Freddie Mac 2006 Annual Report Download - page 37

in part by slower home price appreciation in certain areas. Consistent with this trend, our REO expenses increased to
$60 million in 2006 from $40 million in 2005.
Net charge-oÅs for 2006 increased to $147 million, representing approximately 1.0 basis point of our average credit
guarantee portfolio, compared with $109 million for 2005, representing approximately 0.8 basis points. The increase in net
charge-oÅs primarily relates to a regional economic downturn aÅecting properties in the North Central region of the U.S.
We reported an income tax beneÑt for 2006 of $108 million as compared with income tax expense of $367 million in
2005. In 2006, we reduced our tax reserves by $174 million as a result of a favorable U.S. Tax Court decision and a separate
Internal Revenue Service settlement. Our negative eÅective tax rate in 2006, and the decrease in our eÅective tax rate over
the past three years, also resulted from declines in pre-tax income, year-over-year increases in tax credits related to our
investments in low-income housing tax credit partnerships and interest earned on tax-exempt housing related securities.
Capital Management
Our primary objective in managing capital is preserving our safety and soundness. We also seek to have suÇcient capital
to support our business and mission. As appropriate, we will consider opportunities to return excess capital to stockholders
and to optimize our capital structure. At December 31, 2006, our estimated regulatory core capital was $36.2 billion, with
an estimated regulatory minimum capital surplus of $10.3 billion, and an estimated $2.6 billion in excess of the 30 percent
mandatory target capital surplus.
During 2006, we repurchased $2.0 billion of outstanding shares of common stock and issued $1.5 billion of non-
cumulative, perpetual preferred stock in connection with a plan to replace $2.0 billion of common stock with an equal
amount of preferred stock. During the Ñrst quarter of 2007, we issued $1.1 billion of non-cumulative, perpetual preferred
stock, including $500 million to complete the planned issuance described above and $600 million to replace higher-cost
preferred stock that we redeemed in 2007. Also, during the Ñrst quarter of 2007 we received approval from OFHEO and our
board of directors to repurchase up to an additional $1 billion in common stock in conjunction with the issuance of up to
$1 billion in preferred stock.
Our board of directors approved a dividend per common share of $0.50 for the fourth quarter of 2006, an increase of
6 percent over the $0.47 per share common dividend paid for the Ñrst three quarters of 2006. On March 2, 2007, our board
of directors declared a dividend per common share of $0.50 for the Ñrst quarter of 2007.
Fair Value Results
We believe fair value measures provide an important view of our business economics and risks because fair value takes a
consistent approach to the representation of substantially all Ñnancial assets and liabilities, rather than an approach that
combines historical cost and fair value measurements, as is the case with our GAAP-based consolidated Ñnancial
statements. We use estimates of fair value on a routine basis to make decisions about our business activities. Our
consolidated fair value measurements are an important component of our risk management processes, as we use daily
estimates of the changes in fair value to calculate our Portfolio Market Value Sensitivity, or PMVS, and duration gap
measures. For information about how we estimate the fair value of Ñnancial instruments, see ""NOTE 16: FAIR VALUE
DISCLOSURES'' to our consolidated Ñnancial statements. In addition, we use fair value derived performance measures to
establish corporate objectives and as a factor in determining management compensation.
In 2006, the fair value of net assets attributable to common stockholders, before capital transactions, increased by
$2.5 billion, resulting in a return on the average fair value of net assets attributable to common stockholders of approximately
9.5 percent, compared to a $1.0 billion increase, or 3.7 percent return, in 2005. In addition, the payment of common
dividends and the repurchase of common shares reduced total fair value by $3.3 billion. The fair value of net assets
attributable to common stockholders as of December 31, 2006 was $26.0 billion, compared to $26.8 billion as of
December 31, 2005.
Our attribution of changes in the fair value of net assets relies on models, assumptions, and other measurement
techniques that will evolve over time. The following attribution of changes in fair value is our current estimate of the items
presented (on a pre-tax basis) and excludes the eÅect of returns on capital and administrative expenses.
Our investment activities contributed to the increase in fair value by an estimated $1.3 billion in 2006. This estimate
includes reductions in fair value of approximately $0.9 billion attributable to the net widening of mortgage-to-debt option-
adjusted spreads, or OAS. In 2006, asset-liability management returns and other market conditions did not meaningfully
add to fair value results on the Retained portfolio, which remained generally consistent with 2005 levels.
Our investment activities increased fair value by an estimated $0.5 billion in 2005. This estimate includes reductions in
fair value of approximately $2.7 billion attributable to the net widening of OAS. In 2005, asset-liability management returns
and other market conditions added signiÑcantly to core spread results.
25 Freddie Mac