Freddie Mac 2010 Annual Report Download - page 258

NOTE 18: REGULATORY CAPITAL
On October 9, 2008, FHFA announced that it was suspending capital classification of us during conservatorship in light
of the Purchase Agreement. Concurrent with this announcement, FHFA classified us as undercapitalized as of June 30, 2008
based on discretionary authority provided by statute. FHFA continues to closely monitor our capital levels, but the existing
statutory and FHFA-directed regulatory capital requirements are not binding during conservatorship. We continue to provide
our submissions to FHFA on both minimum and risk-based capital.
Our regulatory minimum capital is a leverage-based measure that is generally calculated based on GAAP and reflects a
2.50% capital requirement for on-balance sheet assets and 0.45% capital requirement for off-balance sheet obligations. Based
upon our adoption of amendments to the accounting standards for transfers of financial assets and consolidation of VIEs, we
determined that, under the new consolidation guidance, we are the primary beneficiary of trusts that issue our single-family
PCs and certain Other Guarantee Transactions and, therefore, effective January 1, 2010, we consolidated on our balance
sheet the assets and liabilities of these trusts. Pursuant to regulatory guidance from FHFA, our minimum capital requirement
was not automatically affected by adoption of these amendments. Specifically, upon adoption of these amendments, FHFA
directed us, for purposes of minimum capital, to continue reporting single-family PCs and certain Other Guarantee
Transactions held by third parties using a 0.45% capital requirement. Notwithstanding this guidance, FHFA reserves the
authority under the GSE Act to raise the minimum capital requirement for any of our assets or activities. On February 8,
2010, FHFA issued a notice of proposed rulemaking setting forth procedures and standards for such a temporary increase in
minimum capital levels.
Our regulatory capital standards in effect prior to our entry into conservatorship on September 6, 2008 are described
below.
Regulatory Capital Standards
The GSE Act established minimum, critical and risk-based capital standards for us.
Prior to our entry into conservatorship, those standards determined the amounts of core capital and total capital that we
were to maintain to meet regulatory capital requirements. Core capital consisted of the par value of outstanding common
stock (common stock issued less common stock held in treasury), the par value of outstanding non-cumulative, perpetual
preferred stock, additional paid-in capital and retained earnings (accumulated deficit), as determined in accordance with
GAAP. Total capital included core capital and general reserves for mortgage and foreclosure losses and any other amounts
available to absorb losses that FHFA included by regulation.
Minimum Capital
The minimum capital standard required us to hold an amount of core capital that was generally equal to the sum of
2.50% of aggregate on-balance sheet assets and approximately 0.45% of the sum of our PCs held by third parties and other
aggregate off-balance sheet obligations. As discussed below, in 2004 FHFA implemented a framework for monitoring our
capital adequacy, which included a mandatory target capital surplus over the minimum capital requirement.
Critical Capital
The critical capital standard required us to hold an amount of core capital that was generally equal to the sum of 1.25%
of aggregate on-balance sheet assets and approximately 0.25% of the sum of our PCs held by third parties and other
aggregate off-balance sheet obligations.
Risk-Based Capital
The risk-based capital standard required the application of a stress test to determine the amount of total capital that we
were to hold to absorb projected losses resulting from adverse interest-rate and credit-risk conditions specified by the GSE
Act prior to enactment of the Reform Act and added 30% additional capital to provide for management and operations risk.
The adverse interest-rate conditions prescribed by the GSE Act included an “up-rate scenario” in which 10-year Treasury
yields rise by as much as 75% and a “down-rate scenario” in which they fall by as much as 50%. The credit risk component
of the stress tests simulated the performance of our mortgage portfolio based on loss rates for a benchmark region. The
criteria for the benchmark region were intended to capture the credit-loss experience of the region that experienced the
highest historical rates of default and severity of mortgage losses for two consecutive origination years.
Classification
Prior to FHFA’s suspension of our capital classifications in October 2008, FHFA assessed our capital adequacy not less
than quarterly.
To be classified as “adequately capitalized,” we must meet both the risk-based and minimum capital standards. If we
fail to meet the risk-based capital standard, we cannot be classified higher than “undercapitalized.” If we fail to meet the
minimum capital requirement but exceed the critical capital requirement, we cannot be classified higher than “significantly
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