MDB-Analytiq

INSTITUTIONAL EQUITY RESEARCH July 22, 2003

New Coverage FANNIE MAE (FNM $65.32)

Industry: Financial Services Sector: Mortgage Finance

Recommendation: SELL Peter Conley* (310) 526-5006 pconley@mdbcapital.com

Price Target: $49.00 Al Kaschalk, CPA (310) 526-5025 akaschalk@mdbcapital.com

PLEASE READ THE DISCLOSURES AT THE END OF THIS REPORT FOR IMPORTANT REQUIRED INFORMATION INCLUDING
RISKS, ANALYST CERTIFICATION AND THE RELATIONSHIP BETWEEN MDB CAPITAL GROUP, LLC AND THE SUBJECT ISSUER.

INITIATING COVERAGE WITH A SELL RATING AND PRICE TARGET OF $49/SHARE.

Investment opinion reflects our cautious outlook around consensus estimates, declining profitability and efficiency
metrics and quality of earnings issues. Ongoing IRS investigation of synfuel tax credits not reflected in current
share price which appear fully priced trading at 9.5x/8.6x adjusted FY2003/2004 consensus diluted Core EPS of
$6.85/$7.60 net of synfuel tax credits. Price target of $49 assumes adjusted FY2005 diluted Core EPS of $7.20, a
PE multiple of 8x FY2005 achieved at the end of 2004 and applying a discount rate of 12%.

Summary of Investment Opinion and Risks:

• Declining long-term profitability, leverage and efficiency trends. Despite robust asset growth and
above trend 22% EPS growth over past 10 quarters, key long term profitability/efficiency metrics remain
below trend for same period.

Metric FY 2002 FY 2000 Change

Shareholder Equity ($ billion) $ 16.3 $ 20.8 $ (4.5)

Return of Assets 0.54% 0.69% -0.15%
Return of Capital 0.56% 0.72% -0.16%
Net Income/earned assets 0.55% 0.70% -0.15%
Loan reserves/loans 0.01% 0.03% -0.02%
Financial leverage 57.34% 35.83% 21.51%
Pre-tax margin 11.43% 13.57% -2.14%
Efficiency ratio 9.38% 14.49% -5.11%
Effective tax rate 23.63% 26.18% -2.55%

• Directional divergence between econometric forecasts and FNM guidance for 2003-2005
increases likelihood of further downward revisions.
Between 1995 and 2002, Fannie Mae grew assets from $316 billion to $887 billion (+16% CAGR) or
4.3x real GDP growth rate and 1.8x the growth rate of the overall US residential mortgage market.
The sustainability of this above-trend performance is now coming into sharp focus as investors seek
to understand the secular growth story. Recent Mortgage Bankers Association of America report
“Macroeconomic and Housing Finance Outlook 2003-2005”, authored by MBAA Chief Economist
Douglas Duncan released July 14, 2003 forecasts modestly increasing mortgage rates with 30Y FRM
at CY2003: 5.7%, CY2004: 6.1%, CY2005: 6.7%, maintaining +160-170 bps spread over the 10Y
treasury. Duncan and staff expect a concomitant sharp decline in mortgage volumes from 2003
“gold-rush” levels of $3.39 trillion to $1.94 trillion for CY2004 (-43.0%) and $1.46 trillion for

MDB Capital Group LLC • 401 Wilshire Blvd., Suite 1020 • Santa Monica, CA 90401 • 310-526-5000 • www.mdbcapital.com
 CY2005 (-25.0%), a -34.0% CAGR. This circumspect outlook from MBAA contrasts sharply with
FNM’s guidance on the Q2:03 earnings conference call characterizing the FY2004-2005 outlook to
be: “The company expects the residential mortgage market to between 8 and 10 percent per year
during the current decade (2003-2010). The company expects core EPS to return to a more
predictable growth path around or above its long-term expectation, which is somewhat faster than
the growth in residential mortgage debt outstanding”.

• Aggressive growth assumptions and unwarranted Street optimism/complacency reach

“tipping point”. Despite recent downward estimate revisions, current Thomson/First Call
consensus EPS estimates stand at $7.23/share and $8.02/share for FY2003/FY2004, respectively.
This +10.9% EPS growth YOY reflects many investors’ “glass half-full” psychology. Of the 22
analysts presently tracked by First Call, 16 analysts (73%) have a Buy Rating on FNM with price
target ranging from $90 - $100 per share. Six analysts have Hold ratings (27%) and none (0%) have a
Sell rating.

