÏ 1999-2018 188 9.99 193 9.99

255,457 6.25% 195,239 6.67%

Adjustment for foreign currency

translation ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (579) (865)

Total due after one year ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $254,878 $194,374

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

issuance costs, hedging results, and the eÅects of currency and debt swaps.

Debentures, notes, and bonds at December 31, 1998, included $135 billion of callable debt, which

generally is redeemable in whole or in part (and, in certain cases, at a speciÑed premium) at the

option of Fannie Mae any time on or after a speciÑed date. At December 31, 1998, debentures, notes,

and bonds did not include any debt instruments that are subject to mandatory redemptions tied to

certain indices or rates after an initial nonredemption period.

B-57
FANNIE MAE

NOTES TO FINANCIAL STATEMENTSÌ(Continued)

The following table summarizes the amounts and call periods of callable debt, the notional

amount of callable swaps, and other option-embedded Ñnancial instruments, excluding $9 billion of

callable debt that was swapped to variable-rate debt. Medium-term notes and subordinated capital

debentures that are redeemable at the Corporation's option are also included in the table.

Year of AmountAverage

Call Date Maturity Outstanding Cost

(Dollars in millions)

Callable Debt and Callable Swaps:

Currently callable ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 1999-2008 $ 563 5.46%

1999 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2000-2024 66,618 6.47

2000 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2001-2026 37,056 6.25

2001 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2003-2026 30,740 5.64

2002 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2005-2027 5,900 6.88

2003 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2006-2028 9,100 5.59

2004 and later ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2007-2012 826 6.88

150,803 6.21%

Other option-embedded Ñnancial instruments 23,220

Total option-embedded Ñnancial

instrumentsÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $174,023

Principal amounts at December 31, 1998 of total debt payable in the years 2000-2004, assuming

callable debt is paid at maturity and assuming callable debt is redeemed at the initial call date, were as

follows:

Assuming

Total Debt by Callable Debt

Year of Redeemed at Initial

Maturity(1) Call Date(1)

(Dollars in millions)

2000ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $38,540 $64,634

2001ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 31,770 34,333

2002ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 24,754 20,177

2003ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 53,206 26,362

2004ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 9,487 3,504

(1) Excludes $9 billion of callable debt that was swapped to variable-rate debt.

In 1998 and 1997, Fannie Mae repurchased or called $77 billion of debt and swaps with an average

cost of 6.71 percent and $31 billion with an average cost of 7.22 percent, respectively. Fannie Mae

recorded extraordinary losses of $40 million ($26 million after tax) in 1998 and $19 million

($12 million after tax) in 1997 on the early extinguishment of debt.

Pursuant to Fannie Mae's Charter Act, approval of the Secretary of the Treasury is required for

Fannie Mae's issuance of its debt obligations.

B-58
FANNIE MAE

NOTES TO FINANCIAL STATEMENTSÌ(Continued)

6. Income Taxes

Components of the provision for federal income taxes for the years ended December 31, 1998,

1997, and 1996, were as follows:

1998 1997 1996

(Dollars in millions)

CurrentÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 692 $1,247 $1,109

Deferred ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 509 22 42

1,201 1,269 1,151

Tax beneÑt of extraordinary loss ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (14) (7) (16)

Net federal income tax provision ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $1,187 $1,262 $1,135

The tax eÅects of temporary diÅerences that gave rise to signiÑcant portions of the deferred tax

assets and deferred tax liabilities at December 31, 1998 and 1997, consisted of the following:

1998 1997

(Dollars in millions)

Deferred tax assets:

MBS guaranty and REMIC feesÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $501 $404

Provision for losses ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 331 339

Other items, net ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 76 55

Deferred tax assetsÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 908 798

Deferred tax liabilities:

Purchase discount and deferred fees ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 420 Ì

Debt-related expenses ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 266 14

BeneÑts from tax-advantaged investmentsÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 93 171

Other items, net ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 16 9

Deferred tax liabilities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 795 194

Net deferred tax assets ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $113 $604

Management anticipates that 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.

Fannie Mae's eÅective tax rates diÅered from statutory federal rates for the years ended

December 31, 1998, 1997, and 1996, as follows:

1998 1997 1996

Statutory corporate rate ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 35% 35% 35%

Tax-exempt interest and dividends received deductions ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (4) (4) (4)

Equity investments in aÅordable housing projects ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (5) (2) (2)

EÅective rate ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 26% 29% 29%

Fannie Mae is exempt from state and local taxes, except for real estate taxes.

B-59
FANNIE MAE

NOTES TO FINANCIAL STATEMENTSÌ(Continued)

7. Earnings per Common Share

The following table sets forth the computation of basic and diluted earnings per common share:

1998 1997 1996

Basic Diluted Basic Diluted Basic Diluted

(Dollars and shares in millions,

except per common share amounts)

Net income before extraordinary loss ÏÏ $3,444 $3,444 $3,068 $3,068 $2,754 $2,754

Less: Extraordinary lossÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (26) (26) (12) (12) (29) (29)

Preferred stock dividend ÏÏÏÏÏÏÏÏÏÏÏÏÏ (66) (66) (65) (65) (42) (42)

Net income available to common

stockholders ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $3,352 $3,352 $2,991 $2,991 $2,683 $2,683

Weighted average common shares ÏÏÏÏÏ 1,029 1,029 1,049 1,049 1,071 1,071

Dilutive potential common shares(1) ÏÏ Ì 8 Ì 7 Ì 9

Average number of common shares

outstanding used to calculate

earnings per common shareÏÏÏÏÏÏÏÏÏ 1,029 1,037 1,049 1,056 1,071 1,080

Earnings before extraordinary itemÏÏÏÏ $ 3.28 $ 3.26 $ 2.87 $ 2.84 $ 2.53 $ 2.51

Net earnings ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 3.26 3.23 2.85 2.83 2.50 2.48

(1) Dilutive potential common shares consist primarily of the dilutive eÅect from employee stock

options and other stock compensation plans.

For additional disclosures regarding Fannie Mae's stock compensation plans and the outstanding

preferred stock, see Notes 8 and 12, respectively.

8. Stock Compensation Plans

At December 31, 1998, Fannie Mae had Ñve stock-based compensation plans, which are described

below. Financial Accounting Standard No. 123 (""FAS 123''), Accounting for Stock-Based Compensation, gives companies the option of either recording an expense for all stock compensation awards

based on fair value at grant date or continuing to follow Accounting Principles Board Opinion No. 25

(""APB Opinion 25'') with the additional requirement that they disclose, in a footnote, pro forma net

income and earnings per common share as if they had adopted the expense recognition provisions of

FAS 123. Fannie Mae elected to apply APB Opinion 25 and related interpretations in accounting for

its plans. As a result, no compensation expense has been recognized for the nonqualiÑed stock options

and Employee Stock Purchase Plan. Had compensation expense been recognized for beneÑts under all

Ñve plans, based on their fair value at grant date and consistent with FAS 123, Fannie Mae's net

income and earnings per common share would have been $3.312 billion and $3.19, $3.025 billion and

$2.80, and $2.701 billion and $2.46 for the years ended December 31, 1998, 1997, and 1996,

respectively.

B-60
FANNIE MAE

NOTES TO FINANCIAL STATEMENTSÌ(Continued)

The fair value of beneÑts under Fannie Mae's stock-based plans was determined using a BlackScholes pricing model. The following table summarizes the major assumptions used in the model.

1998 1997 1996

Risk free rate (1) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 4.04 - 5.79% 5.53 - 6.80% 6.45 - 7.74%

Volatility ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 25-30 23 - 25 21 - 22

Forfeiture ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 15 15 15

Dividend(2) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $.96 $.84 $.76

ExpirationÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 1 - 10 yrs. 1 - 10 yrs. 1 - 10 yrs.

(1) The closing yield on the comparable average life U.S. Treasury on the day prior to grant.

(2) Dividend rate on common stock at date of grant. Dividend rate assumed to remain constant

over the option life.

Employee Stock Purchase Plan

Fannie Mae has an Employee Stock Purchase Plan that allows issuance of up to 36 million shares

of common stock to qualiÑed employees at a price equal to 85 percent of the fair market value on the

grant date. In 1998, Fannie Mae granted each qualiÑed employee, excluding certain oÇcers and other

highly compensated employees, the right to purchase in January 1999 up to 393 shares of common

stock. Under the 1998 oÅering, 1,336,278 common shares were purchased at $54.03 per share,

compared with 1,883,197 common shares purchased at $33.73 per share under the 1997 oÅering. The

Board of Directors has approved a 1999 oÅering under the plan, granting each qualiÑed employee the

right to purchase 348 common shares at $60.99 per share.

