mama 2001 M Steet, NW ‘Telephone 202 633 2000, Washington, DC 20006 Fax 202 833 8500 November 24, 2004 Mr. John James Professional Accounting Fellow Office of the Chief Accountant U.S. Securities and Exchange Commission 450 Fifth Street, NW ‘Washington, DC 20549-0801 RE: Follow-up Issues Related to Accounting for Hedging Activities Dear Mr. James: This letter is in response to your conversation on November 18° where you asked representatives of Fannie Mae (the Company) several follow-up questions related to the Company's letter on FAS 133 that the Company submitted to the SEC on October 19, 2004 (the “FAS 133 Letter”) and the Company's presentation to the SEC staff on November S, 2004. During conversation you requested KPMG to provide you with some additional information from our work papers for the relevant periods, Set out below is the request you have made and our response, We hope the information provided is responsive but if you have any additional questions or need clarification to our response please give me a call at (212) 909 $573. Question L: Show KPMG's analysis regarding the hedged ineffectiveness amounts in 2001- Present and the determination that these were inconsequential. What were the passed review and audit differences? ining in 1999 and through 2001 KPMG was involved in the Company's implementation of SFAS 133. As part of this process, KPMG reviewed the Company's Hedge Accounting Policy Manual (referred to by the Company as the Derivative Accounting Guide). In addition, KPMG reviewed the 67 individual strategies identified in the Hedge Accounting Policy Manual and determined that the accounting treatment for the transactions in the manual was reasonable. During this implementation process the Company analyzed and concluded, and KPMG concurred, that if key terms of the hedging instrument and the hedged item matched then the relationship would be highly effective and there would be no or inconsequential resulting ineffectiveness. (See Exhibit A) In addition, as part of the implementation process, KPMG reviewed the hedge accounting system (referred to by the Company as the SFAS 133 Accounting System) to ensure that the system was appropriately classifying derivatives as either cash flow or fair value hedges or derivatives that do not qualify for hedge accounting. KPMG's computer audit specialists reviewed the functionality and system controls surrounding the hedge accounting system and determined that the system/logic controls were consistent with the Company's Hedge Accounting Policy Manual, (See Exhibit A-1) KPMG monitored hedge effectiveness by reviewing and testing, on an annual basis that the system continued to appropriately identify as hedging relationships, only those where key terms match. Because we had previously concluded there would be no or inconsequential resulting ‘Tha Documents Ar Te Proper KPMG LLP And Are Fred To The ‘SEC For The Sle Ue Ore SEC Aud Sata Adenasve (Coracy, KPMG LLP Ragu Tan Te Deere Be esied annn nswgeermsmmars ee KPMG OCA005( KPMG-SEC-1296735 Confidential treatment requested by KPMG LLP ePMGion 010514 CONFIDENTIALan ineffectiveness no review ot audit differences were posted for any interim or annual periods during 2001, 2002 or 2003. (See Exhibit B) KPMG also reviewed annual analyses prepared by the Company summarizing the ineffectiveness that occurs as a result of differences in reset dates by plus or minus 7 days as well as the duration matching. KPMG reviewed these and concluded that any ineffectiveness from these were inconsequential and below our minimum posting threshold for audit differences. In 2003, the Company's analysis related to duration matching indicated that the ineffectiveness had increased to approximately $12 million and the Company decided to record the ineffectiveness and discontinue their duration matching policy. (See Exhibit C) In June 2004 and September 2004, the Company prepared two analyses intended to quantify the cumulative ineffectiveness since the adoption of SFAS 133 for hedging relationships, both ‘existing and terminated, which included derivatives that had a fair value other than zero at the time the hedging relationship commenced to validate their assertion that there would be no or inconsequential resulting ineffectiveness. The analyses resulted in a cumulative adjustment to ‘AOCI for existing and terminated hedging relationships, which was reviewed by KPMG and posted as a review difference in June 2004. (See Exhibit D). Our review of the September 2004 quarter has not been completed as yet. However, we understand that the Company has recorded the cumulative estimated extrapolated ineffectiveness in the September 2004 quarter. ‘The attached appendices include selected copies of KPMG work papers. The Exhibit B work paper includes references to the “shortcut method”. The work papers were prepared using the Client’s nomenclature at the time. However, this reference to short cut was not intended to represent a reference to the short cut method as described in SAS 133 paragraph 68. Pursuant to 17 C.E.R. § 200.83, KPMG hereby requests that the Securities and Exchange Commission afford confidential treatment under the Freedom of Information Act to this letter and the enclosed documents and that such documents and information not be disclosed pursuant to a request under such Act. The letter and documents have been stamped to indicate that confidential treatment has been requested by KPMG, and have been sequentially numbered KPMG OCA0001 through KPMG OCA0052. The person making this request on behalf of KPMG is David Wagner, Associate General Counsel, KPMG LLP, 757 Third Avenue, New York, New York 10017; (212) 909-5842. Itis KPMG's understanding that, should any person request access to the information referred to herein, and should no other basis appear to exist for withholding such information, the Commission's Freedom of Information Act Officer promptly will notify KPMG of such request and that, if required, KPMG will have ten calendar days in which to submit substantiation of this request for confidentiality. Additionally, should the Commission receive a request for such information by means other than a FOIA request, such as a subpoena, KPMG similarly will be afforded ten days notice. If any further steps are required to secure confidential treatment of these documents, please notify me. KPMG OCA005° Confidential treatment requested by KPMG LLP KPMG-SEC- 1296736, CONFIDENTIAL KPMG-CIV-001929152A Please let me know if you have any additional questions. Very truly yours, awl C bait David C Britt Partner cc: Mr, Alan Beller Director, Division of Corporation Finance Mr. Donald T. Nicolaisen, Chief Accountant Mr. Giovanni P. Prezioso, General Counsel ‘Mr. Paul R. Berger, Associate Director, Division of Enforcement Mr. Richard Grime, Associate Director, Division of Enforcement Freedom of Information Act Officer (w/o encl.) USS. Securities and Exchange Commission Attachments ‘Tease Documents Are Te Property OfKPMG LLP Aud Are Provided To The KPMG OCA005z rr — KPMG-SEC-1296737 CONFIDENTIAL KPMG-CIV-00192916Exhibit A 4 Fannie Mae 'W. P. No, |}-6Be24 Completion Memorandum Auditor ate 12/31/00 Date ‘hoy Purpose KPMG has completed the audit of the balance sheet of Fannie Mae as of 12/31/00, and the related statements of income, stockholders’ equity and cash flows for the fiscal year then ended. This memo summarizes the results and conclusions of our audit procedures that were conducted substantially in accordance with our planned approach. Critical Audit Objectives KPMG identified the implementation of FAS 133 Accounting for Derivative Instruments and Hedging Activities as a critcal audit objective for the audit as the effective date of the Standard is for all fiscal quarters of fiscal years beginning after June 15, 2000. KPMG performed the following testwork over the implementation of FAS 133: * Performed walkthroughs and held discussions with individuals running the Hedge Desk and Long Term Funding Desk to gain an understanding of the current derivatives and hedging process and documented the process and controls in place; - * Performed