Freddie Mac 2005 Annual Report Download

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Progress
CONTINUING
2005 Annual Report

Table of contents

  • Page 1
    2005 Annual Report Progress CONTINUING

  • Page 2
    A MESSAGE FROM THE CHAIRMAN

  • Page 3
    ... year of continuing progress for Freddie Mac. Overall, our business performed well. We were successful in improving our position with customers, meeting extraordinary mission demands, and strengthening our capital position and balance sheet. We grew our mortgage portfolio and our share of the market...

  • Page 4
    ...rate risk management and low debt funding costs. We met the market's changing needs by improving our ability to purchase non-traditional mortgage products and making core improvements in our business operations. We also took major steps forward in such areas as customer satisfaction and market share...

  • Page 5
    ... year. In fact, since December 2003, we have raised this dividend by 81 percent. Regarding our credit and interest-rate risk management record, it remains a hallmark of the industry. Our ready access to callable debt and specialized mortgage risk expertise are key competitive advantages. The company...

  • Page 6
    ... to make the necessary investments to ensure that Freddie Mac has world-class controls, reporting and accounting systems. Our goal is to reduce our expense ratio over time, so that as the company grows, expenses become a diminishing share of our overall business. Serving Our Mission Freddie Mac...

  • Page 7
    ...is no higher priority for Freddie Mac's senior management than completing this work and becoming timely in our financial reporting. This company must become the standard of excellence not only for managing mortgage risk, but for the accounting and internal controls associated with it. Over the past...

  • Page 8
    ... our balance sheet and our expertise to work. We helped jumpstart home rebuilding and community renewal by providing relief to borrowers, originators and servicers. We also brought stability to the market, using our retained portfolio, by committing to buy up to $1 billion of mortgage revenue bonds...

  • Page 9
    ... Freddie Mac employees joined Habitat for Humanity's America Builds on the National Mall. Fifty-one homes were shipped to waiting families in the Gulf Coast region. $580 billion in liquidity. Our dependable presence in the market lowers rates for consumers of conforming mortgages. And it helps make...

  • Page 10
    ... In fact, by year end, Freddie Mac's regulatory core capital grew to more than $35 billion - well above the capital requirements set by our safety and soundness regulator. And we expect to be able to maintain our strong position across a wide range of market conditions. Our credit risks remained low...

  • Page 11
    ...term shareholder value and deliver on our charter mission as a leader in the secondary mortgage market. Much of Freddie Mac's progress is the result of a new, integrated focus on customers. We improved customer service, diversified our lender base and increased our share with key business partners...

  • Page 12
    ... Freddie Mac a top financial services firm of enduring strength, increased transparency and the highest integrity. A company that leads the industry, delivers first-class financial reporting, provides new levels of customer service and makes both single-family and rental housing more accessible...

  • Page 13
    ...It named Freddie Mac to its 2006 list of "Top 100 Corporate Citizens" for best practices in the area of corporate social responsibility. Today, we have the right team, the right plan and a strong, well-capitalized franchise that's focused on serving our vital housing mission and generating value for...

  • Page 14
    Freddie Mac 2005 Annual Report to Stockholders

  • Page 15
    ... Circulars, all available supplements, Ã'nancial reports and other similar information by visiting our Internet website (www.FreddieMac.com) or by writing or calling us at: Freddie Mac Investor Relations Department Mailstop D4O 1551 Park Run Drive McLean, Virginia 22102-3110 Telephone: 571-382-4732...

  • Page 16
    ... PROPERTIES LEGAL PROCEEDINGS SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS MARKET 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 OF FINANCIAL...

  • Page 17
    ... to lenders through this process drives down mortgage rates on loans within the dollar limits set under our charter. These lower rates help make homeownership aÃ...ordable for more families and individuals than would be possible without our participation in the secondary mortgage market. 1 Freddie Mac

  • Page 18
    ...Debt outstanding at year-end, not seasonally-adjusted. Source: Federal Reserve Flow of Funds Accounts of the United States dated June 8, 2006. Growth in the U.S. residential mortgage debt market is aÃ...ected by several factors, including changes in interest rates, employment rates in various regions...

  • Page 19
    ..., and for the year ended December 31, 2005, we reported net income of $2.1 billion. At June 1, 2006, we had 4,905 full-time and 133 part-time employees. Our principal oÇces are located in McLean, Virginia. Types of Mortgages We Purchase Our charter establishes general parameters for the terms...

  • Page 20
    ...&A Ì RISK MANAGEMENT Ì Credit Risks Ì Mortgage Credit Risks Ì Mortgage Credit Risk Management Strategies Ì Underwriting Requirements and Quality Control Standards'' for additional information. Investment and Funding Activities We purchase mortgage loans and mortgage-related securities and hold...

  • Page 21
    ... mortgage-related assets into two or more classes that meet the investment criteria and portfolio needs of diÃ...erent investors. Our principal multi-class Structured Securities qualify for tax treatment as Real Estate Mortgage Investment Conduits, or REMICs. For purposes of this Information Statement...

  • Page 22
    ...purchases of single-family, owner-occupied properties located in metropolitan areas; ‚ increased the multifamily special aÃ...ordable volume target to $3.92 billion, based on HUD's established formula; and ‚ required the certiÃ'cation of information provided in Freddie Mac's Annual Mortgage Report...

  • Page 23
    ... fail to submit a required housing plan or fail to make a good faith eÃ...ort to comply with a plan approved by HUD; or (b) fail to submit certain data relating to our mortgage purchases, information or reports required by law. Fair Lending Our mortgage purchase activities are subject to federal anti...