Employee Stock Ownership Plan

Fannie Mae has an Employee Stock Ownership Plan (""ESOP'') for qualiÑed employees. Fannie

Mae may contribute to the ESOP an amount based on deÑned earnings goals, not to exceed 4 percent

of the aggregate base salary for all participants. The contribution is made in the subsequent year either

in shares of Fannie Mae common stock or in cash that is used to purchase such stock.

Performance Shares

Fannie Mae's Stock Compensation Plans authorize eligible employees to receive performance

awards, generally issued with an award period that can range from three to Ñve years. The

performance awards become actual awards only if Fannie Mae attains the goals set for the award

period. At the end of such time, the awards generally are payable in common stock, in three

installments over a two-year period. The outstanding contingent grants made for the 1999-2001, 1998-

2000, and 1997-1999 periods were 323,640 common shares, 366,712 common shares, and 273,215

common shares, respectively.

NonqualiÑed Stock Options

Stock options may be granted to eligible employees and nonmanagement members of the Board of

Directors. The options generally do not become exercisable until at least one year after the grant date

and generally expire ten years from the grant date. The purchase price of the common stock covered

by each option is equal to the fair value of the stock on the date the option is granted.

B-61
FANNIE MAE

NOTES TO FINANCIAL STATEMENTSÌ(Continued)

The following table summarizes stock option activity for the years 1996 through 1998:

1998 1997 1996

Weighted-average Weighted-average Weighted-average

Options Exercise Price Options Exercise Price Options Exercise Price

(options in thousands)

Balance, January 1 ÏÏÏÏÏÏÏÏÏÏÏ 22,777 $27.15 23,910 $22.24 24,249 $18.90

Granted ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 3,381 67.63 3,373 50.16 3,418 38.67

ExercisedÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (3,712) 19.15 (4,065) 17.46 (3,014) 14.31

Forfeited ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (452) 35.60 (441) 26.16 (743) 21.01

Balance, December 31 ÏÏÏÏÏÏÏÏ 21,994 $34.55 22,777 $27.15 23,910 $22.24

Options vested, December 31ÏÏ 13,729 $23.89 13,275 $20.30 11,767 $17.65

The following table summarizes information about stock options outstanding at December 31,

1998:

Options Outstanding Options Exercisable

Weighted-average Number

Range of Number Remaining Weighted-average of Options Weighted-average

Exercise Prices of Options Contractual Life Exercise Price Exercisable Exercise Price

(options in thousands)

$ 8.00 - $23.97 ÏÏ 8,853 5.0 yrs. $17.94 8,829 $17.94

26.69 - 42.69ÏÏÏ 6,958 7.4 32.79 4,153 31.47

43.00 - 58.69ÏÏÏ 2,829 8.9 51.59 703 51.49

60.31 - 75.16ÏÏÏ 3,354 9.8 67.67 44 61.18

Total ÏÏÏÏÏÏÏ 21,994 7.0 yrs. $34.55 13,729 $23.89

Restricted Stock

In 1998, 98,280 shares of restricted stock were awarded, issued, and placed in escrow under the

Stock Compensation Plans and Restricted Stock Plan for Directors (66,240 shares in 1997); 100,600

shares were released as vesting of participants occurred (138,968 shares in 1997).

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 the Corporation's Retirement Savings Plan, which includes a 401(k) option.

In 1998, employees could contribute up to the lesser of 15 percent of their base salary or the current

annual dollar cap established and revised annually by the Internal Revenue Service (""IRS''), with the

Corporation matching such contributions up to 3 percent of base salary.

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. Fannie Mae's policy is to contribute an amount no less than the minimum required

employer contribution under the Employee Retirement Income Security Act of 1974. Contributions to

B-62
FANNIE MAE

NOTES TO FINANCIAL STATEMENTSÌ(Continued)

the corporate plan reÖect beneÑts attributed to employees' service to date and compensation expected

to be paid in the future. A $7 million contribution was made to the corporate plan in 1998. Corporate

plan assets consist primarily of listed stocks, Ñxed-income securities, and other liquid assets.

At December 31, 1998 and 1997, the projected beneÑt obligations for services rendered were

$229 million and $185 million, respectively, while the plan assets were $238 million and $190 million,

respectively. The pension liability at December 31, 1998 and 1997 was $38 million and $36 million,

respectively, while net periodic pension costs were $9 million and $8 million, respectively.

At December 31, 1998 and 1997, the weighted-average discount rates used in determining the

actuarial present value of the projected beneÑt obligation were 6.75 percent and 7.25 percent,

respectively; the average rates of increase in future compensation levels used in the calculation were

5.75 percent for both 1998 and 1997; and the expected long-term rates of return on assets were

9.00 percent and 9.25 percent, respectively. Fannie Mae uses the straight-line method of amortization

for prior service costs.

Fannie Mae also has an Executive Pension Plan and a Supplemental Pension Plan, which

supplement for key senior oÇcers the beneÑts payable under the retirement plan. Estimated beneÑts

under the supplementary plans are accrued as an expense over the period of employment. Accrued

beneÑts under the Executive Pension Plan generally are funded through a Rabbi trust.

Fannie Mae sponsors a Postretirement 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 a stated deductible has been met.

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 10 years of service may purchase coverage by paying the full premium. The plan is

contributory, with retiree contributions adjusted annually. The expected cost of these postretirement

beneÑts is charged to expense during the years that employees render service. Cost-sharing percentages are based on length of service with Fannie Mae, eligibility for and date of retirement, and a

deÑned dollar beneÑt cap. Fannie Mae does not fund this plan.

Fannie Mae's accrued postretirement health care plan obligation for the years ending December 31, 1998 , and 1997 was $32 million and $27 million, respectively. The net postretirement health

care costs were $8 million in 1998, $6 million in 1997 and $7 million in 1996. In determining the net

postretirement health care cost for 1998, a 5.5 percent annual rate of increase in the per capita cost of

covered health care claims was assumed for 1998; the rate was assumed to decrease gradually to

4.5 percent over four years and remain at that level thereafter. The health care cost trend rate

assumption has a signiÑcant eÅect on the amounts reported. In determining the net postretirement

health care cost for 1997, a 6.25 percent annual rate of increase in the per capita cost of covered health

care claims was assumed for 1997; the rate was assumed to decrease gradually to 4.75 percent over Ñve

years and remain at that level thereafter. To illustrate, increasing the assumed health care cost trend

rates by one percentage point in each year would increase the accumulated postretirement beneÑt

obligation as of December 31, 1998 by $6 million and the aggregate of the service and interest cost

components of net postretirement health care cost for the year by $1 million.

The weighted-average discount rates used in determining the health care cost and the year-end

accumulated postretirement beneÑt obligation were 6.75 percent at December 31, 1998, and 7.25 percent at December 31, 1997.

B-63
FANNIE MAE

NOTES TO FINANCIAL STATEMENTSÌ(Continued)

10. Line of Business Reporting

Management analyzes corporate performance on the basis of two lines of business: Portfolio

Investment and Credit Guaranty.

The Portfolio Investment business includes the management of asset purchases and funding

activities for Fannie Mae's mortgage and nonmortgage investment portfolios. Income is derived

primarily from the diÅerence, or spread, between the yield on mortgage loans and nonmortgage

investments, and the borrowing costs related to those loans and investments.

The Credit Guaranty business involves guaranteeing the credit performance of both single-family

and multifamily mortgage loans for a fee. Guaranty fees for MBS are based on a market rate of return

for the credit risk assumed. For mortgages held in portfolio, the Credit Guaranty business charges the

Portfolio Investment business a guaranty fee similar to what it would charge on an MBS. These

""notional'' guaranty fees are classiÑed as net interest income for the Credit Guaranty business. Net

interest income for the Credit Guaranty business also includes interest on capital invested in guaranty

activities and income from temporary investment of principal and interest payments on guaranteed

mortgages prior to remittance to investors, and is net of interest charges paid to the Portfolio

Investment business for delinquent loans.

