Freddie Mac 2004 Annual Report Download - page 102

stock to employees and non-employee directors as part of our stock-based compensation plans. See
""NOTE 11: STOCK-BASED COMPENSATION'' to the consolidated Ñnancial statements for a description
of these plans.
For a summary of our preferred stock outstanding at December 31, 2004 and information on redemption
dates for our preferred stock issuances, see ""NOTE 9: STOCKHOLDERS' EQUITY'' to the consolidated
Ñnancial statements.
Capital Adequacy
We regularly assess the adequacy of our capital to conÑrm that we hold capital suÇcient to satisfy all of
our Ñnancial obligations, even if economic circumstances deteriorate unexpectedly and severely.
The GSE Act establishes our capital standards, and OFHEO has issued regulations that set our
minimum, critical and risk-based capital requirements. We operate with the intention to hold capital that
exceeds all regulatory requirements.
The risk-based capital standard determines the amount of capital that we must hold to absorb projected
losses resulting from future adverse interest-rate and credit-risk conditions speciÑed by the GSE Act, plus
30 percent mandated by the GSE Act to cover management and operations risk. The risk-based capital
standard is based on stress test results calculated under two interest-rate scenarios prescribed by the GSE Act,
one in which 10-year Treasury yields rise by as much as 75 percent (up-rate scenario) and one in which they
fall by as much as 50 percent (down-rate scenario). The credit component of the stress tests simulates the
performance of our mortgage portfolio based on loss rates for the Benchmark Region. The criteria for the
Benchmark Region are set forth by the GSE Act and are intended to 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 of that amount to cover management and operations risk. Total capital
includes Core capital and general reserves for mortgage and foreclosure losses and any other amounts available
to absorb losses that OFHEO includes by regulation. Core capital consists of the par value of outstanding
common stock (common stock issued less common stock held in treasury), the par value of outstanding
perpetual noncumulative preferred stock, additional paid-in capital and retained earnings as determined in
accordance with GAAP.
The minimum capital standard requires us to hold an amount of Core capital that is generally the sum of
2.50 percent of aggregate on-balance sheet assets, as determined in accordance with GAAP, and approxi-
mately 0.45 percent of outstanding mortgage-related securities guaranteed by us and other aggregate oÅ-
balance sheet obligations. As discussed below, in 2004 OFHEO implemented a framework for monitoring our
capital adequacy which includes a targeted capital surplus of 30 percent of our minimum capital requirement.
The critical capital standard requires us to hold an amount of Core capital that is generally the sum of
1.25 percent of aggregate on-balance sheet assets, as determined in accordance with GAAP, and approxi-
mately 0.25 percent of outstanding mortgage-related securities guaranteed by us and other aggregate oÅ-
balance sheet obligations.
We evaluate ongoing capital compliance under changing market conditions through regular assessments
of the impact of these conditions on the level of our minimum capital surplus and our actions. We measure the
eÅects of key drivers, including the level of interest rates, the slope of the yield curve and changes in implied
market volatilities. Our assessment process is designed to ensure that we maintain a signiÑcant minimum
capital surplus across a wide range of economic scenarios. We also monitor the level and variability of our
capital surplus relative to our targeted 30 percent surplus under the capital monitoring framework temporarily
mandated by OFHEO. Our estimated surplus in excess of the 30 percent target surplus was approximately
$3.6 billion at December 31, 2004. Our sensitivity analysis currently indicates that our actual surplus would
exceed the targeted surplus across a wide range of economic scenarios. We also evaluate ongoing compliance
with the risk-based capital requirement through regular intra-quarter analysis and reporting. We monitor the
eÅects of interest rate changes and risk management actions on the level of risk-based capital surplus.
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