testwork over the current process for valuing and determining correlation for hedge positions; ( * Reviewed Fannie Mae’s Hedge Accounting Policy Manual and determined that the policies and procedures described in the manual are reasonable; + _ Reviewed the 67 transactions identified in the Hedge Accounting Policy Manual and determined that the accounting treatment for the transactions contained in the manual are reasonable based on the information presented; ‘+ _ Held discussions with the Hedge Desk and the Long-Term Funding Desk to gain an understanding of the new processes that would be implemented under FAS 133 and documented the process and controls; ‘+ Performed testwork over the FAS 133 Accounting System and determined thatthe system is reliable and sppropriately classifying derivatives as cash flow hedges, fair value hedges, or hedges that do not qualify for hedge accounting; * KPMG IRM reviewed the functionality and system controls surrounding the FAS 133 Accounting System and determined thatthe system logic/code is in accordance with Fannie Mae’s Hedge Accounting Policy Manual and the requirements of FAS 133; © Reviewed the general ledger reconciliations and standard journal entries and determined the appropriateness of the journal entries and that procedures are in place to ensure that derivative and hedging activity is properly recorded into the general ledger; and ‘+ Reviewed the transition adjustment and supporting documentation and determined that the transition adjustment is proper and correct, Based on the testwork performed above and the audit evidence obtained throughout the engagement, KPMG concludes that Fannie Mae has appropriately addressed the implementation of FAS 133 and is prepared to adopt the Standard on January 1, 2001. d Significant and Unusual Accounting, Auditing and Reporting Matters KPMG identified the amortization of premiums and discounts on purchased mortgages as a significant a objective. Fannie Mae amortizes the discounts and premiums on its purchased mortgages based on a prepayment ‘Thee Decent Are The PeopertyOFKPMG LLP And Ate roid To The {SUC Fer Te Sa Ue OF Fe Ana Sta fae Adare (Capacity, KPMG LLP Requests That There Document Be Accord KPMG OCA000° Confidential treatment requested by KPMG LLP KPMG-SEC-1296738 CONFIDENTIALExhibit A ( ‘model defined and maintained by Portfolio Management. Fannie Mae’s Purchase Discount Integration system PD) amortizes the discounts and premiums on its mortgages based on amortization factors calculated by the Purchase Discount Amortization Management System (PDAMS) for the core business and by the Intex model for REMICSs, KPMG reviewed the process and controls surrounding the amortization of discounts and premiums as part of the Financial Reporting process. KPMG determined that the controls in place are adequate to ensure that the amortization of discounts and premiums is in accordance with FAS 91 Accounting for Nonrefundable Fees and Costs Associated with Originating or Acquiring Loans and Initial Direct Costs of Leases. Revisions to the Audit Strategy and Plan The audit approach, as outlined in the Audit Strategy Document and the Planning Memorandum at GB-13 and GB- 13-1, was implemented as planned with no significant changes. Consideration of Fraud In assessing the risk of material misstatement of the financial statements due to fraud, KPMG considered the Potential for material misstatements due to fraudulent financial ‘Teporting and material misstatements due to misappropriation of assets. KPMG used professional judgment in assessing the significance and relevance of fraud isk factors identified in all categories indicated on ‘wip 511 — Consideration of Fraud in a Financial Statement ‘Audit: Document at GB-20. KPMG inguired of management regarding (1) management's understanding of the risk of fraud in the Corporation ‘and (2) whether they have knowledge of fraud that has been perpetrated on or within the Corporation. ( KPMG also discussed with the engagement partners matters that were taken into consideration during the client evaluation process, which have a bearing on the fraud risk assessment. During the performance of these procedures and through the course of the audit, KPMG did not identify any financial misstatements that may be due to fraud. Other and Financial Statement Presentation There is sufficient audit evidence in the workpapers and review to substantiate that an unqualified opinion with an additional paragraph covering the fair value balance sheet is warranted and that the financial statements are free of ‘material misstatements. KPMG did not identify any matters that may cause substantial doubt about the Corporation's ability to continue as a going concern. In accordance with Chapter 64 of the Audit Service Manual-US., the audit team is required to identify and investigate audit differences and prepare a summary of unadjusted audit differences. No unadjusted audit differences ‘were noted during the audit. Review Process ‘The engagement responsibilities for each member of the audit service team, as described in section 20 - KPMG ‘Audit Service Team Responsibilities, ofthe Audit Service Manual-U.S., have been complied with during the performance of the audit of Fannie Mae as of and for the ‘year ended December 31, 2000. The audit and the audit report are in compliance with Firm and professional standards, and the work papers adequately support our opinion on the financial statements of the client. All audit work has ‘been subjected to review in accordance with firm standards, to ensure that the work was performed adequately and to enable a proper assessment of the results of the i work and the audit conclusion drawn thereon. ‘The engagement responsibilities of the engagement partner included reviewing and approving the key work papers Jn adden, no pnor year quad cifferencey require. X reVeAS aL. ‘Tog Docent Ar The Property OF KPMG LLP And re Proved Te Te ‘Cont, KPMG LEP Repent Ts hoe Boers Bed KPMG OCA0002 ‘Cotati Treatment Perea! To! CPR See Su KPMG-SEC-1296739 Confidential treatment requested by KPMG LLP KPMG.CIV.00192918 CONFIDENTIALExnipit A 7. ‘elated tothe critical audit objectives and other work papers the partner considered necessary to obtain a clear understanding of the accounting, auditing, and reporting matters discussed in this completion memorandum. The engagement responsibilities for the concurring review partner included reviewing and concurring with the conclusions in the key work papers related to the critical audit objectives and additional work papers as the concurring review partner considered necessary based on the reviews of the key work papers related to the critical audit objectives and this completion memorandum. Approv: x Kenneth D. Russell, Engagement Partner ‘Thee Dezamens Are Te Property OCKPMG LLP And Ars Proied To he ‘SHC or The Saie Ure OFF be SEC Avda Sua Acetate ‘Capac, KPMG LLP Rague Tt These Document Be Acored KPMG OCA000: Confidential treatment requested by KPMG LLP KPMG-SEC-1296740 CONFIDENTIAL. KPMG-CIV-00192919esreoros ee 3 - Exhibit A ives and other work papers the partner considered necessary to obtain a clear |. Understanding ofthe accounting, aditing, and reporting matters discussed inthis completion memorandum. The engagement responsibilities forthe concurring review partner included reviewing and concurring withthe Conclusions in the key work papers related to the critical audit objectives and additional work papers as the concurring review partner considered necessary based on the reviews of the key work papers related tothe critical audit objectives and this completion memorendum. Caprio, In-Cherge Accountant ——_—__—_—__—_.