Fannie Mae assigns actual direct revenues and expenses among its lines of business and uses

estimates to apportion overhead and other corporate items. For instance, administrative expenses are

allocated on the basis of direct expenses for the line of business or, where not assignable to a particular

associated business, are based on revenues, proÑts, or volumes, as applicable. Capital is allocated to

the separate businesses through an assessment of the interest rate and credit risk associated with each

business.

The following table sets forth Fannie Mae's Ñnancial performance by line of business for the years

ended December 31, 1998, 1997, and 1996.

1998(1) 1997 1996

Portfolio Credit Portfolio Credit Portfolio Credit

Investment Guaranty Total Investment Guaranty Total Investment Guaranty Total

(Dollars in millions)

Net interest income ÏÏÏÏÏÏÏÏÏ $3,460 $ 650 $ 4,110 $3,483 $ 466 $ 3,949 $3,191 $ 401 $3,592

Guaranty fees ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (823) 2,052 1,229 (746) 2,020 1,274 (712) 1,908 1,196

Fee and other income, net ÏÏÏ 158 117 275 88 37 125 83 3 86

Credit-related expenses ÏÏÏÏÏÏ Ì (261) (261) Ì (375) (375) Ì (409) (409)

Administrative expenses ÏÏÏÏÏ (184) (524) (708) (174) (462) (636) (160) (400) (560)

Federal income taxes ÏÏÏÏÏÏÏÏ (707) (494) (1,201) (745) (524) (1,269) (679) (472) (1,151)

Extraordinary itemÌ early

extinguishment of debt ÏÏÏÏ (26) Ì (26) (12) Ì (12) (29) Ì (29)

Net income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $1,878 $1,540 $ 3,418 $1,894 $1,162 $ 3,056 $1,694 $1,031 $2,725

(1) Results include the recognition of additional non-recurring tax beneÑts associated with

investments qualifying for low-income housing tax credits, and additional amortization of

premiums or discounts and deferred or prepaid guaranty fees that were recorded in the

fourth quarter of 1998.

B-64
FANNIE MAE

NOTES TO FINANCIAL STATEMENTSÌ(Continued)

11. Dividend Restrictions

Fannie Mae's payment of dividends is subject to certain statutory restrictions, including approval

by the Director of the OÇce of Federal Housing Enterprise Oversight of any dividend payment that

would cause Fannie Mae's capital to fall below speciÑed capital levels.

Fannie Mae has exceeded the applicable capital standard since the adoption of these restrictions

in 1992 and, consequently, has been making dividend payments without the need for Director

approval.

Payment of dividends on common stock is also subject to payment of dividends on preferred stock

outstanding.

12. Preferred Stock

The following table presents the nonvoting preferred stock outstanding as of December 31, 1998

and 1997.

Shares Issued Stated Annual

and Value Dividend Redeemable

Issue Date Outstanding Per Share Rate On or After

Series A ÏÏÏÏÏÏÏÏ March 1, 1996 7,500,000 $50 6.41% March 1, 2001

Series B ÏÏÏÏÏÏÏÏ April 12, 1996 7,500,000 50 6.50 April 12, 2001

Series C ÏÏÏÏÏÏÏÏ September 20, 1996 5,000,000 50 6.45 September 20, 2001

Series D ÏÏÏÏÏÏÏÏ September 30, 1998 3,000,000 50 5.25 September 30, 1999

Total ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 23,000,000

Holders of preferred stock are entitled to receive noncumulative, quarterly dividends when, and if,

declared by Fannie Mae's Board of Directors. Payment of dividends on preferred stock is not

mandatory, but has priority over payment of dividends on common stock. After the speciÑed period,

preferred stock is redeemable at its stated value at the option of Fannie Mae.

13. OÅ-Balance-Sheet Credit Risk

Fannie Mae is a party to transactions involving Ñnancial instruments with oÅ-balance-sheet risk.

Fannie Mae uses these instruments to fulÑll its statutory purpose of meeting the Ñnancing needs of the

secondary mortgage market and to reduce its own exposure to Öuctuations in interest rates. These

Ñnancial instruments include MBS, commitments to purchase mortgages or to issue and guarantee

MBS, credit enhancements, and certain hedge instruments. These instruments involve, to varying

degrees, elements of credit and market risk in excess of amounts recognized on the balance sheet.

Guaranteed Mortgage-Backed Securities

As issuer and guarantor of MBS, Fannie Mae is obligated to disburse scheduled monthly

installments of principal and interest (at the certiÑcate rate) and the full UPB of any foreclosed

mortgage to MBS investors, whether or not any such amounts have been received. Fannie Mae is also

obligated to disburse unscheduled principal payments received from borrowers.

Fannie Mae's credit risk is mitigated to the extent that sellers of pools of mortgages elect to

remain at risk for the loans sold to the corporation or other credit enhancement was provided to

protect against the risk of loss from borrower default. Lenders have the option to retain the primary

B-65
FANNIE MAE

NOTES TO FINANCIAL STATEMENTSÌ(Continued)

default risk, in whole or in part, in exchange for a lower guaranty fee. Fannie Mae, however, bears the

ultimate risk of default.

Commitments

Fannie Mae enters 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.

Fannie Mae will also accept mandatory or lender-option delivery commitments not issued

pursuant to a master commitment. These commitments may be for portfolio or 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.

The cost of funding future portfolio purchases generally is hedged upon issuance of, or conversion

to, a mandatory commitment. Therefore, the interest rate risk relating to loans purchased pursuant to

those commitments is largely mitigated.

Hedge Instruments

Fannie Mae typically uses derivative instruments that simulate short sales of Treasury securities,

interest rate swaps, swaptions, interest rate caps, and deferred rate-setting agreements to hedge

against interest rate movements. Changes in the value of these hedge instruments caused by

Öuctuations in interest rates are expected to oÅset changes in the value of the items hedged.

Consequently, the primary risks associated with these hedging instruments are that (1) changes in the

value of the item hedged will not substantially oÅset changes in the value of the hedge instrument, and

(2) the counterparty to the agreement will be unable or unwilling to meet the terms of the agreement.

Credit risk on derivative instruments that simulate short sales of Treasury securities arises from

the possible inability or unwillingness of the counterparty to pay any diÅerence between the agreedupon price and the current price for the referenced securities at settlement. This risk is reduced

through evaluation of the creditworthiness of counterparties and continuous monitoring of hedge

positions. The amount of deferrable net unrealized gains on open hedge positions was $34 million at

December 31, 1998, compared with $3 million of unrealized losses at December 31, 1997. Total

deferred gains and losses on closed positions were $172 million and $473 million, respectively, at

December 31, 1998, compared with $188 million and $231 million, respectively, at December 31, 1997.

Fannie Mae reduces counterparty risk on interest rate swaps, swaptions, and interest rate caps by

dealing only with experienced counterparties with high credit quality, diversifying these derivative

instruments across many counterparties, and ensuring that these derivative instruments generally are

executed under master agreements that provide for netting of certain amounts payable by each party.

In addition, counterparties are obligated to post collateral if Fannie Mae is exposed to credit loss on

the related derivative instruments exceeding an agreed-upon threshold. The amount of required

collateral is based on credit ratings and the level of credit exposure. Fannie Mae generally requires

overcollateralization from counterparties whose credit ratings have dropped below predetermined

levels. Fannie Mae regularly monitors the exposures on its derivative instruments by valuing the

positions via dealer quotes and internal pricing models. At December 31, 1998, 93 percent of the

notional amount of Fannie Mae's outstanding interest rate swaps, swaptions, and interest rate caps

were with counterparties rated A or better (68 percent with counterparties rated AA or better), and

100 percent of the notional amount of outstanding swaps, swaptions, and interest rate caps were

subject to collateral arrangements. At December 31, 1998, six counterparties represented approxiB-66
FANNIE MAE

NOTES TO FINANCIAL STATEMENTSÌ(Continued)

mately 69 percent of the total notional amount of the outstanding interest rate swaps, swaptions, and

interest rate caps.

Counterparty risk on deferred rate-setting arrangements is limited to the cash receivable, if any,

due under the deferred rate-setting agreement. This risk is reduced through evaluating the

creditworthiness of counterparties.