  • Page 24
    ... the purchase of loans aÃ...ected by those laws. New Program Approval We are required under our charter and the GSE Act to obtain the approval of the Secretary of HUD for any new program for the purchasing, servicing, selling, lending on the security of, or otherwise dealing in, conventional mortgages...

  • Page 25
    ...interest rates and maturities of these securities), as well as new types of mortgage-related securities issued subsequent to the enactment of the Financial Institutions Reform, Recovery and Enforcement Act of 1989. The Secretary of the Treasury has performed this debt securities approval function by...

  • Page 26
    ... investors to lose conÃ'dence in our reported Ã'nancial information, which would likely have an adverse eÃ...ect on the trading price of our securities. If we fail to meet our reporting obligations, this could aÃ...ect our ability to maintain the listing of our securities on the New York Stock Exchange...

  • Page 27
    ... our business operations. We outsource certain key functions to external parties, including processing functions for trade capture, market risk management analytics, and asset valuation (Blackrock Financial Management, Inc.), and processing functions for mortgage loan underwriting (Electronic Data...

  • Page 28
    ... to us meet these guidelines. See ""MD&A Ì RISK MANAGEMENT Ì Credit Risks Ì Mortgage Credit Risk Ì Mortgage Credit Risk Management Strategies Ì Underwriting Requirements and Quality Control Standards'' and ""Ì Institutional Credit Risk Ì Mortgage Seller/Servicers'' for information about how...

  • Page 29
    ...nancial services industry generally may adversely aÃ...ect our business activities. Our business activities may be aÃ...ected by a variety of legislative and regulatory actions related to the activities of banks, savings institutions, insurance companies, securities dealers and other regulated entities...

  • Page 30
    ... to purchase mortgages to meet our mission objectives while providing favorable returns for our business. Furthermore, competitive pricing pressures may make our products less attractive in the market and negatively impact our proÃ'tability. We also compete for low-cost debt funding with Fannie Mae...

  • Page 31
    ...or more key lenders could result in a decline in market share and revenues. Our business depends on our ability to acquire a steady Ã-ow of mortgage loans from the originators of those loans. We purchase a signiÃ'cant percentage of our single-family mortgages from several large mortgage lenders. The...

  • Page 32
    ... at the meeting by the following votes: Votes for Votes Against Abstentions 613,265,113 874,878 3,496,775 MARKET 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...

  • Page 33
    ... on such payments and ""NOTE 9: STOCKHOLDERS' EQUITY'' to the consolidated Ã'nancial statements for additional information regarding our preferred stock dividend rates. Holders As of June 1, 2006, we had 2,343 common stockholders of record. Transfer Agent and Registrar Computershare Trust Company...

  • Page 34
    ... estimates; ‚ volatility of reported results due to changes in fair value of certain instruments or assets; ‚ the rate of growth in total outstanding U.S. residential mortgage debt and the size of the U.S. residential mortgage market; ‚ preferences of originators in selling into the secondary...

  • Page 35
    SELECTED FINANCIAL DATA(1) At or for the Year Ended December 31, 2005 2004 2003 2002 2001 (dollars in millions, except share-related amounts) Income Statement Data Net interest income Non-interest income (loss Net income before cumulative eÃ...ect of changes in accounting principles Cumulative eÃ......

  • Page 36
    ... to buy up to $1 billion in mortgage revenue bonds, enabling state housing finance authorities to make low-cost mortgages and home repair loans for up to 10,000 low- and moderate-income families. Fair Value Management We believe fair value measures provide an important view of our business economics...

  • Page 37
    ..., from December 31, 2004. Subsequent to the issuance of our Information Statement Supplement dated May 30, 2006, we increased the fair value of net assets at December 31, 2005 by $0.1 billion to correct an error in the calculation of the fair value of our debt securities issued. 21 Freddie Mac

  • Page 38
    ... whole loans and the minority interests in consolidated real estate investment trusts, or REITs, as well as other securities by increasing the amount of market data used in the valuation process. In addition, our fair value results were aÃ...ected by the agreement to settle the securities class action...

  • Page 39
    ...and Rate/Volume Analysis 2005 Interest Income (Expense)(1) $ 4,037 29,684 33,721 1,773 Average Balance(1)(2) Interest-earning assets: Mortgage loans(6)(7)(8 Mortgage-related securities(8)(9 Total Retained portfolio Investments(10 Securities purchased under agreements to resell and Federal funds...

  • Page 40
    ...-rate assets, and higher interest expense on derivatives in qualifying hedge accounting relationships. Another factor in the decline in Net interest income for 2005 was the result of our decision to cease the PC market-making and support activities conducted through our Securities Sales and Trading...

  • Page 41
    ... income on mortgage loans and mortgage-related securities declined by $835 million, or 3 percent. We earned lower interest income on these investments during 2004 compared to 2003 because we increased purchases of lower-coupon non-agency mortgage-related securities (such as variable-rate securities...

  • Page 42
    ...to compensate for the strength or weakness of our PC prices relative to competing securities. It is important to note that the increase in buy-downs generates up-front fees that, beginning in 2003, are deferred and recognized over time as a component of Income on Guarantee obligation. 26 Freddie Mac

  • Page 43
    ... higher mortgage interest rates in 2004 compared to 2003 and the associated impact on prepayment speeds used in our amortization models, which increased the expected weighted average lives of outstanding PCs and slowed the pace of amortization. The contractual management and guarantee fee rate in...

  • Page 44
    ... 5,541 $4,065 $2,904 Liquidation rate for outstanding PCs and Structured Securities(2 24% 29% 63% (1) Related to upfront cash payments in the form of credit fees and buy-down payments that are received from counterparties to guarantee transactions that are accounted for pursuant to FIN 45...