——— Steve Gallotta, Concurring Review Partner Cpa, ‘Confideatat Treatment Pursuaet To 17 CFR Section 200.83, KPMG OCA000: Conia entment requested by KPMG LLP KPMG-SEC-1296 n PMG-SEC-1296741 KPMG-CIV-00192920Exhibit A Fannie Mae Implementation of FAS 133 1231/00 Purpose: To document the procedures performed to address the accounting implementation of FAS 133, Accounting for Derivative Instruments Procedures and Results: ‘ote: The testwork performed over Fannie Mae's implementation of FAS 133 was completed jointly between KPMG and Fannie Mae’s Office of Auditing. Testwork was performed by KPMG or by ‘assessment of the implementation of FAS 133, as well as discussion of the Office of Auditing’s procedures and the conclusions reached, ‘The following are the procedures performed and results noted by KPMG regarding Fannie Mae's implementation of FAS 133: 1. Gain an understanding of the current Derivatives and Hedging process and document the Process and controls in place as well as looking at the valuing and determination of correlation for hedge the controls currently in place related to derivatives and hedging. KPMG also performed prork over the valuing and determination of corelation for hedge positions. See wip £20 series _for the Derivatives and Hedging process memo and testwork performed. 2, Read the Hedge Accounting Policy Manual a) determine that the policies and procedures Contained in the manual are in accordance with the requirements of FAS 133, * KPMG reviewed the Hedge Accounting Policy Manual and determined that the policies and Procedures in the manual are reasonable 3. Review the 67 transactions identified by Fannie Mae and determine that the transactions and the Sccounting treatment for the transactions as contained in the Hedge Accounting Policy Manual ‘are in accordance with the requirements of FAS 133, * KPMG reviewed the 67 transactions identified inthe Hedge Accounting Policy Manual and determined thatthe accounting treatment for the transactions contained in the mamual cre reasonable based on the information presented. 4. Gain an understanding of the FAS 133 Account System through discussions with Financial Reporting andthe affected business units such as the Hedge Desk and the Long. Term Funding various interfaces that occur with STAR, ORION, and DEBTS. * KPMG held discussions with the Hedge Desk (Jack Scott and Ursula (O'Donnell) and the Long-Term Funding Desk (Don Sinclair) about the new processes that would be implemented under FAS 133. See wlp Gf-) and _34-2- for a summary of the meetings. \ ‘Toes Documents Ate Te Frpety OTKPMG LLP And Are Proved To The ‘Coot, KPMG LU Req Tat The Bown Be etre KPMG OCAO000! KPMG-SEC- 1296: Confidential treatment requested by KPMG LLP KPMG.CIV.00192: CONFIDENTIALExhibit A Fannie Mae Implementation of FAS 133 - 12/31/00 * KPMG performed walkthroughs and discussions with Financial Reporting and Systems Development to gain an understanding of the FAS 133 Accounting System and the interfaces that occur with STAR, ORION, and DEBTS See wip. EB eerigir a summary of the meetings. 4 5. Perform testwork over the FAS 133 Accounting System to ensure that the system is reliable and appropriately classifying derivatives as cash flow hedges, fair value hedges, or hedges that do ‘not qualify for hedge accounting. In addition, to determine that the linkage between the underlying debt and related derivative is appropriately recorded. * KPMG selected a sample of transactions and traced the transactions through the source -gstem (Le. STAR) to the FAS 133 Accounting System to ensure that the FAS 133 Accounting ‘System was properly classifying the hedge transactions. KPMG determined that the transactions were properly classified as a cash flow hedge, fair value hedge, or a hedge that does not qualify for hedge accounting (DNO) in the FAS 133 Accounting System. See w/p ‘the testwork performed. ° KPMG did not test the linkage between short-term notes and the FAS 133 Accounting System. Testwork over the STN linkage was performed by the Office of Auditing. KPMG ‘will review the testwork performed to determine that the STN were properly linked. See discussion of the Office of Auditing’s procedures and conclusions below,/ 6. Review the functionality and system controls of the FAS 133 Accounting System as well as the system code to ensure that the system logic agrees with the requirements of FAS 133. * KPMG IRM reviewed the functionality and system controls surrounding the FAS 133 Accounting System and determined that the system logic/code is in accordance with the Hedge Accounting Policy Manual and the requirements of FAS 133. See wip C= Bef Jor the KPMG IRM memo regarding the FAS 133 Accounting System review. 7. Review the FAS 133 Accounting System documentation, * KPMG IRM reviewed the following system documentation related to the FAS 133 Accounting System: Production Readiness Components Architecture Design Templates Implementation Plan Database Model Screen Captures Project Timeline Visual Basic Scripts Technology Recovery, ACP Guide. ‘See wip {34 ___ for the KPMG IRM memo regarding the FAS 133 Accounting System review. vv VVVVVY 8. Determine the appropriateness ofthe standard journal entries and identify the related general ledger accounts affected by FAS 133. Trace the journal entries to the general ledger. Perform a walkthrough of the process of recordi the journal entries to the general ledger to determine ‘that controls are adequate to ensure that transactions are properly recorded, eee ee erento KPMG OcAo00E KPMG-SEC- 1296: Confidential treatment requested by KPMG LLP KPMG.CIV.00192: CONFIDENTIALExnipit A «KPMG obtained the general ledger reconciliations, standard journal entries, and general ledger from Mona Patel, Financial Reporting. KPMG reviewed the journal entries and determined that the entries are proper for recording derivatives and hedging activities under FAS 133. KPMG traced and agreed the entries to the general ledger w/o/x. KPMG also reviewed the general ledger reconciliations, noting that procedures are in place and adequate to ensure that transactions are properly recorded. See FAS 133 Implementation binder for the general ledger reconciliations, standard journal entries, and general ledger. 9. Determine the appropriateness of the FAS 133 transition adjustment at 1/1/01. © KPMG obtained the supporting documentation for the FAS 133 transition adjustment at 1/1/01 from Mona Patel, Financial Reporting. KPMG reviewed the supporting documentation for the transition adjustment and determined that the transition adjustment is proper and correct. Sec wip OBS for the feu per former \ ‘The following are the procedures performed by the Office of Auditing and the conclusions reached based on the Office of Auditing’s testwork: 1. Determine whether the linkage between short term notes and related derivatives are appropriately recorded in DEBTS. © Short term notes are appropriately linked and recorded in DEBTS. During testwork, it was noted that the FAS 133 system is classifying the short term notes based on a calendar year, not on a business calendar, therefore the system is not taking into account holidays in determining the five business day tolerance. Per discussion with Mona Patel, currently, there are manual adjustments in place but they are currently in the development process of having it automated. 2. Determine that controls are adequate to ensure that the value of derivatives recorded in the DEBTS system is accurately captured by the FAS 133 Accounting System. © Using official management reports produced by the DEBTS system, OA traced and agreed a sample of derivatives to the value in the FAS 133 system. OA determined that controls are adequate to ensure that the value of derivatives recorded in DEBTS is accurately captured by the FAS 133 Accounting System. 3. Identify the degree to which systems and documentation are adequate to meet the requirements of FAS 133. Ensure that there is appropriate documentation of hedge objectives, identification of the derivative hedging instrument and identification of the debt instrument to which the derivative is linked. «© As part of its Debt Funding Audit, OA reviewed the appropriateness and adequacy of documentation surrounding derivative and hedging activity such as documentation of hedge objectives, identification of the derivative hedging instrument and identification of the debt instrument to which the derivative is linked. OA determined that the documentation was adequate. 