Federal Home Loan Mortgage
Annual Report 2006

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2006 Annual Report Freddie Mac Facts n Since 1970, Freddie Mac has made home n Since December 2003, we have possible more than 50 million times. increased the dividend on our common n More than half of all Freddie Mac stock by 92%. mortgage purchases support housing n Freddie Mac Foundation celebrated its for low- to moderate-income families. 15th anniversary last year. More than 90% of all the apartment units financed by Freddie Mac are for low- to moderate-income families. n Corporate Responsibility Officer Magazine has named Freddie Mac to its list of “100 Best Corporate Citizens” for 2007, putting our company near the top of America’s corporations based on environmental responsibility, corporate governance and ethics, fairness toward employees, accountability to local community, providing responsible products and service to customers and maintaining a healthy rate of return for investors. n Freddie Mac’s annual Hoops for the Homeless event raised more than $900,000 for homeless families in 2006. n Freddie Mac 2006 workplace awards: Fortune Magazine “Best Companies for Minorities” Latina Style Magazine “Best Places for Women — Honorary” Hispanic Business Inc. “Top Companies for Diversity” Business Ethics Magazine “100 Best Corporate Citizens” Washington Business Journal “Top Local Corporate Philanthropists” Company Overview Congress chartered Freddie Mac in 1970 with the mission of bringing liquidity, stability and affordability to the nation’s mortgage markets and expanding homeownership and affordable rental housing opportunities. Since then, Freddie Mac has made home possible more than 50 million times. As one of the largest purchasers of mortgage loans in the United States, Freddie Mac provides a vital link between mortgage lenders and investors. We don’t make mortgage loans directly to homebuyers. Rather, we benefit consumers by providing lenders across the country with a steady flow of low-cost mortgage funding in good times and bad. Because Freddie Mac also provides assistance for affordable rental housing, we’ve helped make home possible for more than 4 million renters. Our mission of expanding affordable housing opportunities is the foundation of our business. It forms the framework for our business activities, shapes the products we bring to market and drives the services we provide to the nation’s housing and mortgage industry. Everything we do comes back to making America’s mortgage markets liquid and stable and increasing opportunities for homeownership and affordable rental housing across America. n Freddie Mac 2006 Annual Report A Message from the Chairman 2006 was a challenging year in the U.S. housing and mortgage markets, and Freddie Mac shared in those challenges. But even though housing weakened last year, Freddie Mac gained some strength. Housing starts tumbled by 13 percent in 2006. Home purchases fell 10 percent. Mortgage originations dropped and home prices began to decline in a number of local markets. And the possibility of further weakness in the sector remains a leading concern for economic growth in 2007 — particularly if accompanied by widespread loan defaults or a severe tightening of credit standards. At this writing, defaults and late payments have remained relatively low on prime mort- gages, which are made to lower-risk borrowers and account for the lion’s share of home loans. But late payments have risen swiftly over the past year on subprime mortgages, those made to borrowers having spottier credit histories and posing higher risks. Yet despite last year’s many challenges — which included reduced housing affordability, rising mission demands, tight spreads, intense competition and voluntary limits on our retained portfolio — Freddie Mac made continued progress. We increased our earnings, served our vital public mission and strengthened our franchise. We did not meet all our 2006 objectives, particularly as to financial reporting and internal controls. This was very disappointing to me and to your entire management team. But we have implemented a sound, comprehensive plan to make the needed improvements and are moving ahead briskly. The timing of this annual report is itself one small sign of progress. Our plan should allow us to resume quarterly reporting in the second half of 2007. Key Accomplishments Building Shareholder Value I’ll begin by summarizing Freddie Mac’s improved business and financial performance. Our net income grew last year to approximately $2.2 billion, up roughly 4 percent from 2005. Return on common equity was 8.6 percent, up from 7.7 percent for 2005. Fair value, another very important measure of our performance, grew before capital transactions by approximately $2.5 billion last year, compared to a $1.0 billion increase in 2005. Fair value return on equity was approximately 9.5 percent, rebounding from 3.7 percent the previous year. This improved performance was based on several factors. For starters, we achieved strong growth of 10.6 percent in our credit guarantee portfolio — slightly outpacing the overall market. By earning high marks for customer satisfaction and purchasing a broader range of loans, we were able to buy not only a larger volume but also a more representative mix of mortgages in 2006. This performance reflected the company’s enhanced responsiveness and the efforts of our sales force. We ended the year with a total of $1.5 trillion in mortgage securities issued — up from less than $1 trillion in 2001. Another key to Freddie Mac’s success in 2006 was our disciplined management of interest-rate risk. One of the many reasons was our extensive use of callable debt — which we use more than most mortgage investors and believe gives us a real comparative advantage in managing risk. As a result, we came through a challenging year well positioned to deal with a broad range of interest-rate conditions, and with the value of our shareholders’ equity well protected from interest rate swings. On the credit risk side, Freddie Mac’s exposures remained well controlled and our total single-family 90-day delinquencies actually declined during the year. At year’s end, only 6 percent of our total mortgage portfolio was in nontraditional mortgages and the portfolio’s average loan-to-value ratio was 57 percent. Experience and recent market developments tell us to be careful, however, and we are keeping a watchful eye on our 2006 book of business. While we are in better position than many, we have set aside increased loan loss reserves, as our credit portfolio remains vulnerable to significant declines in house prices. Low funding costs were another building block of our success in 2006, with improvements across the yield curve. As an example, our funding cost advantage relative to LIBOR for our 10-year Reference Notes® securities increased in 2005 and 2006 by almost 20 basis points. We’ve said before that when spreads are tight, we may lose some return on the asset side, but we can often make up ground on the debt side. That is exactly what we did last year, by capitalizing on our improved funding costs. Freddie Mac 2006 Annual Report Capital management remains a priority for us. Freddie Mac increased our common dividend again in 2006 to $2.00 per share annually, bringing the total increase in our dividend to 92 percent since the end of 2003. Moreover, we returned $2 billion to our common shareholders in a preferred-for-common restructuring. All told, we returned some $3.3 billion to common shareholders last year — the most in Freddie Mac history. Going forward, Freddie Mac remains strongly capitalized. With a strong balance sheet, our estimated regulatory core capital grew in 2006 to over $36 billion. As we complete our financial reporting and internal controls remediation, I hope we will be in a better position to return some of the capital in excess of our statutory minimum that we have accumulated over the past several years. And I’m pleased to report that, consistent with discussions with our regulator, our board has approved an additional $1 billion in common repurchases and preferred offerings this year. Serving Our Mission As a government-sponsored enterprise (GSE), Freddie Mac faced mounting mission challenges in 2006: reduced affordability, rising concerns about credit quality and predatory lending, a housing sector losing momentum, and HUD affordable housing goals of unprecedented difficulty. Despite these challenges, we served our mission well — providing liquidity, affordability and stability to the housing finance market, and to a broader economy hoping to see a “soft landing” for housing. I am proud that Freddie Mac’s affordable performance in 2006 was among our strongest ever. We believe we met the most demanding affordable housing goals in the company’s history, pending determination by the U.S. Department of Housing and Urban Development. Of the nearly 3.3 million homes we financed last year, almost 56 percent were affordable to low- or moderate-income families. We served 300,000 first-time homebuyers. And in another record year for our growing multifamily business, we financed almost half a million affordable apartment homes. We also believe we achieved two of our three subgoals, although we reported to HUD that we just missed one of the extremely challenging subgoals by