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Rebuilding confidence.
Leading responsibly.
2004 ANNUAL REPORT

Table of contents

  • Page 1
    Rebuilding confidence. Leading responsibly. 2004 ANNUAL REPORT

  • Page 2
    A message from the Chairman

  • Page 3
    ..., the high quality of our board is a heartening sign of strong leadership and oversight for Freddie Mac. FULFILLING OUR MISSION Freddie Mac's mission is to provide liquidity, stability and affordability to the housing market. On the first two, we have done a good job. Mortgage money has been...

  • Page 4
    ... new products last year than in the previous four years combined. By year's end, our GSE market share had rebounded toward historic levels - climbing six percentage points from its 2003 low. And we expect to build on our gains this year. The substantial improvement in our mortgage security prices...

  • Page 5
    ... working from traditional strengths and adding new ones: a strong balance sheet and capital position; low and rigorously managed levels of risk; improved market share and funding costs; and a stronger competitive position with customers. We're doing more on our affordable mission. And the year...

  • Page 6
    ... a strong business model, increasing customer focus, much improved funding costs and a dynamic, growing housing market. Dick Syron acted decisively to bring in new top executives who quickly gelled into a cohesive team. This helps make even our hard decisions a bit easier. Today there's a new sense...

  • Page 7
    ...our accounting and financial controls are yielding tangible results. They will make us not only a better reporting company, but a better-run company as well. By creating a culture of accountability and teamwork, we are streamlining and improving our operations. And that is helping Freddie Mac remain...

  • Page 8
    ... the global markets to finance housing in America. Today, we're exploring new approaches to meet the challenges of our mission, such as increased mortgage funding for minority and immigrant households, and creative new investment options designed to meet investors' changing needs. Doing so means we...

  • Page 9
    ... drive me every day at Freddie Mac. We're delivering new technology-based initiatives and executing on strategies to return the company to timely financial reporting, make it easier for our customers to do business with us, and help fulfill the company's mission. The operational challenges ahead for...

  • Page 10
    ...housing for families and to develop our signature program - Freddie Mac's Hoops for the Homeless - to raise awareness and money to combat family homelessness. Our foundation works every day to prevent child abuse and neglect, find homes for foster children and develop our young people. Our employees...

  • Page 11
    ... for making payments on our securities. Neither the U.S. nor any agency or instrumentality of the U.S. other than Freddie Mac is obligated to fund our mortgage purchase or Ã'nancing activities or to guarantee our securities or other obligations. The publication of this Information Statement and...

  • Page 12
    ...BUSINESS PROPERTIES LEGAL PROCEEDINGS SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS MARKET PRICE FOR THE COMPANY'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES FORWARD-LOOKING STATEMENTS SELECTED FINANCIAL DATA MANAGEMENT'S DISCUSSION AND ANALYSIS...

  • Page 13
    ...An investment banking company New York, New York John B. McCoy** Retired Chairman and Chief Executive OÇcer Bank One Corporation A Ã'nancial services company Columbus, Ohio Eugene M. McQuade President and Chief Operating OÇcer Freddie Mac McLean, Virginia Shaun F. O'Malley (Lead Director) Chairman...

  • Page 14
    ... fourth quarter and full-year 2005, including the timely Ã'ling of a minimum capital report with our regulator, the OÇce of Federal Housing Enterprise Oversight, or OFHEO, that complies with U.S. generally accepted accounting principles, or GAAP, at the end of January 2006. In 2004 and continuing...

  • Page 15
    ... on the basis of price, products, structure and service, by buying and selling mortgages in the form of whole loans (i.e., mortgage loans that have not been securitized) and mortgage-related securities. We also compete for low-cost debt funding with Fannie Mae, the Federal Home Loan Banks and other...

  • Page 16
    ...various legal investment laws and other regulations; ‚ access to the Federal Reserve Banks' book-entry system, which provides book-entry issuance, transfer, payment and settlement for our mortgage-related and debt securities; ‚ discretionary authority of the Secretary of the Treasury to purchase...

  • Page 17
    ... Rural Housing Service, or RHS, or partially guaranteed by the Department of Veterans AÃ...airs, or VA. Loan Quality Under our charter we must limit our mortgage purchase and resecuritization activities, so far as practicable, to mortgages that are of a quality, type and class that generally meet the...

  • Page 18
    .../Servicer Guide. We may modify these guidelines or grant waivers for some multifamily mortgages, including mortgages on properties that have favorable debt coverage or loan-to-value ratios (a) that we consider to have superior management, (b) that are located where the demand for rental housing...

  • Page 19
    ... payment of principal and interest related to low- and moderate-income multifamily mortgage loans that are originated and held by state and municipal housing Ã'nance agencies to support tax-exempt multifamily housing revenue bonds. For more information see ""MD&A ÃŒ OUR RETAINED AND TOTAL MORTGAGE...

  • Page 20
    .... Purchases and sales of TBA-eligible PCs occur daily. Prices are generally quoted and accepted based only upon the name of the issuer (e.g., Freddie Mac), the type of PC (e.g., 30-year Ã'xed rate), the coupon of the PC, the quantity and the settlement month. Each type of TBA trade has a single...

  • Page 21
    ... Securities to report all borrower credit information, including monthly mortgage payments, to all credit bureau and reporting agencies. Several states have enacted laws aimed at predatory lending practices, generally with regard to loans exceeding thresholds based on annual percentage rates...

  • Page 22
    ... in ""Table 3 ÃŒ Current and Future Housing Goals for 2005, 2006, 2007 and 2008'' below. In addition, HUD established three new home purchase subgoals for mortgages that Ã'nance purchases of single-family, owner-occupied properties located in metropolitan areas (reÃ'nanced mortgages are excluded...

  • Page 23
    ...underwriting guidelines and expanded and targeted initiatives to reach underserved populations. Our strategies to meet the new goals and subgoals may result in the purchase of loans that oÃ...er lower expected returns on our investment and are likely to increase our exposure to potential credit losses...

  • Page 24
    ... may not make any dividend payment on common or preferred stock if, after paying such dividend, we would fail to meet our minimum capital or risk-based capital requirements. For additional information about our regulatory capital requirements, see ""NOTE 10: REGULATORY CAPITAL'' to the consolidated...

  • Page 25
    ... related to the activities of banks, savings institutions, insurance companies, securities dealers and other regulated entities that comprise a signiÃ'cant part of our customer base. Among the legislative and regulatory provisions applicable to these entities are capital requirements for federally...

  • Page 26
    ... fees. Litigation and claims resolution are subject to many uncertainties and are not susceptible to accurate prediction. For additional information on these proceedings, see ""NOTE 13: LEGAL CONTINGENCIES'' and ""NOTE 14: INCOME TAXES'' to the consolidated Ã'nancial statements. Freddie Mac...

  • Page 27
    ... and Restated Employee Stock Purchase Plan. Of the 689,544,489 shares of common stock outstanding on the record date for the meeting, 602,265,372 shares were present in person or by proxy at the meeting. As shown in Table 4 below, the following persons were elected to our Board of Directors at the...

  • Page 28
    MARKET PRICE FOR THE COMPANY'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES Market Information Our common stock, par value $0.21 per share, is listed on the New York Stock Exchange, or NYSE, and the PaciÃ'c Stock Exchange under the symbol FRE. From time to ...

  • Page 29
    ...NOTE 9: STOCKHOLDERS' EQUITY'' to the consolidated Ã'nancial statements for additional information regarding our preferred stock dividend payments. Holders As of May 13, 2005, we had approximately 2,500 common stockholders of record. Securities Authorized for Issuance under Equity Compensation Plans...

  • Page 30
    ...investment funding and risk management purposes; ‚ The rate of growth in total outstanding U.S. residential mortgage debt and the size of the U.S. residential mortgage market; ‚ The possibility of further concentration of mortgage loan sourcing in a smaller number of originators; ‚ Preferences...

  • Page 31
    ... PCs issued and Structured Securities (unpaid principal balances)(6 Total mortgage portfolio (unpaid principal balances)ÏÏÏÏÏ Ratios Return on average assets(7 Return on common equity(8 Return on total equity(9 Dividend payout ratio on common stock(10 Equity to assets ratio(11 $ 9,137...

  • Page 32
    ... administering payments on these securities. Net interest income is primarily the diÃ...erence between interest income earned on mortgages and mortgage-related assets and interest expense owed on debt. To manage the interest-rate and other market risks associated with funding portfolio investments and...

  • Page 33
    ... fee on outstanding PCs and Structured Securities and certain pre-2003 fees that seller/servicers paid to us at the time of securitization that are amortized into Management and guarantee income over the estimated life of the PC. The decrease in the total Management and guarantee income rate...