4, Perform a follow-up review of a sample of derivatives entered into subsequent to October 1, 2000 to ensure that all the required documentation is being prepared and completed in accordance with Fannie Mae's Hedge Accounting Policy Manual and FAS 133. ‘Tha Documents Are Ta Property OF KFMG LLP Aad Are rod To The SEC or Te Soe Ue OFF SEC anata Serine Adan, (Capacity, KPMG LLP Requests Tat These Documents Be Accorded KPMG OCA000 Confidential treatment requested by KPMG LLP KPMG-SEC-1296744 CONFIDENTIAL KPMG-CIV-00192!Exhibit A Fannie Mae Implementation of FAS 133 1231/00 © OA determined that the required documentation is being prepared and completed in accordance with Fannie Mae's Hedge Accounting Policy Manual. 5. Perform testwork over the generation of reports from the FAS 133 Accounting System. Verify the accuracy of data reported to management on the FAS 133 Financial Statement Impact ‘Analysis Report. Ensure that the appropriate accounting treatment of options/swaptions, caps, floors, and collars is used. © OA traced and agreed the key management report (ie. FAS 133 Financial Statement Impact Analysis Report) produced by the FAS 133 Accounting System to supporting documentation and verified the accuracy of the data. OA determined that the report generated from the FAS 133 system is accurate and adequate for management purposes. Seema KPMG OCAOO0E ‘Catal Trstet Pursuant To 11 CF Seton 053 Confidential treatment requested by KPMG LLP KPMG-SEC-1296745 CONFIDENTIAL. KPMG-CIV-00192924Exhibit A Fannie Mae FAS 133 Implementation Transactions Walkthrough of FAS 133 Accounting System June 27, 2000 FAS 133 Accounting System Transactions Walkthrough, June 27, 2000, 2pm Participants: KPMG Assurance — Jennifer Gee KPMG IRM ~ Tom Pruszkowski and David Frei Fannie Mae Financial Reporting — Mona Patel Fannie Mae Office of Auditing - Karen McBamette The walkthrough of 10 transactions was performed in order to gain comfort over the FAS transactions. In addition, the walkthrough was performed to determine that the system logic/code is in accordance with the Fannie Mae Hedge Accounting Policy Manual. KPMG obtained two reports from Mona Patel, Financial Reporting, in order to select the sample. The first report is the Hedge Classification Summary Report by Transaction ‘Number. This report is generated from the FAS 133 Accounting System via Sybase tables and exported into Excel. This report sorted the swap transactions by transaction type and number. For example, CF-2 is a cash flow hedge that resembles transaction 2 as identified in Fannie Mae’s Hedge Accounting Policy Manual. KPMG identified the transaction types that made up the majority of the population. The second report is the ‘Swaps and Options Inventory. This report is generated from the STAR system. This report details the total population of options and swaps within the STAR system. KPMG used these two reports to select its sample. KPMG selected six transactions from the transaction types identified in the Hedge Classification Summary Report by Transaction Number. KPMG selected another four transactions from the STAR Report to trace into the FAS 133 system. The April 2000 accounting period was used. See attached schedule for the transactions walkthrough sample items selected. KPMG familiarized itself with the transaction types selected from the Hedge Classification Summary Report and identified the key criteria needed to determine the hedge classification using the example transactions in Fannie Mae’s Hedge Accounting Policy Manual. The following are the criteria identified for the six transaction types: © Transaction #13 — This transaction is a discount note termed out with variable rate debt and basis swap shorter than the funding swap. The variable rate debt and the receipt leg of the basis swap are based on the same index with matching reset date and reset frequency. The basis swap pay and receipt leg are both variable. The receipt leg of the funding swap and the pay leg of the basis swap is based on the same index with matching reset dates and reset frequency. The funding swap has a ‘maturity date longer than the basis swap. The notional balance of the basis swap is equal to or less than the discount note amount. ‘eer rrr NEL asad ae eee eo KPMG OCAOO0! Confidential treatment requested by KPMG LLP KPMG-SEC- 1296746, CONFIDENTIAL. KPMG-CIV-0019:Exhibit A Fannie Mae FAS 133 Implementation Transactions Walkthrough of FAS 133 Accounting System June 27, 2000 © Transaction #2 — This transaction is di8couiit notes termed out with debt and term-out ‘swap shorter than the funding swap. The receipt leg of the funding swap and the pay leg of the term-out swap is based on the same index with matching reset dates and reset frequency. The funding swap has a maturity date longer than the term-out swap. ‘The notional balance of the term-out swap is equal to or less than the original discount note amount. ‘© Transaction #38 — This transaction is discount notes swapped to long-term fixed rate debt with a callable swap and termed out with fixed rate debt. The funding swap is callable. The receipt leg of the funding swap and the pay leg of the debt swap is based on the same index with matching reset dates and reset frequency. The funding swap has a maturity date longer than the debt swap. The notional balance of the debt swap is equal to or less than the original discount note amount. © Transaction #4 — This transaction is discount notes termed out with callable debt and term-out swap shorter than the funding swap. The term-out debt is callable. The receipt leg of the funding swap and the pay leg of the term-out swap is based on the same index with matching reset dates and reset frequency. The funding swap has a ‘maturity date longer than the term-out swap. The notional balance of the term-out swap is equal to or less than the original discount note amount. \ © Transaction #44 — This transaction is variable rate debt swapped to variable rate debt with a basis swap. This transaction does not quality for hedge accounting. If the variable pay side of the swap was linked to an asset which received variable based on the same index, then it would qualify for hedge accounting. © Transaction #5 — This transaction is discount notes termed out with callable debt and term-out swap greater than the funding swap. The term-out debt is callable. The receipt leg of the funding swap and the pay leg of the term-out swap is based on the same index with matching reset dates and reset frequency. The funding swap has a maturity date shorter than the term-out swap. The notional balance of the term-out swap is equal to or less than the original discount note amount. Mona Patel utilized the STAR system to identify the key criteria to determine the classification of the hedge for the six sample items selected from the Hedge Classification Summary Report. KPMG noted that the items selected were properly classified by the FAS 133 Accounting System and that no exceptions were noted. For the four sample items selected from the STAR Swaps and Options Inventory Report, Mona Patel utilized the FAS 133 Accounting System and located the items to determine the transaction type as well as to identify linked transactions. See attached sample items for the transaction type identified for each swap selected. The following are the criteria identified for the transaction types related to the four STAR sample items: ‘The Documents Art Te Property Of KPMG LLY And Ar Proved 'SeC'For Te Sle Une Gt SEC Anata Sa ete Ada Cepc, “Condi Teme Parent TeV CPR een KPMG OCA001( Confidential treatment requested by KPMG LLP KPMG-SEC-1296747 CONFIDENTIAL. KPMG-CIV-00192926Exnipit A oh 8 Fannie Mae FAS 133 Implementation Transactions Walkthrough of FAS 133 Accounting System June 27, 2000 Transaction #15 - This transaction is discount notes termed out with non-USD debt swapped to variable and shorter than the funding swap. The term-out debt is foreign denominated debt. The debt swap has a variable pay leg is variable and fixed receipt leg. The receipt leg of the funding swap and the pay leg of the debt swap is based on the same index with matching reset dates and reset frequency. The funding swap has a maturity date longer