less than 700 loans out of more than 900,000 eligible mortgage purchases. The difficulty of this challenge was magnified by market forces affecting the entire housing sector that made the average home less affordable in 2006. It also highlighted the GSEs’ need to strike a balance between striving to achieve demanding housing goals and ensuring that we do not encourage imprudent lending. When Hurricane Katrina riveted the nation’s attention in 2005, Freddie Mac was there to help. In 2006, long after most television cameras were gone, Freddie Mac stayed actively involved in rebuilding the Gulf Coast region. After the hurricanes struck, we pledged to Freddie Mac 2006 Annual Report buy $1 billion in mortgage revenue bonds (MRBs) from state and local housing finance agencies in the Gulf. We fully met that commitment in 2006, less than 12 months later. The MRBs we have purchased will provide low-cost financing for more than 10,000 families. In addition, Freddie Mac provided well over $700 million in mortgage funding last year for multifamily properties along the Gulf Coast. Freddie Mac acted last year to ease the increasing strains on housing affordability. We supported our lenders by introducing an innovative 40-year product that combines the advantages of a fixed-rate loan with lower monthly costs. And we expanded our special workforce housing initiative to include military families, as well as police, firefighters, teachers and nurses. Those who defend us from harm, teach our children and care for our sick should be able to live in the communities they serve. This February, in order to protect consumers and raise underwriting standards, Freddie Mac took the lead in announcing that after September 1, we will not buy subprime mortgages that pose an unacceptable risk of excessive payment shock and possible foreclosure. As a GSE, we feel a responsibility not only to help families buy their own homes, but to help them keep their homes, as well. Freddie Mac also exerted responsible leadership in 2006 by addressing concerns about credit quality and practices in the housing finance market. For instance, we developed and instituted workout policies that can significantly reduce the odds of home loss through foreclosure. We also continued educating consumers on how to avoid predatory practices, and maintained our pioneering policies that led the industry in recent years to reject abusive loans that limit consumers’ rights. Strengthening Our Team We strengthened Freddie Mac last year by building out the company’s executive team in several areas vital to our success. Of great interest to our investors is the addition of Buddy Piszel as Chief Financial Officer. Buddy brings experience and zeal to the task of making Freddie Mac’s financials more transparent, accessible and useful to investors. Other key additions included our new head of Enterprise Operational Risk, Gareth Davies; General Auditor, Kirk Die; Corporate Controller, Jim Egan; Chief Information Officer, Jim Hughes; Senior Vice President for Market Risk Oversight, Manoj Singh; and Vice President for Internal Controls, Jim Larkin, among others. Of course, the strength of our team goes far beyond its executives. Freddie Mac’s greatest asset is its skilled and dedicated employees, and their efforts are critical to our success. So we were gratified by our enhanced employee engagement in 2006, and we thank all our employees for their hard work. Freddie Mac 2006 Annual Report Challenges to be Addressed While Freddie Mac reached many of our goals last year, some major challenges remained unmet. Foremost among them was the essential task of getting current in our financials and strengthening our internal controls. There’s no question this has taken longer than any of us expected. Fortunately, we have developed and are carrying out a comprehensive plan that embodies our detailed blueprint for completing this job. We have first-rate teams and project leaders implementing this plan and they are making good progress. Our goal is to return to quarterly financial reporting this year. And we are working assiduously to improve our internal controls systems and infrastructure. As I said in last year’s letter to stockholders, Freddie Mac must become the standard of excellence not only for managing mortgage risk, but for the accounting and internal controls associated with it. The highly competitive, tight-spread environment we faced last year is another ongoing challenge for us in 2007. Our improved funding costs are part of the answer, as I mentioned. More broadly, we must continue to take other steps going forward — as with our expanded use of structured securities, for example — to generate acceptable returns in spite of tight margins. Freddie Mac worked hard to hold its own in market share last year. While last year’s 43 percent share was marginally below our 2005 figure, we consciously turned away some business that would not have served our mission or return objectives, rather than pursue additional share for share’s sake. Looking ahead, we are focused on pricing issues as well as strong customer relationships. Senior management is also keenly focused on Freddie Mac’s expenses. Although these rose modestly last year — mostly in professional services related to our financial remediation — their rate of growth still was exceeded by the rate of growth in our business. This was in keeping with our long-term goal of managing administrative expenses to be a decreasing percentage of our mortgage portfolio, subject to the near-term imperative that we complete our needed investments in financial reporting and internal controls. Building a stronger future for this company includes building support for the GSE model. Freddie Mac continues to strongly support an appropriate legislative solution that would strengthen our oversight and enable us to fulfill our vital housing mission. And we are playing a constructive role toward that end. Throughout 2006, we worked closely with our regulators at OFHEO and HUD, with the Administration and with Congress, to achieve balanced legislative and regulatory solutions that address the concerns of the past but are consistent with the growing demands of the future. This will remain a focus for me, and for this company, until the job is done. Freddie Mac 2006 Annual Report Our guiding principle in this is that we support an independent regulatory structure modeled on that for banks. Once legislation is enacted, it is likely to remain in place for a very long time. Accordingly, we feel we have a responsibility to housing, our shareholders and the country at large to make our views known. That’s why I have explained publicly how the GSEs will become even more important in the years to come. And that, in turn, is why I have asked decision-makers not to unduly hamper the GSEs, just as the nation is about to need us most. Conclusion Looking at 2006 as a whole — from our growing guarantee volumes and earnings, to our vital housing mission, to our internal and external progress — one overarching fact emerges. While we did not accomplish everything we wanted to, Freddie Mac ended the year in a stronger position than we began it. Our challenge is to put enough years like that back to back and become a high performer. All my experience makes me confident that this is what is happening at Freddie Mac — and our trajectory is clear. However, it is your confidence in this company that truly matters. For it is what allows us to make home possible for America’s families; to exert responsible leadership; and to lower costs for homeowners and renters alike. The congressional genius in designing the GSEs was to accomplish a public mission not with federal expenditures, but using private capital. So thank you for your confidence in this franchise. It is what makes the GSE model work. And our aim every day is to earn it. n Sincerely, Richard F. Syron Chairman and Chief Executive Officer Freddie Mac 2006 Annual Report 2006 Annual Report to Stockholders INFORMATION STATEMENT AND ANNUAL REPORT TO STOCKHOLDERS For the Ñscal year ended December 31, 2006 This Information Statement contains important Ñnancial and other information about Freddie Mac. We will supplement this Information Statement periodically. You should read all available supplements together with this Information Statement. We also provide information about the securities we issue in the OÅering Circular for each securities program and any supplement for each particular oÅering. You can obtain copies of the Information Statement, OÅering Circulars, all available supplements, Ñnancial reports and other similar information by visiting our Internet website (www.freddiemac.com) or by writing or calling us at: Freddie Mac Investor Relations Department Mailstop 486 8200 Jones Branch Drive McLean, Virginia 22102-3110 Telephone: 571-382-4732 or 1-800-FREDDIE (800-373-3343) shareholder@freddiemac.com Our principal oÇces are located at 8200 Jones Branch Drive, McLean, Virginia 22102 (telephone: 703-903-2000). THIS INFORMATION STATEMENT IS DATED MARCH 23, 2007 TABLE OF CONTENTS BUSINESSÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ REGULATION AND SUPERVISION ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ RISK FACTORS ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ MARKET FOR THE COMPANY'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ FORWARD-LOOKING STATEMENTS ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ SELECTED FINANCIAL DATAÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ EXECUTIVE SUMMARY ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ CONSOLIDATED RESULTS OF OPERATIONS ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ CONSOLIDATED BALANCE SHEETS ANALYSIS ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ CONSOLIDATED FAIR VALUE BALANCE SHEETS ANALYSIS ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ LIQUIDITY AND CAPITAL RESOURCES ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ RISK MANAGEMENT ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Operational Risks ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Interest-Rate Risk and Other Market Risks ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Credit Risks ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ OFF-BALANCE SHEET ARRANGEMENTSÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ CRITICAL ACCOUNTING POLICIES AND ESTIMATES ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ PORTFOLIO BALANCES AND ACTIVITIESÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ QUARTERLY SELECTED FINANCIAL DATA ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ RISK MANAGEMENT AND DISCLOSURE COMMITMENTS ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ PROPERTIES ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ LEGAL PROCEEDINGS ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSUREÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ CONTROLS AND PROCEDURES ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ EXECUTIVE COMPENSATION ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND Page 1 6 10 17 21 22 23 23 28 40 47 50 56 56 60 66 80 81 85 91 92 94 152 152 152 152 152 153 154 RELATED STOCKHOLDER MATTERSÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 154 CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS AND DIRECTOR INDEPENDENCE ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ PRINCIPAL ACCOUNTANT FEES AND SERVICES ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ CERTIFICATIONS ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ RATIOS OF EARNINGS TO FIXED CHARGES AND EARNINGS TO COMBINED FIXED CHARGES AND PREFERRED STOCK DIVIDENDSÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ ADDITIONAL FINANCIAL INFORMATION ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ INDEX OF ACRONYMS ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 154 154 155 156 156 157 i Freddie Mac This Information Statement and Annual Report includes forward-looking statements, which may include expectations and objectives for our operating results, Ñnancial condition, business, remediation of internal controls and trends and other matters that could aÅect our business. You should not unduly rely on our forward-looking statements. Actual results might diÅer signiÑcantly from our forecasts and expectations due to several factors that involve risks and uncertainties, including those described in ""BUSINESS,'' ""RISK FACTORS,'' ""FORWARD-LOOKING STATEMENTS'' and ""MANAGE- MENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS,'' or MD&A. These forward-looking statements are made as of the date of this Information Statement and we undertake no obligation to update any forward-looking statement to reÖect events or circumstances after the date of this Information Statement, or to reÖect the occurrence of unanticipated events. Overview BUSINESS Freddie Mac is a stockholder-owned company chartered by Congress in 1970 to stabilize the nation's residential mortgage markets and expand opportunities for homeownership and aÅordable rental housing. Our mission is to provide liquidity, stability and aÅordability to the U.S. housing market. We fulÑll our mission by purchasing residential mortgages and mortgage-related securities in the secondary mortgage market. We are one of the largest purchasers of mortgage loans in the U.S. We purchase mortgages and bundle them into mortgage-related securities that can be sold to investors. We can use the proceeds to purchase additional mortgages from primary market mortgage lenders, thus providing them with a continuous Öow of funds. We also purchase mortgage loans and mortgage-related securities for our investments portfolio. We Ñnance our purchases for our investments portfolio and manage associated interest-rate and other market risks primarily by issuing a variety of debt instruments and entering into derivative contracts in the capital markets. Though we are chartered by Congress, our business is funded completely with private capital. We are responsible for making payments on our securities. Neither the U.S. government nor any other agency or instrumentality of the U.S. government is obligated to fund our mortgage purchase or Ñnancing activities or to guarantee our securities and other obligations. Our Charter and Mission The Federal Home Loan Mortgage Corporation Act, which we refer to as our charter, forms the framework for our business activities, shapes the products we bring to market and drives the services we provide to the nation's residential housing and mortgage industries. Our charter also determines the types of mortgage loans that we are permitted to purchase, as described in ""Business Activities Ì Types of Mortgages We Purchase.'' Our mission is deÑned in our charter: ‚ to provide stability in the secondary market for residential mortgages; ‚ to respond appropriately to the private capital market; ‚ to provide ongoing assistance to the secondary market for residential mortgages (including activities relating to mortgages on housing for low- and moderate-income families involving a reasonable economic return that may be less than the return earned on other activities) by increasing the liquidity of mortgage investments and improving the distribution of investment capital available for residential mortgage Ñnancing; and ‚ to promote access to mortgage credit throughout the U.S. (including central cities, rural areas and other underserved areas) by increasing the liquidity of mortgage investments and improving the distribution of investment capital available for residential mortgage Ñnancing. To facilitate our mission, our charter provides us with special attributes including: ‚ exemption from the registration and reporting requirements of the Securities Act of 1933, or the Securities Act, and the Securities Exchange Act of 1934, or the Exchange Act. We are, however, subject to the general antifraud provisions of the federal securities laws and have committed to the voluntary registration of our common stock with the Securities and Exchange Commission under the Exchange Act; ‚ favorable treatment of our securities under various investment laws and other regulations; ‚ discretionary authority of the Secretary of the Treasury to purchase up to $2.25 billion of our securities; and ‚ exemption from state and local taxes, except for taxes on real property that we own. Our activities in the secondary mortgage market beneÑt consumers by providing lenders a steady Öow of low-cost mortgage funding. This Öow of funds helps moderate cyclical swings in the housing market, equalizes the Öow of mortgage funds regionally throughout the U.S. and makes mortgage funds available in a variety of economic conditions. In addition, the supply of cash made available to lenders through this process reduces mortgage rates on loans within the dollar limits 1 Freddie Mac set in accordance with our charter. These lower rates help make home ownership aÅordable for more families and individuals than would be possible without our participation in the secondary mortgage market. Residential Mortgage Debt Market We compete in the large and growing U.S. residential mortgage debt market. This market consists of a primary mortgage market that links homebuyers and lenders and a secondary mortgage market that links lenders and investors. At December 31, 2006, our Total mortgage portfolio was $1.8 trillion, while the total U.S. residential mortgage debt outstanding was estimated to be approximately $10.9 trillion. Growth in the U.S. residential mortgage debt market is aÅected by several factors, including changes in interest rates, employment rates in various regions of the country, home ownership rates, home price appreciation, lender preferences regarding credit risk and borrower preferences regarding mortgage debt. The amount of residential mortgage debt available for us to purchase and the mix of available loan products are also aÅected by several factors, including the volume of single- family mortgages meeting the requirements of our charter and the purchase and securitization activity of other Ñnancial institutions. See ""RISK FACTORS.'' Following several years of substantial growth in the residential mortgage market, driven by historically low interest rates and a strong housing market with record home sales and signiÑcant home price appreciation, the residential mortgage market slowed in 2006. Home sales declined, inventories of homes for sale increased and the rate of home price appreciation slowed. However, mortgage rates remained low by historical standards and continued to contribute to demand in the residential mortgage market. Home price appreciation is an important market indicator for us because it represents the general trend in