  • Page 34
    ... fair value of net assets attributable to common stockholders, before common dividends and capital transactions, increased by $4.7 billion, or 21 percent, from December 31, 2003, a return that exceeds our long-term expectations. Capital We have submitted to OFHEO amended minimum capital reports for...

  • Page 35
    ... fourth quarter of 2004, we ceased our PC market-making and support activities accomplished through our Securities Sales & Trading Group business unit and our external Money Manager program. For a discussion of purchases into the Total mortgage portfolio, see ""VOLUME STATISTICS.'' Freddie Mac 23

  • Page 36
    ...-or-market valuation adjustments for loans held-for-sale and basis adjustments related to purchase commitment hedging activities. Basis adjustments are modiÃ'cations to the carrying value of these mortgage loans. (2) Includes PCs, Structured Securities and non-Freddie Mac mortgage-related securities...

  • Page 37
    ... and 2003, respectively, that pertain to our guarantee of the payment of principal and interest on (a) multifamily mortgage loans that are originated and held by state and municipal housing Ã'nance agencies to support tax-exempt multifamily housing revenue bonds, (b) tax-exempt multifamily housing...

  • Page 38
    ... Values of Financial Instruments,'' or SFAS 107, and are a tool to communicate our Ã'nancial position and results on a fair value basis. See ""CONSOLIDATED FAIR VALUE BALANCE SHEETS'' and ""NOTE 16: FAIR VALUE DISCLOSURES'' to the consolidated Ã'nancial statements for more information. Freddie Mac...

  • Page 39
    ..., at fair value Non-mortgage-related securities: Available-for-sale, at fair value Trading, at fair value Other assets(2) Derivative assets, at fair value Guarantee asset for Participation CertiÃ'cates, at fair value Selected debt securities, net Securities sold, not yet purchased, at fair...

  • Page 40
    ... as interest rate curves, market volatilities and pricing spreads, which can be validated using external sources such as third party pricing services, dealer marks and market observable transactions. Model-based valuations without market inputs are required for products with limited price discovery...

  • Page 41
    ... In general, we account for such transfers as either sales, secured borrowings or Ã'nancial guarantee transactions. We evaluate whether transfers of PCs or Structured Securities qualify as sales based upon the requirements of SFAS No. 140, ""Accounting for Transfers and Servicing of Financial Assets...

  • Page 42
    ... in 2004, 2003 and 2002 that relates to transfers of PCs or Structured Securities that were accounted for as sales. Table 12 Ì Securitization Activity Accounted for as Sales Year Ended December 31, 2004 2003 2002 (dollars in millions) Transfers of Freddie Mac securities that were accounted for as...

  • Page 43
    ... designated as cash Ã-ow hedges generally hedge interest-rate risk related to forecasted issuances of debt. For these hedging relationships to qualify for hedge accounting both at inception and over the life of the derivative, we must estimate the probable future level of certain types of debt...

  • Page 44
    ... on the loan loss reserves in 2003. See ""NOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES'' and ""NOTE 6: LOAN LOSS RESERVES'' to the consolidated Ã'nancial statements for more information about our process for determining the loan loss reserves. The process for determining the level of loan loss...

  • Page 45
    ... of our mortgage-related and non-mortgage-related investments, we recognize interest income using the eÃ...ective interest method in accordance with SFAS No. 91, ""Accounting for Nonrefundable Fees and Costs Associated with Originating or Acquiring Loans and Initial Direct Costs of Leases,'' or SFAS...

  • Page 46
    ... for more information on interest income and impairment recognition on securities. Recently Issued Accounting Pronouncements See ""NOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES'' to the consolidated Ã'nancial statements for more information concerning our accounting policies and recently...

  • Page 47
    ... gains (losses Hedge accounting gains (losses Gains (losses) on investment activity ÏÏÏ Gains (losses) on debt retirement Resecuritization fees Other income Total non-interest income (loss Non-interest expense Salaries and employee beneÃ'ts Professional services Occupancy expense...

  • Page 48
    ...(1) Rate Volume Interest income: Mortgage loans 4,007 Mortgage-related securities 28,460 Total Retained portfolio 32,467 Cash and investments 3,136 Total income on interest-earning assets ÏÏÏ 35,603 Interest expense: Short-term debt Long-term debt Total interest expense on debt securities...

  • Page 49
    ...our investments in mortgage-related securities were generally hedged by entering into forward sales of mortgage-related securities. When determining the fair value of these positions, the held investment was valued at the current market, or spot price, while the forward sale commitment was valued at...

  • Page 50
    ... to Changes in(1) Rate Volume Interest income: Mortgage loans Mortgage-related securities Total Retained portfolio Cash and investments Total income on interest-earning assets ÏÏÏ Interest expense: Short-term debt Long-term debt Total interest expense on debt securities ÏÏ Due to...

  • Page 51
    .... During 2002 and into 2003, we terminated pay-Ã'xed swaps to help manage the funding mismatch caused by the decrease in the expected lives of mortgage investments and increase in the balance of long-term debt. In 2002, the portfolio of swaps designated in hedge accounting relationships was in a net...

  • Page 52
    ... drivers of Net interest income and yields are described in detail below. Investment asset mix. The purchase, sale and liquidation of assets within the Retained portfolio and the Cash and investments portfolio, which we collectively refer to as our portfolios, has a signiÃ'cant impact Freddie Mac 40

  • Page 53
    ... on mortgage loans underlying PCs and Structured Securities in short-term investments until related payments are Due to PC investors. The interest earned on these investments is reported as a component of interest income on Cash and investments. As described above, mortgage interest rates were...

  • Page 54
    ... fair value hedges of existing debt. In both cases, termination of the hedge accounting relationship, including the actions we took in 2004 related to pay-Ã'xed and receive-Ã'xed swaps, resulted in the associated deferred hedging gain or loss being amortized into Net interest income over the life of...

  • Page 55
    ... average mortgage lives increased. Net interest income also beneÃ'ted from decreases in long-term debt expense and net growth in the Retained portfolio. Interest expense on derivative contracts increased with purchases of additional pay-Ã'xed swaps, which were acquired in a rising rate environment...

  • Page 56
    ... guarantee income also includes amortization of pre-2003 deferred fees, including credit fees and buy-down fees on PCs and Structured Securities that have not been previously sold under SFAS 125/140 or that have not been previously subject to Ã'nancial guarantee accounting under FIN 45. Freddie Mac...

  • Page 57
    ...sale of mortgage loans, which we report as Gains (losses) on investment activity. In the Ã'rst quarter of 2003, we improved our methodology for estimating the expected weighted average lives of mortgages with related deferred fees, including credit fees and buy-down fees. The improvements we Freddie...

  • Page 58
    .../servicers. Beginning in 2003, these upfront fees are amortized into income as a component of Income on ""Guarantee obligation for Participation CertiÃ'cates'' or are included in the determination of the gain or loss on the sale of mortgage loans. We expanded the use of our market adjusted pricing...

  • Page 59
    ...related income was driven by an approximate 53 basis point decline in the 30-year mortgage rate during the third quarter and the associated higher estimated prepayment speeds used in our amortization models which accelerated recognition of deferred fees. 2Q04 vs. 1Q04 Management and guarantee income...

  • Page 60
    ... $110 million model-related adjustment made in the Ã'rst quarter of 2003 discussed above. The change in the cash Ã-ow portion of Management and guarantee income was relatively small, reÃ-ective of the decrease in average outstanding PCs. Gains (Losses) on Guarantee Asset Gains (losses) on Guarantee...

  • Page 61
    ...ects our estimation of future guarantee fee cash Ã-ows and consequently, the fair value of the guarantee asset. Return of investment for each year was consistent with the growth of the outstanding PCs and Structured Securities, as shown in ""Table 8 ÃŒ Freddie Mac's Total Mortgage Portfolio Based on...

  • Page 62
    ... value of our guarantee asset declined as we collected Management and guarantee income related to our guarantee asset, as described above. Through the Ã'rst two quarters of 2003, our average single-family portfolio mortgage coupon rate was signiÃ'cantly higher than prevailing 30-year mortgage rates...

  • Page 63
    ...The initial fair value of contractual guarantee fees is the equivalent of our Guarantee asset for Participation CertiÃ'cates, at fair value. (2) Related to outstanding PCs and Structured Securities (including other PCs and Structured Securities held in our Cash and investments portfolio). Income on...

