Freddie Mac 2008 Annual Report Download - page 87

delinquent, but rather we purchase loans from pools (a) when the loans are modified, (b) when foreclosure sales occur,
(c) when the loans have been delinquent for 24 months, or (d) when the loans are 120 days or more delinquent and when the
cost of guarantee payments to PC holders, including advances of interest at the PC coupon, exceeds the expected cost of
holding the non-performing mortgage in our mortgage-related investments portfolio.
Our operational changes for purchasing delinquent loans from PC pools did not impact our process or timing of
modifying the loans, and thus, have had no effect on the existing loss mitigation alternatives that are available to us or our
servicers. This change in practice does not have an impact on our credit losses, as measured by the amount of charge-offs,
nor on the cure rates of modified loans. However, when viewed in isolation, this change in practice results in a higher
provision for credit losses associated with our PCs and Structured Securities and a reduction in our losses on loans
purchased.
Losses on loans purchased decreased from $1.9 billion in 2007 to $1.6 billion in 2008 due to the decline in the volume
of our purchases resulting from the operational changes discussed above. Although the volume of our purchases of
delinquent loans declined, the number of loans purchased due to modification increased, particularly in the second half of
2008. The implementation of our Streamlined Modification Program beginning in late 2008 and the HASP in 2009 may
result in an increased volume of purchases of loans modified with concessions to the borrower and for which we may
recognize significant losses on loans purchased. The reduction in losses due to the decline in volume of our purchases during
2008 was significantly offset by decreases in the fair values of impaired and delinquent loans, which caused higher losses on
a per-loan basis. The fair values of impaired and delinquent loans are based on market pricing, which declined throughout
2008, with the most severe declines occurring during the fourth quarter. We expect to recover a portion of these losses over
time since the market-based valuations imply losses that are higher than our historical experience. See “Recoveries on Loans
Impaired upon Purchase” for discussion of recoveries on those previously purchased loans.
Losses on loans purchased increased from $148 million in 2006 to $1.9 billion in 2007 due to the combination of higher
volumes of our impaired and delinquent loan purchases during 2007 as compared to 2006 as well as declines in fair values
for these loans.
The total number of loans we purchase from PC pools is dependent on a number of factors, including management
decisions about the timing of repurchases, the expected increase in loan delinquencies within our PC pools resulting from the
current adverse conditions in the housing market, our temporary suspension of foreclosures discussed above and directives
from our Conservator, including our recently implemented Streamlined Modification Program and the recently announced
HASP. The credit environment remains fluid, and the number of loans that we purchase from PC pools will continue to be
affected by events and conditions that occur nationally and in regional markets, as well as changes in our business practices
to respond to the current conditions.
Securities Administrator Loss on Investment Activity
In August 2008, acting as the security administrator for a trust that holds mortgage loan pools backing our PCs, we
invested in $1.2 billion of short-term, unsecured loans which we made to Lehman on the trust’s behalf. We refer to these
transactions as the Lehman short-term lending transactions. These transactions were due to mature on September 15, 2008;
however, Lehman failed to repay these loans and the accrued interest. On September 15, 2008, Lehman filed a chapter 11
bankruptcy petition in the Bankruptcy Court for the Southern District of New York. To the extent there is a loss related to an
eligible investment for the trust, we, as the administrator are responsible for making up that shortfall. During 2008, we
recorded a $1.1 billion loss to reduce the carrying amount of this asset to our estimate of the net realizable amount on these
transactions. See “OFF-BALANCE SHEET ARRANGEMENTS” for further discussion.
Income Tax Expense (Benefit)
For 2008, 2007 and 2006, we reported income tax expense (benefit) of $5.6 billion, $(2.9) billion and $(45) million,
respectively, resulting in effective tax rates of (12)%, 48% and (2)%, respectively. The volatility in our effective tax rate over
the past three years is primarily the result of fluctuations in pre-tax income. Our 2006 effective tax rate benefited from
releases of tax reserves of $174 million primarily as a result of a U.S. Tax Court decision and a separate settlement with the
IRS. Included in income tax expense for 2008, is a non-cash charge of $22.2 billion to establish a partial valuation allowance
against our net deferred tax assets. See “NOTE 14: INCOME TAXES” to our consolidated financial statements for additional
information.
Segment Earnings
Our business operations consist of three reportable segments, which are based on the type of business activities each
performs — Investments, Single-family Guarantee and Multifamily. The activities of our business segments are described in
“BUSINESS — Our Business and Statutory Mission — Our Business Segments” and are subject to the direction of the
Conservator, as discussed in “BUSINESS — Conservatorship and Related Developments — Managing Our Business During
Conservatorship”. Certain activities that are not part of a segment are included in the All Other category; this category
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