value associated with the single-family mortgage loans underlying our Mortgage Participation CertiÑcates, or PCs, and Structured Securities. As home prices appreciate, the risk of borrower defaults generally declines and the severity of credit losses also declines. Estimates of nationwide home price appreciation varied for 2006, with some indicating a slight overall decline in home prices and others indicating moderate growth. However, by any measure, the nationwide rate of home price appreciation is well below that seen in recent years and we expect that it will continue to weaken in the near term. Despite the slowdown in the housing market, total residential mortgage debt outstanding in the U.S. grew by an estimated 9 percent in 2006 as compared with 14 percent in 2005. We expect that the amount of total residential mortgage debt outstanding will continue to rise in 2007, though at a slower rate than in the past few years. Table 1 includes some important indicators for the U.S. residential mortgage market. Table 1 Ì Mortgage Market Indicators Year-Ended December 31, 2005 2006 2004 Home sale units (in thousands)(1) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Home price appreciation(2) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Single-family mortgage originations (in billions) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ ReÑnancing share of single-family mortgage originations ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ U.S. residential mortgage debt outstanding (in billions)(3) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 6,737 6% 7,463 13% $ 3,000 $ 3,257 43% 44% $10,921 $10,046 7,161 12% $2,906 46% $8,847 (1) Includes sales of new and existing detached single-family homes in the U.S. and excludes condos/co-ops. Sources: National Association of Realtors news release dated February 27, 2007 (sales of existing homes) and U.S. Census Bureau news release dated February 28, 2007 (sales of new homes). (2) Source: Freddie Mac's Conventional Mortgage Home Price Index release dated March 5, 2007. (3) U.S. residential mortgage debt outstanding as of December 31 for 2006, 2005 and 2004. Source: Federal Reserve Flow of Funds Accounts of the United States dated March 8, 2007. Primary Mortgage Market Ì Our Customers Our customers are predominantly lenders in the primary mortgage market that originate mortgages for homebuyers. These lenders include mortgage banking companies, commercial banks, savings banks, community banks, credit unions, state and local housing Ñnance agencies and savings and loan associations. A lender that originates a mortgage can hold the mortgage in its own portfolio, securitize the mortgage or sell the mortgage to a secondary mortgage market investor, such as Freddie Mac. We acquire a signiÑcant portion of our single-family mortgages from several large lenders. In 2006, three mortgage lenders each accounted for 10 percent or more of our single-family mortgage purchase volume. These lenders collectively accounted for approximately 51 percent of this volume. In addition, in 2006, our top ten lenders represented approximately 76 percent of our single-family mortgage purchase volume. These top lenders are among the largest mortgage loan originators in the U.S. We have contracts with a number of mortgage lenders that include a commitment by the lender to sell us a minimum percentage or dollar amount of its mortgage origination volume. These contracts typically last for one year. If a mortgage lender fails to meet its contractual commitment, we have a variety of contractual remedies, including the right to assess certain fees. As the mortgage industry has been consolidating, we, as well as our competitors, have been seeking 2 Freddie Mac increased business from a decreasing number of key lenders. We are continuing to work to diversify our customer base and thus reduce the risk and impact of losing a key customer. See ""RISK FACTORS Ì Competitive and Market Risks.'' Secondary Mortgage Market We participate in the secondary mortgage market generally by buying whole loans (i.e., mortgage loans that have not been securitized) and mortgage-related securities for our Retained portfolio and by issuing guaranteed mortgage-related securities. We do not lend money directly to homebuyers. Our principal competitors are the Federal National Mortgage Association, or Fannie Mae, a similarly chartered government-sponsored enterprise, or GSE, the Federal Home Loan Banks and other Ñnancial institutions that retain or securitize mortgages, such as commercial and investment banks, dealers and thrift institutions. We compete on the basis of price, products, structure and service. Business Activities We generate income primarily through two business activities Ì portfolio investment activities and credit guarantee activities Ì operating as one business segment. For a summary and description of our Ñnancial performance and Ñnancial condition, see ""MD&A'' and ""CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA'' and the accompanying notes to our consolidated Ñnancial statements. At December 31, 2006, we had total assets of $813.1 billion and total stockholders' equity of $28.3 billion, and for the year ended December 31, 2006, we reported net income of $2.2 billion. At February 28, 2007, we had 5,400 full-time and 135 part-time employees. Our principal oÇces are located in McLean, Virginia. Types of Mortgages We Purchase Our charter establishes general parameters for the terms and principal amounts of the mortgages we may purchase, as described below. We also purchase mortgage-related securities that are backed by single-family or multifamily mortgages. Within our charter parameters, the residential mortgage loans we purchase or that underlie mortgage-related securities we purchase generally fall into one of two categories: ‚ Single-Family Mortgages. Single-family mortgages are secured by one- to four-family properties. The types of single-family mortgages we purchase include 40-year, 30-year, 20-year, 15-year and 10-year Ñxed-rate mortgages, interest-only mortgages, adjustable-rate mortgages, or ARMs, and balloon/reset mortgages. ‚ Multifamily Mortgages. Multifamily mortgages are secured by properties with Ñve or more residential rental units. These mortgages have terms generally ranging from Ñve to thirty years. Our multifamily mortgage products, services and initiatives are designed primarily to Ñnance aÅordable rental housing for low- and moderate-income families. Conforming Loan Limits. Our charter places a dollar amount cap, called the ""conforming loan limit,'' on the size of the original principal balance of single-family mortgage loans we purchase. This limit is determined annually using a methodology that is based on changes in the national average price of a one-family residence, as surveyed by the Federal Housing Finance Board, or FHFB, each October. For 2007 and 2006, the conforming loan limit for a one-family residence was set at $417,000; for 2005, the limit was set at $359,650; and for 2004, the limit was set at $333,700. Higher limits apply to two- to four-family residences. The conforming loan limits are also 50 percent higher for mortgages secured by properties in Alaska, Guam, Hawaii and the U.S. Virgin Islands. No comparable limits apply to our purchases of multifamily mortgages. Loan-to-Value Ratios and Mortgage Insurance. Under our charter, mortgages that are not guaranteed or insured by any agency or instrumentality of the U.S. government are referred to as ""conventional mortgages.'' Our charter requires that we obtain additional credit protection if the unpaid principal balance of a conventional single-family mortgage that we purchase exceeds 80 percent of the value of the property securing the mortgage. See ""MD&A Ì RISK MANAGE- MENT Ì Credit Risks Ì Mortgage Credit Risk Ì Credit Enhancements'' for more information regarding the credit enhancements and other credit protections we obtain. Loan Quality. Under our charter, our mortgage purchases are limited, so far as practicable, to mortgages we deem to be of a quality, type and class that generally meet the purchase standards of private institutional mortgage investors. To manage credit risks with respect to our mortgage purchases, we have developed internal credit policies and appraisal, underwriting and other purchase policies and guidelines. We design mortgage loan underwriting guidelines to enable primary mortgage market lenders to assess the creditworthiness of the borrower and the borrower's capacity to fulÑll the obligations of the mortgage. We review these guidelines in an eÅort to ensure their eÅectiveness and to address the needs of the changing marketplace Ì including the needs of minorities, low- and moderate-income borrowers and other borrowers who are underserved by the traditional housing Ñnance system. In many cases, underwriting standards are tailored under contracts with individual customers. We have also been expanding the share of mortgages we purchase that were underwritten by our seller/servicers using alternative automated underwriting systems or agreed-upon underwriting 3 Freddie Mac standards that diÅer from our systems or guidelines. See ""MD&A Ì RISK MANAGEMENT Ì Credit Risks Ì Mortgage Credit Risk Ì Underwriting Requirements and Quality Control Standards'' for additional information regarding our underwriting