  • Page 64
    ... 29% Year Ended December 31, 2003 $ 151 $3,241 30% 1Q 2003 $ 231 $3,557 36% 2Q 2003 $ 157 $3,727 22% $ 193 $4,065 25% 3Q 2003 4Q 2003 (dollars in millions) Amortization income related to: Credit and buy-down fees received Initial fair value of contractual guarantee fees Income on ""Guarantee...

  • Page 65
    ... receive- and pay-Ã'xed interest-rate swaps, respectively. We use swaptions and other option-based derivatives to adjust the contractual funding of our debt in response to changes in the expected lives of assets in the Retained portfolio. Mortgage borrowers generally have the right to prepay their...

  • Page 66
    ...during 2004. The asset mix in the Retained portfolio has moved toward a greater proportion of non-agency, Ã-oating-rate mortgage-related securities, which generally require lower interest-rate protection than Ã'xed-rate products. Also, the gradual increase in market interest rates and the Ã-attening...

  • Page 67
    ... Notional % of Total June 30, 2003 Notional % of Total September 30, 2003 Notional % of Total December 31, 2003 Notional % of Total (dollars in billions) Receive-Ã'xed swaps: Fair value hedge No hedge designation(2 Total Pay-Ã'xed swaps: Cash Ã-ow hedge No hedge designation(2 Total $ 89...

  • Page 68
    ... provides a quarterly and full year summary of the period-end notional amounts and gains and losses related to swaps, swaptions and other derivatives that we used to manage interest-rate risk but were not accounted for in hedge accounting relationships for 2004 and 2003. Table 27 Ì Derivatives Not...

  • Page 69
    ... forward swap rates. Forwardstarting swaps represent interest-rate swap agreements scheduled to begin on a future date. During 2004, signiÃ'cant portions of our swaps not in hedge accounting relationships were forward-starting. Both spot and forward swap rates were volatile during the year causing...

  • Page 70
    ...of-cost-or-market valuation adjustments 2) (179) 8 Total gains (losses) on investment activity 348) $(1,114) $1,799 (1) We reclassiÃ'ed $524 million for full year 2003 from Gains (losses) on sale of mortgage loans and available-for-sale securities to Gains (losses) on trading securities to conform...

  • Page 71
    ...on the sale of mortgage loans and available-for-sale securities during 2003 compared to 2002 were primarily attributable to the increasing volume of sales of PCs and Structured Securities in these years, as well as sales of Treasury and agency debt securities originally purchased for asset/liability...

  • Page 72
    ... the comparatively low credit quality of these securities. See ""CONSOLIDATED BALANCE SHEETS ANALYSIS Ì Cash and Investments'' for more information about our non-agency, mortgage-related securities at December 31, 2004 and 2003. Also see ""NOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES'' to our...

  • Page 73
    ... consists of fees associated with servicing and technology-related programs, including Loan Prospector», various fees related to multifamily loans (including application and other fees) and various other fees received from mortgage originators and servicers. In 2004 and 2003, other income also...

  • Page 74
    ...that are backed by non-Freddie Mac mortgage-related securities, which are oÃ...-balance sheet obligations; and our provision for uncollectible interest on single-family loans underlying PCs held by third parties. REO operations income (expense) includes certain costs associated with the acquisition of...

  • Page 75
    ... sale of a multifamily property. Our total credit losses, deÃ'ned as ""Real estate owned operations income (expense)'' plus ""net chargeoÃ...s,'' rose slightly in 2004 but were still low, totaling approximately 1.1 basis points of the average Total mortgage portfolio (after excluding non-Freddie Mac...

  • Page 76
    ... penalty Loss contingency expense Selected aÃ...ordable housing transaction fees Amortization of credit enhancements Realized losses on certain guarantees Loan Prospector»-related expenses Special charitable contributions(1 Disposition of certain technology-related assets Other(2 Total Other...

  • Page 77
    ...reaching a closing agreement with the Internal Revenue Service, or IRS, relating to the tax treatment of dividends paid on step-down preferred stock issued by our two REIT subsidiaries. For more information regarding this tax reserve adjustment, see ""SUBSEQUENT ACCOUNTING REVISIONS.'' These eÃ...ects...

  • Page 78
    ... in unattractive mortgage-to-debt option-adjusted spreads. While Ã'xed-rate investment opportunities were relatively less attractive than in 2003, this was mitigated by lower liquidation rates compared to 2003 and purchases of Ã-oating rate, non-agency mortgage-related securities. Freddie Mac 66

  • Page 79
    ...the payment of principal and interest and are subject to the credit risk associated with the underlying mortgage loan collateral (or non-agency mortgage-related security collateral, where applicable). (3) Agency mortgage-related securities are generally not separately rated by credit rating agencies...

  • Page 80
    ... stock Subtotal Other non-mortgage-related securities held for PC market-making and support activities(3 Other mortgage-related securities held for PC market-making and support activities(3)(4 Securities purchased under agreements to resell and Federal funds sold ÏÏÏÏÏ Cash and investments...

  • Page 81
    ... and support activities of our Securities Sales & Trading Group business unit and the discontinuation of our external Money Manager program. In contrast, our balances of Cash and cash equivalents and Securities purchased under agreements to resell and Federal funds sold increased by a combined $23...

  • Page 82
    ...2003 Fair Value(2) Interest-rate swaps: Pay-Ã'xed Receive-Ã'xed Basis (Ã-oating to Ã-oating Total interest-rate swaps Option-based: Call swaptions Put swaptions Other option-based derivatives(3)(4 Total option-based Futures Foreign-currency swaps Subtotal Prepayment management agreement...

  • Page 83
    ... PC market-making and support activities conducted through our Securities Sales & Trading Group business unit and external Money Manager Program during the fourth quarter of 2004. As noted previously, changes in fair values either are recorded in current income or, to the extent our accounting hedge...

  • Page 84
    ... in accounting(1 Transfer-out to the loan loss reserve during the period(2 Additions, net of repurchases: Fair value of newly-issued guarantee obligations(3 Deferred gains on newly-executed guarantees Amortization income related to:(4) Credit and buy-down fees received Initial fair value of...

  • Page 85
    ... 38 ÃŒ Total Stockholders' Equity December 31, 2004 2003 (dollars in millions) Preferred stock Common stock Additional paid-in capital Retained earnings AOCI related to: Available-for-sale securities Cash Ã-ow hedge relationships(1 Minimum pension liability Total AOCI Treasury stock Total...

  • Page 86
    ... non-mortgage-related securities we held in our Retained portfolio and Cash and investments portfolio that were classiÃ'ed as available-for-sale totaled $610.1 billion and $598.5 billion at December 31, 2004 and 2003, respectively. AVERAGE CONSOLIDATED BALANCE SHEETS AND RATE/VOLUME ANALYSIS Table...

  • Page 87
    ...: Mortgages loans Mortgage-related securities in the Retained portfolio Total Retained portfolio Investments Securities purchased under agreements to resell and Federal funds sold Total interest-earning assets Interest-bearing liabilities: Short-term debt Long-term debt Total debt securities...

  • Page 88
    ... December 31, 2003 Carrying Carrying Amount(2) Fair Value Amount(2) Fair Value (dollars in billions) Assets Mortgage loans Mortgage-related securities(3 Retained portfolio Cash and cash equivalents Investments Securities purchased under agreements to resell and Federal funds sold Derivative...

  • Page 89
    ... a mortgage is purchased or that arises over its life. Therefore, in the normal course of business, we consistently have limited net exposures to these risks. See ""RISK MANAGEMENT Ì Interest-Rate Risk and Other Market Risks'' for more information. Return on risk positions are fair value estimates...

  • Page 90
    ... rates and other market factors on the unhedged portion of the projected cash Ã-ows from the credit guarantee business. The value changes associated with net buy-ups and Ã-oat are considered in return on risk positions (deÃ'ned above) because they relate to hedged positions. Fee income Fee income...

  • Page 91
    ... mortgage backed securities 10,878 Mortgage revenue bonds 1,944 Manufactured housing Total non-agency mortgage-related securities 115,736 Total Non-Freddie Mac mortgage-related securities purchased into the Retained portfolio 119,774 Total new business purchases 494,588 19% Mortgage purchases...

  • Page 92
    ... by pledging collateral or agreeing to accept losses on loans that default. The drop in purchases with credit enhancements in 2003 compared to 2004 and 2002 was due primarily to a decline in the number of loans purchased that are covered by primary mortgage insurance, or PMI, which is not required...

  • Page 93
    ... other credit protections. (3) See ""RISK MANAGEMENT Ì Credit Risks Ì Mortgage Credit Risk'' for more information. Single-family mortgage loans purchased with loan-to-value ratios above 80 percent accounted for 15 percent, 12 percent and 16 percent for the years ended December 31, 2004, 2003 and...