  • Page 45
    ... Derivative Gains (Losses) Fair value hedges-open(5 Cash Ã-ow hedges-open(5)(6 No hedge designation(3 Total Consolidated Statements of Income for the Years Ended December 31, 2004 2003 Hedge Hedge Hedge Accounting Derivative Accounting Derivative Accounting Gains Gains Gains Gains Gains...

  • Page 46
    ... in Derivative gains (losses) as compared to 2003. Had these pay-Ã'xed and receive-Ã'xed swaps remained in hedge accounting relationships, the related accrual of periodic settlements would have instead been reported as a component of Net interest income (loss). The increase in the 30 Freddie Mac

  • Page 47
    ...rates increased during the third quarter of 2003, our call swaptions declined in value and we incurred losses on commitments to purchase or sell mortgages and mortgage-related securities. These losses were partially oÃ...set by gains on pay-Ã'xed swaps. Hedge Accounting Gains (Losses) Hedge accounting...

  • Page 48
    .... A sharp increase in mortgage interest rates during the third quarter of 2003 reduced the value of our held-for-sale mortgage loan portfolio, resulting in lower-of-cost-or-market valuation adjustments that totaled $(178) million in the third quarter of 2003. Gains (Losses) on Debt Retirement During...

  • Page 49
    ... of loans underwritten using alternate underwriting tools prior to purchase has increased. In the process of reviewing our accounting policies and practices during 2005, 2004 and 2003, we identiÃ'ed certain errors not material to our Ã'nancial statements that related to income in previously reported...

  • Page 50
    ... 31, 2003. However, a decrease in the estimated incurred losses for the multifamily mortgage portfolio, driven primarily by an increase in the estimated fair value of multifamily properties in certain areas, partially oÃ...set the increase resulting from the single-family portfolio. 34 Freddie Mac

  • Page 51
    ... of the impact of these investments on our income tax expense. Other Expenses Reserve for legal settlements On April 20, 2006, we announced that we reached an agreement in principle to settle the securities class action and stockholder derivative lawsuits that relate to our restatement. The $339...

  • Page 52
    .... During 2005, strong demand from other investors, combined with fewer mortgage loan originations, generally resulted in unattractive mortgage-to-debt optionadjusted spreads on agency Ã'xed-rate products. Net unrealized gains (losses) on mortgage-related securities, pre-tax was a 36 Freddie Mac

  • Page 53
    .... Table 18 Ì Fair Value of Available-For-Sale and Trading Mortgage-Related Securities in the Retained Portfolio 2005 December 31, 2004 (in millions) 2003 Available-for-sale securities: Mortgage-related securities issued by: Freddie Mac 351,447 Fannie Mae 43,306 Ginnie Mae 1,115 Other 231,356...

  • Page 54
    ... 5,764 Preferred stock Total available-for-sale non-mortgage-related securities 42,165 Trading securities: Mortgage-related securities issued by: Freddie Mac Fannie Mae Ginnie Mae Other Total trading mortgage-related securities Non-mortgage-related securities: Asset-backed securities Debt...

  • Page 55
    ..., variable-rate mortgage-related securities, which generally require less interest-rate protection than Ã'xed-rate products. Also, the gradual increase in market interest rates and the Ã-attening of the yield curve in 2005 has reduced the interest-rate risk of our existing Ã'xed-rate investments...

  • Page 56
    ...derivatives of that type. See Table 35 under ""RISK MANAGEMENT ÃŒ Interest-Rate Risk and Other Market Risks'' for additional information regarding derivative counterparty credit exposure. Table 23 also provides the weighted-average Ã'xed rate of our pay-Ã'xed and receiveÃ'xed swaps. 40 Freddie Mac

  • Page 57
    ... Securities. Consequently, the fair value of some guarantee assets increases, while the fair value of other guarantee assets decreases. In 2005 and 2004, the primary drivers aÃ...ecting the net increase in our Guarantee asset balance were our business volumes and changes in mortgage interest rates...

  • Page 58
    ...) Maximum Balance, Net Outstanding at Any Month End Reference Bills» securities and discount notes Medium-term Notes Securities sold under agreements to repurchase and Federal funds purchased Swap collateral obligations Hedging-related basis adjustments Short-term debt securities Current...

  • Page 59
    ... the Year Weighted Average (3) Balance, Net EÃ...ective Rate(4) (dollars in millions) Maximum Balance, Net Outstanding at Any Month End Reference Bills» securities and discount notes Medium-term Notes Securities sold under agreements to repurchase and Federal funds purchased Swap collateral...

  • Page 60
    ..., net of taxes, with respect to cash Ã-ow hedge relationships at December 31, 2005, approximately $5.9 billion relates to hedges associated with the forecasted issuances of non-callable debt securities with maturities or interest payment frequencies of approximately one month to one year. Such debt...

  • Page 61
    ... fair value balance sheets, we use a number of Ã'nancial models. See ""RISK MANAGEMENT ÃŒ Operational Risks'' and ""RISK MANAGEMENT ÃŒ Interest-Rate Risk and Other Market Risks'' for information concerning the risks associated with these models. Key Components of Changes in Fair Value of Net Assets...

  • Page 62
    ... guarantee fee income lost because of prepayments. We hedge interest-rate exposure related to net buy-ups (up-front payments made by us that increase the guarantee fee that we will receive over the life of the pool) and Ã-oat (expected gains or losses resulting from our mortgage security program...

  • Page 63
    ... and security-speciÃ'c data, interest-rate paths, cash Ã-ows and prepayment rates. We use these models and assumptions in running our business, and we rely on many of the models in producing our Ã'nancial statements and measuring, managing and reporting interest-rate and other market risks. The use...