than the debt swap. The notional balance of the debt swap is equal to or less than the original discount note amount. © Transaction #5 — See above. Transaction #1 — This transaction is discount notes swapped to long-term, fixed rate funding. However, the short-term note linkage relationship has not been established and cannot yet be tested. © Transaction #38 - See above. Mona Patel then utilized the STAR system to identify the key criteria to determine the hedge classification. KPMG noted that the items selected were properly classified by the FAS 133 Accounting System and that no exceptions were noted. “aero eae eon “onda Testes Pua Tot CFR Secon KPMG OCA001 Confidential treatment requested by KPMG LLP KPMG-SEC-1296748, CONFIDENTIAL. KPMG-CIV-00192927: Exnipit A Fannie Mae. a FAS 133 Implementation ‘Transactions Walkthrough ‘Sample Items u Transaction Type CUSIP Linked CUSIP Linked CUSIP and Number CUSIP Identification Type Identification Type 1 CFI3A2 313SWD924 os (313SW123 IRS 2 CF2 313SWi418 IRS 343SW0721 os 3 CF38 314SWD040 os 313SWI530 IRS 4CF4 313SWD834 Ds ‘313SWi273, IRS 5 DNQ44 313SWD926 Ds 31364G3L1 DS basis swap 6 FVS ‘313SWD857 os 313SWI204 IRS Note: The above six sample items were selected from the product mix reported generated from the FAS 133 Accounting System. ‘Transaction Type CUSIP Identification and Number 7 313SWO914 CF2 8 313SWi204 CF15, FV5, CF1 9 313SWiS42 CF-38 49 3138778 CF Note: The above four sample items were selected from the STAR ‘Swaps and Options Inventory Report. ow eae tacaed Pav eH Ree KPMG OCA001 Confidential treatment requested by KPMG LLP KPMG-SEC-1296749 CONFIDENTIAL. KPMG-CIV-00192!EAN A NAG ae January 11, 1999 Robert Wilkins Financial Accounting Standards Board 401 Merritt 7 P.O. Box 5116 Norwalk, CT 06856-5116 Dear Bob: This letter sets forth our understanding of our telephone conversation on December 16, 1998. As you recall, in our conversation we asked for clarification of the treatment prescribed by FASB Statement No. 133, Accounting for Derivative Instruments and Hedging Activities. Our particular issue related to how hedge ineffectiveness, as it relates to cash flow hedges, should be measured. The example we discussed during the call was how Fannie Mae issues 90-Day Discount Notes and then enters into an interest rate swap whereby we receive three-month LIBOR and pay a ~ fixed rate, Historically, there has been high probability that the spread between the Discount Note rate and the three-month LIBOR rate remains within a narrow range. For example purposes, we will consider 15 basis points to be the average spread. To illustrate our understanding of the conclusions reached in the call, the following example is used. On January 1, 1999, Fannie Mae determines that it needs $100 million of three-year, fixed-rate funding. To satisfy this need, it enters into a 3-year interest rate swap linked to the planned rollover of its 90-Day Discount Notes for the next three years. This transaction is accounted for as a cash flow hedge, with the swap marked to market through comprehensive income because the swap qualifies as a hedge of the planned issuance of Discount Notes. On January 1, 199, Fannie Mae assumes that the spread between Discount Notes and three-month LIBOR will be 15 basis points for the next three years. The reset dates on the floating leg of the swap match the rollover date of the Discount Notes. Jan, 1, 1999 Discount 90-Day Dis Notes Frio Discount] for3 yeas) Jan. 1, 1999 Interest Rate = month LIB ‘Swap ($100 million notional, reprices every 90 days, 3-year term) ~~ 6.50% ($100 milion notional. 3-year erm) EE eee eee tetera KPMG 0CA0013 y:/ at ‘ConheutlTratnat Pursue! ToT CFR Sean ns KPMG-SEC-1296750. Conia entment requested by KPMG LLP KPMG sEC.1296750Exnipit A ~ If at a repricing date the spread between the two indices has moved to 17 basis points, but the expectation remains that the future spread will average 15 basis points, then the only ineffectiveness that will be recognized in earnings will be the two basis points associated with the current transaction. No ineffectiveness will be recognized for the future anticipated rollover of Discount Notes. Only in the even it is determined that we no longer believe 15 basis points is a reasonable expectation for the spread between the two indices will we record ineffectiveness for the future anticipated transactions and then only in the event the ineffectiveness results in an overhedge. In summary, as long as management's documented assumption regarding the spread between Discount Notes and three-month LIBOR is maintained, no ineffectiveness will need to be Tecorded in earnings for the future anticipated transactions, If there is an other than temporary change in the relationship between the two indices, management should revise its assumption and use the new spread assumption going forward. The new assumption may or may not result in recording ineffectiveness on the future anticipated transactions through earnings depending on whether the change in spread is an over or under hedge. If you have any questions regarding the interpretation of our conversation, please contact me at (202) 752-2146. a Sincerely, Jonathan Boyles acct we KPMG OCA01 rt tare ec fide estment quested by KPMG LLP KPMG-SEC- 1296751 COMaDENTn eee eeGiona01oaee Exhibit A-1 73 [VAs - kbie » To Harry Argires at June 29, 2000 Washington, DC From Joseph Nelson Washington, DC Ret cwindowseomptaS3éa- meme.doe Fannie Mae FAS 133 Accounting System Background ‘The Financial Accounting Standards Board (FASB) established SFAS 133 regulation for reporting hedge related derivative activities. The Fannie Mae FAS 133 Accounting ‘System is a prototype system, in the latter stages of development, should ensure compliance with FAS 133 requirements. The FAS 133 system distinguishes Fannie rc Mae's hedge related derivatives into different hedge classifications for financial & reporting purposes. In addition, the FAS 133 system assists the financial reporting users at Fannie Mae to analyze hedge classification changes for various hedging activities, Fannie Mae is required to be compliant with SFAS 133 accounting standards beginning in the fiscal year 2001. As part of the audit of Fannie Mae's financial systems, KPMG’s Information Risk ‘Management (IRM) group was tasked to review the functionality and system controls of the Fannie Mae SFAS 133 system prototype. The objective of the review included determining that the system processed hedge related transactions accurately and in conformity with the mandates of SFAS 133. The scope of the review included conducting interviews of Fannie Mae personnel to obtain an understanding of Fannie Mae’s FAS 133 Accounting System and reviewing the system code to ensure that the system logic agreed with the accounting rules.. In addition, we analyzed key documents delivered to us by Fannie Mae’s Financial Reporting and Computer Information Services (CIS) departments. We also observed two test trials of the FAS 133 Accounting System involving tracing specified transactions through the system and comparing system output to expected results. ‘The first interview/test run was conducted on June 20, 2000 with: ‘* Mona Patel — Financial Analyst , Financial Reporting Jennifer Gee ~ Auditor, KPMG, LLP ‘The second interview/test-run was conducted on June 27, 2000 with: © Mohammed Kamal - Developer, CIS ae rine ae KPMG OCA001 tt re ers ree Confidential treatment requested by KPMG LLP KPMG-SEC- 1296782 CONFIDENTIAL oo 293,Confidential treatment requested by KPMG LLP KPMG-SEC-1296 CONFIDENTIAL Exhibit A-1 heel! Page 2 July 1, 2000 ‘¢ Michael Chen-Young ~ Developer, CIS Jennifer Gee — Auditor, KPMG, LLP carer obtained and reviewed include: FAS 133 Production Readiness Components * FAS 133 Architecture Design Templates © Statement of Financial Accounting Standards No 133: ‘Accounting for Derivative Instruments and Hedging Activities, Implementation Plan FAS 133 Accounting System FAS 133 Database Model Screen Captures FAS 133 Accounting System Project Timeline FAS 133 Technology Recovery, ACP Guide FASS 133 Accounting System, Powerpoint Presentation