  • Page 94
    ... by the high average credit scores of mortgage loans purchased of 719, 729 and 722 for the years ended December 31, 2004, 2003 and 2002, respectively. Credit scores are ranked on a scale of approximately 300 to 850 points. The slight decrease in the average credit score in 2004 resulted from...

  • Page 95
    ...of common and preferred stock. We measure our cash Ã-ow position on a daily basis, netting uses of cash (principally, the settlement of mortgage and non-mortgage investment security purchases, principal and interest payments on debt and mortgage securities, net payments on derivative instruments and...

  • Page 96
    ... from principal accretion related to zero-coupon subordinated debt. See ""NOTE 8: DEBT SECURITIES AND SUBORDINATED BORROWINGS'' and ""NOTE 9: STOCKHOLDERS' EQUITY'' to the consolidated Ã'nancial statements for further information. Debt Securities We Ã'nance our purchases of mortgage loans, mortgage...

  • Page 97
    ... of Reference Bills» securities and other discount notes, which are short-term instruments with maturities of one year or less that are sold on a discounted basis, paying only principal at maturity. Our Reference Bills» program consists of large issues of short-term debt that we auction to dealers...

  • Page 98
    ...which we exchange newly issued debt securities for similar outstanding debt securities held by investors. These transactions are not accounted for as repurchases, but rather as debt exchanges. Credit Ratings. Our ability to access the capital markets and other sources of funding, as well as our cost...

  • Page 99
    ... maintain capital reserves to meet mortgage funding needs; ‚ provide diverse sources of liquidity; and ‚ help manage the interest-rate risk inherent in mortgage-related assets. The non-mortgage-related securities in the Cash and investments portfolio consist principally of assetbacked securities...

  • Page 100
    ...each derivative type and the maturity proÃ'le of the positions in ""RISK MANAGEMENT ÃŒ Interest-Rate Risk and Other Market Risks.'' Dividend payments on preferred stock are not reÃ-ected on Table 47, since all classes of preferred stock are non-cumulative. See ""NOTE 9: STOCKHOLDERS' EQUITY'' to the...

  • Page 101
    ...985 $ During 2004 and 2003, we added approximately $2.0 billion and $4.0 billion, respectively, to Core capital primarily from Net income, partially oÃ...set by the payment of common and preferred stock dividends. Our Board of Directors approved a dividend per common share of $0.35 for Ã'rst quarter...

  • Page 102
    ... capture the region that experienced the highest historical rates of default and severity of mortgage losses for two consecutive origination years. The risk-based capital requirement is the amount of Total capital needed to absorb the stress test losses in the most adverse scenario, plus 30 percent...

  • Page 103
    ... related to a closing agreement entered into with the IRS concerning our REIT subsidiaries. See ""NOTE 14: INCOME TAXES'' to the consolidated Ã'nancial statements for further information. (2) Core capital consists of the par value of outstanding common stock (common stock issued less common stock...

  • Page 104
    ...) delivery or credit fees for higher-risk mortgages and (iii) other forms of credit enhancements received from counterparties or mortgage loan insurers. Most of the remaining credit guarantee activity occurs through our Cash Window or our MultiLender Program. Single-family mortgage loans we purchase...

  • Page 105
    ... of the payment of principal and interest; ‚ Freddie Mac pass-through certiÃ'cates which are backed by tax-exempt housing revenue bonds and related taxable bonds and/or loans; and ‚ mortgage loans held by third parties for which we provide a credit guarantee. For our purchase and securitization...

  • Page 106
    ... credit guarantee business, we routinely enter into forward purchase and sale commitments for mortgage loans and mortgage-related securities. Pursuant to SFAS 133, a portion of these commitments are accounted for as derivatives under GAAP, with their fair value reported as either Derivative assets...

  • Page 107
    ...Audit Committee of the Board of Directors. Within the Enterprise Risk Oversight function, the Operational Risk Oversight group, the Market Risk Oversight group and the Credit Risk Oversight group each provide independent oversight. Oversight of our financial reporting processes and internal controls...

  • Page 108
    ... access to our systems. We identiÃ'ed material weaknesses related to system security, change management and information technology application and general controls during our control reviews in 2004. These weaknesses related not only to Ã'nancial reporting systems, but other business applications...

  • Page 109
    ... requirements to help ensure that our sellers and servicers have the capability and incentive to meet our standards. See ""Credit Risks'' and ""BUSINESS Ì Predatory Lending'' for more information on how we manage the risk of sellers and servicers. Internal Controls over Financial Reporting...

  • Page 110
    ... vendors. Entity-level controls include components such as: our Code of Conduct, employee hotline, anti-fraud program and compliance program. Third party controls are those controls that ensure the information and services we receive from third party vendors are well controlled and meet our quality...

  • Page 111
    ... practice. Market Risk Oversight fulÃ'lls its mission by reporting to senior management concerning the key investment strategies and market risks taken throughout the corporation, the consistency of market risk positions with stated strategies and the appropriateness of limits and policies related...

  • Page 112
    ... and/or future earnings. This risk arises principally because we hedge mortgage-related investments with LIBOR- and Treasury-based interest-rate derivatives. We do not actively manage the basis risk arising from funding Retained portfolio investments with our debt securities, also referred to as...

  • Page 113
    ... of mortgage assets for our PMVS and duration gap measures. To mitigate prepayment model risk, we perform extensive monthly testing of actual results against model results and sensitivity analysis to facilitate informed asset selection and risk management decisions. However, expected returns can...

  • Page 114
    ...and sale commitments for mortgage loans and mortgage-related securities. Most of these commitments are derivatives subject to the requirements of SFAS 133 and accordingly must be recorded at fair value on our consolidated balance sheets. Prepayment Management Agreement. Practices of seller/servicers...

  • Page 115
    Swap Guarantee Derivatives. We guarantee the payment of principal and interest on (a) multifamily mortgage loans that are originated and held by state and municipal housing Ã'nance agencies to support taxexempt multifamily housing revenue bonds, (b) tax-exempt multifamily housing revenue bonds that ...

  • Page 116
    ... and collateral agreements; and ‚ stress-testing to evaluate potential exposure under possible adverse market scenarios. On an ongoing basis, we review the credit fundamentals of all of our derivative counterparties to conÃ'rm that they continue to meet internal standards. Internal ratings, credit...

  • Page 117
    ...management agreement and swap guarantee derivatives. (10) Consists of OTC derivative agreements for forward purchase and sale commitments. (11) See ""Credit Risks Ì Mortgage Credit Risk Ì Mortgage Credit Risk Management Strategies'' for additional information about credit derivatives. Freddie Mac...

  • Page 118
    ... market stress test also assumes high OTC counterparty default rates coupled with low recovery rates to calculate our potential exposure to each OTC counterparty. To date, we have not incurred any credit losses on OTC derivative counterparties or set aside speciÃ'c reserves for institutional credit...

  • Page 119
    ... item. For further information, see ""NOTE 12: DERIVATIVES'' to the consolidated Ã'nancial statements. (5) Includes gains or losses reclassiÃ'ed from AOCI, net of taxes, as a result of the termination of cash Ã-ow hedge designations because we determined that the related forecasted transaction is...

  • Page 120
    ... reclassiÃ'cations to income of net deferred losses related to closed cash Ã-ow hedges during future periods. Table 52 summarizes the notional amounts for each type of derivative, including our new contracts, maturities and terminations during the year. This information indicates the level and...

  • Page 121
    ...$756,778 Beginning Balance Year Ended December 31, 2003 Derivative Notional Amount(1) New Maturities/ Contracts Terminations(2) (dollars in millions) Ending Balance Interest-rate swaps: Pay-Ã'xed Receive-Ã'xed Basis (Ã-oating to Ã-oating Total interest-rate swaps Option-based: Call swaptions...

  • Page 122
    ... in Derivative Fair Values Year Ended December 31, 2004 2003 (dollars in millions) Beginning balance Ì Net asset (liability Net change in: Futures(1 Commitments Credit derivatives Swap guarantee derivatives Other derivatives:(2) Changes in fair value Fair value of new contracts entered into...

  • Page 123
    ... Value(1) In Excess of 5 Years Interest-rate swaps: Pay-Ã'xed Receive-Ã'xed Basis (Ã-oating to Ã-oating Total interest-rate swaps Option-based: Call swaptions Put swaptions Other option-based derivatives Total option-based Futures Foreign-currency swaps Prepayment management agreement...

  • Page 124
    ... date. Generally, the interest rate associated with the variable leg of the swap is set when the Ã'rst payment cycle begins and is periodically reset thereafter. Measurement of Interest-Rate Risk We measure our exposure to key interest-rate risks every day against both internal management limits...