standards. Investment and Funding Activities We purchase mortgage loans and mortgage-related securities and hold them in our Retained portfolio for investment purposes. We invest in mortgage-related securities issued by GSEs or government agencies, referred to as agency securities. We also invest in non-agency mortgage-related securities. Our portfolio purchases replenish the capital available for mortgage lending. We face competition from other Ñnancial institutions that buy mortgage-related securities issued by the GSEs and non-agency issuers. We manage our Retained portfolio through a strategy of long-term capital deployment. We apply our expertise in mortgage markets and mortgage assets to identify attractive asset purchase opportunities while managing our interest-rate risk. Our asset selection process may contemplate restructuring activities to improve our investment returns and fair value results. We may purchase mortgage loans and mortgage-related securities with less attractive investment returns as part of our eÅorts to achieve our aÅordable housing goals and subgoals. In response to a request by the OÇce of Federal Housing Enterprise Oversight, or OFHEO, we announced on August 1, 2006 that we would voluntarily limit the growth of our Retained portfolio to no more than 2.0 percent annually (and 0.5 percent quarterly on a cumulative basis), based on its carrying value as contained in our minimum capital report to OFHEO Ñled on July 28, 2006, which was $710.3 billion. We expect to keep the limit, which was eÅective as of July 1, 2006, in place until we return to producing and publicly releasing quarterly Ñnancial statements prepared in conformity with U.S. generally accepted accounting principles, or GAAP. Changes in the carrying value of our Retained portfolio are aÅected by several factors, including purchases, sales, prepayments on mortgage-related investments and changes in fair value primarily related to changes in interest rates. As market interest rates change, we may adjust our purchase and/or sale decisions in order to remain within the limit. We issue short-, medium- and long-term debt securities, subordinated debt securities and preferred stock to Ñnance purchases of mortgages and mortgage-related securities and other business activities. Our debt funding program is designed to oÅer liquid securities to the global capital markets in a transparent and predictable manner. By diversifying our investor base and the types of debt securities we oÅer, we believe we enhance our ability to maintain continuous access to the debt markets under a variety of conditions. We manage our debt funding costs by issuing debt of various maturities that is either callable (i.e., redeemable at our option at one or more times before its scheduled maturity) or non-callable. Our funding mix also helps us manage our interest-rate risk by closely matching the interest obligations on our debt with the expected cash inÖows from our mortgage-related investments. To further manage interest-rate risks, we use a variety of derivatives. We also use Structured Securities, described below, to restructure cash Öows from mortgage-related securities, retaining a portion of these restructured cash Öows. See ""MD&A Ì RISK MANAGEMENT Ì Interest-Rate Risk and Other Market Risks'' for more information. Because of our GSE status and the special attributes granted to us under our charter, our debt securities and those of other GSE issuers trade in the so-called ""agency sector'' of the debt markets. This highly liquid market segment exhibits its own yield curve reÖecting our ability to borrow at lower rates than many other corporate debt issuers. As a result, we mainly compete for funds in the debt issuance markets with Fannie Mae and the Federal Home Loan Banks, which issue debt securities of comparable quality and ratings. However, we also compete for funding with other debt issuers. The demand for, and liquidity of, our debt securities, and those of other GSEs, beneÑt from their status as permitted investments for banks, investment companies and other Ñnancial institutions under their statutory and regulatory framework. Competition for funding can vary with economic, Ñnancial market and regulatory environments. For additional information about our debt securities, see ""MD&A Ì LIQUIDITY AND CAPITAL RE- SOURCES Ì Liquidity Ì Debt Securities.'' Credit Guarantee Activities We guarantee the payment of principal and interest on mortgage-related securities in exchange for a fee, which we refer to as a guarantee fee. The types of mortgage-related securities we guarantee include the following: ‚ PCs we issue; ‚ single-class and multi-class Structured Securities we issue; and ‚ securities related to tax-exempt multifamily housing revenue bonds. We enhance our ability to attract a representative mix of mortgage debt outstanding by diversifying our seller base, expanding new product capabilities and improving customer service. Through investor and dealer outreach programs, 4 Freddie Mac securitization product development and improvements to liquidity, transparency and predictability, we attract a broad array of investors. Our eÅorts to improve the supply of, and demand for, our products are critical to their liquidity and support our mission. The securitization market is extremely competitive and we have reduced our guarantee fees on new business in order to maintain our market share. At the same time, the expected future credit costs associated with our new credit guarantee business have increased. We make trade-oÅs in our pricing in order to support liquidity in various segments of the residential mortgage market, to support the liquidity and price performance of our PCs and to acquire business in pursuit of our aÅordable housing goals and subgoals. In addition, we seek to maintain our share of the total residential mortgage securitization market and our share of the GSE securitization market by improving customer service, and expanding our customer base, the types of mortgages we guarantee and the products we oÅer. Because the price performance of, and demand for, our PCs have generally been less than Fannie Mae's securities, we may use market-adjusted pricing for our guarantees through which we provide guarantee fee or other transaction fee price adjustments to partially oÅset weaknesses in prevailing security prices. We believe these price-adjustments increase the competitiveness of our credit guarantee business. The use of such market-adjusted pricing reduces the proÑtability of our new credit guarantee business over its life. Guarantees of PCs. We issue single-class mortgage-related securities that represent undivided interests in pools of mortgages we have purchased. We refer to these mortgage-related securities as PCs. We guarantee the payment of principal and interest to the holders of our PCs. We issue most of our PCs in transactions in which our customers sell us mortgage loans in exchange for PCs. Other PC investors may include pension funds, insurance companies, securities dealers, money managers, foreign central banks and other Ñxed-income investors. Investors may choose to hold these PCs in their portfolios or sell them to others. Our guarantee increases the marketability of our PCs, providing additional liquidity to the mortgage market. Guarantees of Structured Securities. We also issue securities representing beneÑcial interests in pools of PCs and certain other types of mortgage-related assets. We refer to these mortgage-related securities as Structured Securities. We guarantee the payment of principal and interest on most of the Structured Securities we issue. By issuing Structured Securities, we seek to provide liquidity to alternative segments of the mortgage market. We issue many of our Structured Securities in transactions in which securities dealers or investors sell us the mortgage-related assets underlying the Structured Securities in exchange for the Structured Securities. We also sell Structured Securities to securities dealers or investors in exchange for cash. We issue single-class Structured Securities and multi-class Structured Securities. Single-class Structured Securities pass through the cash Öows on the underlying mortgage-related assets. Multi-class Structured Securities divide the cash Öows of the underlying mortgage-related assets into two or more classes that meet the investment criteria and portfolio needs of diÅerent investors. Our principal multi-class Structured Securities qualify for tax treatment as Real Estate Mortgage Investment Conduits, or REMICs. For purposes of this Information Statement, multi-class Structured Securities include Structured Securities backed by non-agency mortgage-related securities. Guarantees Related to Tax-Exempt Multifamily Housing Revenue Bonds. We guarantee the payment of principal and interest on tax-exempt multifamily housing revenue bonds that support pass-through certiÑcates issued by third parties. These housing revenue bonds are collateralized by mortgage loans on low- and moderate-income multifamily housing projects. In addition, we guarantee the payment of principal and interest related to low- and moderate-income multifamily mortgage loans underlying tax-exempt multifamily housing revenue bonds. PC and Structured Securities Support Activities. We support the liquidity and depth of the market for PCs through