  • Page 64
    ... these assets. LIQUIDITY AND CAPITAL RESOURCES Liquidity Our business activities require that we maintain adequate liquidity to make payments upon the maturity or repurchase of our debt securities, purchase mortgage loans, mortgage-related securities and other investments, make payments of principal...

  • Page 65
    ...program, we sell large issues of long-term debt that provide investors worldwide with a high-quality, liquid investment vehicle. Reference Notes» securities are regularly issued, non-callable Ã'xed-rate securities, which we currently issue with original maturities ranging from two through ten years...

  • Page 66
    ... investments or credit guarantee opportunities. We may also sell or Ã'nance the securities in this portfolio to maintain capital reserves to meet mortgage funding needs, provide diverse sources of liquidity, or help manage the interest-rate risk inherent in mortgage-related assets. The non-mortgage...

  • Page 67
    ...our consolidated Ã'nancial statements for additional information. On April 20, 2006, we reached an agreement in principle to settle the securities class action lawsuits and the shareholder derivative lawsuits related to our restatement. The settlement of these actions includes a cash payment of $410...

  • Page 68
    ..., the timing of payments due under these obligations is uncertain. See ""NOTE 15: EMPLOYEE BENEFITS'' to our consolidated Ã'nancial statements for additional information. (5) Purchase commitments represent our obligations to purchase mortgage loans and mortgage-related securities from third parties...

  • Page 69
    ..., we have strengthened our processes to validate model assumptions, code, theory, and the system applications that utilize our models. We are currently improving our model oversight processes and enhancing our staÇng both within the business areas and in our risk oversight functions. 53 Freddie Mac

  • Page 70
    ... Credit Risk Management Strategies ÃŒ Underwriting Requirements and Quality Control Standards'' and ""Institutional Credit Risk ÃŒ Mortgage Seller/Servicers'' for information about how we mitigate the risks associated with delegated underwriting. We are making signiÃ'cant investments to build new...

  • Page 71
    ... quality issues associated with information provided to us by seller/servicers related to mortgage loans underlying our PCs and Structured Securities and the use of that data within our operational transaction systems and Ã'nancial reporting systems. As we continue the remediation activities noted...

  • Page 72
    ...will pay the outstanding principal balance of mortgage loans and mortgage-related securities held in the Retained portfolio, known as prepayment risk, and the resulting potential mismatch in the timing of our receipt of cash Ã-ows on our assets versus the timing of our obligation to make payments on...

  • Page 73
    ... mortgage-related investments with debt securities. We do not actively manage the basis risk arising from funding Retained portfolio investments with our debt securities, also referred to as mortgage-to-debt option-adjusted spread risk. See ""CONSOLIDATED FAIR VALUE BALANCE SHEETS ANALYSIS Ì Key...

  • Page 74
    ... Interest-Rate Risk and Other Market Risks'' and ""CONSOLIDATED FAIR VALUE BALANCE SHEETS ANALYSIS Ì Key Components of Changes in Fair Value of Net Assets Ì Changes in mortgage-to-debt OAS '' for further information. ‚ PMVS-L shows the estimated loss in pre-tax portfolio market value, expressed...

  • Page 75
    ... after the date of the commitment. To facilitate larger and more predictable debt issuances that contribute to lower funding costs, we use interest-rate derivatives to economically hedge the interest-rate risk exposure from the time we commit to purchase a mortgage to the time the related debt is...

  • Page 76
    ... deliver cash, securities or a combination of both having that market value to satisfy its obligation to us under the derivative. We actively manage our exposure to counterparty credit risk using several tools, including: ‚ review of external rating analyses; ‚ strict standards for approving new...

  • Page 77
    ... netting agreements 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 our internal standards...

  • Page 78
    ... Rating(1) AAA AA AA AA A A A Subtotal(5 Other derivatives(6 Prepayment management agreement Commitments Credit derivatives Swap guarantee derivativesÏÏÏÏ Total derivatives Number of Counterparties(2) Notional Amount Total Exposure at Fair Value(3) Exposure, Net of Collateral...

  • Page 79
    ..., the features of the mortgage itself, the type of property securing the mortgage and by the general economy, especially the movement of house prices. To manage our mortgage credit risk, we focus on three key areas: underwriting requirements and quality control standards; portfolio diversiÃ'cation...

  • Page 80
    .... Other forms of credit enhancements on single-family mortgage loans include indemniÃ'cation agreements (under which we may require a lender to reimburse us for credit losses realized on mortgages), government guarantees, collateral (including cash or high-quality marketable securities) pledged by...

  • Page 81
    ...: Single-family Multifamily Structured Securities backed by non-Freddie Mac mortgage-related securities Mortgage loans in the Retained Portfolio: Single-Family Multifamily Total Unpaid Principal Balance Product Distribution Single-family 30-year Ã'xed 15-year Ã'xed ARMS/Variable-rate Option...

  • Page 82
    ..., our Retained portfolio makes investments in non-Freddie Mac mortgage-related securities that were originated in this market segment. Substantially all of these securities were rated ""AAA'' by one or more rating agencies at the time of purchase. Second, we guarantee securities backed by subprime...

  • Page 83
    ... Second/vacation home Investment Total (1) Purchases and ending balances are based on the unpaid principal balance of the single-family mortgage portfolio (excluding non-Freddie Mac mortgage-related securities, alternative collateral deals that are not backed by prime mortgage loans and that...

  • Page 84
    ... cash out reÃ'nances. As a practical matter, however, no-cash out reÃ'nances tend to have lower loan-to-value ratios and borrowers with higher credit scores than purchase transactions and as such, have better overall performance than purchase transactions. Property Type. Single-family mortgage loans...