  • Page 125
    ... short-term interest-earning assets and interestbearing liabilities and all derivatives on a pre-tax basis. When we calculate the expected loss in portfolio market value and duration gap, we also take into account the cash Ã-ows related to certain credit guaranteerelated items, including net buy...

  • Page 126
    ... the exposure of the fair value of net assets attributable to common stockholders to changes in interest rates, they do not capture the potential impact of certain other market risks, such as changes in volatility, basis, prepayment model, mortgage-to-debt spread and foreign currency risk. The...

  • Page 127
    ... and quality control processes, we seek to understand the underlying risk in a given mortgage we securitize or purchase for our Retained portfolio to ensure that we adequately price for the risk we assume. Our current business model relies on a process of delegated underwriting for the single-family...

  • Page 128
    ... quantitative credit risk management tools to evaluate and purchase single-family mortgages and monitor the related mortgage credit risk. Loan Prospector» combines information on the key indicators of mortgage default risk, such as loan-to-value ratios, credit scores and other mortgage and borrower...

  • Page 129
    ... on single-family mortgage loans include collateral (including cash or high-quality marketable securities) pledged by a lender, government guarantees, and recourse agreements (under which we may require a lender to repurchase loans that default). In some instances, our agreements with insurers limit...

  • Page 130
    ... Securities Securities Securities Securities(2) (dollars in millions) Freddie Mac issued PCs and Structured Securities Single-family: Conventional: 30-year Ã'xed-rate(3 15-year Ã'xed-rate ARMs/Ã-oating-rate(4 Seconds(5 FHA/VA RHS and other federal guarantee loans Alternative collateral deals...

  • Page 131
    ... the year ended December 31, 2003 to conform with the 2004 presentation. Product mix aÃ...ects the credit risk proÃ'le of our Total mortgage portfolio. In general, 15-year Ã'xed-rate mortgages exhibit the lowest default rate among the types of single-family mortgage loans we securitize and purchase...

  • Page 132
    ... mortgage-related securities, alternative collateral deals and that portion of Structured Securities that is backed by Ginnie Mae CertiÃ'cates) by original and estimated current loan-to-value ratio ranges, credit scores, loan purpose, property type and occupancy type is shown in Table 62. Freddie...

  • Page 133
    ... charter requires that mortgage loans purchased with loan-to-value ratios above 80 percent be covered by mortgage insurance or other credit enhancements. (3) Current market values are estimated by adjusting the value of the property at origination based on changes in the market value of house prices...

  • Page 134
    and 2003 from 72 percent for the year ended December 31, 2002. Mortgage loans with higher loan-to-value ratios (and therefore lower levels of borrower equity) at the time of purchase are also protected by credit enhancements, since our charter requires that loans with loan-to-value ratios above 80 ...

  • Page 135
    ...of non-performing assets, we have limited loss exposure due to the credit enhancements associated with these securities. Prior to 2004, alternative collateral deals consisted only of Structured Securities backed by non-agency securities, which were primarily backed by subprime mortgage loans; and to...

  • Page 136
    ... single-family Total mortgage portfolio, excluding non-Freddie Mac mortgage-related securities, alternative collateral deals and that portion of Structured Securities that is backed by non-Freddie Mac mortgage-related securities. (2) Some mortgage loans may go through a foreclosure alternative more...

  • Page 137
    ...of the borrower's mortgage or to implement another foreclosure alternative. Other single-family loss mitigation activities include providing default management tools designed to help single-family servicers manage non-performing loans more eÃ...ectively. These tools include Early Indicator», a system...

  • Page 138
    ... agreements may result in us making payments to the seller/servicer. Credit Performance. The eÃ...ectiveness of our credit risk management activities is reÃ-ected, in part, in the level of credit losses relative to our Total mortgage portfolio (excluding non-Freddie Mac mortgagerelated securities...

  • Page 139
    ... non-Freddie Mac mortgage-related securities and that portion of Structured Securities that is backed by Ginnie Mae CertiÃ'cates) by geographic region. Table 66 ÃŒ Single-Family ÃŒ Non-Credit-Enhanced Delinquencies ÃŒ By Region(1)(2) 2004 December 31, 2003 2002 Northeast Southeast North central...

  • Page 140
    ... a result, we have experienced higher than average early defaults and delinquency rates on these mortgage loans originated in 2000, but they represent only one percent of the single-family Total mortgage portfolio (excluding non-Freddie Mac mortgage-related securities and that portion of Structured...

  • Page 141
    ... are limited in many instances to amounts less than the full amount of the loss. (5) Equal to REO operations income (expense) plus Charge-oÃ...s, net. (6) Calculated as credit gains (losses) divided by the average Total mortgage portfolio, excluding non-Freddie Mac mortgage-related securities and...

  • Page 142
    ... in both 2003 and 2002 largely due to house price growth, recoveries from credit enhancements and reimbursements from seller/servicers. REO income arises when the fair market value of the acquired asset exceeds the carrying value of the mortgage loan or when we are able to sell the REO at amounts...

  • Page 143
    ... CREDIT AND OTHER RISKS'' to the consolidated Ã'nancial statements for a description of these regions. (2) Includes recoveries of charge-oÃ...s primarily resulting from foreclosure alternatives and REO acquisitions on loans where a share of default risk has been assumed by servicers, mortgage insurers...

  • Page 144
    .... (7) Calculated using the average Total mortgage portfolio, excluding non-Freddie Mac mortgage-related securities and that portion of Structured Securities that is backed by Ginnie Mae CertiÃ'cates. We maintain two loan loss reserves ÃŒ Reserve for losses on mortgage loans held-for-investment and...

  • Page 145
    ... from agreements with the following entities: ‚ mortgage seller/servicers; ‚ mortgage loan insurers; ‚ issuers, guarantors or third party providers of credit enhancements on non-Freddie Mac mortgagerelated securities held in our Retained portfolio; ‚ mortgage investors and originators; and...

  • Page 146
    .... We manage institutional credit risk on non-Freddie Mac mortgage-related securities by only purchasing securities that meet our investment guidelines and performing ongoing analysis to evaluate the creditworthiness of the issuers and servicers of these securities and the bond insurers that...

  • Page 147
    ... ""NOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES'' to the consolidated Ã'nancial statements for more information on impairments. Mortgage Investors and Originators. We are exposed to pre-settlement risk through the purchase, sale and Ã'nancing of mortgage loans and mortgage-related securities...

  • Page 148
    .... In 2005 and thereafter, we will record tax beneÃ'ts related to REIT preferred stock dividend payments in the consolidated Ã'nancial statements consistent with the closing agreement. See ""NOTE 14: INCOME TAXES'' to the consolidated Ã'nancial statements for additional information. Freddie Mac 136

  • Page 149
    ... Preferred stock Total non-mortgage-related securities 29,830 Total available-for-sale securities 620,291 Trading securities Retained portfolio Mortgage-related securities issued by: Freddie Mac 11,398 Fannie Mae 385 Ginnie Mae 59 Total mortgage-related securities 11,842 Cash and investments...

  • Page 150
    ... Rate(3) (dollars in millions) Maximum Balance, Net Outstanding at Any Month End Discount notes(4 Medium-term notes Securities sold under agreements to repurchase and Federal funds purchased(5 Swap collateral obligations(6 Securities sold, not yet purchased Short-term debt securities Current...

  • Page 151
    ..., liquid mortgage securities for use as collateral in short-term borrowings from dealer counterparties. ‚ For purposes of this commitment, we will maintain liquidity needed to meet our obligations to pay principal and interest related to our outstanding debt maturities, to pay PC investors the...

  • Page 152
    ... future default costs of mortgage loans and mortgage-related securities. In this analysis, we adjust the house-price assumption used in the base case to estimate the level and sensitivity of potential credit costs associated with our existing single-family mortgage portfolio. See ""NOTE 2: TRANSFERS...

  • Page 153
    CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Freddie Mac 141

  • Page 154
    ... To the Board of Directors and Stockholders of Freddie Mac: In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of income, of cash Ã-ows, and of stockholders' equity present fairly, in all material respects, the Ã'nancial position of Freddie Mac...

  • Page 155
    FREDDIE MAC CONSOLIDATED STATEMENTS OF INCOME Year Ended December 31, 2004 2003 2002 (dollars in millions, except sharerelated amounts) Interest income Mortgage loans Mortgage-related securities in the Retained portfolio Cash and investments Total interest income Interest expense Short-term ...