• Current IRS investigation of Section 29 synthetic fuel tax credits pose direct and collateral
risks difficult to quantify for FNM in terms of adequacy of accounting disclosure, increased
regulatory scrutiny, potential for adverse tax ruling and related cost of capital and
profitability impacts. We estimate contribution to Core Business Earnings from synfuel tax credits
for H1:03 to be approximately $0.19/share (5.2% of six months diluted EPS), up from an estimated
contribution to FY2002 diluted EPS of $0.29/share (4.5% full year). Since 1998, Section 29 tax
credits utilized by FNM are estimated to be in the range of $500 million to $1.0 billion through
participation in such SPEs such as Pace Carbon Fuels, LP. Pace Carbon is presently being audited by
the IRS for compliance with synthetic fuel tax credit issues addressed in IRS Announcement 2003-46
(www.irs.gov).

In summary, the scope and complexity of exogenous factors render prudent risk modeling a significant
challenge. On balance, investment risks outweigh rewards.

Key Investment Considerations:

• Adequacy of financial disclosure and earnings quality taking center stage. With a reported
Q2:03 EPS of $1.86, FNM achieved 28 consecutive quarters of sequential EPS growth since Q2:96.
We applaud this remarkable achievement and believe FNM may be one (if not the only one) of only a
few companies that can lay claim to such a stellar record. With revised guidance, EPS outlook is now
relatively flat over the next four-to-six quarters. However, we can’t help notice the correlation in the
slope of the effective corporate tax rate and the key profitability metrics. In reviewing financial
statement footnotes and tax disclosures, FNM has indicated that its tax credits have been
predominately Section 42 Low Income Housing Tax Credits. Recently, FNM disclosures have been
more forthcoming, i.e., “tax credits related to losses on certain affordable housing tax-advantaged
equity investments and other investment tax credits.”

• Headline risk dominates reward. From a risk/reward perspective, the stock reward (principally
price appreciation) appears to be well documented in the short-term. The bull case is predicated on a
historically PE multiple of 9.3x on consensus Core Business EPS estimate for FY03 of $7.20 per share
(PE was 9.2x in 1994 and a historical PE low of 7.9x in 1990), a history of increasing dividends and a
share buyback program (approximately 49 million shares remaining). However, we believe headline
risk will continue to dominate the financial picture for FNM over the next several quarters and serve to
focus investor attention to investment risk. Accordingly, we believe the scope and complexity of risk
factors surrounding FNM will result in a shift toward lower valuation multiples.
2
MDB Capital Group LLC • 401 Wilshire Blvd., Suite 1020 • Santa Monica, CA 90401 • 310-526-5000 • www.mdbcapital.com
 • Section 29 Synthetic Fuel Tax Credits. Since 1998, we estimate that FNM has utilized synthetic fuel
tax credits in the range of $500 million to $1.0 billion. While arguably modest in dollar terms relative to
FNM’s assets and operating income, the attendant lack of disclosure and transparency around this issue
bears understanding. On June 27, 2003, the Internal Revenue Service (IRS) announced (IRS
Announcement 2003-46) that they were reviewing the use of Section 29 Tax Credits and that they had
“suspended” the issuance of private letter rulings (PLR) pending the outcome of their investigation.
Specifically, the IRS statement says: “The IRS has reason to question the scientific validity of test
procedures and results that have been presented as evidence that fuel underwent a significant chemical
change.” A Section 29 tax credit is earned through the production of synthetic fuel and is from a 1980
law signed by then President Jimmy Carter aimed at reducing dependence on imported oil.

Investors may be aware of the economic risks the current IRS investigation holds for companies
primarily in the utility industry. Over the past four weeks, a number of utilities have filed Form 8-K
disclosures revising financial guidance and quantifying the potential impact from the current IRS
proceedings. A partial list of recent corporate disclosures is included in the table below and illustrates
synthetic fuel tax credits estimated contribution to 2004 EPS.