Slides Visual Basic Scripts ee eccee Observations Transaction Tests — System Logic Six of the most common and four random financial transactions were selected to be reviewed and tested. ‘The transaction tests were conducted on June 20 and 27, 2000 as noted above. Each transaction was identified and correctly classified prior to input to the prototype system to establish baseline expectations. It was observed that there were no exceptions to the FAS 133 data processing or output for the selected transactions. System Documentation Proprietary documents were generally determined to be outdated and in some cases, incomplete. For example, although the system database model was said to be current; it did not contain the various relationships within and between different functional tables as expected. Based upon discussion with Fannie Mae personnel, there is no plan to update and/or correct the FAS 133 systems development documentations at this time. Fannie Mae management should consider updating and completing the FAS 133 system documentation Segregation of Duties ‘Admit KPMG OCA001' KPMG-CIV-0019:Exhibit A-1 Page 3 July 1, 2000 There is only one end user who has complete knowledge at the application level. The backup user has moved to a different department within Fannie Mae and no other person at this time has been designated nor trained as the new backup user. The Financial Reporting department is currently in the process of restructuring. An adhoc/unofficial user's manual is being developed. However, this document was not provided to or reviewed by us during the course of our review fieldwork. Consideration should be given to selecting and providing cross training to a back-up employee Security ‘The FAS 133 Accounting System application is stored in a multi-user environment and is secured by a password. The application was not tested for resistance to a password cracking program and should be subjected to a penetration test. During the interview process, it was determined that server security needs to be examined. ‘The network environment was down during the first trial of the system, but the primary user was able to proceed due to the fact she remained logged in from the previous evening. This extended period of login without activity is a security issue \ that should be examined more closely. The data from DEBTS will be delivered to the FAS 133 Accounting System via file transfer protocol (FTP) in the future. This mode of information transfer has inherent risks which should be evaluated and mitigated prior to migrating the system to production. ‘Thank you for the opportunity to be of assistance and support the audit. If you have any questions, please contact me at 202/533-4332. “uses Irena teats Cantey, KPMG LLP Regus Tat The Dace Be KPMG OCA0017 a Treemet Pareat ToT CPR Sen Confidential treatment requested by KPMG LLP KPMG-SEC-1296754 CONFIDENTIAL. KPMG-CIV-0019:Exhibit A-1 Fannie Mae Walkthrough of AS ES ag S through of cou tem aenroues ofa 26, 2000 ne SY FAS 133 Accounting System Walkthrough, June 20, 2000, 1pm Participants: KPMG Assurance — Jennifer Gee KPMG IRM ~ Tom Pruszkowski and David Frei Fannie Mae Financial Reporting - Mona Patel Fannie Mae Office of Auditing ~ Karen McBamette The walkthrough was performed in order to gain an understanding of how the system works and to understand how the system interfaces with source ‘systems such as STAR, DEBTS, and ORION. The FAS 133 Accounting System utilizes Sybase tables to compile date from the source systems. Once the compilation is completed, a manual reconciliation of the control totals in the system to official management reports generated off the source system is performed. An Essbase database is used to slice and dice the information. A Visual Basic (VB) application is used to extract data from STAR into the Sybase tables. The FAS 133 system generates reports which are saved to Microsoft Excel so the data can be scrubbed, reconciled, and used to produce final management reports. See attached screen prints from the FAS 133 Accounting System, ‘There are three main menu items: File, Essbase, and Utilities, Within the File menu, there are four optic : Interface, Run Process, Browse and Exit. ‘The Interface options allows the user to select the accounting period (year + month, for example, April 2000 is 200004) and version. Version 01 represents historical values and version 02 represents ‘market values. Version 02 has currently been eliminated. The user can also select a data source to import data from the different sources (STAR, DEBTS, or ORION). The ORION and STAR data is loaded based on queries run against the database which separate the interest rate swaps, debt swaps, caps, etc. The DEBTS data is loaded from an email file containing market values and termouts. The FAS 133 system extracts the data from the saved file. In the future, the DEBTS data will be delivered via file transfer protocol (FTP), a mode for information transfer. After loading the data, users can use this screen to view the loaded data. This option creates the Sybase tables, The Run Process option is used once the data is loaded and the data is verified for accuracy. See Utilities menu, Control Total option below. The Run Process option allows the user to select the accounting period, version, and tolerance. The tolerance relates to the allowable range for the reset dates. It defaults to five. The user is able to run auditing processes for the selected month and tolerance. The three processes are Audit Caps and Swaptions hedge type, Run FAS 133, and Run After Adjustments. The processes are stored procedures and generate reports, The reports are extracted to Excel and manually scrubbed. The data is also extracted to the Essbase database to Produce reports and compare the data against the Excel scrubbed data, ‘The Browse option allows the user to browse selected tables and reports. It gives the user the ability to sort or select data by different criteria and export the output to Excel or other files for further processing. et OFKOMG LLP Ant re Pod Te The ‘iris NP LR at Te Ben rd KPMG OCAO001E KPMG-SEC-12967 Confidential treatment requested by KPMG LLP KEMG-SEC1296755 CONFIDENTIALFannie Mae FAS 133 Implement: ‘Walkthrough of FAS 133 Accounting System June 20, 2000 Within the Essbase menu item, there are five options: Select Accounting Period, Login to Essbase, Load to Essbase, Calculate Essbase, and Essbase Report. The Essbase menu item is used to export data to the Essbase database. Within the Utilities menu item, there are three options: Control Totals, Adjustments, FCUR and Debt Swap Relationships. The Control Totals option allows the user to verify the data loaded from the source systems. This, option is used after the Interface option under the File menu and before the Run Process option under the File menu. The screen lets the user input expected totals and verifies the data with the totals loaded through the electronic interfaces. The manually entered expected totals are from official management report. The totals from STAR are already downloaded through the interface and the FAS 133 system will then calculate the differences. From DEBTS, the notional balances are used as a controV/benchmark to ensure that the population is complete. Besides the notional amounts, the market values from DEBTS are used. The FAS 133 system will calculate any differences from expected totals. Differences are resolved. ‘The Adjustments option is used to make adjusts to the data. ‘The FCUR and Debt Swap Relationships option is not currently being used because the foreign currency swaps have not been incorporated into the FAS 133 system. =e, KPMG OCA0015 Confidential treatment requested by KPMG LLP KPMG-SEC-12967: CONFIDENTIAL. KPMG-CIV-00192935Exhibit A-1 Menu Layout ET yore eee ee KPMG OCA002( Confidential treatment requested by KPMG LLP KPMG-SEC-1296 CONFIDENTIAL. KPMG-CIV-0019: 36Exhibit A-1 . Interface Screen rene re) ST Aa Allows user to select Year+Month(yyyymm) and version; then import data from different sources (STAR, DEBTS or ORION). After loading data users are also able to view the loaded data through this screen. KPMG OCA002: Confidential treatment requested by KPMG LLP KPMG-SEC-12967: CONFIDENTIAL. KPMG-CIV-00192!Exhibit A-1 Browse Screen \ oN Allows user to browse selected tables. It also allows to view report output. In addition the screen gives users option to sort or select data by different criterias. Users also able to export output to excel or text files for further processing. ea ean KPMG OCA002 Confidential treatment quested by KPMG LLP KPMG-SEC-I296759 CONFIDENTIAL. KPMG-CIV-00192938Exhibit A-1 Process Screen This screen allows user to run auditing process for a selected month and tolerance. Rarer kare aera KPMG OCA002 Confidential treatment requested by KPMG LLP KPMG-SEC-1296760 CONFIDENTIAL. KPMG-CIV-00192939Exhibit A-1 Essbase Screen or |e 1938 ern j Month i © January y any CxO aang Cer Canna Pe en eee See This screen is used to export data to Essbase. 