  • Page 156
    ...$23 pledged as collateral that may be repledged Total non-mortgage-related securities Total mortgage-related and non-mortgage-related securities Securities purchased under agreements to resell and Federal funds sold Cash and investments Accounts and other receivables, net Derivative assets, at...

  • Page 157
    FREDDIE MAC CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY Year Ended December 31, 2004 Shares Amount Shares 2003 Amount Shares (dollars and shares in millions) 2002 Amount Preferred stock, at redemption value Balance, beginning of year Preferred stock issuances Preferred stock redemptions ...

  • Page 158
    ... held-for-investment mortgages Proceeds from sales of REO Net (increase) decrease in securities purchased under agreements to resell and Federal funds sold Derivative premiums and terminations, net Investments in housing tax credit partnerships Net cash used for investing activities Cash Ã-ows...

  • Page 159
    ... mortgage market includes providing its credit guarantee for residential mortgages originated by mortgage lenders and investing in mortgage loans and mortgage-related securities held in Freddie Mac's Retained portfolio. Through its credit guarantee activities, Freddie Mac securitizes mortgage loans...

  • Page 160
    ...cant inÃ-uence, but not control. Under the equity method of accounting, Freddie Mac reports its recorded investment as part of Other assets on the consolidated balance sheets and recognizes its share of the entity's net income or losses in the consolidated statements of income with an oÃ...set to the...

  • Page 161
    ... mortgage loans underlying PCs. Buy-Ups and Buy-Downs are discussed further below in ""Guarantor Swap Transactions Executed Prior to January 1, 2003.'' Cash Ã-ows related to the repayment of the original issue discount on short-term, zero-coupon debt are reported as operating activities. Freddie Mac...

  • Page 162
    ... Cash Flow Information and Present Value in Accounting Measurements'' (""CON 7''). These recourse obligations are valued independently of corresponding GAs. The resulting gain (loss) on sale of transferred PCs and Structured Securities is reÃ-ected in Freddie Mac's consolidated statements of income...

  • Page 163
    ..., Freddie Mac may receive various types of seller-provided credit enhancements that correspond to securitized mortgage loans. The accounting for the primary components of Guarantor Swaps executed prior to January 1, 2003 follows. Accounting For Guarantee Fees, Buy-Up, Buy Down and Credit Fees...

  • Page 164
    ... described above in ""Transfers of Financial Assets that Qualify as Purchases or Sales.'' Guarantor Swap Transactions Executed on or after January 1, 2003 Freddie Mac accounts for Guarantor Swaps that were executed on or after January 1, 2003 pursuant to the requirements of FASB Interpretation No...

  • Page 165
    ... unpaid principal balance of securitized mortgage loans. Periodic amortization of recognized Deferred Guarantee Income is reÃ-ected in earnings as a component of Income on ""Guarantee obligation for Participation CertiÃ'cates.'' Accounting For Buy-Ups, Buy-Downs and Credit Fees ÃŒ Cash payments that...

  • Page 166
    ... IN MORTGAGE-RELATED ASSETS'' for a discussion of the attribution of GA and PC Residual-related cash Ã-ows. Due to Participation CertiÃ'cate Investors Timing diÃ...erences between Freddie Mac's receipt of scheduled and unscheduled principal and interest payments from seller/servicers on mortgages...

  • Page 167
    ...Ã'cate investors. Scheduled and unscheduled principal payments received by Freddie Mac that relate to its investment in PCs are reported as a reduction to its investment in PCs on the consolidated balance sheets. Mortgage Loans Mortgage loans that management may sell are classiÃ'ed as held-for-sale...

  • Page 168
    ... sheet date. The homogeneous pools of single-family mortgage loans are determined based on common underlying characteristics including year of origination, loan-to-value ratio and geographic region. In determining the loan loss reserves for singlefamily loans, Freddie Mac determines the point within...

  • Page 169
    ... Loans'' in ""NOTE 6: LOAN LOSS RESERVES'' for further discussion. Freddie Mac has the option to purchase mortgage loans out of PC pools under certain circumstances, such as to resolve an existing or impending delinquency or default. Freddie Mac's general practice is to purchase the mortgage loans...

  • Page 170
    .... See ""NOTE 16: FAIR VALUE DISCLOSURES'' for more information on how Freddie Mac determines the fair value of securities. The company records forward purchases and sales of securities that are speciÃ'cally exempt from the requirements of SFAS 133 on a trade date basis. Securities underlying forward...

  • Page 171
    ... upon an underlying asset, index, reference rate or other variable. They may be privately negotiated contractual agreements that can be customized to meet speciÃ'c needs, including certain commitments to purchase and sell mortgage loans, mortgage-related securities and debt securities, or they may...

  • Page 172
    ... gain or loss on sale of corresponding mortgage loans (either in whole loan or securitized form); or ‚ Recognized as interest income over the life of the corresponding mortgage loans at the point that, where applicable, such mortgage loans are reclassiÃ'ed as held-for-investment. Freddie Mac 160

  • Page 173
    .... The fair value of options to purchase shares of Freddie Mac common stock, including options issued pursuant to the ESPP, is estimated using a Black-Scholes option pricing model, taking into account the exercise price and expected life of the option, the market value of the underlying stock and its...

  • Page 174
    ... to owners. For Freddie Mac, comprehensive income is composed of net income plus changes in the unrealized gains and losses on available-for-sale securities, the eÃ...ective portion of derivatives accounted for as cash Ã-ow hedge relationships, and changes in the minimum pension liability. Reportable...

  • Page 175
    ... that time, Freddie Mac is reporting the income statement eÃ...ects of derivatives not currently designated in hedge accounting relationships under SFAS 133 in a single line item on the company's consolidated statements of income, Derivative gains (losses) for all periods presented. Prior to 2003, the...

  • Page 176
    ... of credit quality since origination acquired by completion of a transfer for which it is probable, at acquisition, that the investor will be unable to collect all contractually required payments receivable. SOP 03-3 requires purchased loans and debt securities to be recorded initially at...

  • Page 177
    ...-related securities that are issued by either Ginnie Mae or non-agency issuers. Freddie Mac guarantees the payment of principal and interest on all issued PCs and Structured Securities. Freddie Mac issues PCs in several diÃ...erent ways: ‚ Single-family mortgage loans that are purchased by Freddie...

  • Page 178
    ...Securities. See ""NOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES ÃŒ Due to Participation CertiÃ'cate Investors'' for more information. (3) With respect to mortgage loans purchased through Freddie Mac's Cash Window that were internally securitized as PCs and held as available-for-sale investments...

  • Page 179
    ...PCs or Structured Securities Backed by Single-Family Mortgages Freddie Mac recognizes GAs and GOs for PCs backed by residential mortgage loans and multifamily mortgage loans in conjunction with transfers accounted for as sales under SFAS 125/140 as well as, beginning on January 1, 2003, transactions...

  • Page 180
    ...LIBOR'') rate is generally used to discount such cash Ã-ows. Additionally, projected credit related costs that are factored into the GO-related cash Ã-ows are benchmarked periodically to the non-conforming loan securitization market. Like recognized GAs, Freddie Mac recognized as GOs the average of...

  • Page 181
    ... spread is necessary to calibrate the implied market value of the modeled discounted cash Ã-ows to the traded price. (3) Scenario average Prepayment rates are simulated on a monthly frequency, although rates reported above represent an unpaid principal balance weighted average of annualized values...

  • Page 182
    ...2.3 relates solely to GAs associated with PCs backed by single-family mortgage loans. (3) Includes interest-only securities that were issued by Freddie Mac as part of a resecuritization transaction for which sale accounting treatment was applied, and Freddie Mac securities that were (a) purchased at...

  • Page 183
    ...of Cash Flows Year Ended December 31, 2004 2003(1) 2002 (dollars in millions) Cash Ã-ows from: Transfers of Freddie Mac securities that were accounted for as sales Cash Ã-ows received on retained interests: GAs(2 PC residuals(2 Other Retained Interests Purchases of delinquent or foreclosed loans...

  • Page 184
    ... above for 2004 and 2003 do not consider cash Ã-ows received that relate to credit enhancements that were previously recorded as a component of recognized GAs. With respect to amounts reported in 2002, Freddie Mac recorded total income of $820 million associated with recognized GAs. Approximately...

  • Page 185
    ... ACCOUNTING POLICIES'' for further information regarding FIN 46-R. Low-Income Housing Tax Credit Partnerships Freddie Mac invests as a limited partner in low-income housing tax credit partnerships formed for the purpose of providing funding for aÃ...ordable multifamily rental properties. These...

