Freddie Mac 2006 Annual Report Download - page 36

guarantees at their inception. These trends have also contributed to a decline in the overall expected returns on our credit
guarantee activities.
During 2006, 2005 and 2004, the growth rates of our credit guarantee portfolio were 10.6 percent, 10.5 percent and
4.0 percent, respectively. For 2006, we estimate that our share of the total residential mortgage securitization market
declined slightly due, in part, to lower purchase volumes of non-agency mortgage-related securities into our Retained
portfolio. Also, our share of the GSE securitization market declined to approximately 43 percent in 2006 from approximately
45 percent in 2005 due to competitive pressures.
The credit quality of our guarantee portfolio remains strong, with a weighted average current loan-to-value ratio of
approximately 57 percent as of the end of 2006 as compared with 56 percent at the end of 2005, and the portfolio remains
geographically well diversiÑed. In addition, our guarantee portfolio has beneÑted from several years of strong home price
appreciation. However, as discussed in ""BUSINESS,'' the mortgages added to our portfolio in recent years do not have the
beneÑt of signiÑcant home price appreciation and, in some markets, recent values of the properties underlying the mortgages
have declined. As recently acquired credit guarantee business matures and enters its peak default years, we anticipate that
default rates and loss severities will trend higher.
As the residential mortgage market continues to grow, competition among loan originators and other market factors,
such as relatively low interest rates and generally high home prices, have led to a higher proportion of variable-rate
mortgage products and the proliferation of new mortgage products that oÅer borrowers a variety of payment options. We
increased our purchases of these variable-rate and non-traditional mortgage products as they became more prevalent in the
market. However, at December 31, 2006, long-term, Ñxed-rate mortgages comprised more than 80 percent of our credit
guarantee portfolio. During 2006, interest-only mortgages comprised approximately 16 percent of our purchases and, at
December 31, 2006, comprised approximately 5 percent of the total credit guarantee portfolio. Mortgages with optional
payment terms, referred to as ""option ARMs,'' comprised approximately 2 percent of purchases and approximately 1 percent
of our total credit guarantee portfolio. We generally seek higher compensation for the additional credit risk inherent in these
products; however, our ability to do so has been limited due to competition for this business.
Summary of 2006 Financial Results
GAAP Results
Net income was $2.2 billion in 2006, up 4 percent compared to $2.1 billion in 2005. In 2006, diluted earnings per
common share increased by $0.09 reÖecting the increase in net income and the reduction in the diluted weighted average
number of common shares outstanding, arising from our repurchase of approximately 32.7 million common shares during
the year, partially oÅset by an increase in preferred dividends associated with our issuance of $1.5 billion in new preferred
stock. Pre-tax income declined by $0.5 billion to $2.1 billion in 2006 from $2.6 billion in 2005.
Net interest income declined to $4.2 billion in 2006 from $5.4 billion in 2005. While our Retained portfolio declined
slightly year-over-year, the average balance of our interest-earning assets increased, as did the related average yields.
Notwithstanding this improvement, net interest income declined as we replaced, at higher contractual interest rates,
approximately $129 billion in long-term debt, which either matured or was repurchased during 2006.
Derivative gains (losses), a component of non-interest income, includes another component of our investment returns;
interest received or paid on interest rate swaps. In 2006, we recognized $92 million of interest income, as compared to
$337 million of interest expense in 2005, an improvement of $429 million. This change primarily resulted from the impact of
rising short-term interest rates, and partially oÅset the reduction in net interest income discussed above.
Management and guarantee income increased to $1.7 billion in 2006 from $1.5 billion in 2005; however, our contractual
guarantee fee rate declined modestly as the average balance of outstanding PCs increased by approximately 15 percent
during 2006.
Total non-interest expenses were unchanged year over year at $3.0 billion. Administrative expenses increased slightly to
$1.6 billion in 2006 from $1.5 billion in 2005, primarily due to higher professional services costs related to improving
technology and our internal control over Ñnancial reporting. Our administrative expenses declined as a percent of the average
total mortgage portfolio to 9.3 basis points from 9.7 basis points in 2005.
In 2006 and 2005, our provision for credit losses was $215 million and $251 million, respectively. The provision for
credit losses in 2005 included $128 million related to properties aÅected by Hurricane Katrina, of which we reversed
$82 million in 2006 because the related payment and delinquency experience on aÅected properties was better than expected.
Absent the adjustments related to Hurricane Katrina in both years, from 2005 to 2006 our provision for credit losses
increased by $174 million due to credit deterioration in our single-family credit guarantee portfolio as more loans
transitioned through delinquency to foreclosure and the expected severity of losses on a per-property basis increased, driven
24 Freddie Mac