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FNM Finer Point

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Finally after a lot of emails from Minyans we are getting to the bottom of the problem of the drop in the AOCI component of capital. The problem, in my opinion, is even worse.

A Minyan writes, "Overall shareholder's equity did decline by $1 billion. This decline was attributed to income of $2 billion less comprehensive income declines of $3 billion (comprised of a decline in unrealized gains of $1.5 billion and net hedging activity of $1.5 billion). So the way I see it (and us), FNM did have a decline in capital."

The income that was reported on the income statement did not include the costs of hedging their duration risk nor their derivative activity; it was buried in the balance sheet. Apparently GSE reporting requires only that the income statement reflect changes in the time value of derivatives and not the fair value.

Our interpretation is that FNM made $500 million net of their dynamic hedging activity. But in addition to this dynamic hedging (buying and selling bonds to adjust their duration risk), they also purchase various derivatives as part of their overall hedging activity. These derivatives were written down by $1.5 billion for the quarter to reflect fair value.

So overall there was a decline in shareholder's equity and therefore a loss for the quarter.

It seems that form takes precedence over substance here. If we are wrong, we welcome a rebuttal from the company or anyone else. Again, not advice--just trying to help educate.

Position in FNM

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