a variety of activities, including educating dealers and investors about the merits of trading and investing in PCs, enhancing disclosure related to the collateral underlying our securities and introducing new mortgage-related securities products and initiatives. We support the price performance of our PCs through a variety of strategies, including the issuance of Structured Securities and the purchase and sale by our Retained portfolio of PCs and other agency securities, including Fannie Mae securities. While some purchases of PCs may result in expected returns that are substantially below our normal thresholds, this strategy is not expected to have a material eÅect on our long-term economic returns. Depending upon market conditions, including the relative prices, supply of and demand for PCs and comparable Fannie Mae securities, as well as other factors, such as the voluntary limit on the growth of our Retained portfolio, there may be substantial variability in any period in the total amount of securities we purchase or sell for our Retained portfolio in accordance with this strategy. We may increase, reduce or discontinue these or other related activities at any time, which could aÅect the liquidity and depth of the market for PCs. The To Be Announced Market. In connection with our credit guarantee activities, we issue PCs that represent pools of mortgages with similar characteristics. Because these PCs are homogeneous and are issued in high volume, they are highly 5 Freddie Mac liquid and trade with similar securities on a ""generic'' basis, also referred to as trading in the To Be Announced, or TBA, market. A TBA trade in Freddie Mac securities represents a contract for the purchase or sale of PCs to be delivered at a future date; however, the speciÑc PCs that will be delivered to fulÑll the trade obligation, and thus the speciÑc characteristics of the mortgages underlying those PCs, are not known (i.e., ""announced'') at the time of the trade, but only shortly before the trade is settled. The Securities Industry and Financial Markets Association publishes guidelines pertaining to the types of mortgages that are eligible for TBA trades. The use of the TBA market increases the liquidity of mortgage investments and improves the distribution of investment capital available for residential mortgage Ñnancing, thereby helping us to accomplish our statutory mission. During 2006, we issued approximately $264.7 billion of PCs backed by single-family mortgage loans that were eligible to be delivered to settle TBA trades, representing approximately 74 percent of our total guaranteed PCs and Structured Securities issuances. Available Information Our Information Statements, Supplements and other Ñnancial disclosure documents are available free of charge on our website at www.freddiemac.com. (We do not intend this internet address to be an active link and are not using references to this internet address here or elsewhere in this Information Statement to incorporate additional information into this Information Statement.) Our corporate governance guidelines, Codes of Conduct for employees and members of the board of directors (and any amendments or waivers that would be required to be disclosed) and the charters of the board's Ñve standing committees (the Audit; Finance and Capital Deployment; Mission, Sourcing and Technology; Governance, Nominating and Risk Oversight; and Compensation and Human Resources Committees) are also available on our website at www.freddiemac.com. Printed copies of these documents may be obtained upon request from our Investor Relations department. Department of Housing and Urban Development REGULATION AND SUPERVISION The U.S. Department of Housing and Urban Development, or HUD, has general regulatory power over Freddie Mac, including power over new programs, aÅordable housing goals and fair lending. HUD periodically conducts reviews of our activities to ensure conformity with our charter and other regulatory obligations. For example, HUD is currently reviewing certain of our investments and other assets and liabilities. Housing Goals We are subject to aÅordable housing goals set by HUD. The goals, which are set as a percentage of the total number of dwelling units underlying our total mortgage purchases, have risen steadily since they became permanent in 1995. The goals are intended to expand housing opportunities for low- and moderate-income families, low-income families living in low- income areas, very low-income families and families living in HUD-deÑned underserved areas. The goal relating to low- income families living in low-income areas and very low-income families is referred to as the ""special aÅordable'' housing goal. This special aÅordable housing goal also includes a multifamily subgoal that sets an annual minimum dollar volume of qualifying multifamily mortgage purchases. In addition, HUD has established three subgoals that are expressed as percentages of the total number of mortgages we purchased that Ñnance the purchase of single-family, owner-occupied properties located in metropolitan areas. The HUD goals and subgoals are summarized in Table 2 below. Our performance with respect to the goals and subgoals, as reported to HUD, is set forth in Table 3. Table 2 Ì Housing Goals and Home Purchase Subgoals for 2006 through 2008(1) Housing Goals 2007 2006 2008 Low- and moderate-income goal ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Underserved areas goal ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Special aÅordable goal ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 56% 39 27 Multifamily special aÅordable volume target (dollars in billions) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $3.92 53% 55% 38 38 23 25 $3.92 $3.92 Home Purchase Subgoals 2006 2007 2008 Low- and moderate-income subgoalÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Underserved areas subgoalÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Special aÅordable subgoal ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 47% 34 18 47% 33 18 46% 33 17 (1) An individual mortgage may qualify for more than one of the goals or subgoals. Each of the goal and subgoal percentages will be determined independently and cannot be aggregated to determine a percentage of total purchases that qualiÑes for these goals or subgoals. 6 Freddie Mac Table 3 Ì Housing Goals and Home Purchase Subgoals and Reported Results(1) Housing Goals and Reported Results Year Ended December 31, 2005 2006 2004 Goal Result Goal Result Goal Result Low- and moderate-income goal ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Underserved areas goal ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Special aÅordable goalÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Multifamily special aÅordable volume target (dollars in billions) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 53% 55.9% 38 23 $3.92 42.6 26.5 $14.01 52% 54.1% 37 22 42.2 24.5 $3.92 $11.41 50% 51.6% 31 20 32.3 22.7 $2.11 $7.77 Home Purchase Subgoals and Reported Results Year Ended December 31, 2006 2005 Subgoal Result Subgoal Result Low- and moderate-income subgoal ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Underserved areas subgoal ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Special aÅordable subgoalÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 46% 33 17 46.9% 33.7 16.9 45% 32 17 46.9% 35.4 17.8 (1) An individual mortgage may qualify for more than one of the goals or subgoals. Each of the goal and subgoal percentages and each of our percentage results is determined independently and cannot be aggregated to determine a percentage of total purchases that qualiÑes for these goals or subgoals. Meeting our aÅordable housing goals and subgoals is increasingly challenging and there can be no assurance that we will do so. See ""RISK FACTORS Ì Legal and Regulatory Risks.'' However, we view the purchase of mortgage loans that count toward our aÅordable housing goals to be a principal part of our mission and business and we are committed to facilitating the Ñnancing of aÅordable housing for low- and moderate-income families. We reported to HUD that we met our three aÅordable housing goals and the multifamily special aÅordable volume target subgoal for 2006. With respect to the home purchase subgoals, we reported that we met the low- and moderate- income subgoal and the underserved areas subgoal. However, our result for the special-aÅordable subgoal was 16.9 percent as compared with the subgoal of 17.0 percent. HUD has determined that we met the goals and subgoals for 2005 and 2004, and will evaluate our performance with respect to 2006. We are engaged in ongoing discussions with HUD regarding interpretive issues relating to the purchase and counting of mortgages for purposes of housing goals and subgoals performance for 2006. If the Secretary of HUD Ñnds that we failed to meet a housing goal established under section 1332, 1333, or 1334 of the Federal Housing Enterprises Financial Safety and Soundness Act of 1992, or the GSE Act, and that achievement of the housing goal was feasible, the GSE Act states that the Secretary shall require the submission of a housing plan with respect to the housing goal for approval by the Secretary. The housing plan must describe the actions we would take to achieve the unmet goal in the future. HUD has the authority