  • Page 186
    ... 31, 2003, the company had investments in 15 trusts related to non-mortgagerelated, asset-backed securities in which Freddie Mac had a signiÃ'cant variable interest. These trusts had total assets of $7.9 billion. As an investor, Freddie Mac's maximum exposure to loss consisted of the book value of...

  • Page 187
    ... are collateralized by mortgage loans on low- and moderate-income multifamily housing projects. Second, Freddie Mac issues passthrough certiÃ'cates which are backed by tax-exempt multifamily housing revenue bonds and related taxable bonds and/or loans. Freddie Mac guarantees all scheduled principal...

  • Page 188
    ... maximum potential amount of payments Freddie Mac could be required to make under such guarantees was $9.2 billion and $8.4 billion, respectively, which represents the outstanding unpaid principal balance of the underlying mortgage loans. At both December 31, 2004 and 2003, the total fair value of...

  • Page 189
    ... the loan and the original seller is unable to perform under a separate agreement to reimburse the servicer for those servicing premiums. Freddie Mac's servicing related premium guarantees are payable according to a vesting schedule for up to Ã've years from the date of purchase of servicing rights...

  • Page 190
    ...Total mortgage-related securities Cash and investments portfolio Non-mortgage-related securities: Asset-backed securities Corporate debt securities Obligations of states and political subdivisions Commercial paper Preferred stock Total non-mortgage-related securities Total available-for-sale...

  • Page 191
    ... this review, management has determined that these securities are not other than temporarily impaired. See ""NOTE 2: TRANSFERS OF SECURITIZED INTERESTS IN MORTGAGE-RELATED ASSETS'' for further information on Freddie Mac's estimates of credit exposure and credit support. ‚ Fannie Mae securities and...

  • Page 192
    ... Mac's investments in mortgage-related securities held by its Securities Sales & Trading Group business unit were generally hedged by entering into forward sales of mortgage-related securities. When determining the fair value of these positions, the held investment was valued at the current market...

  • Page 193
    ... Fair Value (dollars in millions) Weighted Average Yield(1) Retained portfolio Total mortgage-related securities(2) Due 1 year or less Due after 1 through 5 years Due after 5 through 10 years Due after 10 years Total Cash and investments portfolio Non-mortgage-related securities Asset-backed...

  • Page 194
    ...of an impairment loss. See ""NOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES'' for further information regarding the component of AOCI related to availablefor-sale securities. Table 5.5 Ì AOCI, Net of Taxes, Related to Available-For-Sale Securities Year Ended December 31, 2004 2003 2002 (dollars...

  • Page 195
    ... operations of its PC market-making and support activities accomplished through its Securities Sales & Trading Group business unit and external Money Manager program during the fourth quarter of 2004. Freddie Mac is also required to pledge collateral for margin requirements with some custodians in...

  • Page 196
    ...(beneÃ't) for credit losses during 2003 and 2002, respectively. As a result of these reclassiÃ'cations, it increased recoveries by $26 million and $15 million for the full years ended December 31, 2003 and 2002, respectively. (2) It is Freddie Mac's practice to purchase mortgage loans from the pools...

  • Page 197
    ... single-family loans totaled $157 million, $160 million and $129 million for the years ended December 31, 2004, 2003 and 2002, respectively. Delinquency Rates Table 6.3 summarizes the delinquency rates for Freddie Mac's Total mortgage portfolio, excluding non-Freddie Mac mortgage-related securities...

  • Page 198
    ... bidder at foreclosure sales of properties that collateralize non-performing single-family and multifamily mortgage loans owned by the company. Upon acquiring single-family properties, Freddie Mac establishes a marketing plan to sell the property as soon as practicable by either listing it with...

  • Page 199
    ...adjustments. (3) EÃ...ective rate previously reported for December 31, 2003 has been revised. Freddie Mac Ã'nances the purchase of mortgage loans and mortgage-related securities primarily through the issuance of Senior debt and Subordinated debt. Senior Debt, Due Within One Year As indicated in Table...

  • Page 200
    ... Rate(3) (dollars in millions) Maximum Balance, Net Outstanding at Any Month End Discount notes(4 Medium-term notes Securities sold under agreements to repurchase and Federal funds purchased(5 Swap collateral obligations(6 Securities sold, not yet purchased Short-term debt securities Current...

  • Page 201
    ... at December 31, 2004 and 2003, respectively. These debt instruments represent medium-term notes that permit persons acting on behalf of deceased beneÃ'cial owners to require Freddie Mac to repay principal prior to their contractual maturity date. (5) Amounts for 2003 have been revised to conform...

  • Page 202
    ...accounted for as extinguishments of debt based on the diÃ...erence between the principal amount of the debt securities repurchased (adjusted for deferred premiums, discounts, and hedging gains and losses) and current market prices, and the write-oÃ... of related deferred debt issuance costs. Freddie Mac...

  • Page 203
    ... to Additional paid-in capital. Table 9.1 provides a summary of Freddie Mac's preferred stock outstanding at December 31, 2004. Table 9.1 Ì Preferred Stock Issue Date Total Redemption Total Shares Shares Par Price per Outstanding Redeemable(2) Authorized Outstanding Value Share Balance(1) On or...

  • Page 204
    ... capture the region that experienced the highest historical rates of default and severity of mortgage losses for two consecutive origination years. The risk-based capital requirement is the amount of Total capital needed to absorb the stress test losses in the most adverse scenario, plus 30 percent...

  • Page 205
    ... related to a closing agreement entered into with the Internal Revenue Service (""IRS'') concerning the company's REIT subsidiaries. See ""NOTE 14: INCOME TAXES'' for further information. (2) Core capital consists of the par value of outstanding common stock (common stock issued less common stock...

  • Page 206
    ...of OFHEO before engaging in certain capital transactions, including the repurchase of any shares of common stock, redemption of any preferred stock or payment of preferred stock dividends above stated contractual rates. Freddie Mac also must submit a written report to the Director of OFHEO after the...

  • Page 207
    ...options granted under the Employee Plans allow for the purchase of Freddie Mac's common stock at an exercise price equal to the fair value of the common stock on the grant date. Options generally may be exercised for a period of 10 years from the grant date, subject to a vesting schedule Freddie Mac...

  • Page 208
    ... RSUs with dividend equivalent rights to non-employee members of the Board of Directors (""Directors''). Under the Directors' Plan, on the date of the annual meeting, each reelected or reappointed Director is granted an option to purchase shares of Freddie Mac's common stock with a market value of...

  • Page 209
    ...' Plan. Table 11.2 Ì Employee Plans and Directors' Plan Stock Options Activity 2004 Weighted Average Exercise Price Year Ended December 31, 2003 Stock Weighted Average Options Exercise Price 2002 Weighted Average Exercise Price Stock Options Stock Options Outstanding, beginning of year Granted...

  • Page 210
    ...-average assumptions used in determining the fair value of options granted under Freddie Mac's stock-based compensation plans using a Black-Scholes option pricing model. Table 11.5 Ì Assumptions Used to Determine the Fair Value of Options Employee Stock Purchase Plan 2003 Employee and Directors...

  • Page 211
    ... (b) credit risk-sharing agreements where Freddie Mac remits or receives payments based upon the default performance of certain mortgage loans; and (c) swap guarantee derivatives where Freddie Mac guarantees the sponsor's or the borrower's performance as a counterparty on certain interest-rate swaps...

  • Page 212
    ...the cash Ã-ows of a forecasted transaction. Freddie Mac uses interest-rate swaps, futures, foreign-currency swaps and forward purchase and sale commitments to hedge the changes in cash Ã-ows associated with the forecasted issuances of debt, forecasted purchase or sale of mortgage-related assets, and...

  • Page 213
    ...designated as cash Ã-ow hedges for 2004, 2003 and 2002. At December 31, 2004, the maximum remaining length of time over which Freddie Mac has hedged the exposure related to the variability in future cash Ã-ows on forecasted transactions is 29 years. However, over 90 percent of the AOCI, net of taxes...

  • Page 214
    ...and current executives and, in one of the suits, members of Freddie Mac's Board of Directors alleging breach of Ã'duciary duty and seeking indemniÃ'cation in connection with the restatement. Both cases were ultimately assigned to the same judge in New York who is handling the securities class action...

  • Page 215
    ..., Freddie Mac's former outside auditor, alleging breach of contract for failing to properly conduct audits of the company's Ã'nancial statements. No ruling is sought against Freddie Mac, which is named as a nominal party to that suit. ERISA Lawsuits. Two class action lawsuits were Ã'led in 2003 in...