ND = Not disclosed.
Generated Tax Est. EPS % of Total
Company Symbol Price Yield Credits ($MM) (1) benefit (2) 2004 EPS (9) EPS
Fannie Mae FNM $ 65.32 2.8% 1,282 $ 0.420 (8) $ 8.02 5.2%
Progress Energy PGN 40.96 5.5% 950 0.700 (6) 3.84 18.2%
TECO Energy, Inc. TE 11.90 6.4% 250 0.057 (3) 0.97 5.9%
PPL Corporation PPL 40.72 3.8% 120 0.150 (4) 3.75 4.0%
Vectren Corporation VVC 22.73 4.8% 25 0.170 (9) 1.86 9.1%
Marriott International MAR 38.22 0.8% ND 0.110 (5) 2.07 5.3%
DTE Energy DTE 36.79 5.6% ND 1.070 (7) 3.74 28.6%

Prices as of closing on July 21, 2003.

1. Total synthetic fuel tax credits earned/generated from the sale of synthetic fuels.
2. Estimated EPS benefit based on net synthetic fuel tax credits available (generated less used).
3. Per July 3, 2003 press release, $10.0 million of tax credits used in Q1:03 net income or $0.057/share.
assuming 175.9 million of diluted common shares. Company reported EPS of $0.01 in Q1:03.
4. PPL estimates that tax credit faciltiy estimated to add $0.15/share per year through 2007.
5. Marriott's synthetic fuel business resulted in $159.0 millin of tax credits for 2002 and added $0.11 per share to profit.
The company recently announced that it sold 50% of its stake in the business.
6. Through 3/31/03, PGN had generated $950 million in tax credits, of which $503 million have
been carried forward ($447 million used). Estimated 240.0 million shares outstanding.
7. In 2002, DTE used approximatley $180 million of tax credits. DTE has approximately 168 million sshares outstanding.
8. Based on first half of 2003 percentage of EPS attributable to synthetic fuel tax credits.
9. Estimated based on net income contribution in 2004 of $12 million from synfuel tax credits on 68 million of common shares.
10. Consensus EPS estimates for 2004 per I/B/E/S Earnings Estimates..

3
MDB Capital Group LLC • 401 Wilshire Blvd., Suite 1020 • Santa Monica, CA 90401 • 310-526-5000 • www.mdbcapital.com
The following Summary Analysis of Tax Credits of FNM covering the period of 1998 – 2003 is depicted below.

FANNIE MAE
Summary Analysis of Tax Credits
For the period 1998-2003

Fiscal Year

($ in Millions, except per share data) 1998 1999 2000 2001 2002 H1: 2003 Total (22 Qtrs)

Total Taxable Income $ 4,606 $ 6,265 $ 6,031 $ 7,767 $ 6,048 $ 4,012 $ 34,728
Statutory Tax Liability (1) $ 1,612 # $ 2,193 # $ 2,111 # $ 2,718 # $ 2,117 # $ 1,404 # $ 12,155
Total Taxes Paid 1,187 1,514 1,583 2,041 1,429 970 8,724
Difference between Statutory Tax Liability & Federal Taxes paid $ 425 $ 679 $ 528 $ 677 $ 688 $ 434 $ 3,431
Effective Tax Rate (2) 25.8% 24.2% 26.2% 26.3% 23.6% 24.2%

Composition of Difference between Statutory Tax Liability & Taxes Paid:

Tax-Exempt Interest & Dividend Received Deductions (3) $ 216 # $ 294 # $ 302 # $ 311 # $ 302 # $ 189 # $ 1,614
Equity Investments in Affordable Housing Projects (3),(4),(5) 208 # 384 # 226 # 367 # 385 # 246 # 1,817
Total Adjustments to Statutory Tax Liability $ 425 # $ 679 # $ 528 # $ 677 # $ 688 # $ 434 # $ 3,431
Fannie Mae Section 42 Tax Credit Ceiling:
Section 42 Tax Credit Statutory Annual Ceiling (6) $ 380 $ 380 $ 380 $ 380 $ 400 $ 220 $ 2,140
Fannie Mae Market share Section 42 Tax Credits (7) 25% 25% 25% 25% 25% 25% 25%
Maximum Annual Fannie Mae Section 42 Tax Credits (in $) $ 95 $ 95 $ 95 $ 95 $ 100 $ 55 $ 535

Imputed Section 29 Synthetic Fuel Tax Credits (8) $ 113 # $ 289 # $ 131 # $ 272 # $ 285 # $ 191 # $ 1,282