Credit Enhancements

Fannie Mae provides credit enhancement and, in some cases, liquidity support for certain

Ñnancings involving taxable or tax-exempt housing bonds issued by state and local governmental

entities to Ñnance multifamily housing for low- and moderate-income families. In these transactions,

Fannie Mae issues an MBS, pledges an interest in certain mortgages it owns, or otherwise provides

contractual assurance of payment to a trustee for the bonds or another credit party in the transaction.

Fannie Mae's direct credit enhancement in a multifamily housing bond transaction improves the

rating on the bond, thus resulting in lower-cost Ñnancing for multifamily housing.

B-67
FANNIE MAE

NOTES TO FINANCIAL STATEMENTSÌ(Continued)

Credit Exposure for OÅ-Balance-Sheet Financial Instruments

The following table presents the contract or notional amount of derivative instruments at

December 31, 1998 and 1997.

1998 1997

(Dollars in billions)

Contractual Amounts:

MBS outstanding(1) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 834.0 $ 709.1

MBS in portfolio ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (197.4) (130.4)

Net MBS outstanding(1) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 636.6 $ 578.7

Master commitments:

Mandatory ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 31.7 $ 38.2

Optional ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 56.1 45.9

Portfolio commitments:

Mandatory ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 11.1 3.6

Optional ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 1.6 1.6

MBS commitments:

Optional ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Ì 0.1

Notional Amounts(2):

Simulated short sales of Treasury securities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 3.6 1.6

Interest rate swaps(3)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 95.8 96.1

Debt swaps(4) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 46.6 52.7

Asset swaps (5) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 0.4 1.0

Interest rate caps ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 14.5 Ì

Swaptions ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 12.7 Ì

Credit enhancements ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 6.6 7.3

Other guaranteesÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2.8 2.6

(1) Net of $588 million in allowance for losses in 1998 and $523 million in 1997. Includes

$160.2 billion and $94.3 billion of MBS with lender or third-party recourse at December 31,

1998 and 1997, respectively.

(2) Notional amounts do not necessarily represent the market or credit risk of the derivative

instrument positions.

(3) The weighted-average interest rate being received under these swaps was 5.32 percent and

the weighted-average interest rate being paid was 6.53 percent at December 31, 1998,

compared with 5.85 percent and 6.79 percent, respectively, at December 31, 1997.

(4) The weighted-average interest rate being received under these swaps was 5.48 percent and

the weighted-average interest rate being paid was 5.18 percent at December 31, 1998,

compared with 5.94 percent and 5.65 percent, respectively, at December 31, 1997.

(5) The weighted-average interest rate being received under these swaps was 5.86 percent and

the weighted-average interest rate being paid was 5.32 percent at December 31, 1998,

compared with 6.03 percent and 6.27 percent, respectively, at December 31, 1997.

Contract or notional amounts do not necessarily represent the market or credit risk of the

derivative instrument positions. The notional amounts of the derivative instruments are used to

calculate contractual cash Öows to be exchanged. In addition, any measurement of risk is meaningful

B-68
FANNIE MAE

NOTES TO FINANCIAL STATEMENTSÌ(Continued)

only to the extent that oÅsetting arrangements, such as master netting agreements and the value of

related collateral, are included.

Fannie Mae's exposure to credit loss for derivative instruments can be estimated by calculating

the cost, on a present value basis, to replace at current market rates all those derivative instruments

outstanding for which the Corporation was in a gain position. Fannie Mae's net exposure (taking into

account master netting agreements) was $46 million at December 31, 1998, and $26 million at

December 31, 1997. Fannie Mae expects the net credit exposure to Öuctuate as interest rates change.

14. Concentrations of Credit Risk

Concentrations of credit risk exist when a signiÑcant number of counterparties (e.g., borrowers,

lenders, and mortgage insurers) engage in similar activities or are susceptible to similar changes in

economic conditions that could aÅect their ability to meet contractual obligations.

The following table presents UPB by primary default risk and the general geographic distribution

of properties underlying mortgages in the portfolio or backing MBS outstanding at December 31, 1998

and 1997.

Geographic Distribution

1998 Gross UPB NortheastSoutheastMidwestSouthwestWestTotal

(Dollars in millions)

Fannie Mae risk ÏÏÏÏÏÏÏÏÏÏÏ $ 867,272 20% 20% 18% 15% 27% 100%

Lender or shared risk ÏÏÏÏÏÏ 184,386 15 19 21 16 29 100

Total ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $1,051,658 19% 20% 19% 15% 27% 100%

Geographic Distribution

1997 Gross UPB NortheastSoutheastMidwestSouthwestWestTotal

(Dollars in millions)

Fannie Mae risk ÏÏÏÏÏÏÏÏÏÏÏ $ 780,771 20% 21% 17% 15% 27% 100%

Lender or shared risk ÏÏÏÏÏÏ 115,045 16 18 18 14 34 100

Total ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 895,816 20% 20% 17% 15% 28% 100%

No signiÑcant concentration exists at the state level except for California, where, at both

December 31, 1998 and 1997, 20 percent of the gross UPB of mortgages in portfolio and backing MBS

were located.

To minimize credit risk, Fannie Mae requires primary mortgage insurance or other credit

protection if the loan-to-value (""LTV'') ratio of a single-family conventional mortgage loan (the UPB

of the loan divided by the value of the mortgaged property) is greater than 80 percent when the loan is

delivered to Fannie Mae.

Fannie Mae accepts conventional loans delivered with mortgage insurance from 15 insurance

organizations. At December 31, 1998, $257 billion in current UPB of single-family conventional

mortgage loans in portfolio and underlying MBS outstanding was covered by primary mortgage

insurance at acquisition. Six companies, all rated AA or higher, represented approximately 93 percent

of that insurance coverage. Fannie Mae monitors on a regular basis the performance and Ñnancial

strength of its mortgage insurers.

B-69
FANNIE MAE

NOTES TO FINANCIAL STATEMENTSÌ(Continued)

The following table presents the original LTV ratio distribution of single-family loans in portfolio

or backing MBS outstanding at December 31, 1998 and 1997.

Loan-to-Value Ratio

60% Over

1998 Gross UPB or less 61Ó70% 71Ó75% 76Ó80% 81Ó90% 90% Total

(Dollars in millions)

Fannie Mae riskÏÏÏÏÏÏÏ $832,048 20% 16% 16% 23% 14% 11% 100%

Lender or shared risk ÏÏ 149,165 6 8 12 33 22 19 100

Total ÏÏÏÏÏÏÏÏÏÏÏÏÏ $981,213 18% 15% 15% 25% 15% 12% 100%

Loan-to-Value Ratio

60% Over

1997 Gross UPB or less 61Ó70% 71Ó75% 76Ó80% 81Ó90% 90% Total

(Dollars in millions)

Fannie Mae riskÏÏÏÏÏÏÏ $752,654 19% 15% 15% 23% 16% 12% 100%

Lender or shared risk ÏÏ 86,195 9 10 12 26 24 19 100

Total ÏÏÏÏÏÏÏÏÏÏÏÏÏ $838,849 18% 14% 15% 23% 17% 13% 100%

The rate at which mortgage loans prepay tends to be sensitive to the level and direction of

prevailing market interest rates. In a declining interest rate environment, higher-rate mortgage loans

will pay oÅ at a faster rate; conversely, in an increasing interest rate environment, lower-rate mortgage

loans will prepay at a slower rate. The following table presents the distribution by note rate of Ñxedrate, single-family loans in the mortgage portfolio or underlying MBS at December 31, 1998 and 1997.

Fixed-Rate Loans by Note Rate(1)

7.00% 8.00% 9.00% 10.00%

Under to to to and

Gross UPB at December 31, 7.00% 7.99% 8.99% 9.99% over Total

(Dollars in billions)

1998 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $201 $484 $155 $30 $14 $884

Percent of total ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 23% 55% 17% 3% 2% 100%

1997 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 83 $380 $227 $45 $20 $755

Percent of total ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 11% 50% 30% 6% 3% 100%

(1) Excludes housing revenue bonds and non-Fannie Mae securities.

15. Disclosures of Fair Value of Financial Instruments

The basic assumptions used and the estimates disclosed in the Fair Value Balance Sheets

represent management's best judgment of appropriate valuation methods. These estimates are based

on pertinent information available to management as of December 31, 1998 and 1997. In certain cases,

fair values are not subject to precise quantiÑcation or veriÑcation and may change as economic and

market factors, and management's evaluation of those factors, change.