  • Page 216
    ... regular audits of Freddie Mac's tax returns for prior years, some of which relate to matters connected with the restatement. Freddie Mac continues to respond to these inquiries. See ""NOTE 14: INCOME TAXES'' for more information. The Committee on Energy and Commerce of the House of Representatives...

  • Page 217
    ...assets: Deferred fees related to securitizations Basis diÃ...erences related to assets held-for-investment Credit related items and reserve for loan losses Employee compensation and beneÃ't plans Cash Ã-ow hedge deferrals and unrealized (gains) losses related to available-forsale securities Total...

  • Page 218
    ... 14.3 reconciles the statutory federal tax rate to the eÃ...ective tax rate. Table 14.3 ÃŒ Reconciliation of Statutory to EÃ...ective Tax Rate Year Ended December 31, 2004 2003 2002 Statutory corporate rate Tax-exempt interest Tax credits Provision (beneÃ't) related to tax contingencies OFHEO civil...

  • Page 219
    ...the same questions at issue in the 1985 through 1993 cases, involve the character of losses on dispositions of mortgage-related securities. Tax Treatment of REITs. In February 1997, Freddie Mac formed two REIT subsidiaries that issued a total of $4.0 billion in step-down preferred stock to investors...

  • Page 220
    ... administrative and legal process, the recognition of such additional liability could have a material adverse impact on Freddie Mac's results of operations in the quarter in which it was recognized. Based on current knowledge and after consultation with counsel, management does not currently believe...

  • Page 221
    ...Ã'ned beneÃ't pension plan (""Pension Plan'') covering substantially all of its employees. Pension Plan beneÃ'ts are based on years of service and the employee's highest average compensation (up to legal plan limits) over any consecutive 36 months of employment. Freddie Mac's general practice is to...

  • Page 222
    ... value of future expected beneÃ'ts, assuming current salary levels remain in eÃ...ect. The change in the minimum pension liability recognized in AOCI, net of taxes, was a $2 million decrease for the year ended December 31, 2004 and a $10 million increase for year ended December 31, 2003. Freddie Mac...

  • Page 223
    ... Used to Determine Net Periodic BeneÃ't Cost Pension BeneÃ'ts Year Ended December 31, 2004 2003 2002 Post-Retirement Health BeneÃ'ts Year Ended December 31, 2004 2003 2002 Major Assumptions: Discount rate Rate of future compensation increase Expected long-term rate of return on plan assets...

  • Page 224
    ... a basis for selecting the discount rate shown in Table 15.4. The expected long-term rate of return on plan assets for 2004 and 2003 is estimated using a portfolio return calculator model. The model considers the historical returns and the future expectations for returns for each asset class in the...

  • Page 225
    ...31, 2004, 2003 and 2002, respectively, related to these plans. These expenses were included in Salaries and employee beneÃ'ts on the consolidated statements of income. See ""NOTE 13: LEGAL CONTINGENCIES'' for more information regarding civil litigation and a DOL investigation of Freddie Mac's Thrift...

  • Page 226
    ... Fair Value(3) 2003 Carrying Amount(2) Fair Value (dollars in billions) Assets Mortgage loans Mortgage-related securities(4 Retained portfolio Cash and cash equivalents Investments Securities purchased under agreements to resell and Federal funds sold Derivative assets Guarantee asset for...

  • Page 227
    ... or market value of Freddie Mac as a whole. Freddie Mac reports assets and liabilities that are not Ã'nancial instruments (such as property, plant and equipment and deferred taxes), as well as certain Ã'nancial instruments that are not covered by the SFAS 107 disclosure requirements (such as pension...

  • Page 228
    ... Sales & Trading Group business unit and the external Money Manager program during the fourth quarter of 2004. The fair values of Investments are estimated using the methods described above in ""Mortgage-related securities.'' Securities purchased under agreements to resell and Federal funds...

  • Page 229
    ...zero coupon discount notes. The fair value of the short-term zero coupon discount notes is based on a discounted cash Ã-ow model with market inputs. The valuation of other debt securities is generally based on market prices obtained from broker/dealers, reliable third-party pricing service providers...

  • Page 230
    ... initial fair value. For information concerning the company's valuation methodologies and accounting policies related to guarantee-related credit losses, see ""NOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES,'' and ""NOTE 2: TRANSFERS OF SECURITIZED INTERESTS IN MORTGAGE-RELATED ASSETS.'' Reserve...

  • Page 231
    ... Sales & Trading Group business unit and its external Money Manager program, which was a component of the $48,585 million balance at December 31, 2003. See ""NOTE 5: RETAINED PORTFOLIO AND CASH AND INVESTMENTS PORTFOLIO'' for more information about the securities Freddie Mac holds. Freddie Mac...

  • Page 232
    ..., PR, PA, RI, VI, VT, VA, WV); North central (IL, IN, IA, MI, MN, ND, OH, SD, WI); Southeast (AL, FL, GA, KY, MS, NC, SC, TN); Southwest (AR, CO, KS, LA, MO, NE, NM, OK, TX, WY). Mortgage Lenders A signiÃ'cant portion of Freddie Mac's single-family mortgage purchase volume is generated from several...

  • Page 233
    ... market value of each counterparty's derivatives outstanding is calculated to determine the amount of the company's net credit exposure, which is equal to derivatives in a net gain position by counterparty after giving consideration to collateral posted. Freddie Mac's collateral agreements require...

  • Page 234
    ..., Freddie Mac formed two majority-owned REIT subsidiaries funded through the issuance of common stock (99.9 percent of which is held by Freddie Mac) and a total of $4.0 billion of perpetual, step-down preferred stock issued to outside investors. The dividend rate on the step-down preferred stock is...

  • Page 235
    ...potential common shares for the years ended December 31, 2004, 2003 and 2002. (2) The eÃ...ect of dilutive common equivalent shares outstanding includes: (a) the weighted average shares related to stock options (including the ESPP) that have an exercise price lower than the average market price during...

  • Page 236
    ... Chairman of the Board in January 2000. Prior to that, he was Chairman and Chief Executive OÇcer of the American Stock Exchange for Ã've years, President of the Federal Reserve Bank of Boston for Ã've years and President of the Federal Home Loan Bank of Boston for three years. Eugene M. McQuade was...

  • Page 237
    ...Ã'xed-income investments, including mortgages and private placement bonds, at New England Mutual Life Insurance Company and held various real estate Ã'nance positions at both Cigna and Phoenix Mutual Insurance Companies. Joan E. Donoghue was named Freddie Mac's Senior Vice President, General Counsel...

  • Page 238
    ...in securities regulation and corporate Ã'nance matters. John F. Woods was named Senior Vice President and Principal Accounting OÇcer in October 2003 and Corporate Controller in February 2005. Prior to that, Mr. Woods served as Senior Vice President, Control and Accounting in Funding and Investments...

  • Page 239
    ... of Directors, OÇcers and Employees'' of our Proxy Statement for our annual meeting of stockholders to be held on July 15, 2005 and is incorporated by reference into this Information Statement. PRINCIPAL ACCOUNTANT FEES AND SERVICES Information regarding principal accountant fees and services is...

  • Page 240
    ... and cash Ã-ows of Freddie Mac as of, and for, the periods presented in this Information Statement. Date: June 14, 2005 MARTIN F. BAUMANN Martin F. Baumann Executive Vice President and Chief Financial OÇcer /s/ * These certiÃ'cations do not address our internal control over Ã'nancial reporting or...

  • Page 241
    ..., as adjusted by Total Ã'xed charges. RATIO OF EARNINGS TO COMBINED FIXED CHARGES AND PREFERRED STOCK DIVIDENDS 2004 Year Ended December 31, 2003 2002 2001 (dollars in millions) 2000 Income before cumulative eÃ...ect of change in accounting principles, net of taxes Add: Income tax expense Minority...

  • Page 242
    ... of record by the company's transfer agent in accordance with Freddie Mac's bylaws and New York Stock Exchange requirements. DIVIDEND PAYMENT Approved by Freddie Mac's Board of Directors, dividends on the company's common stock and non-cumulative preferred stock in 2004 and the Ã'rst Ã've...

  • Page 243
    ...Employee Stock Purchase Plan Federal National Mortgage Association Financial Accounting Standards Board Federal Housing Administration Credit scores initially developed by Fair, Issac and Co., Inc. Financial Accounting Standards Board Interpretation Subordinated debt securities issued by Freddie Mac...

  • Page 244
    ... SOP TBA TDR U.S. VA VIE Qualifying Special Purpose Entities Standard & Poor's Stock Appreciation Rights Securities and Exchange Commission Statement of Financial Accounting Standards The AICPA's Statement of Position To Be Announced Troubled Debt Restructuring United States Department of Veterans...

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