2 KPMG ocAD02« KPMG-SEC-1296761 Confidential treatment requested by KPMG LLP KPMG-CIV-00192940 CONFIDENTIALExhibit A-1 Essbase Report Screen = ‘This screen allows to view data from Essbase, which gives user the capability to view data in many different fashion. reper eo HONG tt ree Sng, coekrmene nema KPMG OCAOO2! Conde men eqs by KPMG LLP kon. sec.taera CONFIDENTIAL. KPMG-CIV-00192941Exhibit A-1 Control Total Screen ‘After loading all data from extemal sources, the user uses this screen to verify the data in total level. The screen allows user to enter expected total, then it verifies the data with totals loaded through the interfaces. ‘Teese Documents Are The Property OTKPMG LLP. SS” —keme ocavee Confidential treatment requested by KPMG LLP CONFIDENTIAL Ecenrasinn PruGcnraienExhibit A-1 Adjustment Screen \ 4 ‘ i This screen allows user to perform manual change to the data. The system keeps audit trail, so user can go and find out the changed history. ‘Ths Dacamens Are To Property OF KPMG LLP And Ae Provie ‘Cicer LL Regn Tan The Become ered KPMG OCA002 Confidential treatment roquested by KPMG LLP CONFIDENTIAL KPMG-SEC-1296764 KPMG-CIV-00192943Exhibit A-1 FCUR & DS relationship Screen This screen is used to manage Debt Swap and Foreign Currency relationship. ‘pny. Noe Lt het Tn Te Bc cred KPMG OCA002 Confidential treatment requested by KPMG LLP KPMG-SEC-1296765 CONFIDENTIAL. KPMG-CIV-00192944ATTACHED IS THE RELEVANT EXCERPT FROM, Exhibit B OUR WORK PAPERS THAT ADDRESSES ONGOING . MONITORING OF KEY TERMS MATCHING: + Process Analysis Document.us IW {Derivatives & Hedging (6/02Rey) gq = Perod-na Fannie Mae 12/31/02 Prepared by Date WIP terse Marissa Dobbs 8/02 PAR. N Purpose ‘The purpose of this working paper is to understand how the entity manages strategic business risks and processes significant classes of transactions that led to identifying the process as key. It documents: = understanding of how each key process operates; m= understanding of the process-level business / financial statement risks and controls based on follow through on strategic business risks; = understanding of financial statement risks and financial statement controls based on follow through on significant classes of transactions, t= the relationship between each Process Analysis Document and the related audit objective(s). The engagement team’s understanding of the entity’s business that is documented throughout this working paper is obtained using techniques including enquiry, observation, inspection and analytical procedures, together with the team’s previous experience. This understanding is used to develop audit objectives, make preliminary assessments of the risk of significant misstatement for each audit objective, support the preliminary assessments of the risk of significant misstatement and plan remaining audit procedures. ‘The Process Analysis Document-US includes the following sections: 1 Plan for the Process Analysis Tl __ Process Operations IL Process-level Risks and Controls IV __ Significant Classes of Transactions and Controls, V Summary of Findings Preparation of this document is to begin as process analysis is planned and then continually throughout the process analysis phase of the audit. The Appendix Guidance to this working paper is not intended to be filed as part of the ‘engagement working papers. Detach the Appendix Guidance prior to filing the approved document in the working papers. KPMG OCA0029 Confidential treatment requested by KPMG LLP KPMG-SEC- 1296766, CONFIDENTIAL. KPMG-CIV-00192945‘The Decent re The Property OF KPMG LL keh) Process Analysis Document-US Derivatives & Hedging (5/02 Rev) ‘¢Atthe end of each day a final Hedge Summary and Position Summary (POSSUM) is generated and distributed in the market room for review. There are actually seven types of Hedge Summaries generated during the hedge reporting process (depending on the risk ‘being hedged): 1) Risk-free Shortcut Hedge, 2) LIBOR shortcut hedge, 3) Agency shortcut hedge, 4) Risk Free Total Fair Value hedge, 5) LIBOR Total Fair Value hedge, 6) Agency Total Fair Value hedge, and 7) Combined Total Fair Value hedge. (NOTE: Ifa hedge qualifies for the shortcut method, the Hedge Summary is prepared only when new positions are added or lifted and when the hedge is closed out, If a hedge does not qualify for the short-cut method, Hedge Summaries are prepared on a daily basis.) A monthly Hedge Status Report is generated by HTS which is a summary of each hedge, is distributed to the following: Treasurer, Assistant Treasurer, SVP of Audit, SVP and Controller, ‘VP of Financial Reporting, Director of Finance in Financial Reporting; Director of Finance in Portfolio Management, VP of Financial Reporting and Planning, to monitor adherence to policy and strategy [Control JS]. Assessing Hedge Effectiveness/Correlation ‘The Hedge Desk assesses hedge effectiveness at the inception of the hedge and on a daily basis. Under FAS 133, ifthe critical terms of the hedging instrument and of the hedged items do match, then no hedge ineffectiveness can be assumed and the Hedge Desk’s “short-cut method” can be used. Fannie Mae attempts to enter into transactions that will achieve the short-cut method to ded extent possible. Th r section IV below for interest ate swags and discount notes lauance, ‘This criteria include 1) that the risk being hedged must be an eligible risk which includes the US Treasury (risk-free) rate,, the LIBOR swap rate, and the Agency rate and 2) that the derivative used must be within certain duration ranges of the anticipated debt issuances. Also, the short-cut method cannot be used ‘when the Hedge Desk is hedging odd-maturity or callable debt. Under the short-cut method, the determination of hedge effectiveness is monitored by Fannie Mae on a monthly basis using the Hedge Status Report [Control J5]. (See mark to market processing section above). Under FAS133, if the critical terms of the hedging instrument and of the hedged item do not match, the Hedge Desk must assess the effectiveness of the hedges via the long haul method. Hedge effectiveness (correlation) and the ability to account for a hedge under FAS 133, is maintained if the dollar value of the cumulative changes in the fair value of the hedge offset the dollar value of the inverse cumulative changes in the fair value of the hedged transaction within 80 percent to 125 percent (dollar offset correlation test) or if the effective yield (actual yield adjusted for hedge results) is within 15 basis points of the target yield (deminimus rule). All anticipated transaction hedged positions are marked-to-market, correlation is measured, and the amount of hedge ineffectiveness is determined on a daily basis by the Hedge Desk. (See mark-to- ‘market processing discussed above.) These amounts are reported on the Hedge Summary and Position Summary Report. Financial Accounting is notified via memorandum when hedges fall out of correlation. Financial Accounting also performs an independent calculation of accounting correlation and compares their calculation to the Hedge Summary Reports [Control J15]. When a hedge meets the correlation or deminimus measures, no action is required. When a hedge position is in 12 Sones ree