Although management uses its 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 Fannie Mae would realize in a market

transaction. The accompanying Fair Value Balance Sheets do not represent an estimate of the overall

market value of the corporation as a going concern, which would take into account future business

opportunities.

B-70
FANNIE MAE

NOTES TO FINANCIAL STATEMENTSÌ(Continued)

Fair Value Balance Sheets

Assets

December 31, 1998 December 31, 1997

CostFair Value CostFair Value

(Dollars in millions)

Assets:

Mortgage portfolio, net ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $415,223 $424,171 $316,316 $325,500

Investments ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 58,515 58,557 64,596 64,608

Cash and cash equivalents ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 743 743 2,205 2,205

Other assets ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 10,533 8,933 8,556 6,489

485,014 492,404 391,673 398,802

OÅ-balance-sheet items:

Guaranty fee income, net ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Ì 3,698 Ì 3,357

Swaps in gain position, net ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Ì 32 Ì 4

Other ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Ì 34 Ì Ì

Total assetsÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $485,014 $496,168 $391,673 $402,163

Liabilities and Net Assets

Liabilities:

Noncallable debt:

Due within one year ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $202,260 $202,957 $156,725 $158,526

Due after one yearÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 123,396 131,268 85,699 91,177

Callable debt:

Due within one year ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 3,153 3,144 18,675 17,464

Due after one yearÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 131,482 131,774 108,675 108,706

460,291 469,143 369,774 375,873

Other liabilities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 9,270 7,844 8,106 7,137

OÅ-balance-sheet items:

Swaps in loss position, net ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Ì 4,296 Ì 3,168

Other ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Ì Ì Ì 3

Total liabilitiesÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 469,561 481,283 377,880 386,181

Net asset value, net of tax eÅect ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 15,453 $ 14,885 $ 13,793 $ 15,982

See accompanying Notes to Fair Value Balance Sheets.

Notes to Fair Value Balance Sheets

The following discussion summarizes the signiÑcant methodologies and assumptions used in

estimating the fair values presented in the accompanying Fair Value Balance Sheets.

Mortgage Portfolio, Net

The fair value calculations of Fannie Mae's mortgage portfolio considered such variables as

interest rates, credit quality, and loan collateral. Because an active market does not exist for a large

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 Fannie Mae's securitization business would charge for a pool of loans with similar

B-71
FANNIE MAE

NOTES TO FINANCIAL STATEMENTSÌ(Continued)

characteristics was subtracted from the weighted-average interest rate less servicing fees. The method

for estimating this guaranty fee and the credit risk associated with the mortgage portfolio is described

under ""Guaranty Fee Income, Net.''

Fannie Mae then employed an option-adjusted spread (""OAS'') approach to estimate fair values

for both notional MBS (the mortgage loan portfolio) and MBS held in portfolio. The OAS represents

the risk premium or incremental interest spread over Treasury 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.

Investments

Fair values of Fannie Mae's investment portfolio were based on actual quoted prices or prices

quoted for similar Ñnancial instruments.

Cash and Cash Equivalents

The carrying amount of cash and cash equivalents was used 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 currency swap receivables and certain

deferred items that have no fair value, approximates their carrying amount. Net currency swap

receivables are included in other assets at their fair value.

Guaranty Fee Income, Net

MBS are not assets owned by Fannie Mae, except when acquired for investment purposes, nor are

MBS recorded as liabilities of Fannie Mae. On MBS outstanding, the Corporation receives a guaranty

fee calculated on the outstanding principal balance of the related mortgages. The guaranty fee

represents a future income stream for the Corporation. Under generally accepted accounting principles, this guaranty fee is recognized as income over 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, and taking into account estimated prepayments.

Fannie Mae estimates the credit loss exposure attached to the notional MBS, MBS held in

portfolio, and oÅ-balance-sheet MBS where the Corporation has the primary risk of default. Fannie

Mae deducts estimated credit losses from the projected guaranty fee cash Öows to arrive at the fair

value. Estimated credit losses are calculated with an internal forecasting model based on actual

historical loss experience for the Corporation. The net guaranty fee cash Öows are then valued through

an OAS method similar to that described under ""Mortgage Portfolio, Net.''

Swap Obligations, Net

Fannie Mae enters into interest rate swaps, including callable swaps that in general extend or

adjust the eÅective maturity of certain debt obligations. Under these swaps, Fannie Mae generally

pays a Ñxed rate and receives a Öoating rate based on a notional amount. Fannie Mae also enters into

interest rate swaps that are linked to speciÑc bond investments (""asset swaps'') or speciÑc debt issues

B-72
FANNIE MAE

NOTES TO FINANCIAL STATEMENTSÌ(Continued)

(""debt swaps''). The fair value of interest rate swaps is estimated based on either the expected cash

Öows or quoted market values of these instruments. The eÅect of netting under master agreements is

included in determining swap obligations in a gain position or loss position.

In addition, Fannie Mae enters into swaptions and interest rate caps. Under a swaption, Fannie

Mae has the option to enter into a swap, as described above, at a future date. Fannie Mae uses interest

rate caps to eÅectively manage its interest expense in a period of rising interest rates by entering into

an agreement whereby a counterparty makes payments to the Corporation for interest rates above a

speciÑed rate. The fair values of these derivative instruments are estimated based on either the

expected cash Öows or the quoted market values of these instruments.

Noncallable and Callable Debt

The fair value of Fannie Mae's noncallable debt was estimated by using quotes for selected debt

securities of the Corporation with similar terms. Similar to the valuation of the mortgage portfolio, the

fair value of callable debt was estimated with an OAS model.

Other Liabilities

Other liabilities include accrued interest payable, amounts payable to MBS holders, estimated

losses on MBS, net currency swap payables, and several other smaller liability categories. The fair

value of other liabilities, excluding currency swap payables and certain deferred items that have no fair

value, approximates their carrying amount. Currency swap payables are included as a component of

other liabilities at their fair value. Credit loss exposure for MBS is included as a component of the net

MBS guaranty fee.

The fair value amount also includes the estimated eÅect on deferred income taxes of providing for

federal income taxes, at the statutory corporate tax rate of 35 percent, for the diÅerence between net

assets at fair value and at cost.

B-73
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.

1998 Quarter Ended

December September June March

(Dollars in millions, except per common share amounts)

Interest incomeÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $7,895 $7,724 $7,351 $7,025

Interest expense ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 6,919 6,657 6,320 5,989

Net interest incomeÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 976 1,067 1,031 1,036

Guaranty fees ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 261 324 323 321

Fee and other income, net ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 71 69 79 56

Provision for losses ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 20 15 10 5

Foreclosed property expenses ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (70) (80) (79) (82)

Administrative expensesÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (185) (179) (174) (170)

Income before federal income taxes and

extraordinary item ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 1,073 1,216 1,190 1,166

Provision for federal income taxesÏÏÏÏÏÏÏÏÏÏÏÏÏ (174) (354) (339) (334)

Income before extraordinary item ÏÏÏÏÏÏÏÏÏÏÏÏÏ 899 862 851 832

Extraordinary itemÌearly extinguishment of

debt (net of tax eÅect) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (10) (5) (3) (8)

Net income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 889 $ 857 $ 848 $ 824

Preferred stock dividendsÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (18) (16) (16) (16)

Net income available to common stockholders ÏÏ $ 871 $ 841 $ 832 $ 808

Basic earnings per common share(1):

Earnings before extraordinary itemÏÏÏÏÏÏÏÏ $ .86 $ .83 $ .81 $ .79

Extraordinary item ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (.01) (.01) Ì (.01)

Net earnings ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ .85 $ .82 $ .81 $ .78

Diluted earnings per common share(1):

Earnings before extraordinary itemÏÏÏÏÏÏÏÏ $ .85 $ .82 $ .80 $ .78

Extraordinary item ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (.01) (.01) Ì (.01)

Net earnings ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ .84 $ .81 $ .80 $ .77

Cash dividends per common share ÏÏÏÏÏÏÏÏÏÏÏÏ $ .24 $ .24 $ .24 $ .24

(1) The total of the four quarters does not equal the amount for the year because the amount for

each period is calculated independently based on the weighted-average number of common

shares outstanding during the period.