  • Page 85
    ... the years ended December 31, 2005, 2004 and 2003, respectively. The increase in foreclosure alternatives in 2005 was primarily driven by forbearance agreements related to single-family loans aÃ...ected by Hurricane Katrina. We require multifamily servicers to closely manage mortgage loans they have...

  • Page 86
    ... that comparison, we remit or receive payments based upon the default performance of the speciÃ'ed mortgage loans. These agreements are accounted for as credit derivatives rather than Ã'nancial guarantees, in part, because we may make payments to the seller/servicer under these agreements (depending...

  • Page 87
    ... quality, than loans originated in reÃ'nancing transactions. As a result, we have experienced higher than average early defaults and delinquency rates on these mortgage loans originated in 2000, but they represent less than one percent of the single-family Total mortgage portfolio. 71 Freddie Mac

  • Page 88
    ... are limited in some instances to amounts less than the full amount of the loss. (4) Equal to REO operations income (expense) plus Charge-oÃ...s, net. (5) Calculated as credit gains (losses) divided by the average Total mortgage portfolio, excluding non-Freddie Mac mortgage-related securities and...

  • Page 89
    ... 39 ÃŒ Single-Family ÃŒ Delinquency Rates-By Region'' 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 mortgage insurers, servicers, or other...

  • Page 90
    ... areas and increased incurred losses as delinquencies occur for loans that are experiencing higher default rates based on their year of origination. Credit Risk Sensitivity. Our credit risk sensitivity analysis assesses the assumed increase in the present value of expected single-family mortgage...

  • Page 91
    ... of our single-family mortgage seller/servicers to help us better understand their control environment and its impact on the quality of loans sold to us. We use this information to determine the terms of business we conduct with a particular seller/servicer. We manage the credit risk associated with...

  • Page 92
    .... 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 93
    ... securities. We manage this risk carefully, sharing the risk in some cases with third parties through the use of primary loan-level mortgage insurance, pool insurance and other credit enhancements. ""NOTE 4: FINANCIAL GUARANTEES'' to the consolidated Ã'nancial statements provides information about...

  • Page 94
    ... housing tax credit partnerships, certain Structured Securities trusts (T-Series transactions or alternative collateral deals), and certain asset-backed investment entities. See ""NOTE 3: VARIABLE INTEREST ENTITIES'' to the consolidated Ã'nancial statements for additional information related to...

  • Page 95
    ... cash Ã-ows and discounts them at the spot rate related to each cash Ã-ow. The remaining 32 percent of our derivatives portfolio is valued based on prices obtained from third parties or using models with signiÃ'cant market inputs. The fair values for all of our debt securities are based on prices...

  • Page 96
    ... In general, we account for such transfers as sales of Ã'nancial assets or as 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 and...

  • Page 97
    ...If our documentation and assessments are not adequate, the derivative does not qualify for hedge accounting. Derivatives designated as cash Ã-ow hedges generally hedged interest-rate risk related to forecasted issuances of debt. For these hedging relationships to qualify for hedge accounting both at...

  • Page 98
    ... on Investments in Securities For most 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...

  • Page 99
    ... Ã'nancial statements for more information on interest income and impairment recognition on securities. Accounting Changes and Recently Issued Accounting Pronouncements See ""NOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES'' to the consolidated Ã'nancial statements for more information concerning...

  • Page 100
    ... FHA/VA Ì Fixed-rate Rural Housing Service, or RHS, and other federally guaranteed loans Total single-family Multifamily: Conventional Fixed-rate Variable-rate Total conventional RHS Total multifamily Total mortgages (1) Based on unpaid principal balances. Excludes mortgage loans traded...

  • Page 101
    ...(8 FHA/VA(9 RHS and other federally guaranteed loans Total single-family Multifamily: Conventional Total multifamily Total mortgage purchases Non-Freddie Mac mortgage-related securities purchased for Structured Securities: Alternative collateral deals backed by: Option ARMs Ginnie Mae Certi...

  • Page 102
    ... collateral deals. (10) Includes Structured Securities backed by non-agency securities, which were backed by a mixture of prime, FHA/VA and subprime mortgage loans. (11) 2004 data represents $1,462 million of Ã'xed-rate and $90 million of variable-rate non-Freddie Mac single-family mortgage-related...

  • Page 103
    ... established by us that are not guaranteed by us. (5) Principal-only strips backed by Freddie Mac mortgage-related Securities held in the Retained portfolio are classiÃ'ed as multi-class for the purpose of this table. (6) See ""NOTE 4: FINANCIAL GUARANTEES,'' for a discussion of our guarantees of...

  • Page 104
    ... Option ARMs Balloon/Resets FHA/VA RHS and other federally guaranteed loans Total single-family Multifamily: Conventional Total multifamily Non-Freddie Mac mortgage-related securities purchased for Structured Securities: Alternative collateral deals backed by: Option ARMs Ginnie Mae Certi...

  • Page 105
    ...presented. Due to the use of weighted-average common shares outstanding when calculating earnings (loss) per share, the sum of the four quarters may not equal the full-year amount. Earnings (loss) per share amounts may not recalculate using the amounts in this table due to rounding. 89 Freddie Mac

  • Page 106
    ... the company and OFHEO dated September 1, 2005 constituting the written agreement are available on the Investor Relations page of our website at www.freddiemac.com/investors/reports.html#commit. As noted in these letters, disclosures may be affected by situations where current financial statements...

  • Page 107
    ... credit enhancement providers after giving eÃ...ect to certain assumptions about counterparty default rates. (3) Based on single-family Total mortgage portfolio, excluding Structured Securities backed by Ginnie Mae CertiÃ'cates. (4) Calculated as the ratio of net present value of increase in credit...