to take enforcement actions against us, including issuing a cease and desist order or assessing civil money penalties, if we: (a) fail to submit a required housing plan or fail to make a good faith eÅort to comply with a plan approved by HUD; or (b) fail to submit certain data relating to our mortgage purchases, information or reports as required by law. See ""RISK FACTORS Ì Legal and Regulatory Risks.'' While the GSE Act is silent, HUD has indicated that it has authority under the GSE Act to establish and enforce a separate speciÑc subgoal within the special aÅordable housing goal. Fair Lending Our mortgage purchase activities are subject to federal anti-discrimination laws. In addition, the GSE Act prohibits discriminatory practices in our mortgage purchase activities, requires us to submit data to HUD to assist in its fair lending investigations of primary market lenders and requires us to undertake remedial actions against lenders found to have engaged in discriminatory lending practices. In addition, HUD periodically reviews and comments on our underwriting and appraisal guidelines for consistency with the Fair Housing Act and the GSE Act. Predatory Lending A core component of our mission is to facilitate the Ñnancing of aÅordable housing for low- and moderate-income families. Predatory lending practices include the origination of loans with excessive interest rates or Ñnancing costs. Such practices are in direct opposition to our mission, our goals and our practices. Since 2000, we have taken a number of voluntary steps to combat predatory lending and support responsible lending. We have instituted anti-predatory lending policies intended to prevent the purchase or assignment of mortgage loans with unacceptable terms or conditions or resulting from unacceptable practices. In addition to the purchase policies we have instituted, we promote consumer education and Ñnancial literacy eÅorts to help borrowers avoid abusive lending practices and we provide competitive mortgage products to reputable mortgage originators so that borrowers have a greater choice of Ñnancing options. 7 Freddie Mac New Program Approval We are required under our charter and the GSE Act to obtain the approval of the Secretary of HUD for any new program for the purchasing, servicing, selling, lending on the security of, or otherwise dealing in, conventional mortgages that is signiÑcantly diÅerent from programs that have been approved by HUD or that were approved or engaged in before the date the GSE Act was enacted in 1992; or that represents an expansion of programs above limits expressly contained in any prior approval regarding the dollar volume or number of mortgages or securities involved. HUD must approve any new program unless the Secretary determines that the new program is not authorized under our charter or that the program is not in the public interest. OÇce of Federal Housing Enterprise Oversight OFHEO is the safety and soundness regulator for Freddie Mac and Fannie Mae. The GSE Act established OFHEO as a separate oÇce within HUD, substantially independent of the HUD Secretary. OFHEO is headed by a Director who is appointed by the President and conÑrmed by the Senate. The OFHEO Director is responsible for ensuring that Freddie Mac and Fannie Mae are adequately capitalized and operating safely in accordance with the GSE Act. OFHEO's authority with regard to Freddie Mac and Fannie Mae includes authority to: ‚ issue regulations to carry out its responsibilities; ‚ conduct examinations; ‚ require reports of Ñnancial condition and operation; ‚ develop and apply critical, minimum and risk-based capital standards, including classifying the capital levels not less than quarterly; ‚ prohibit excessive executive compensation under prescribed standards; and ‚ impose temporary and Ñnal cease-and-desist orders and civil money penalties, provided certain conditions are met. From time to time, OFHEO also has adopted examination guidance on a number of diÅerent topics, including accounting practices, corporate governance and compensation practices. OFHEO also has exclusive administrative enforcement authority that is generally similar to that of other federal Ñnancial institutions regulatory agencies. That authority can be exercised in the event we fail to meet regulatory capital requirements; violate our charter, the GSE Act, OFHEO regulations, a written agreement with or order issued by OFHEO; or engage in conduct that signiÑcantly threatens our Core capital. Core capital consists 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, as determined in accordance with GAAP. Consent Order On December 9, 2003, we entered into a consent order and settlement with OFHEO that concluded its special investigation of the company related to our restatement. Under the terms of the consent order, we agreed to undertake certain remedial actions related to governance, corporate culture, internal controls, accounting practices, disclosure and oversight. We have taken actions to comply with the terms of the consent order and OFHEO continues to monitor our progress. Nontraditional Mortgage Product Risks In December 2006, OFHEO notiÑed us that it expects us to take action consistent with the Interagency Guidance on Nontraditional Mortgage Product Risks adopted in October 2006 by the federal Ñnancial institutions regulatory agencies. The Interagency Guidance clariÑes how Ñnancial institutions should oÅer nontraditional mortgage products in a safe and sound manner and in a way that clearly discloses the risks that borrowers may assume. We have submitted a report to OFHEO describing the actions we propose to take consistent with the Interagency Guidance. Our proposed actions include measures to consistently apply the principles of the Interagency Guidance to all of our mortgage purchases. It is possible that implementation of the Interagency Guidance and the actions we propose to take will reduce the number of mortgages available to us for purchase and increase the diÇculty we face in meeting our aÅordable housing goals and subgoals. See ""RISK FACTORS Ì Legal and Regulatory Risks.'' Capital Standards OFHEO's oversight of our safety and soundness includes the implementation, monitoring and enforcement of capital standards. OFHEO's regulatory capital requirements include ratio-based minimum and critical capital requirements and a risk-based capital requirement designed to ensure that we maintain suÇcient capital to survive a sustained severe downturn in the economic environment. The GSE Act requires OFHEO to classify our capital adequacy at least quarterly. OFHEO has always classiÑed us as ""adequately capitalized,'' the highest possible classiÑcation. 8 Freddie Mac If we were classiÑed as less than adequately capitalized, our ability to pay dividends on common or preferred stock could be restricted. Also, if a dividend payment on our common or preferred stock would cause us to fail to meet our minimum capital or risk-based capital requirements, we would not be able to make the payment without prior written approval from OFHEO. For additional information about our regulatory capital requirements, see ""NOTE 10: REGULATORY CAPITAL'' to our consolidated Ñnancial statements. In a letter dated January 28, 2004, OFHEO created a framework for monitoring our capital due to our higher operational risk, including our inability to produce timely Ñnancial statements in conformity with GAAP. The letter directed that we maintain a mandatory target capital surplus of 30 percent over our minimum capital requirement, subject to certain conditions and variations; that we submit weekly reports concerning our capital levels; and that we obtain 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. For additional information about the OFHEO mandatory target capital surplus framework, see ""NOTE 10: REGULATORY CAPITAL'' to our consolidated Ñnancial statements. Also, see ""RISK FACTORS Ì Legal and Regulatory Risks Ì Developments aÅecting our legislative and regulatory environment could materially harm our business prospects or competitive position'' for more information. Department of the Treasury Under our charter, the Secretary of the Treasury has approval authority over our issuances of notes, debentures and substantially identical types of unsecured debt obligations (including the interest rates and maturities of these securities), as well as new types of mortgage-related securities issued subsequent to the enactment of the Financial Institutions Reform, Recovery and Enforcement Act of 1989. The Secretary of the Treasury has performed this debt securities approval function by coordinating GSE debt oÅerings with Treasury funding activities. The Treasury Department is reviewing its process for approving our debt oÅerings. Securities and Exchange Commission While we are exempt from Securities Act and Exchange Act registration and reporting requirements, we are dedicated to fulÑlling our commitment to register our common stock under the Exchange Act. We plan to begin the process of registering our common stock with the SEC after resuming timely quarterly Ñnancial reporting. Once this process is complete, we will be subject to the Ñnancial reporting requirements applicable to registrants under the Exchange Act, including the requirement to Ñle with the SEC annual reports on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K. In