B-74
FANNIE MAE

QUARTERLY RESULTS OF OPERATIONS (Unaudited)Ì(Continued)

1997 Quarter Ended

December September June March

(Dollars in millions, except per common share amounts)

Interest incomeÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $6,884 $6,651 $6,514 $6,329

Interest expense ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 5,848 5,658 5,544 5,379

Net interest incomeÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 1,036 993 970 950

Guaranty fees ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 324 320 317 313

Fee and other income, net ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 29 33 33 30

Provision for losses ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Ì (20) (40) (40)

Foreclosed property expenses ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (77) (71) (61) (66)

Administrative expensesÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (167) (159) (159) (151)

Income before federal income taxes and

extraordinary item ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 1,145 1,096 1,060 1,036

Provision for federal income taxesÏÏÏÏÏÏÏÏÏÏÏÏÏ (339) (319) (309) (302)

Income before extraordinary item ÏÏÏÏÏÏÏÏÏÏÏÏÏ 806 777 751 734

Extraordinary itemÌearly extinguishment of

debt (net of tax eÅect) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (12) (2) 2 Ì

Net income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 794 $ 775 $ 753 $ 734

Preferred stock dividendsÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (16) (16) (17) (16)

Net income available to common stockholders ÏÏ $ 778 $ 759 $ 736 $ 718

Basic earnings per common share(1):

Earnings before extraordinary itemÏÏÏÏÏÏÏÏ $ .76 $ .73 $ .70 $ .68

Extraordinary item ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (.01) Ì Ì Ì

Net earnings ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ .75 $ .73 $ .70 $ .68

Diluted earnings per common share(1):

Earnings before extraordinary itemÏÏÏÏÏÏÏÏ $ .75 $ .72 $ .69 $ .67

Extraordinary item ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (.01) Ì Ì Ì

Net earnings ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ .74 $ .72 $ .69 $ .67

Cash dividends per common share ÏÏÏÏÏÏÏÏÏÏÏÏ $ .21 $ .21 $ .21 $ .21

(1) The total of the four quarters does not equal the amount for the year because the amount for

each period is calculated independently based on the weighted-average number of common

shares outstanding during the period.

B-75
FANNIE MAE

NET INTEREST INCOME AND AVERAGE BALANCES (Unaudited)

1998 1997 1996

(Dollars in millions)

Interest income:

Mortgage portfolioÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 25,676 $ 22,716 $ 20,560

Investments and cash equivalents ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 4,319 3,662 3,212

Total interest income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 29,995 26,378 23,772

Interest expense(1):

Short-term debt ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 4,809 3,659 3,395

Long-term debt ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 21,076 18,770 16,785

Total interest expense ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 25,885 22,429 20,180

Net interest income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 4,110 3,949 3,592

Tax equivalent adjustment(2) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 304 283 247

Net interest income tax equivalent basis ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 4,414 $ 4,232 $ 3,839

Average balances:

Interest-earning assets(3):

Mortgage portfolio, net ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $352,169 $298,698 $268,629

Investments and cash equivalents ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 75,369 63,441 57,161

Total interest-earning assetsÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $427,538 $362,139 $325,790

Interest-bearing liabilities(1):

Short-term debt ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 89,890 $ 68,691 $ 63,974

Long-term debt ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 319,638 277,129 246,733

Total interest-bearing liabilities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 409,528 345,820 310,707

Interest-free fundsÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 18,010 16,319 15,083

Total interest-bearing liabilities and interest-free funds ÏÏÏÏÏÏÏÏÏÏÏÏ $427,538 $362,139 $325,790

Average interest rates(2):

Interest-earning assets:

Mortgage portfolio, net ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 7.38% 7.67% 7.71%

Investments and cash equivalents ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 5.76 5.82 5.68

Total interest-earning assetsÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 7.09 7.34 7.36

Interest-bearing liabilities(1):

Short-term debt ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 5.29 5.29 5.22

Long-term debt ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 6.60 6.77 6.82

Total interest-bearing liabilities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 6.31 6.48 6.49

Investment spread(4)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ .78 .86 .87

Interest-free return(5) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ .25 .31 .31

Net interest margin(6) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 1.03% 1.17% 1.18%

(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 pro forma adjustments to permit comparison of yields on tax-advantaged and

taxable assets.

(3) Includes average balance of nonperforming loans of $2.6 billion in 1998 and $2.2 billion in

1997 and 1996.

(4) Consists primarily of the diÅerence between the yield on interest-earning assets, adjusted for

tax beneÑts of nontaxable income, and the eÅective cost of funds on interest-bearing

liabilities.

(5) Consists primarily of the return on that portion of the investment portfolio funded by equity

and non-interest-bearing liabilities.

(6) Net interest income, on a tax equivalent basis, as a percentage of the average investment

portfolio.

B-76
FANNIE MAE

RATE/VOLUME ANALYSIS (Unaudited)

Attributable to

changes in(1) Increase

(Decrease) Volume Rate

(Dollars in millions)

1998 vs. 1997

Interest income:

Mortgage portfolio ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $2,960 $3,930 $(970)

Investments and cash equivalents ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 657 684 (27)

Total interest income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 3,617 4,614 (997)

Interest expense(2):

Short-term debt ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 1,150 1,134 16

Long-term debt ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2,306 2,814 (508)

Total interest expense ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 3,456 3,948 (492)

Net interest income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 161 $ 666 $(505)

1997 vs. 1996

Interest income:

Mortgage portfolio ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $2,156 $2,287 $(131)

Investments and cash equivalents ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 450 361 89

Total interest income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2,606 2,648 (42)

Interest expense(2):

Short-term debt ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 264 251 13

Long-term debt ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 1,985 2,059 (74)

Total interest expense ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2,249 2,310 (61)

Net interest income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 357 $ 338 $ 19

(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 the eÅective maturity or repricing date, taking into consideration the eÅect of

derivative Ñnancial instruments.

B-77
MANAGEMENT

Directors

The age and background, as of March 29, 1999, of each of the members of the Board of Directors

of Fannie Mae are as follows:

First

Principal Occupation, Became Other

Name and Age Business Experience, and Residence Director Directorships(1)

Stephen B. Ashley, 59 Chairman and Chief Executive OÇcer, The 1995 Exeter Fund, Inc.; The GeneAshley Group, a group of commercial and multi- see Corporation; Hahn Autofamily real estate, brokerage and investment motive Warehouse, Inc.;

companies, January 1997 to present; Chairman Manning & Napiers Insurance

and Chief Executive OÇcer, Sibley Mortgage Fund, Inc.

Corporation, a mortgage banking company, 1985

to 1996; Chairman and Chief Executive OÇcer,

Sibley Real Estate Services, Inc., a property

management company, 1985 to 1996; Livonia,

New York

Roger E. Birk, 68 Former President and Chief Operating OÇcer of 1985 Golden Bear Golf Inc.; Mutual

the Corporation, November 1987 until his retire- of America Capital Corp.;

ment in January 1992; Tequesta, Florida Penske Corp.; WellPoint

Health Networks Inc.

Kenneth M. Chairman and Chief Executive OÇcer, The Du- 1998 The Boeing Company; Cinergy

Duberstein, 54 berstein Group, an independent strategic plan- Corporation; Global Vacation

ning and consulting company, July 1989 to Group; St. Paul Companies,

present; Chief of StaÅ to the President of the Inc.