Diluted Shares Outstanding 1,037.4 1,030.7 1,009.2 1,006.3 997.1 986.5 1,011.2
Section 29 Impact on a Diluted Share Basis $ 0.11 $ 0.28 $ 0.13 $ 0.27 $ 0.29 $ 0.19 $ 1.27

Reported Diluted "Core EPS" (9) $ 3.23 $ 3.72 $ 4.29 $ 5.72 $ 6.31 $ 3.70 $ 26.97

Estimated % of Reported "Core EPS" from Section 29 Tax Credits 3.4% 7.5% 3.0% 4.7% 4.5% 5.2% 4.7%

Footnote Explanations:

1. Tax liability assuming federal statutory tax rate of 35%.

2. Effective tax rate calculated as the period's actual taxes paid divided by period's taxable income.
3. Per FY 2002 Form 10-K, Note 6 to the Financial Statements. For years 1998-1999, see Footnote 5.
4. Per Tax Reform Act of 1986 - Section 42 Low Income Housing Tax Credits.
5. For years 1998-1999, FNM disclosed that Investment Tax Credits related to "Equity Investments in Affordable Housing Projects. Per Form 8-K Current Report dated April 15, 2003, FNM disclosed per
Footnote 8 that such Investment Tax Credits include "Equity Investments in Affordable Housing Projects and "Other Investment Tax Credits."
6. Per the 2003 Federal Budget OMB.
7. Per Company reports.
8. Implied Section 29 Synthetic Fuel Tax Credits calculated as "Equity Investments in Afford. Housing Projects" less "Maximum Annual Fannie Mae Section 42 Tax Credits."
9. EPS reported per Fannie Mae 10-K for periods noted.

As the outcome of the IRS investigation remains to be seen, it is our view companies that utilized synthetic
fuel tax credits bear exposure to a potential adverse tax ruling to include PLR revocation, thereby impacting
future tax credit utilization as well as the possibility of the revocation of previously utilized tax credits. In the
interim, investors have begun to normalize EPS, PE multiples and price targets to reflect net income on a
“net of tax credit” basis. In addition, credit rating agencies, notably Standard & Poor’s, have announced they
are following developments closely for credit implications. Of particular concern to us is the possibility,
albeit remote, of tax credit revocation for FNM. In analyzing collateral risks, investors should seek to
understand FNM’s Enterprise Minimum Capital Requirements published by OFHEO on June 30, 2003. At
March 31, 2003, FNM’s core capital was $29.5 billion and exceeded FNM’s minimum capital requirement of
$28.3 billion by $1.3 billon. This excess of $1.3 billion compares with a historical aggregate utilization of $1.0
billion in synfuel tax credits.

4
MDB Capital Group LLC • 401 Wilshire Blvd., Suite 1020 • Santa Monica, CA 90401 • 310-526-5000 • www.mdbcapital.com
UPDATE:
Fannie Accounting Probes Turn Up New, Pervasive Errors

Wednesday September 28, 2005 9:15 PM EDT

(Updates with new information about Fannie's stock price and regulatory capital and comments
from the Treasury Department.)

By Dawn Kopecki
Of DOW JONES NEWSWIRES

WASHINGTON -(Dow Jones)- Investigators combing through Fannie Mae's (FNM) finances
have found new and pervasive accounting violations showing executives embellished the
company's earnings over the years by overvaluing its assets, underreporting credit losses and
misusing tax credits - on top of what's already been disclosed, according to people close to or
who have been involved in the inquiries.

The company's stock fell by 10.7% - its single largest daily percentage drop since the stock
market crash of 1987 - after the new findings were reported on this newswire Thursday afternoon.

Several of these people examining Fannie's books also said evidence indicates the company
purchased so-called finite insurance policies to hide earnings losses after they were incurred. That
is one of several other issues that have surfaced as problematic in recent months. Securities
regulators, including New York State Attorney General Eliot Spitzer, are cracking down on
corporations they say bolstered earnings by using abusive financial reinsurance policies that are
more akin to loans where little or no risk is transferred to the insurer.

These people said Fannie's accounting problems uncovered thus far stand in stark contrast to
those found at fellow government-sponsored enterprise Freddie Mac (FRE), whose earnings
restatement in 2003 showed the company deferred roughly $5.3 billion in excess, after-tax profits
to future quarters. The GSEs - which buy mortgages, guarantee their payment and bundle them as
securities that are sold off or held in portfolio - own or guarantee nearly half of the $8 trillion
residential mortgage market. Their accounting scandals, however, have left the companies
vulnerable to increasing criticism in Washington where lawmakers are considering legislation to
rein in the home financing giants.