  • Page 108
    CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA 92 Freddie Mac

  • Page 109
    ... POLICIES,'' the company changed its method of accounting for interest expense related to callable debt instruments as of January 1, 2005, and its method for determining gains and losses on sales of certain guaranteed securities as of October 1, 2005. McLean, Virginia June 28, 2006 93 Freddie Mac

  • Page 110
    FREDDIE MAC CONSOLIDATED STATEMENTS OF INCOME Year Ended December 31, 2005 2004 2003 (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 111
    ...: Non-mortgage-related securities: Available-for-sale, at fair value 42,165 Securities purchased under agreements to resell and Federal funds sold 15,159 Cash and investments 67,792 Accounts and other receivables, net 6,373 Derivative assets, at fair value 7,097 Guarantee asset, at fair value...

  • Page 112
    ... securities, net of reclassiÃ'cation adjustments Changes in unrealized gains (losses) related to cash Ã-ow hedge relationships, net of reclassiÃ'cation adjustments Change in minimum pension liability AOCI, net of taxes, end of year Treasury stock, at cost Balance, beginning of year Common stock...

  • Page 113
    ...-for-investment mortgages Proceeds from sales of REO Net decrease (increase) in securities purchased under agreements to resell and Federal funds sold Repurchase of REIT preferred stock Derivative premiums and terminations, net Investments in housing tax credit partnerships Net cash used for...

  • Page 114
    ... income. Additional information about the valuation methods used for our guarantee-related assets and liabilities is discussed in ""NOTE 2: TRANSFERS OF SECURITIZED INTERESTS IN MORTGAGE-RELATED ASSETS.'' We also changed our estimate of reserves for uncollectible interest on single-family mortgage...

  • Page 115
    ...ect for the years ended December 31, 2004 and 2003. Table 1.2 Ì Pro Forma Information Ì Change in Accounting for Interest Expense Related to Callable Debt Year Ended December 31, 2004 2003 (in millions, except sharerelated amounts) As reported: Net income Basic earnings per common share Diluted...

  • Page 116
    ... expense Ì Housing tax credit partnerships. Cash and Cash Equivalents and Statements of Cash Flows Highly liquid investment securities that have an original maturity of three months or less and are used for cash management purposes are accounted for as cash equivalents. Cash collateral we obtained...

  • Page 117
    ...types of seller-provided credit enhancements related to the underlying mortgage loans. We also issue and transfer Structured Securities to third parties in exchange for PCs and non-Freddie Mac mortgage-related securities. We recognize the fair value of our contractual right to receive guarantee fees...

  • Page 118
    ... Securities held by us as investments and represent the fair value of the expected future cash Ã-ows associated with the guarantee contracts (including cash Ã-ows related to Management and guarantee fees and our Guarantee obligation) that are inherent within such securities. 102 Freddie Mac

  • Page 119
    ... Due to Participation CertiÃ'cate investors. Scheduled and unscheduled principal payments received by us that relate to our investment in PCs are reported as a reduction to our investment in PCs on the consolidated balance sheets. Mortgage Loans Mortgage loans that we may sell are classiÃ'ed as held...

  • Page 120
    ..., including year of origination, loan-to-value ratio and geographic region. In determining the loan loss reserves for impaired single-family loans at the balance sheet date, we determine the point within the range of probable losses that represents the best estimate of losses. The factors used to...

  • Page 121
    ...-foreclosure sale are charged-oÃ... against Reserve for losses on mortgage loans held-for-investment. For transfers to REO, losses arise when the carrying basis of the loan (including accrued interest) exceeds the fair value of the foreclosed property (after deduction for estimated selling costs and...

  • Page 122
    ... value is based 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 or debt securities...

  • Page 123
    ... the hedged item aÃ...ects earnings. Amounts reported in AOCI related to changes in the fair value of commitments to purchase or sell securities that are designated as cash Ã-ow hedges are recognized as basis adjustments to the assets held which are amortized in earnings as interest income using the...

  • Page 124
    ... balance sheets. The fair value of options to purchase shares of our 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 an estimate of the expected life of the option, the market value of...

  • Page 125
    ... mortgage loans and mortgage-related securities traded, but not yet settled. (2) Due to timing diÃ...erences in our receipt of principal and interest payments from mortgage servicers and subsequent pass-through of payments to PC investors, the unpaid principal balances of the underlying mortgage loans...

  • Page 126
    .... For performing loans, our enhanced approach uses the capital markets to obtain estimated subordination levels based on rating agency models and dealer price quotes on proxy securities with collateral characteristics matched to our portfolio to value the expected credit losses and the...

  • Page 127
    ... asset Table 2.2 summarizes the key assumptions associated with the fair value measurements of the recognized Guarantee asset. The assumptions included in this table for 2004 and 2003 relate to those used in our internal models to measure the fair value of the Guarantee asset for single-family loans...

  • Page 128
    ... of Cash Flows Year Ended December 31, 2005 2004 2003 (in millions) Cash Ã-ows from: Transfers of Freddie Mac securities that were accounted for as sales Cash Ã-ows received on the Guarantee asset(1 Other Retained Interests principal and interest(2 Purchases of delinquent or foreclosed loans...

  • Page 129
    ..., we were not the primary beneÃ'ciary of any asset-backed investment trusts. Structured Securities ÃŒ T-Series Transactions In T-Series transactions (or alternative collateral deals), a seller or sellers of mortgage loans transfers mortgage loans to a trust speciÃ'cally for the purpose of issuing...

