Freddie Mac 2008 Annual Report Download - page 64

business credit tightened considerably during the second half of 2008 as financial institutions curtailed their lending
activities. This contributed to significant increases in credit spreads for both mortgage and corporate loans.
These macroeconomic conditions contributed to a substantial increase in the number of delinquent loans in our single-
family mortgage portfolio during 2008 as well as the rate of transition of these loans from delinquency through foreclosure.
Significant increases in market-reported delinquency rates for mortgages serviced by financial institutions during 2008 were
reported not only for subprime and Alt-A loans, but also for prime loans. This delinquency data suggests that continuing
home price declines and growing unemployment are now affecting behavior by a broader segment of mortgage borrowers,
increasing numbers of whom are “underwater,” or owing more on their mortgage loans than their homes are currently worth.
Our loan loss severities, or the average amount of recognized losses per loan, and redefault rates on modified loans also
significantly increased during 2008, especially in California, Florida, Arizona and Nevada, where we have significant
concentrations of mortgage loans with higher average loan balances than in other states.
We are operating in a challenging environment. A number of our major customers or counterparties have failed, been
acquired, or received substantial government assistance in 2008, including Washington Mutual Bank, Lehman Brothers
Holdings Inc., or Lehman, JP Morgan Chase & Co., American International Group, Inc., Bank of America Corporation,
Merrill Lynch & Co., Inc., IndyMac Bank, FSB, Citigroup Inc. and Wachovia Corporation. In an attempt to stabilize the
markets and restore liquidity, the U.S. government introduced several unprecedented programs to provide various forms of
financial support to market participants. One of these programs, the Troubled Asset Relief Program, or TARP, was created
pursuant to EESA to help stabilize the financial markets and has provided more than $250 billion of capital investments into
U.S. financial institutions. Many of our largest single-family seller/servicers participated and have received capital from
Treasury through the TARP. Another of these programs involves guarantees by the FDIC of the debt obligations issued by
banks that elect to participate in the program. Certain of these programs and reduced investor demand for corporate debt
have limited our access to long-term and callable funding. Uncertainty in the debt market has also contributed to an increase
in our borrowing costs relative to the U.S. Treasury market and LIBOR indices. See “LIQUIDITY AND CAPITAL
RESOURCES” for further information.
Adverse market developments have been the principal drivers of our substantially increased losses for 2008. Our
provision for credit losses increased from $2.9 billion in 2007 to $16.4 billion in 2008, principally due to increased estimates
of incurred losses on loans we own or guarantee caused by the deteriorating economic conditions as evidenced by our
increased rates of delinquency and foreclosure; increased mortgage loan loss severities; and, to a lesser extent, heightened
concerns that certain of our seller/servicer counterparties may fail to perform their recourse or repurchase obligations to us.
For information regarding how we derive our estimate for the provision for credit losses, see “CRITICAL ACCOUNTING
POLICIES AND ESTIMATES.”
The deteriorating market conditions during 2008 also led to a considerably more pessimistic outlook for the
performance of the non-agency mortgage-related securities we own. We recorded security impairments on non-agency
mortgage-related securities of $16.6 billion in 2008. The loans backing these securities exhibited much worse delinquency
behavior as compared to loans in our single-family mortgage portfolio, which includes loans we have guaranteed. The
deteriorating market conditions not only contributed to poor performance during 2008, but significantly impacted our
expectations regarding future performance, both of which are critical in assessing security impairments. Furthermore, the
mortgage-related securities backed by subprime loans, Alt-A and other loans and MTA loans, have significantly greater
concentrations in the states that are undergoing the greatest economic stress, including California, Florida, Arizona and
Nevada. Our non-agency mortgage-related securities backed by other loans, include securities backed by FHA/VA mortgages,
home equity lines of credit and other residential loans. Additionally, during the second half of 2008 there were significant
negative ratings actions and sustained categorical asset price declines most notably in the mortgage-related securities backed
by MTA loans, which are a type of option ARM. Our non-agency mortgage-related securities backed by subprime and Alt-A
and other loans do not include a significant amount of option ARM. At December 31, 2008 and 2007, our net unrealized
losses on mortgage-related securities were $38.2 billion and $10.1 billion, respectively. Our net unrealized losses related to
non-agency mortgage-related securities backed by MTA loans of $4.7 billion and $1.3 billion at December 31, 2008 and
2007, respectively. We believe that these unrealized losses on non-agency mortgage-related securities at December 31, 2008
were principally a result of decreased liquidity and larger risk premiums in the non-agency mortgage market. The
combination of all of these factors not only had a material, negative impact on our view of expected performance, but also
significantly reduced the likelihood of more favorable outcomes, resulting in a substantial increase in other-than-temporary
impairments in 2008.
Due to the rapid deterioration of market conditions discussed above, the uncertainty of future market conditions on our
results of operations and the uncertainty surrounding our future business model as a result of our placement into
conservatorship, we recorded a $22.2 billion non-cash charge in the second half of 2008 in order to establish a partial
valuation allowance against our net deferred tax assets. As a result, at December 31, 2008, we had a remaining deferred tax
asset of $15.4 billion, principally representing the tax effect of unrealized losses on our available-for-sale securities portfolio.
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