Freddie Mac 2006 Annual Report Download - page 38

Our credit guarantee activities increased fair value by an estimated $1.9 billion in 2006, including a $0.3 billion increase
attributable to reduced estimates of the impact of Hurricane Katrina. During 2005, our credit guarantee activities increased
fair value by an estimated $1.1 billion, which included a reduction in fair value of approximately $1.2 billion related to the
change in valuation methodology on our Guarantee asset and Guarantee obligation and a $0.4 billion decrease attributable to
2005 estimates of the impact of Hurricane Katrina.
During 2006, we recognized a more signiÑcant mark-to-market decline in our existing credit guarantee portfolio due to
the eÅect of credit deterioration and increased market risk premiums on our Guarantee obligation. In addition, we estimate
that the fair value of new business entered into during 2006 was lower than the fair value of new business entered into
during 2005.
We revised the method we previously used to report the impact that changes in OAS have on fair value results. This
methodology change had no impact on the actual change in the fair value of net assets, only our attribution of that change.
This change was made in order to more closely align the process we use to report the impact of changes in OAS with the
interest-rate risk management framework of our investment activities. See ""CONSOLIDATED FAIR VALUE BAL-
ANCE SHEETS ANALYSIS Ì Discussion of Fair Value Results Ì How we estimate the impact of changes in mortgage-
to-debt OAS on fair value results,'' for additional information about this change.
Business Outlook
Portfolio Growth and Credit
We expect that the amount of U.S. residential mortgage debt outstanding will continue to rise in 2007, at a rate more in
line with an expected long-term growth projection of 7.0 to 9.5 percent. While our Total mortgage portfolio should beneÑt
from continued growth in mortgage debt outstanding, we expect that our GSE and total securitization market shares will be
under pressure in 2007 as our primary competitors bid for mortgages and there is continued consolidation in the mortgage
lending business. We will manage the Retained portfolio in accordance with the voluntary temporary growth limit until we
resume producing and publicly releasing quarterly Ñnancial statements prepared in conformity with GAAP.
We expect near-term credit losses to rise while still remaining below longer-term historical levels, as home price
appreciation slows.
Fair Value Returns
We expect to achieve long-term returns, before capital transactions, on the average fair value of net assets attributable
to common stockholders in the low-to mid-teens, although period-to-period returns may Öuctuate substantially due to
market conditions. These long-term expectations are based on assumptions regarding rates of growth in our business, spreads
that we expect to earn and a return over a period of years to capital levels consistent with current statutory requirements,
among other factors. Our assumptions do not contemplate that the challenging market conditions and competitive pressures
we are currently experiencing will continue through the next several years. We have also made no assumptions regarding any
potential impact of pending legislation or regulatory actions, discussed more extensively in ""Legislative and Regulatory
Matters.'' Our actual results may diÅer materially from these expectations.
Capital Management
Management expects to initiate a common stock repurchase in conjunction with the issuance of preferred stock under
the new $1 billion authorization from time to time depending on market conditions.
Financial Reporting
An important milestone for our return to quarterly reporting will be the progress achieved in the remediation of internal
controls and implementation of new accounting systems. Throughout 2007, we will evaluate our remediation progress each
quarter to determine whether we have reduced the risk of a material misstatement. It is our objective to resume quarterly
Ñnancial reporting in the second half of 2007. See ""RISK MANAGEMENT Ì Operational Risks Ì Internal Control Over
Financial Reporting'' and ""RISK FACTORS Ì Business and Operational Risks.''
Risk Management
Our portfolio investment and credit guarantee activities expose us to three broad categories of risk: (a) operational risks,
(b) interest-rate and other market risks, and (c) credit risks. Risk management is a critical aspect of our business.
EÅectively managing risk enables us to accomplish our mission and generate revenue and long-term value.
Operational Risks Ì Internal Control Over Financial Reporting
In 2006, we continued working on initiatives to improve our Ñnancial reporting infrastructure and remediate material
weaknesses and other deÑciencies in our internal controls. Although we have made substantial progress on our plan, we
26 Freddie Mac