Freddie Mac 2005 Annual Report Download - page 51

Housing Tax Credit Partnerships
Operating losses of our housing tax credit partnerships, which are recorded as a component of Non-interest expense,
have increased over the last three years as our investments in these partnerships have increased. The increased investment
in Housing tax credit partnerships have generated related tax beneÑts, which consist of tax credits and the tax deductibility of
the operating losses. See ""Income Tax Expense'' for a description 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 million expense recorded in 2005 for Reserves for
legal settlements includes this settlement, net of expected insurance proceeds. This expense is in addition to the $75 million
expense we recorded in 2003 for a loss contingency reserve related to legal proceedings arising from the restatement. See
""NOTE 13: LEGAL CONTINGENCIES'' to our consolidated Ñnancial statements for more information.
Realized losses on certain guarantees
The increase in Realized losses on certain guarantees during 2005 resulted primarily from the application of our new
approach for determining the initial fair values of our guarantee-related assets and liabilities that employs more direct
market-based information. Such losses arise in connection with our Guarantor Swap transactions and in 2005 were partly
driven by our eÅorts to meet the aÅordable housing goals and subgoals established by HUD. When determining the fees we
will charge customers with respect to providing our credit guarantee, we consider all of the mortgage loans we expect to
guarantee. However, the recognition of realized losses on certain guarantees or the deferral of guarantee income is
determined based upon the speciÑc loan pools formed that underlie our PCs and Structured Securities. Our new approach
for valuing our guarantee-related assets and liabilities is discussed in ""NOTE 2: TRANSFERS OF SECURITIZED
INTERESTS IN MORTGAGE-RELATED ASSETS'' to our consolidated Ñnancial statements.
Amortization of credit enhancements
Amortization of our credit enhancement asset accelerates when the related PC or Structured Security liquidates. Total
Guaranteed PCs and Structured Securities Issued liquidated at roughly the same pace in 2005 and 2004, resulting in
relatively Öat amortization expense during these years. These securities liquidated at a much faster pace in 2003 compared to
2004 and 2005 because mortgage interest rates declined during the Ñrst half of 2003, resulting in relatively higher
amortization expense.
Other expenses
Other expenses in 2003 included a $125 million civil money penalty we paid in connection with the OFHEO consent
order. We entered into certain multifamily aÅordable transactions during 2003 that contained a number of contractual
incentives, including the payment of fees totaling $124 million in the third and fourth quarters of 2003 and $41 million in the
Ñrst quarter of 2004. We did not enter into similar transactions during 2005.
Income Tax Expense
For 2005, 2004 and 2003, our eÅective tax rates were 14 percent, 21 percent and 31 percent, respectively. The decrease
in the eÅective tax rate over the past three years is primarily due to the decline in pre-tax income and year-over-year
increases in tax credits related to our investments in housing tax credit partnerships and interest earned on tax-exempt
securities. Tax beneÑts associated with our investments in housing tax credit partnerships reduced Income tax expense by
$476 million, $378 million and $302 million for 2005, 2004 and 2003, respectively. We expect tax credits resulting from our
investments in housing tax credit partnerships to grow in the future. However, our ability to use all of the tax credits
generated by existing or future investments in housing tax credit partnerships to reduce our federal income tax liability may
be limited, depending on the amount of our future federal income tax liability, which cannot be predicted with certainty.
Our eÅective tax rate for 2004 beneÑted from a $94 million reduction to our tax reserves as a result of a closing
agreement we entered into with the Internal Revenue Service relating to the tax treatment of dividends paid on step-down
preferred stock issued by our two REIT subsidiaries. In 2003, we recorded a non-tax deductible $125 million OFHEO civil
money penalty and a $75 million loss contingency reserve described above in ""Other expenses,'' which increased our
eÅective tax rate.
35 Freddie Mac