Freddie Mac 2006 Annual Report Download - page 28

Our PCs and Structured Securities are also an integral part of our mortgage purchase program and any decline in the
price performance of or demand for our PCs could have an adverse eÅect on the proÑtability of our securitization Ñnancing
activities. There is a risk that our PC and Structured Securities support activities may not be suÇcient to support the
liquidity and depth of the market for PCs.
A reduction in our credit ratings could adversely aÅect our liquidity.
Nationally recognized statistical rating organizations play an important role in determining, by means of the ratings they
assign to issuers and their debt, the availability and cost of debt funding. We currently receive ratings from three nationally
recognized statistical rating organizations for our unsecured borrowings. Our credit ratings are important to our liquidity.
Actions by governmental entities or others could adversely aÅect our credit ratings. A reduction in our credit ratings could
adversely aÅect our liquidity, competitive position, or the supply or cost of equity capital or debt Ñnancing available to us. A
signiÑcant increase in our borrowing costs could cause us to sustain losses and impair our liquidity by requiring us to Ñnd
other sources of Ñnancing.
Fluctuations in interest rates could negatively impact our reported net interest income, earnings and fair value of net
assets.
Our portfolio investment activities and credit guarantee activities expose us to interest-rate and other market risks and
credit risks. Changes in interest rates Ì up or down Ì could adversely aÅect our net interest yield. Although the yield we
earn on our assets and our funding costs tend to move in the same direction in response to changes in interest rates, either
can rise or fall faster than the other, causing our net interest yield to expand or compress. For example, when interest rates
rise, our funding costs may rise faster than the yield we earn on our assets, causing our net interest yield to compress until
the eÅect of the increase is fully reÖected in asset yields. Changes in the slope of the yield curve could also reduce our net
interest yield.
Changes in interest rates could reduce our GAAP net income materially, especially if actual conditions vary
considerably from our expectations. For example, if interest rates rise or fall faster than estimated or the slope of the yield
curve varies other than expected, we may incur signiÑcant losses. Changes in interest rates may also aÅect prepayment
assumptions thus potentially impacting the fair value of our assets, including investments in our Retained portfolio, our
derivative portfolio and our Guarantee asset. When interest rates fall, borrowers are more likely to prepay their mortgage
loans by reÑnancing them at a lower rate. An increased likelihood of prepayment on the mortgages underlying our
mortgage-related securities may adversely impact the performance of these securities. An increased likelihood of prepayment
on the mortgage loans we hold may also negatively impact the performance of our Retained portfolio. Interest rates can
Öuctuate for a number of reasons, including changes in the Ñscal and monetary policies of the federal government and its
agencies, such as the Federal Reserve. Federal Reserve policies directly and indirectly inÖuence the yield on our interest-
earning assets and the cost of our interest-bearing liabilities. The availability of derivative Ñnancial instruments (such as
options and interest-rate and foreign-currency swaps) from acceptable counterparties of the types and in the quantities
needed could also aÅect our ability to eÅectively manage the risks related to our investment funding. Our strategies and
eÅorts to manage our exposures to these risks may not be as eÅective as they have been in the past. See ""MD&A Ì RISK
MANAGEMENT Ì Interest-Rate Risk and Other Market Risks'' for a description of the types of market risks to which
we are exposed and how we manage those risks.
Higher credit losses and increased expected future credit costs could adversely aÅect our Ñnancial condition and/or
results of operations.
There can be no assurances that our risk management strategies will be eÅective to manage our credit risks or that our
credit losses will not be higher than expected. Higher credit losses on our guarantees could require us to increase our
allowances for credit losses through charges to earnings. Other credit exposures could also result in Ñnancial losses.
Although we regularly review credit exposures to speciÑc customers and counterparties, default risk may arise from events or
circumstances that are diÇcult to detect or foresee. In addition, concerns about, or default by, one institution could lead to
signiÑcant liquidity problems, losses or defaults by other institutions. This risk may also adversely aÅect Ñnancial
intermediaries, such as clearing agencies, clearinghouses, banks, securities Ñrms and exchanges with which we interact.
These potential risks could ultimately cause liquidity problems or losses for us as well.
Changes in the mortgage credit environment also aÅect our credit guarantee activities through the valuation of our
Guarantee obligation. If expected future credit costs increase and we are not able to increase our guarantee fees due to
competitive pressures or other factors, then the overall proÑtability of our new business would be lower and could result in
losses on guarantees at their inception. Moreover, an increase in expected future credit costs generally increases the fair
value of our existing Guarantee obligation.
16 Freddie Mac