  • Page 130
    ... Structured Securities. We do not expect the maximum potential interest payments we would be required to make associated with these guarantees to signiÃ'cantly exceed 120 days of interest at the certiÃ'cate rate, given that we generally begin a process to purchase the defaulted mortgages when they...

  • Page 131
    ...the original seller is unable to perform under its separate servicing agreement to reimburse the servicer for those servicing premiums. Our 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. The maximum...

  • Page 132
    ...Value Retained portfolio Mortgage-related securities issued by: Freddie Mac 354,573 Fannie Mae 43,784 Ginnie Mae 1,085 Other 231,693 Obligations of states and political subdivisions 11,022 Total mortgage-related securities 642,157 Cash and investments portfolio Non-mortgage-related securities...

  • Page 133
    ... Investment portfolio. The unrealized losses on mortgage-related securities included in Other and Asset-backed securities are principally a result of movements in interest rates. The extent and duration of the decline in fair value relative to the amortized cost have met our criteria that are used...

  • Page 134
    ... for each individual security held at the balance sheet date. The numerator for the individual security yield consists of the sum of (a) the year-end interest coupon rate multiplied by the year-end unpaid principal balance and (b) the annualized amortization income or expense calculated for December...

  • Page 135
    ... Pledged to Freddie Mac Our counterparties are required to pledge collateral for reverse repurchase transactions and most interest-rate swap agreements, after giving consideration to collateral posting thresholds generally related to a counterparty's credit rating. Even though it is our practice...

  • Page 136
    ... includes the unpaid principal balance of mortgage loans plus other amortized basis adjustments, which are modiÃ'cations to their carrying value. (3) Impaired loans with no related valuation allowance primarily represent performing single-family troubled debt restructuring loans. 120 Freddie Mac

  • Page 137
    ...collateralize nonperforming single-family and multifamily mortgage loans owned by us. Upon acquiring single-family properties, we establish a marketing plan to sell the property as soon as practicable by either listing it with a sales broker or by other means, such as arranging a real estate auction...

  • Page 138
    ...Rate(2) Reference Bills» securities and discount notes 183,357 $181,468 Medium-term Notes 2,035 2,032 Securities sold under agreements to repurchase and Federal funds purchased 450 450 Swap collateral obligations 8,736 8,768 Hedging-related basis adjustments N/A (5) Short-term debt securities...

  • Page 139
    ... securities Ì Non-callable Variable-rate: Medium-term Notes Ì Callable(5 Medium-term Notes Ì Non-callable(6 Zero-coupon: Medium-term Notes Ì Callable Medium-term Notes Ì Non-callable Foreign-currency-related and hedging-related basis adjustments ÏÏÏ Total senior debt, due after one year...

  • Page 140
    ... shares, on speciÃ'ed dates, at their redemption price plus dividends accrued through the redemption date. In addition, all 17 classes of preferred stock are perpetual and non-cumulative, and carry no signiÃ'cant voting rights or rights to purchase additional Freddie Mac stock or securities. Costs...

  • Page 141
    ... of aggregate on-balance sheet assets and approximately 0.25 percent of the sum of outstanding mortgage-related securities we guaranteed and other aggregate oÃ...-balance sheet obligations. Risk-Based Capital The risk-based capital standard requires the application of a stress test to determine the...

  • Page 142
    ... statistical rating organizations in a quantity such that the sum of Total capital plus the outstanding balance of qualifying subordinated debt will equal or exceed the sum of 0.45 percent of outstanding guaranteed PCs and Structured Securities and 4 percent of on-balance sheet assets at the end of...

  • Page 143
    ...for at least one year after the grant date, with vesting provisions contingent upon service requirements. ‚ Stock options granted allow for the purchase of our common stock at an exercise price equal to the fair market value of our common stock on the grant date. Options generally may be exercised...

  • Page 144
    ...Ã'ed under Internal Revenue Code Section 423. Under the ESPP, substantially all full-time and part-time employees that choose to participate in the ESPP have the option to purchase shares of common stock at speciÃ'ed dates, with an annual maximum market value of $20,000 per employee as determined...

  • Page 145
    ...' Plan. Table 11.2 Ì Employee Plans and Directors' Plan Stock Options Activity 2005 Stock Options Weighted Average Exercise Price Year Ended December 31, 2004 Weighted Stock Average Options Exercise Price 2003 Stock Options Weighted Average Exercise Price Outstanding, beginning of year Granted...

  • Page 146
    ... related to stock-based compensation plans recorded in Salaries and employee beneÃ'ts was $69 million, $59 million and $65 million for the years ended December 31, 2005, 2004 and 2003, respectively. NOTE 12: DERIVATIVES We use derivatives to conduct our risk management activities. We principally use...

  • Page 147
    ...ows associated with the forecasted issuances of debt, forecasted purchase or sale of mortgage-related assets, and foreign-currency Ã-uctuations. For a derivative qualifying as a cash Ã-ow hedge, changes in fair value are generally reported in AOCI, net of taxes, on the consolidated balance sheets to...

  • Page 148
    ... 2003. On April 20, 2006, we announced an agreement in principle to settle the securities class action lawsuits, as well as the shareholder derivative actions described below. The settlement of these actions includes a cash payment of $410 million, including the application of expected net insurance...

  • Page 149
    ... of the Employee Retirement Income Security Act, or ERISA. Both actions were consolidated and transferred to the same judge in New York who is handling the securities and derivative lawsuits described above and are still pending. Department of Labor Investigation. In July 2003, the Department of...

  • Page 150
    ... from the Internal Revenue Service, or IRS, in connection with its regular audits of our tax returns for prior years, some of which relate to matters connected with the restatement. We continue to respond to these inquiries. See ""NOTE 14: INCOME TAXES'' for more information. FEC Investigation...

