Freddie Mac 2009 Annual Report Download - page 75

value during 2009 of $12.8 billion primarily due to (i) tighter mortgage-to-debt OAS and (ii) the recognition in earnings of
other-than-temporary impairments related to these securities.
We have significant credit enhancements on the majority of the non-agency mortgage-related securities backed by
subprime first lien, option ARM and Alt-A loans we hold, particularly through subordination. These credit enhancements are
one of the primary reasons we expect our actual losses, through principal or interest shortfalls, to be less than the fair value
declines of these securities. However, during 2009, we experienced a rapid depletion of credit enhancements on certain of the
securities backed by subprime first lien, option ARM and Alt-A loans due to poor performance of the underlying collateral.
Interest Rate and Other Market Risks
Our investments in mortgage loans and mortgage-related securities provide a source of liquidity and stability for the
home mortgage finance system, but also expose us to interest rate risk and other market risks. The recent market
environment has remained volatile. Throughout 2008 and 2009, we adjusted our interest rate risk models to reflect rapidly
changing market conditions. In particular, these models were adjusted during 2009 to reflect changes in prepayment
expectations resulting from the MHA Program, including mortgage refinancing expectations. During 2009, our interest rate
risk, as measured by PMVS and duration gap, remained consistently low. For more information, see “QUANTITATIVE AND
QUALITATIVE DISCLOSURES ABOUT MARKET RISK.”
Operational Risks
Operational risks are inherent in all of our business activities and can become apparent in various ways, including
accounting or operational errors, business interruptions, fraud and failures of the technology used to support our business
activities. Our risks of operational failure may be increased by vacancies or turnover in officer and key business unit
positions and failed or inadequate internal controls. These operational risks may expose us to financial loss, interfere with
our ability to sustain timely and reliable financial reporting, or result in other adverse consequences.
Management, including the company’s Chief Executive Officer and Chief Financial Officer, conducted an evaluation of
the effectiveness of our internal control over financial reporting and our disclosure controls and procedures as of
December 31, 2009. As of December 31, 2009, we had one material weakness which remained unremediated related to
conservatorship, causing us to conclude that both our internal control over financial reporting and our disclosure controls and
procedures were not effective as of December 31, 2009. Given the structural nature of this weakness, we believe it is likely
that we will not remediate this material weakness while we are under conservatorship. In view of our mitigating activities
related to the material weakness, we believe that our consolidated financial statements for the year ended December 31, 2009
have been prepared in conformity with GAAP. For additional information on our disclosure controls and procedures and
related material weakness in internal control over financial reporting, see “CONTROLS AND PROCEDURES.”
Effective January 1, 2010, we adopted amendments to the accounting standards for transfers of financial assets and
consolidation of VIEs. We face significant operational risk with respect to the operational and systems changes we have been
required to make in connection with our adoption of these amendments. For more information, see “RISK FACTORS —
Business and Operational Risks — We face additional risks related to our adoption of changes in accounting standards
related to securitization entities” and “NOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING PRINCIPLES — Recently
Issued Accounting Standards, Not Yet Adopted Within These Consolidated Financial Statements — Accounting for Transfers
of Financial Assets and Consolidation of VIEs” to our consolidated financial statements.
Off-Balance Sheet Arrangements
We enter into certain business arrangements that are not currently recorded on our consolidated balance sheets or may
be recorded in amounts that differ from the full contract or notional amount of the transaction. Most of these arrangements
relate to our financial guarantee and securitization activity for which we record guarantee assets and obligations, but the
related securitized assets are owned by third parties. These off-balance sheet arrangements may expose us to potential losses
in excess of the amounts currently recorded on our consolidated balance sheets.
Our maximum potential off-balance sheet exposure to credit losses relating to our PCs, Structured Securities and other
mortgage-related guarantees is primarily represented by the unpaid principal balance of the related loans and securities held
by third parties, which was $1,495 billion and $1,403 billion at December 31, 2009 and December 31, 2008, respectively.
Based on our historical credit losses, which in the fourth quarter of 2009 averaged approximately 51 basis points of the
aggregate unpaid principal balance of our total mortgage portfolio, we do not believe that the maximum exposure is
representative of our actual exposure on these guarantees. See “OFF-BALANCE SHEET ARRANGEMENTS” for further
information.
Effective January 1, 2010, the concept of a QSPE was removed from GAAP and entities previously considered QSPEs
must now be evaluated for consolidation. As a result, commencing in the first quarter of 2010, we have consolidated our
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