United States, 1988 to 1989

Stephen Friedman, 61 Senior Principal, Marsh McLennan Risk Capital 1996 Risk Capital Holdings Inc.;

Corp., an insurance brokerage, money manage- Wal-Mart Stores, Inc.

ment, and consulting Ñrm, since March 1998;

Limited Partner, December 1994 to present, Senior Chairman from December 1994 to March

1998, and Co-Chairman or sole Chairman, December 1990 to November 1994, Goldman,

Sachs & Co., an investment banking Ñrm; New

York, NY

Thomas P. Dean of The Wharton School of the University 1991 CVS Corporation; Fiserv, Inc.;

Gerrity, 57 of Pennsylvania, an educational institution, July IKON OÇce Solutions, Inc.;

1990 to present; President of CSC Consulting, a Reliance Group Holdings, Inc.;

subsidiary of Computer Sciences Corporation, Sunoco, Inc.

and Vice President of Computer Sciences Corporation, May 1989 to June 1990; Chairman and

Chief Executive OÇcer, Index Group, a technology-oriented consulting company, 1969 to April

1989; Haverford, Pennsylvania

Jamie S. Gorelick, 48 Vice Chair of the Corporation, May 1997 to 1997

present; Deputy Attorney General of the United

States, March 1994 to April 1997; General Counsel to the U.S. Department of Defense, May 1993

to March 1994; Partner, Miller, Cassidy, Larroca

& Lewin, a law Ñrm, January 1981 to April 1993;

Chevy Chase, Maryland

James A. Chairman of the Executive Committee of the 1990 Cummins Engine Company,

Johnson, 55 Board, January 1999 to present; Chairman of the Inc.; Dayton Hudson CorporaBoard of Directors and Chief Executive OÇcer of tion; Kaufman and Broad

the Corporation, February 1991 to Decem- Home Corporation; United

ber 1998; Vice Chairman of the Board of the HealthCare Corporation

Corporation, January 1990 to January 1991;

Managing Director, Shearson Lehman Brothers,

Inc., an investment banking Ñrm, April 1985 to

December 1989; Washington, D.C.

B-78
First

Principal Occupation, Became Other

Name and Age Business Experience, and Residence Director Directorships(1)

Vincent A. President and Chief Executive OÇcer, AEA In- 1991 Dal-Tile International, Inc.

Mai, 58 vestors Inc., a private investment company, April

1989 to present; Managing Director, Shearson

Lehman Brothers, Inc., an investment banking

Ñrm, 1974 to April 1989; Port Washington, New

York

Ann McLaughlin, 57 Chairman, October 1996 to present, Vice Chair- 1994 AMR Corporation (and its

man, August 1993 to September 1996, The subsidiary, American AirAspen Institute, a nonproÑt organization; Presi- lines); Donna Karan Internadent, Federal City Council, May 1990 to Septem- tional Inc.; General Motors

ber 1995; President and Chief Executive OÇcer, Corporation; Harman InternaNew American Schools Development Corpora- tional Industries, Inc.; Host

tion, June 1992 to April 1993; Visiting Fellow, Marriott Corporation; Kellogg

Urban Institute, January 1989 to June 1992; Company; Nordstrom Inc.

Chairman, President's Commission on Aviation

Security and Terrorism, September 1989 to May

1990; U.S. Secretary of Labor, December 1987 to

December 1989; Washington, D.C.

Joe K. Pickett, 53 Chairman and Chief Executive OÇcer, Home- 1996

Side Lending, Inc. (successor entity to BancBoston Mortgage Corporation), a mortgage banking

company, April 1990 to present; Jacksonville,

Florida

Jack Quinn, 49 Partner, Arnold & Porter, a law Ñrm, 1982 to 1998

1992 and February 1997 to present; Counsel to

the President of the United States, November 1995 to February 1997; Chief of StaÅ and

Counselor to the Vice President of the United

States, May 1993 to November 1995; Counsel

and Deputy Chief of StaÅ to the Vice President

of the United States, January 1993 to May 1993

Franklin D. Raines, 50 Chairman of the Board of Directors and Chief 1991 America Online, Inc.;

Executive OÇcer of the Corporation, Janu- PÑzer Inc.

ary 1999 to present; Chairman of the Board and

Chief Executive OÇcer-Designate, May 1998 to

December 31, 1998; Director, U.S. OÇce of Management and Budget, September 1996 to

May 1998; Vice Chairman of the Corporation,

September 1991 to August 1996

Eli J. Segal(2), 56 President and Chief Executive OÇcer of The 1997 Tower Air Inc.

Welfare to Work Partnership, a non-proÑt organization, February 1997 to present; Assistant

to the President of the United States, January

1993 to February 1996; Washington, D.C.

Lawrence M. President and Chief Operating OÇcer of the 1991 The Chubb Corporation;

Small, 57 Corporation, February 1992 to present; Presi- Marriott International, Inc.

dent and Chief Operating OÇcer-Designate of

the Corporation, September 1991 to January

1992; Vice Chairman and Chairman of the Executive Committee, January 1990 to July 1991,

Sector Executive, January 1985 to December

1989, Citicorp/Citibank, a Ñnancial institution;

Washington, D.C.

Jose H. Partner, Akin, Gump, Strauss, Hauer & Feld, 1993 Wal-Mart Stores, Inc. π

Villarreal(2), 45 L.L.P., a law Ñrm, August 1994 to present; Partner, McGinnis, Lochridge & Kilgore, L.L.P., a

law Ñrm, July 1993 to August 1994; Associate

Director, White House OÇce of Presidential Personnel, April 1993 to June 1993; Presidential

Transition Team, November 1992 to March

1993; Deputy Campaign Manager, Clinton Campaign, June 1992 to November 1992; Associate,

McGinnis, Lochridge & Kilgore, February 1991

to May 1992; San Antonio, Texas

B-79
First

Principal Occupation, Became Other

Name and Age Business Experience, and Residence Director Directorships(1)

Karen Hastie Partner, Crowell & Moring, a law Ñrm practicing 1988 Continental Airlines, Inc.;

Williams, 54 in the District of Columbia, 1982 to present; Crestar Financial

Washington, D.C. Corporation; Gannett Co.,

Inc.; Washington Gas

Company

(1) Companies with a class of securities registered pursuant to Section 12 of the Securities

Exchange Act of 1934 or subject to the requirements of Section 15(d) of that Act or any

company registered as an investment company under the Investment Company Act of 1940.

Certain directorships of other companies also are noted in the principal occupation column.

(2) Appointed by the President of the United States, who has authority to appoint Ñve directors.

The term of each director will end on the date of the May 1999 annual meeting of stockholders,

except that the President of the United States may remove any director that the President appointed

for good cause.

Executive OÇcers

The age and business experience, as of March 29, 1999, of each of the executive oÇcers of Fannie

Mae, are as follows:

Franklin D. Raines, 50, has been the Chairman of the Board of Directors and Chief Executive

OÇcer since January 1999. Mr. Raines was Chairman of the Board and Chief Executive OÇcerDesignate from May 1998 to December 1998. Mr. Raines was Director, OÇce of Management and

Budget from September 1996 to May 1998, and Vice Chairman of the Corporation from September 1991 to August 1996.

James A. Johnson, 55, has been Chairman of the Executive Committee from January 1999 to

present. Mr. Johnson was Chairman of the Board of Directors and Chief Executive OÇcer of the

Corporation from February 1991 to December 1998. Mr. Johnson was Vice Chairman of the Board of

Directors from January 1990 to January 1991. Mr. Johnson was a Managing Director in Corporate

Finance at Shearson Lehman Brothers, Inc. from April 1985 to December 1989.

Lawrence M. Small, 57, has been President and Chief Operating OÇcer since February 1992.

Mr. Small was President and Chief Operating OÇcer-Designate of the Corporation from September

1991 to January 1992. Prior to his employment with the Corporation, Mr. Small was with Citicorp/

Citibank, where he was Vice Chairman and Chairman of the Executive Committee from January 1990

to July 1991.

Jamie S. Gorelick, 48, has been Vice Chair since May 1997. Ms. Gorelick was Deputy Attorney

General of the United States from March 1994 to April 1997. Ms. Gorelick served as General Counsel

to the United States Department of Defense from May 1993 to March 1994 and was a Partner with

Miller, Cassidy, Larroca & Lewin, a law Ñrm, from January 1981 to April 1993.

J. Timothy Howard, 50, has been Executive Vice President and Chief Financial OÇcer since

February 1990.

William E. Kelvie, 51, has been Executive Vice President and Chief Information OÇcer since

November 1992.

Robert J. Levin, 43, has been Executive Vice PresidentÌHousing and Community Development

since June 1998. Mr. Levin was Executive Vice PresidentÌMarketing from June 1990 to June 1998.

Ann D. Logan, 44, has been Executive Vice PresidentÌSingle-Family Mortgage Business since

June 1998. Ms. Logan was Executive Vice President and Chief Credit OÇcer from May 1993 to

June 1998.

B-80
Adolfo Marzol, 38, has been Executive Vice President and Chief Credit OÇcer since July 1998.

