Freddie Mac 2008 Annual Report Download - page 235

Prior to our entry into conservatorship, those standards determined the amounts of core capital and total capital that we
were to maintain to meet regulatory capital requirements. Core capital consisted of the par value of outstanding common
stock (common stock issued less common stock held in treasury), the par value of outstanding non-cumulative, perpetual
preferred stock, additional paid-in capital and retained earnings (accumulated deficit), as determined in accordance with
GAAP. Total capital included core capital and general reserves for mortgage and foreclosure losses and any other amounts
available to absorb losses that FHFA included by regulation.
Minimum Capital
The minimum capital standard required us to hold an amount of core capital that was generally equal to the sum of
2.50% of aggregate on-balance sheet assets and approximately 0.45% of the sum of our PCs and Structured Securities
outstanding and other aggregate off-balance sheet obligations. As discussed below, in 2004 FHFA implemented a framework
for monitoring our capital adequacy, which included a mandatory target capital surplus over the minimum capital
requirement.
Critical Capital
The critical capital standard required us to hold an amount of core capital that was generally equal to the sum of 1.25%
of aggregate on-balance sheet assets and approximately 0.25% of the sum of our PCs and Structured Securities outstanding
and other aggregate off-balance sheet obligations.
Risk-Based Capital
The risk-based capital standard required the application of a stress test to determine the amount of total capital that we
were to hold to absorb projected losses resulting from adverse interest-rate and credit-risk conditions specified by the GSE
Act prior to enactment of the Reform Act and added 30% additional capital to provide for management and operations risk.
The adverse interest-rate conditions prescribed by the GSE Act included an “up-rate scenario” in which 10-year Treasury
yields rise by as much as 75% and a “down-rate scenario” in which they fall by as much as 50%. The credit risk component
of the stress tests simulated the performance of our mortgage portfolio based on loss rates for a benchmark region. The
criteria for the benchmark region were intended to capture the credit-loss experience of the region that experienced the
highest historical rates of default and severity of mortgage losses for two consecutive origination years.
Classification
Prior to FHFA’s suspension of our capital classifications in October 2008, FHFA assessed our capital adequacy not less
than quarterly.
To be classified as “adequately capitalized,” we must meet both the risk-based and minimum capital standards. If we
fail to meet the risk-based capital standard, we cannot be classified higher than “undercapitalized.” If we fail to meet the
minimum capital requirement but exceed the critical capital requirement, we cannot be classified higher than “significantly
undercapitalized.” If we fail to meet the critical capital standard, we must be classified as “critically undercapitalized.” In
addition, FHFA has discretion to reduce our capital classification by one level if FHFA determines in writing that (i) we are
engaged in conduct that could result in a rapid depletion of core or total capital, the value of collateral pledged as security
has decreased significantly, or the value of the property subject to mortgages held or securitized by us has decreased
significantly, (ii) we are in an unsafe or unsound condition or (iii) we are engaging in unsafe or unsound practices.
If we were classified as adequately capitalized, we generally could pay a dividend on our common or preferred stock or
make other capital distributions (which includes common stock repurchases and preferred stock redemptions) without prior
FHFA approval so long as the payment would not decrease total capital to an amount less than our risk-based capital
requirement and would not decrease our core capital to an amount less than our minimum capital requirement. However,
because we are currently subject to the regulatory capital monitoring framework described below, we are required to obtain
FHFA’s prior approval of certain capital transactions, including common stock repurchases, redemption of any preferred stock
or payment of dividends on preferred stock above stated contractual rates.
If we were classified as undercapitalized, we would be prohibited from making a capital distribution that would reduce
our core capital to an amount less than our minimum capital requirement. We also would be required to submit a capital
restoration plan for FHFA approval, which could adversely affect our ability to make capital distributions.
If we were classified as significantly undercapitalized, we would be prohibited from making any capital distribution that
would reduce our core capital to less than the critical capital level. We would otherwise be able to make a capital distribution
only if FHFA determined that the distribution would: (a) enhance our ability to meet the risk-based capital standard and the
minimum capital standard promptly; (b) contribute to our long-term financial safety and soundness; or (c) otherwise be in the
public interest. Also under this classification, FHFA could take action to limit our growth, require us to acquire new capital
or restrict us from activities that create excessive risk. We also would be required to submit a capital restoration plan for
FHFA approval, which could adversely affect our ability to make capital distributions.
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