  • Page 151
    ... due to an increase in interest rates since the date on which we had entered into the respective arrangements; and ‚ Customer Relationships. Our business relationships with a substantial number of mortgage originating institutions that sold mortgages to us on a regular basis. Tax Court Rulings. On...

  • Page 152
    ... employees. Pension Plan beneÃ'ts are based on an employee's years of service and highest average compensation, up to legal plan limits, over any consecutive 36 months of employment. Pension Plan assets are held in trust and the investments consist primarily of funds comprised of listed stocks and...

  • Page 153
    ... Value of Plan Assets: Fair value of plan assets at October 1 (prior year Actual return on plan assets Employer contributions BeneÃ'ts paid Fair value of plan assets at September 30 Funded Status: Funded status at September 30 Unrecognized net actuarial loss Unrecognized prior service cost...

  • Page 154
    ... to Determine Net Periodic BeneÃ't Cost Pension BeneÃ'ts Year Ended December 31, 2005 2004 2003 Postretirement Health BeneÃ'ts Year Ended December 31, 2005 2004 2003 Discount rate Rate of future compensation increase Expected long-term rate of return on plan assets 5.75% 4.50 7.00 6.00% 4.50...

  • Page 155
    .... Employees become vested in our discretionary contributions after 5 years of service. We also maintain a non-qualiÃ'ed deÃ'ned contribution plan for our oÇcers, designed to make up for beneÃ'ts lost due to limitations on eligible compensation imposed by the Internal Revenue Code and to make up...

  • Page 156
    ... the years ended December 31, 2005, 2004 and 2003, respectively, related to these plans. These expenses were included in Salaries and employee beneÃ'ts on our consolidated statements of income. See ""NOTE 13: LEGAL CONTINGENCIES'' for more information regarding civil litigation and a Department of...

  • Page 157
    ... Balance Sheets(1) December 31, 2005 Carrying Amount(2) Fair Value 2004 Carrying Amount(2) Fair Value (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...

  • Page 158
    ...-for-investment, for fair value balance sheet purposes. We determine the fair value of mortgage loans, excluding delinquent single-family loans purchased out of pools, based on comparisons to actively traded mortgage-related securities with similar characteristics, with adjustments for yield, credit...

  • Page 159
    ... on end-of-day closing prices obtained from third-party pricing services. Derivative forward purchase and sale commitments are valued using the methods described for mortgage-related securities valuation above. The fair value of derivative assets considers the impact of institutional credit risk...

  • Page 160
    ...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 161
    ...total liabilities and minority interests reported on our consolidated fair value balance sheets, less the fair value of net assets attributable to preferred stockholders. NOTE 17: CONCENTRATION OF CREDIT AND OTHER RISKS Mortgages and Mortgage-Related Securities Table 17.1 summarizes the geographical...

  • Page 162
    .... Collateral posting thresholds are tied to a counterparty's credit rating. Derivative exposures and collateral amounts are monitored on a daily basis using both internal pricing models and dealer price quotes. Collateral is typically transferred within one business day based on the 146 Freddie Mac

  • Page 163
    ...million was purchased between the oÃ...er date and December 31, 2005. The preferred stock continues to be redeemable by the REITs under certain circumstances described in the preferred stock oÃ...ering documents as a ""tax event redemption.'' See ""NOTE 14: INCOME TAXES'' for more information concerning...

  • Page 164
    ... under the caption ""Corporate Governance ÃŒ Audit Committee Financial Expert'' in our Proxy Statement. We also provide information regarding our Section 16 compliance under ""Section 16(a) BeneÃ'cial Ownership Reporting'' in our Proxy Statement, incorporated by reference herein. 148 Freddie Mac

  • Page 165
    ... Ltd. An investment banking company New York, New York Committees A B C D E Audit Compensation and Human Resources Finance and Capital Deployment Governance, Nominating and Risk Oversight Mission and Sourcing Eugene M. McQuade President and Chief Operating OÇcer Freddie Mac McLean, Virginia Shaun...

  • Page 166
    ... Institutions Related to Directors'' of our Proxy Statement for our annual meeting of stockholders to be held on September 8, 2006 and is incorporated by reference into this Information Statement. PRINCIPAL ACCOUNTING FEES AND SERVICES Information regarding principal accountant fees and services is...

  • Page 167
    ... and cash Ã-ows of Freddie Mac as of, and for, the periods presented in this Information Statement. Date: June 28, 2006 Eugene M. McQuade President and Chief Operating OÇcer * For a detailed discussion of our progress with respect to our internal control over Ã'nancial reporting and disclosure...

  • Page 168
    ... any preferred stock dividend requirements using our eÃ...ective tax rate for the relevant periods. (2) Ratio of earnings to combined Ã'xed charges and preferred stock dividends is computed by dividing Earnings, as adjusted by Total Ã'xed charges including preferred stock dividends. 152 Freddie Mac

  • Page 169
    ... FINANCIAL INFORMATION For more information about Freddie Mac stock contact: Freddie Mac Mailstop D4O 1551 Park Run Drive McLean, Virginia 22102-3110 Investor Relations: (571) 382-4732 Toll Free: (800) FREDDIE On the Internet: http://www.FreddieMac.com/investors ANNUAL MEETING The annual meeting...

  • Page 170
    ... Tax Credit Loan-to-Value Management's Discussion and Analysis of Financial Condition and Results of Operations Net present value New York Stock Exchange Option-Adjusted Spread OÇce of Federal Housing Enterprise Oversight Over-the-Counter Mortgage Participation CertiÃ'cate Public Company Accounting...

  • Page 171
    8200 Jones Branch Drive, McLean, Virginia 22102 n www.FreddieMac.com