Mr. Marzol was Senior Vice PresidentÌSingle-Family Business Management from July 1996 to July

1998. Mr. Marzol was Senior Vice PresidentÌCapital Markets from February 1996 to July 1996.

Mr. Marzol was Executive Vice President and Chief Financial OÇcer of Chase Manhattan Mortgage

Corporation, a mortgage company, from July 1993 to January 1996.

Glenn T. Austin, Jr., 50, has been Senior Vice PresidentÌSoutheastern Regional OÇce since

May 1985.

Kenneth J. Bacon, 44, has been Senior Vice President of the Community Development Capital

Corporation since September 1998. Mr. Bacon was Senior Vice PresidentÌNortheastern Regional

OÇce from April 1993 to September 1998.

John Buckley, 42, has been Senior Vice PresidentÌCommunications since November 1991.

Donna Callejon, 36, has been Senior Vice PresidentÌCorporate Development since July 1996.

Ms. Callejon was Senior Vice PresidentÌSingle-Family Marketing from November 1991 to July 1996.

William G. Ehrhorn, 50, has been Senior Vice PresidentÌOperations and Corporate Services

since February 1998. Mr. Ehrhorn was Senior Vice PresidentÌMortgage Operations from May 1993

to February 1998.

Elizabeth S. HarshÑeld, 45, has been Senior Vice PresidentÌMidwestern Regional OÇce since

February 1999. Ms. HarshÑeld was Senior Vice PresidentÌWestern Regional OÇce from February

1996 to February 1999. Ms. HarshÑeld was Senior Vice PresidentÌInvestor Relations from April

1994 to February 1996.

Lynda C. Horvath, 46, has been Senior Vice PresidentÌCapital Markets since July 1996.

Ms. Horvath was Senior Vice PresidentÌCorporate Development from May 1993 to July 1996.

Louis W. Hoyes, 50, has been Senior Vice PresidentÌMultifamily Lending and Investment since

July 1995. Prior to his employment with Fannie Mae, Mr. Hoyes was Managing Director of the

residential segment of Citicorp's Real Estate business in North America, where he held a number of

other positions after joining Citicorp/Citibank in 1973.

Linda K. Knight, 49, has been Senior Vice President and Treasurer since February 1993.

Thomas A. Lawler, 46, has been Senior Vice PresidentÌPortfolio Management since

November 1989.

Thomas A. Lund, 40, has been Senior Vice PresidentÌSouthwestern Regional OÇce since July

1996. Mr. Lund was Vice PresidentÌMarketing in the Southwestern Regional OÇce from January

1995 to July 1996. Prior to his employment with the Corporation, Mr. Lund was Senior Vice

President and General Manager for Negotiated Transactions for the GE Capital Mortgage Corporation from 1990 to 1994.

William R. Maloni, 54, has been Senior Vice PresidentÌGovernment and Industry Relations

since November 1995. Mr. Maloni was Senior Vice PresidentÌPolicy and Public AÅairs from

March 1989 to November 1995.

Peter Niculescu, 39, has been Senior Vice PresidentÌPortfolio Strategy since March 1999. Prior

to his employment with Fannie Mae, Mr. Niculescu was a Managing Director and Co-Head of Fixed

Income Research for Goldman Sachs. He joined Goldman Sachs in 1990 and held a variety of

positions including Managing DirectorÌMortgage Research, Vice PresidentÌMortgage Research and

Corporate Bond Strategist.

Thomas R. Nides, 38, has been Senior Vice PresidentÌHuman Resources since November 1997

and was Vice PresidentÌHuman Resources from May 1997 to November 1997. Mr. Nides was a

Principal with Morgan Stanley from April 1996 to April 1997. Mr. Nides was the Corporation's Vice

PresidentÌHousing Impact from January 1995 to April 1996. He was Chief of StaÅ to the United

B-81
States Trade Representative from May 1993 to December 1994 and Executive Assistant to the

Speaker of the House from May 1989 to May 1993.

Zach Oppenheimer, 39, has been Senior Vice PresidentÌNortheastern Regional OÇce since

November 1998. Mr. Oppenheimer was Vice PresidentÌMarketing in the Northeastern Regional

OÇce from April 1991 through November 1998.

Michael A. Quinn, 44, has been Senior Vice PresidentÌSingle Family Mortgage Business since

June 1998. He was Senior Vice PresidentÌCredit Loss Management from April 1994 to June 1998.

Mr. Quinn was Senior Vice President and Controller from March 1991 to April 1994.

Sampath Rajappa, 53, has been Senior Vice PresidentÌOperations Risk since November 1998.

Mr. Rajappa was Senior Vice President and Controller from April 1994 to November 1998.

Mr. Rajappa joined the Corporation in March 1994 as Corporate Controller. Prior thereto,

Mr. Rajappa was Senior Vice President and Controller for ITT Residential Capital Corporation, a

mortgage banking company, from August 1993 to February 1994.

Jayne J. Shontell, 44, has been Senior Vice PresidentÌInvestor Relations since February 1996.

Ms. Shontell was Senior Vice PresidentÌFinancial and Information Services from November 1992 to

February 1996.

Leanne Spencer, 43, has been Senior Vice President and Controller since November 1998. Ms.

Spencer was Vice PresidentÌFinancial Reporting from June 1993 to November 1998.

Michael Williams, 41, has been Senior Vice PresidentÌCustomer Technology Services since

February 1996. Mr. Williams was Senior Vice PresidentÌCustomer Applications and Technology

Integration from November 1993 to January 1996.

Barry Zigas, 47, has been Senior Vice President and Executive DirectorÌNational Housing

Impact Division since February 1996. Mr. Zigas was Senior Vice PresidentÌHousing Impact Policy

from November 1995 to January 1996, and Vice PresidentÌHousing Impact from June 1993 to

October 1995.

Additional Information

For information concerning executive compensation, stock ownership of management and

directors, certain transactions of executive oÇcers, and any person or group owning more than Ñve

percent of the voting stock of Fannie Mae, reference is made to Fannie Mae's proxy statement, dated

March 30, 1998 for the Corporation's 1998 annual meeting of stockholders and any later proxy

statement published prior to the Corporation's publication of a new Information Statement, which are

incorporated herein by this reference. The proxy statement for Fannie Mae's 1999 annual meeting of

stockholders will be available in April 1999.

Fannie Mae will provide without charge a copy of the Corporation's most recent proxy statement

to each person to whom this Information Statement has been delivered, upon the written or oral

request of such person. Requests for such copies should be directed to the oÇce speciÑed on page 2 of

this Information Statement.

ACCOUNTANTS

The Ñnancial statements of Fannie Mae as of December 31, 1998 and 1997 and for each of the

years in the three-year period ended December 31, 1998, included herein, 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.

B-82
®THIS PAGE INTENTIONALLY LEFT BLANK©
LE004L03/99
Neither we nor the Underwriter have authorized anyone to give any information or

to make any representation not contained

in this OÅering Circular. If given or made,

such information or representation must

not be relied upon as having been autho- 3,000,000 Shares rized by us or the Underwriter. Neither

delivery of this OÅering Circular nor any

sale of Preferred Stock shall under any

circumstances imply that there has been no

change in our aÅairs since the date of this

OÅering Circular or that the information

contained herein is correct as of any time

subsequent to the date of such information.

This OÅering Circular does not constitute

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 solicita- 5.10% Non-Cumulative

tion of an oÅer to buy the Preferred Stock Preferred Stock, Series E by or to any person in any jurisdiction or (stated value $50 per share)

in any circumstance in which such oÅer or

solicitation would be unlawful or not

authorized.

OFFERING CIRCULAR

TABLE OF CONTENTS

Page

Documents Incorporated by Reference 2

Available Information ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2

Summary of the OÅering ÏÏÏÏÏÏÏÏÏÏÏÏÏ 3 Bear, Stearns & Co. Inc.

Fannie Mae ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 5

Use of Proceeds ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 5

Capitalization ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 6

Selected Financial Information ÏÏÏÏÏÏÏÏ 7

Government Regulation and Charter

Act ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 8

Description of Preferred Stock ÏÏÏÏÏÏÏÏ 10

Legality of Investment ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 17

United States TaxationÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 18 April 8, 1999

Underwriting ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 21

Validity of the Preferred Stock ÏÏÏÏÏÏÏÏ 21

Appendix AÌ CertiÑcate of

Designation ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ A-1

Appendix BÌ Information Statement B-1