At Fannie, much of the company's accounting violations have helped them to conceal losses over
the years, rather than delay gains, according to these people. In addition, they said Fannie's
restatement is likely to show that its total cumulative losses will be higher and will include more
"realized" losses, as opposed to paper losses, than the company has previously disclosed and
many investors anticipate. That's attributed, at least in part, to new evidence that Fannie has
artificially pumped up the underlying value of its $768 billion mortgage portfolio and other
investments - compounding the size of the errors that need to be corrected. Unlike Freddie, the
real economic losses at Fannie won't be offset by corresponding gains in future quarters, in part,
because the underlying value of their assets was inflated, these people said.

1
Fannie Mae (FNM) officials declined to comment on specific accounting issues raised in this
story. Fannie's stock closed down $4.99 on heavy trading Thursday at $ 41.71 a share. By
comparison, the company's share price dropped 16.3%, or $4.40 a share, on Black Monday.
Fannie's shares are at their lowest level since July 1997, and are down 41% this year.

The company's board of directors initiated its own review of Fannie's finances last year after the
Office of Federal Housing Enterprise Oversight, in a scathing report delivered to the board 12
months ago, accused executives of manipulating accounting rules. Fannie vehemently defended
its accounting until the Securities and Exchange Commission sided with OFHEO last December
and directed the company to correct errors in its application of two rules under generally accepted
accounting principles or GAAP. Fannie began its multiyear earnings restatement and ousted
former Chief Executive Franklin Raines and Chief Financial Officer Timothy Howard shortly
thereafter.

In addition to the board's internal review, which is targeted for completion before the end of this
year, OFHEO, the SEC, Justice Department, Internal Revenue Service and Labor Department are
conducting their own separate Fannie probes.

A U.S. Treasury spokeswoman repeated the Bush administration's call to rein in Fannie and
Freddie. "Treasury does not participate in any individual enforcement actions that may or may not
be undertaken by OFHEO or the SEC. However, the administration has long called for stronger
oversight of the GSEs," she said.

OFHEO spokeswoman Stefanie Mullin would not comment on any aspects of its examination.
She said the regulator expects to issue its final report on the matter by March 31, 2006.

The regulator, however, said both Fannie and Freddie had adequate regulatory capital on hand as
of June 30 and that it believes Fannie successfully raised a targeted 30% surplus over its
minimum requirement, based on Fannie's current best estimates that have been "certified and
represented" by its management. OFHEO imposed the extra capital surcharge, among other
things, as part of a remedial plan Fannie's board agreed to a year ago Tuesday. OFHEO said
Fannie's $ 5.9 billion surplus "is sufficient to absorb uncertainties in the estimated impact to
capital of the accounting errors, based on current information."

At the same time, the regulator stressed that Fannie's capital assessment - which was released a
few days earlier than expected - could change "as additional information becomes available, such
as Fannie Mae's (FNM) certification of its financial statements; and OFHEO's completion of its
special examination of accounting policies and practices at the company."

Restatement Estimates Subject To Change

The company acknowledged earlier this year that it violated GAAP in recording its derivatives
and a few other transactions, estimating a possible cumulative after-tax loss for the restatement
period from 2001 through mid-2004 of as much as $10.8 billion based on the company's finances
as of Dec. 31. Given the vast volume of data and transactions that need to be reviewed and
revalued, Fannie hasn't updated that estimate as it works through the restatement process - which
isn't expected to be completed until the second half of 2006.

The company has, in fact, warned investors that the 2004 numbers it used to calculate its original
restatement estimates can no longer be relied upon and that the final tally is subject to change.

2
Fannie also told investors last month that it continues to be plagued by poor internal controls
given the "magnitude of material weaknesses that currently exist" and that management is "likely
to conclude" that its financial reporting will also be "ineffective" for 2005.

Chief Executive Daniel Mudd, when asked last week whether the losses from Fannie's
restatement could be higher than previously estimated, told Dow Jones Newswires, "we are
current on all of our disclosures."

