Current Capital Classification
On October 9, 2008, FHFA announced that it will not issue quarterly capital classifications during the conservatorship. FHFA also announced that we were classified as “undercapitalized” as of June 30, 2008 (the most recent date for which results have been published by FHFA). FHFA determined that, as of June 30, 2008, our core capital exceeded our statutory minimum capital requirement by $14.3 billion, or 43.9%, and our total capital exceeded our statutory risk-based capital requirement by $19.3 billion, or 53.1%. Under the Regulatory Reform Act, however, FHFA has the authority to make a discretionary downgrade of our capital adequacy classification should certain safety and soundness conditions arise that could impact future capital adequacy. Accordingly, although the amount of capital we held as of June 30, 2008 was sufficient to meet our statutory and regulatory capital requirements, FHFA downgraded our capital classification to “undercapitalized” based on its discretionary authority provided in the Regulatory Reform Act and events that occurred subsequent to June 30, 2008. FHFA cited the following factors as supporting its decision:
|•||Accelerating safety and soundness weaknesses, especially with regard to credit risk, earnings outlook and capitalization;|
|•||Continued and substantial deterioration in equity, debt and MBS market conditions;|
|•||Our current and projected financial performance and condition, as reflected in our second quarter financial report and our ongoing examination by FHFA;|
|•||Our inability to raise capital or to issue debt according to normal practices and prices;|
|•||Our critical importance in supporting the country’s residential mortgage market; and|
|•||Concerns that a growing proportion of our statutory core capital consisted of intangible assets.|
Under the Regulatory Reform Act, a capital classification of “undercapitalized” requires us to submit a capital restoration plan and imposes certain restrictions on our asset growth and ability to make capital distributions. FHFA may also take various discretionary actions with respect to an enterprise that is classified as undercapitalized, including requiring the enterprise to acquire new capital. FHFA has advised us that, because we are under conservatorship, we will not be subject to these corrective action requirements.
Regulatory Capital Requirements
On October 9, 2008, FHFA announced that our existing statutory and FHFA-directed regulatory capital requirements will not be binding during the conservatorship. FHFA has directed us, during the time we are under conservatorship, to focus on managing to a positive stockholders’ equity while returning to long-term profitability.
As noted above, FHFA also announced on October 9, 2008 that it will not issue quarterly capital classifications during the conservatorship. We will continue to submit capital reports to FHFA during the conservatorship and FHFA will continue to closely monitor our capital levels. Our minimum capital requirement, core capital and GAAP net worth will continue to be reported in our periodic reports onForm 10-Q and Form 10-K, as well as on FHFA’s website. FHFA has stated that it does not intend to report our critical capital, risk-based capital or subordinated debt levels during the conservatorship.
Pursuant to its new authority under the Regulatory Reform Act, FHFA has announced that it will be revising our minimum capital and risk-based capital requirements.
Table 39 displays our regulatory capital classification measures as of September 30, 2008 and December 31, 2007.
Table 39: Regulatory Capital Measures
|September 30,||December 31,|
|(Dollars in millions)|
Core capital (2)
Statutory minimum capital (3)
Surplus (deficit) of core capital over statutory minimum capital
Surplus (deficit) of core capital percentage over statutory minimum capital
|(1)||Amounts as of September 30, 2008 represent estimates that have not been submitted to FHFA. Amounts as of December 31, 2007 represent FHFA’s announced capital classification measures.|
|(2)||The sum of (a) the stated value of our outstanding common stock (common stock less treasury stock); (b) the stated value of our outstanding non-cumulative perpetual preferred stock; (c) our paid-in capital; and (d) our retained earnings. Core capital excludes accumulated other comprehensive income (loss).|
|(3)||Generally, the sum of (a) 2.50% of on-balance sheet assets; (b) 0.45% of the unpaid principal balance of outstanding Fannie Mae MBS held by third parties; and (c) up to 0.45% of other off-balance sheet obligations, which may be adjusted by the Director of FHFA under certain circumstances (See 12 CFR 1750.4 for existing adjustments made by the Director).|
As of September 30, 2008, our core capital was $16.4 billion below our statutory minimum capital requirement; however, as described above, our capital requirements are suspended during the conservatorship. The reduction in our core capital compared to the previous quarter was primarily due to the non-cash charge of $21.4 billion during the third quarter of 2008 relating to our establishment of a valuation allowance with respect to a portion of our deferred tax assets.
Capital Management Actions
Prior to our entry into conservatorship on September 6, 2008, we took a number of management actions during 2008 to preserve and further build our capital, including:
|•||issuing $7.4 billion in equity securities;|
|•||managing the size of our investment portfolio;|
|•||selling assets to reduce the amount of capital that we were required to hold and to realize investment gains;|
|•||reducing our common stock dividend;|
|•||electing not to purchase mortgage assets;|
|•||slowing the growth of our guaranty business;|
|•||increasing our guaranty fee pricing on new acquisitions;|
|•||evaluating our costs and expenses with the expectation to reduce administrative costs; and|
|•||applying other changes to our business practices to reduce our losses and expenses during the period.|
As described above, following our entry into conservatorship, FHFA has advised us to focus our capital management efforts on maintaining a positive stockholders’ equity while returning to long-term profitability. As a result of this change in the focus of our capital management efforts and an increased focus on serving our mission since our entry into conservatorship, we have discontinued or reversed most of the capital management strategies described above.
As of September 30, 2008, we had stockholders’ equity of $9.3 billion, compared to $44.0 billion as of December 31, 2007. Our stockholders’ equity has decreased substantially since December 31, 2007 primarily due to our net loss of $33.5 billion for the nine months ended September 30, 2008. The primary driver of our net loss for the period was a non-cash charge of $21.4 billion in the third quarter of 2008 relating to our establishment of a valuation allowance with respect to a portion of our deferred tax assets. This charge and the other drivers of our net loss for the first nine months of 2008 are described in “Consolidated Results of Operations.” Approximately 50% of our stockholders’ equity as of September 30, 2008 consisted of our remaining deferred tax assets, which could be subject to a further valuation allowance in the future. In addition, the widening of spreads that occurred in October 2008 resulted in mark-to-market losses on our investment securities that have decreased our stockholders’ equity since September 30, 2008.
Our ability to manage our stockholders’ equity is very limited. In order to help maintain a positive stockholders’ equity, we have modified our hedging strategy, as described in “Consolidated Results of Operations.” We are effectively unable to raise equity capital from private sources at this time. Accordingly, if we cannot maintain a positive stockholders’ equity, we may need to draw on Treasury’s funding commitment under the senior preferred stock purchase agreement in order to avoid a mandatory trigger of receivership under the Regulatory Reform Act.