nears KPMG OCA0030 Confidential treatment requested by KPMG LLP KPMG-SEC-1296767 KPMG-CIV-00192946Exhibit B kbinG) Process Analysis Document-US ‘ Derivatives & Hedging (5/02 Rev) compliance but falls ‘out of correlation, the position is monitored for up to five additional consecutive workin to see ition returns to an acceptable level of correlation. If Zorrelation is lost for more than five consecutive workin, ‘an analysis of [ge Position sk. The analysis includes the reasons for the loss of correlation, aT Er any Supporting gis Tor the hedge coming back into corelation. The analysis is submitted to the Controller and CFO for further review. The CFO has the authority to allow the five. comme working days for it torcome back into correlation. If trts— ‘The aforementioned three paragraphs explain Fannie Mae’s intemal process for measuring effectiveness. Consistent with FAS 133, KPMG has indicated that, for quarterly and annual reporting purposes, hedges that do not qualify for the short-cut method must be assessed in strict compliance (80/125 rule instead of deminimus rule) with FAS 133 to continue hedge accounting. Changes in Transaction Terms ‘When a change in transaction terms occurs, the change in transaction terms or assumptions underlying the hedge are documented in a memo. The memo includes the reasons for the change in terms and is filed with the applicable HSM. Hedge Desk ~ Key Controls Summareed ‘Hedge Desk procedures and the Derivatives Accounting guidelines are well documented. ‘© Hedge Strategy Memo is prepared for each transaction and approved by the Treasurer (Linda Knight) or her designate (Nadine Bates, Director LT Funding Desk). [Control J2} . © For swaps and futures, there are signed agreements on file for the counterparty. © Segregation of duties: The strategy is approved by the Treasurer, the debt order is approved by Portfolio Management, the trade ticket is stamped and initialed by the hedge trader, and the trade is executed by the Treasury Front Office (Hedge Desk), confirmed by the Legal Department for swaps or Controller's Office (Financial Reporting) for all others, and settled by the Controller's Office. [Control J3] Hedging activity is reported weekly to the Portfolio Investment Committee (PIC). Financial Reporting confirms the non-swap transactions with dealers and Legal confirms swap trades with dealers. ‘« Atthe end of the day, the Hedge Desk generates reports from the HTS with closing market prices for each instrument within the hedge. «Financial Reporting performs an independent calculation (Excel spreadsheet) of accounting correlation and reviews each hedge daily for accuracy and compliance with FAS 133 requirements.[control J15] «Financial Reporting independently validates the closing prices for futures using Bloomberg closing prices. ‘Financial Reporting confirms and documents the repo rates for each counterparty and each hedging instrument. ‘© Journal entries, wire requests, and the reconci by the Financial Reporting manager. ‘© Reconciliation of collateral posted to the general ledger with counterparty statements is approved by the Financial Reporting manager. jons of the general ledger accounts are ‘Short Term Funding Desk — Key Controls Summarized 13 es eT Property KPMG LL An Ae Poe Te The ened fetuaal To CPR Scions KPMG OCA0031 Confidential treatment requested by KPMG LLP KPMG-SEC-1296768 CONFIDENTIAL. KPMG-CIV-00192947Exhibit C nm ‘ -. #FannieMae pe veworawouw pmemcerdn PAE whil beth Date: ‘August 7, 2002 ERM Bec Ty Ar oer FD LT MiSvecvee hack he mel To: KPMG MS Lede Berge fer From: Paul Sali (2006) > Per heoad beng hed aehebtine Fe Wai De ct badge Fe prove DJ -7 Subject: Duraion Shortut for Anticipatory Hedges of Debt issuances, “72,6 ‘ ye fel it Whe foe enol Per our Dervatives Accounting Guidelines one of the requrements fo actievng the short. F CS o> method of accounting for hedges of debt issuances is a duration matching test between derivatives and hedged debt. We employ a duration matching test as one shortout criterion in lieu of requiring that the notional amount of a derivative equal the anticipated debt issuance amount. Duration ‘matching would produce less hedge Trafi-civeness fan malching Totonal and principal amounts. We analyzed the effectiveness of a sample of these hedges from 2001 (see attached) and concluded that we should maintain the existing duration shortcut method. The duration matching . test produced tight correlation and limited hedge ineffectiveness: ee c overall creation onthe hedges in our sample es 100 percent and the overall hedge ineffectiveness (verhedge) was a loss of $1.5 mifion, which would have had been much less than one cent per share. All hedges were within corelaton ranges for hedge accounting. The weighted average correlation ‘was 99.2 percent on those hedges that would not have required a deminimus test to evaluate whether they could qualfy for hedge accounting. The correlation on individual hedges was weighted by the amount of hedged debt. Correlation on these hedges ranged from 94 percent to 110 percent Those that would have required a deminimus test had a weighted average deminimus result of 3:1 basis points. The corelation on individual hedges was weighed by the amount of hedged debt. Deminimus on these hedges ranged from 1.1 to 8.5 basis points. 1§ The maximum hedge ineffectiveness on an individual hedge (overhedge) was a loss of $4.6 million, * In our analysis, we calculated the overall effectiveness of each hedge based on the specific risk(s) being hedged and aqgregated the results to determine whether the duration shortcut method was close to the results we would have recorded under the long haul method. We selected a representative sample of the hedges that were subject tothe duration shortcut method: We sampled 12 of the 25 hedges that qualified for the duration shortcut method during Sener The hedged debt in our sample accounted for 46.7 percent of hedged debt issuances in 2001. ‘The weighted average term of our sample (weighted by the amount of hedged debt) was only 2 months longer than the hedged debt issuances The sample includes hedges of different risk types. ~~ a party OLKPMG LLP And Ae Prove ¥ ets That There Document Be Actorded KPMG OCA003: Confidential treatment requested by KPMG LLP : . CONFIDENTIAL. KPMG-SEC-1296769 KPMG-CIV-00192948Exhibit C ‘We should maintain the existing duration shortcut method based upon the tight correlation and limited hedge ineffectiveness in our representative sample of anticipatory hedges from 2001. We will reevaluate the duration shortcut method next year using hedges from 2002 in compliance with the annual testing required by the Derivatives Accounting Guidelines, Attachment ce: L. Spencer J. Boyles, J. Pennewell R. Stawarz. M. Lewers M. Treeciak A Hairston |. Sussan eo MOE KOMG exemeed aceon pee Det PL egy, Regen 6e leg VOL warn) - te cohke NSE ne Hfeek meres Ueha be geet : Pretredeteny, oe ee ABT ese, Fete Mee bebe, MH atthia TA da thee T ———C——C=*t pent Reh wed groenph nares, YERME send ; be (eh eedelay + De fem —<— ee heey Ga De epphenkte TF ot shied) Td Bnd Tle C bee denen Yay peered. Kem 6 Concedes OE bored cn DM entre, De deects Shade T deer eT ore TOS mT deat cen (T Trac ethemty ¢ . Ine Heese Deagh applets ef Be theeTenT MOK, Lome A per seamed Cecedinr ( oR esek quite Te enrcne OT onsclts ore oth, De ome. 2 “Tee Dcomeas Are Te Property OFKPMG ELF And Are Poe To The Cin KOME Lo Re seagate” KPMG OCA0033 \Y~ Confidential treatment requested by KPMG LLP CONFIDENTIAL KPMG-SEC-1296770 KPMG-CIV-00192949Weighted average deminimus (just noncorretation) Hedge ineffectiveness Overall correlation (all) ed average correlation _ (just nondeminimus) 1.005862 0,992445616 3.105175373 7 he teePeree $ (1,480,780) > Senge A 1? ee oT ae Hedged debt (sample) ‘> "T~* $35,445,717,927 J eR Hedged debt (total for 2001) $75,923,000,000 o 1% of total 2001 hedged debt 48.69% Weighted average term (sample) 5.98 Weighted average term (total) 517 Difference 0.21 Tere rT Sete Fce sca at sac Sheoeccereace eae Confidential treatment requested by KPMG LLP CONFIDENTIAL KPMG-SEC-1296771 KPMG-CIV-00192950