Fannie Mae (FNM) spokesman Chuck Greener said in a statement that the company's August 9
SEC filing "provided our most recent update regarding the status of accounting issues under
review and the estimated impact of the most significant items affecting restated earnings. We will
continue to provide updates through our regulatory filings as issues are identified and resolved."

Securities attorney John Coffee, director of Columbia Law School's Center on Corporate
Governance, said Fannie's most recent investor disclosures in early August gives the company
"some legal cover," even if the final restatement significantly differs from prior estimates.

Fannie "gave the markets and investors no reason to expect a specific number and let them know
that everything could change," he said. "The August 9 statement would not allow a reasonable
investor to rely upon the previous estimates...when everything is up for grabs."

Company officials have made it clear that they expect to revise previous estimates as new issues
are identified and resolved.

GAAP Violations Found In Credit Losses

The way Fannie booked its credit losses and certain tax credits have both emerged in recent
months as new, and potentially big, problems for the company, according to the people who have
been involved with or are close to the investigations.

Historically, Fannie's exceptionally low losses on the mortgages it guaranteed gave the company
bragging rights on Wall Street and positioned it as an industry leader in credit risk management.

Former CFO Howard boasted in a March 2004 investor speech that Fannie's credit losses had
fallen by more than half since 1990 while its credit book of business grew by roughly five times.
"These are truly remarkable numbers," he said, noting that Fannie's 2003 credit losses were just
over half a basis point, or less than one-tenth of a percentage point, and were "less than 1/20th of
the average losses reported for commercial banks." He continued, "our credit risk management
success is not an accident. It stems from our disciplined approach to the business."

OFHEO, however, disagreed and forced the company in May 2004 to recalculate its credit losses
on a small portion of its total investments - $8 billion of securities backed by manufactured-
housing loans and $300 million of securities backed by aircraft leases. Fannie took a $278.2
million earnings charge during the second quarter of 2004 as a result and said it would record
another $353 million in unrealized losses on its balance sheet over several future quarters to
correct the accounting errors. The company hasn't filed an earnings statement since.

Investigators have since unearthed widespread problems and GAAP violations in how Fannie's
been reporting its credit losses that run much deeper and affect a far greater proportion of the
company's assets than previously believed, according to these people.

3
Tax Credits Scrutinized

(MORE TO FOLLOW) Dow Jones Newswires

09-28-05 2115ET

Investigators have additionally discovered accounting violations with the tax credits Fannie uses
to lower its annual tab with the IRS, according to people who are close to or have been involved
with the investigations. Fannie reduced its corporate-tax rate in 2003 from a statutory minimum
of 35% to an effective rate of 26% by recording tax savings of $988 million in tax credits and
another $479 million from its tax-exempt investments, according to its year-end earnings
disclosure. The company further reduced its corporate-tax rate during the first six months of last
year to 22%, attributing the drop to an increase in its affordable housing tax credits. It recorded
$561 million in tax credits and another $238 million in tax savings from its tax-exempt
investments during the first six months of 2004.

These people say Fannie specifically violated GAAP in using a controversial and lucrative tax
credit it collected as a minor investor in the synthetic fuel industry. The IRS has been conducting
a broad review over the last two years of U.S. companies using the so-called synfuel tax credit -
which was designed to promote alternative fuel production but is widely regarded as a
boondoggle for coal producers. Fannie Mae (FNM) declined to comment on the issue.

In 2003, Fannie Mae (FNM) officials told Dow Jones the company's synfuel tax credits were
minimal and boosted 2002 earnings of $4.53 per share by just over a penny. At the time, the
credits had increased Fannie's earnings per share cumulatively since 1998 by about five cents,
company officials said at the time, declining to elaborate.

Fannie's other tax credits, specifically those tied to its low-income housing investments, are also
under intense scrutiny by investigators, according to these people. The company has disclosed in
the past that it might have to change its accounting for its tax-advantaged investments, which are
primarily ownership stakes in low-income housing tax credit partnerships. Some of those
partnerships, Fannie said, had a "guaranteed economic return from investment grade
counterparties."

Though unlikely, the company said its "maximum exposure to loss" from its low- income housing
tax credit partnerships included its equity investment of $4.7 billion as of June 30, 2004 "plus the
risk of recapture of tax credits previously recognized on these investments" if it was forced to
change that accounting.

The company didn't disclose the amount of tax credits at stake. But Fannie recorded $141 million
of tax "benefits" in 2003 and $214 million in 2002 from its tax-advantaged investments. Those
benefits, which company officials in 2003 said included both synfuel and low-income housing
credits, totaled $967 million from 1997 through 2003, according to Fannie's annual reports.

-By Dawn Kopecki, Dow Jones Newswires; 202-862-6637; Dawn.Kopecki@dowjones.com

(END) Dow Jones Newswires

09-28-05 2115ET
Copyright (c) 2005 Dow Jones & Company, Inc. All Rights Reserved.

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WSJ.com - Fannie Mae Says It Used Tax Credit IRS Is Reviewing Page 1 of 4

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Fannie Mae Says It Used

Tax Credit IRS Is Reviewing advertisement

By DAWN KOPECKI
DOW JONES NEWSWIRES

WASHINGTON -- Fannie Mae acknowledged that it used a tax credit being

ADVERTISEMENTS scrutinized by the Internal Revenue Service, handing more ammunition to critics bent
on toughening federal oversight of the huge mortgage company.
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Add to Personalized fuel ventures to take advantage of the now-disputed credit. The company wouldn't
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along with some low-income housing tax credits -- as "tax-advantaged investments"
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accounting problems. Fannie and Freddie both are under pressure from lawmakers,
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companies, which were created decades ago to buy home loans from banks to boost
the U.S. mortgage market. To accomplish their mission, they are given numerous
advantages, including exemptions from state and local -- but not federal -- taxes. In
return, the companies are supposed to confine their operations to the mortgage
Today In: business.

Fannie Mae isn't the only entity that sought to take advantage of the credit, which is
given to companies that invest in synthetic-fuel production. Scores of utility and

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@ Your Service manufacturing companies have warned investors in recent weeks that they could lose
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FREE report! Get your in formal guidance in late June. The IRS launched an official investigation at that time
Stock Market Outlook. to determine whether the tax credit is being abused, questioning the scientific validity
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of the procedures and tests used in making synthetic fuels.
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Trade 5 Free @ Lind- Fannie Mae officials said its synfuel tax credits are minimal, boosting 2002 earnings
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www.theplayers.tv "These investments are nonmaterial contributors to Fannie Mae's performance," said
spokeswoman Janice Daue. "The information contained in their report was materially
false, it was not based on information provided by Fannie Mae."

Fannie's annual report said it reduced its corporate-tax rate from a statutory minimum
of 35% to an effective rate of 24% last year by recording $214 million of benefits from
its "tax-advantaged investments." Those benefits, which company officials said
include both synfuel and low-income housing credits, totaled $665 million from 1998
through 2002.

MDB's Director of Equity Research, Peter Conley, said Fannie refused to provide the
data itself but he believes his analysis is accurate. Mr. Conley said he extrapolated the
numbers from Fannie's reported income-tax information, statutory limits on Fannie's
low-income tax credits and information provided by other investors in synthetic fuel.

Write to Dawn Kopecki at dawn.kopecki@dowjones.com

COMPANIES
Dow Jones, Reuters
Updated August 13, 2003

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Rep. Baker Questions Fannie Synthetic Fuel Investment - Aug. 13, 2003 Page 1 of 3

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Rep. Baker Questions

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Fannie Synthetic Fuel
Home Investment
August 13, 2003: 11:40 a.m. EST
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WASHINGTON -(Dow Jones)- Rep. Richard Baker, R-La., questioned
CEO of the week
Wednesday the appropriateness of an investment Fannie Mae
Company Research
(FNM) made in the alternative fuels industry given the company's
Deals federally mandated mission to boost the U.S. housing market.
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Financial News in Fannie Mae officials confirmed this week that the company made a
Brief
"small" investment in 1998 in three synthetic fuel limited
Funny Money
partnerships to take advantage of a corporate tax credit which is
Industry Watch now under review by the Internal Revenue Service. The company
Special Reports and fellow government-sponsored enterprise, or GSE, Freddie Mac
(FRE) were chartered by Congress and given special federal perks
Economy to aid in their mission to lower borrowing costs for would-be
World Biz homeowners.
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"This disclosure raises the very troubling question of just how
Commentary
investing in alternative fuel helps Fannie accomplish its
Your Money government-chartered mission of creating homeownership
Mutual Funds opportunities for low-income families," Baker told Dow Jones
Newswires in a statement. A spokesman for Freddie Mac said
Money 101 Freddie has never invested in the synthetic fuel industry.
Portfolio
Calculators Fannie and Freddie's federal charters limit their activities to the
secondary mortgage markets, where they purchases home loans
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and repackages them as securities. But Fannie Mae officials said its
charter also gives the company " general investment powers" to
carry out its mission.
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"These investments are well within our charter authority," Fannie
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Mae spokesman Chuck Greener said in a statement.
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The issue came to light after Santa Monica-based research firm
Find a Mortgage MDB-Analytiq initiated last month coverage on the company with a
rare "sell" rating, noting as key concerns the lack of disclosure
about the credits and their potential impact on earnings if revoked.

A Fannie Mae official, however, said the investment and its benefits
are minimal, although she would not divulge details of the financial
SPECIAL OFFER arrangement. The little-known investments are disclosed--along
with Fannie's low-income housing tax credits--as "tax-advantaged
investments" under "other income" in its financial reports.

"The effects of these tax-advantaged investments are reflected in

our financial statements as filed with the (Securities and Exchange

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Rep. Baker Questions Fannie Synthetic Fuel Investment - Aug. 13, 2003 Page 2 of 3

Commission) in our 10Ks and 10Qs and prepared in accordance

with (generally accepted accounting principles)," Greener said.

"Other tax-advantaged investments, including the (synfuel) credits,

preferred stock, and municipal bond income, only contributed 4%
to the difference between our effective and statutory tax rates," he
said.

Name The investments are drawing criticism in light of recent problems at

Freddie, which is under federal investigation for a series of
Address 1 accounting infractions. Fannie's stock dropped by more than $2 a
share in late-morning trading on news of the tax credit and the
announcement that one of its measures of interest rate risk
Address 2
widened sharply in July. The stock, which closed Tuesday at $63.60
a share, was at $62.28 a share in midday trading.
City

Fannie and Freddie both are under pressure from lawmakers, who
State/Province are weighing a number of bills that would increase federal oversight
-- over the two companies.
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"I can't think of a better example of why serious reform is needed
E-mail to closely monitor Fannie and Freddie's mission compliance," said
Rep. Baker, who chairs the House Financial Services subcommittee
that oversees the companies and is the chief architect of a House
bill that would move their regulator into the U.S. Treasury
Department. Treasury Secretary John Snow is scheduled to largely
Privacy Policy endorse such plans in testimony before the full committee Sept. 10.

In 1999, the most recent year for which data is available, U.S.
corporations claimed about $887 million in synfuel tax credits with
financial companies using about $137 million of that--mostly
through limited partnerships similar to Fannie Mae's investments.
Analysts estimate that U.S. corporations now claim closer to $3
billion annually in synfuel tax credits.

Tax credits are more valuable to companies than tax deductions

because credits actually reduce taxes paid--dollar for dollar.

The IRS launched an official investigation in June to determine

whether the tax credit is being abused, questioning the scientific
validity of the procedures and tests used in making synthetic fuels.

MDB estimates that Fannie Mae's synfuels' interests have produced

anywhere from $500 million to $1.2 billion in actual earnings since
Fannie's initial investment in 1998--numbers the company
disputes.

Fannie Mae officials said the company's synfuel tax credits are
minimal, boosting 2002 earnings of $4.53 per share by just over a
penny. The synfuel tax credits have increased EPS cumulatively
since 1998 by about 5 cents, they said, declining to elaborate.

"These investments are nonmaterial contributors to Fannie Mae's

performance," said Fannie Mae spokesperson said. "The information
contained in their report was materially false, it was not based on
information provided by Fannie Mae."

Fannie's annual report said it reduced its corporate tax rate from a
statutory minimum of 35% to an effective rate of 24% last year by
recording $214 million in benefits from its "tax-advantaged

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Rep. Baker Questions Fannie Synthetic Fuel Investment - Aug. 13, 2003 Page 3 of 3

investments." Fannie officials said 96% of the difference between

the statutory federal tax rate and the effective tax rate were due to
mortgage revenue bonds and low-income housing credits.

-By Dawn Kopecki, Dow Jones Newswires; 202-862-6637;

Dawn.Kopecki@dowjones.com

Dow Jones Newswires 08-13-03 1540ET Copyright (C) 2003 Dow

Jones & Company, Inc. All Rights Reserved.

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