addition, OFHEO issued a supplemental disclosure regulation that will obligate us to submit proxy statements and insider transaction reports to the SEC in accordance with rules promulgated under the Exchange Act. After our common stock is registered under the Exchange Act, our securities will continue to be exempt from the securities oÅering registration requirements of the Securities Act and certain other provisions of the federal securities laws. GSE Regulatory Oversight Legislation We face a highly uncertain regulatory environment in light of GSE regulatory oversight legislation currently under consideration in Congress. During 2005, the House of Representatives and the Senate Committee on Banking, Housing, and Urban AÅairs each passed a bill that would have resulted in signiÑcant changes in the existing GSE regulatory oversight structure. Congressional consideration of those bills ended with the expiration of the 109th Congress in December 2006. A new session of Congress began in January 2007. Legislation has been introduced in the House of Representatives, containing provisions that would substantially alter the current regulatory framework under our charter and the GSE Act. The bill that was introduced includes provisions that would: ‚ give our regulator substantial authority to regulate the amount and composition of our portfolio investments and to require substantial reductions in those investments; ‚ increase the regulator's authority to require us to maintain higher minimum and risk-based capital levels and to approve new products; ‚ modify our aÅordable housing goals; and ‚ for 2007 through 2011, require us to make an annual contribution to an aÅordable housing fund in an amount equal to 1.2 basis points of our average total mortgage portfolio. While new GSE oversight legislation has yet to be introduced in the Senate, we believe the Senate is likely to consider legislation that poses similar issues, but may also include provisions that diÅer materially from any bill considered in the House. Provisions of the bill introduced in the House or any other bill considered by the House or Senate, individually and in certain combinations, could have a material adverse eÅect on our ability to fulÑll our mission, future earnings, stock price and stockholder returns, the rate of growth in our fair value and our ability to recruit qualiÑed oÇcers and directors. We believe appropriate GSE regulatory oversight legislation would strengthen market conÑdence and promote our mission. We cannot predict the prospects for the enactment, timing or content of any Ñnal legislation. 9 Freddie Mac RISK FACTORS Before you invest in our securities, you should know that making such an investment involves risks, including the risks described below and in ""BUSINESS,'' ""FORWARD-LOOKING STATEMENTS,'' ""MD&A'' and elsewhere in this Information Statement. The risks that we have highlighted here are not the only ones that we face. These risks could lead to circumstances where our business, Ñnancial condition and/or results of operations could be adversely aÅected. In that case, the trading price of our securities could decline and you may lose all or part of your investment. Some of these risks are managed under our risk management framework, as described in ""MD&A Ì RISK MANAGEMENT.'' We may also encounter risks of which we are currently not aware or that we currently deem immaterial. These risks also may impair our business operations, Ñnancial results or your investment in our securities. Business and Operational Risks Material weaknesses and other deÑciencies related to internal control over Ñnancial reporting could result in errors, aÅect operating results and cause investors to lose conÑdence in our reported results. EÅective internal control over Ñnancial reporting and eÅective disclosure controls and procedures are essential to management's ability to produce reliable and timely Ñnancial statements and other disclosures and to prevent fraud. While we have not completed our evaluation of our internal control over Ñnancial reporting, we have identiÑed, and may in the future identify, material weaknesses and signiÑcant deÑciencies in our internal controls that impair our ability to produce reliable and timely Ñnancial reports. Because of the material weaknesses, management concluded that our internal control over Ñnancial reporting was not eÅective as of December 31, 2006. A ""material weakness'' is a signiÑcant deÑciency or combination of signiÑcant deÑciencies that results in a more than remote likelihood that a material misstatement of the annual or interim Ñnancial statements will not be prevented or detected. A ""signiÑcant deÑciency'' is a control deÑciency or combination of control deÑciencies that adversely aÅects a company's ability to initiate, authorize, record, process, or report external Ñnancial data reliably in accordance with GAAP such that there is a more than remote likelihood that a misstatement of our annual or interim Ñnancial statements that is more than inconsequential will not be prevented or detected. For a description of our existing material weaknesses and certain of our signiÑcant deÑciencies and our eÅorts to mitigate and remediate them, see ""MD&A Ì RISK MANAGEMENT Ì Operational Risks Ì Internal Control Over Financial Reporting.'' We face continuing challenges because of the deÑciencies in our accounting infrastructure and the operational complexities of our business. We have not made suÇcient progress remediating our material weaknesses and signiÑcant deÑciencies to return to regular, timely reporting and we have been unable to provide investors with timely quarterly Ñnancial reports. In order to devote the resources needed to complete the remediation of our internal control environment, we decided to limit the number of systems and business related initiatives we undertook in 2006 and will undertake in 2007. Because of delays in some of our systems initiatives, lower priority systems initiatives continue to be deferred until we progress further with the remediation of our internal control deÑciencies. As a result, our Öexibility to deploy new products for business and credit-risk management purposes in response to competitive market forces and changing trends has been limited. Additional delays or limits on our ability to implement new initiatives may arise in connection with our remediation activities and could further constrain our ability to introduce new products or execute new business strategies. Such constraints may adversely impact our business and results of operations. Although we have implemented a comprehensive plan to remediate our internal control deÑciencies and return to quarterly Ñnancial reporting, there are a number of factors that may impede our eÅorts to remediate our internal control weaknesses and deÑciencies, including: the complexity associated with the interdependent nature of the remediation activities; uncertainty regarding the quality and sustainability of newly established controls; and potentially ineÅective compensating controls. We cannot be certain that our eÅorts to improve our internal control over Ñnancial reporting will be successful. Controls and procedures, no matter how well designed and operated, provide only reasonable assurance of achieving the desired control objectives. A failure to establish and maintain eÅective internal control over Ñnancial reporting could result in a material error in our reported Ñnancial results and additional delays in our Ñnancial reporting timeline. Depending on the nature of a failure and any required remediation, ineÅective controls could have a material adverse eÅect on our business. Failure to eÅectively and timely implement the remediation plan we have undertaken to correct the identiÑed deÑciencies in our internal control over Ñnancial reporting could similarly adversely aÅect our business. Further, OFHEO could require us to take additional remedial actions. 10 Freddie Mac Delays in meeting our Ñnancial reporting obligations could aÅect our ability to maintain the listing of our securities on the New York Stock Exchange, or NYSE. IneÅective controls could also cause investors to lose conÑdence in our reported Ñnancial information, which may have an adverse eÅect on the trading price of our securities. We rely on internal models for Ñnancial accounting and reporting purposes, to make business decisions, and to manage risks, and our business could be adversely aÅected if those models fail to produce reliable results. We make signiÑcant use of business and Ñnancial models for Ñnancial accounting and reporting purposes and to manage risk. For example, we use models in determining the fair value of Ñnancial instruments for which independent price quotations are not available or reliable or to extrapolate third-party values to our portfolio. We also use models to measure and monitor our exposures to interest-rate and other market risks and credit risk. The information provided by these models is also used in making business decisions relating to strategies, initiatives, transactions and products. Models are inherently imperfect predictors of actual results because they are based on assumptions about future performance. Our models could produce unreliable results for a number of reasons, including invalid or incorrect assumptions underlying the models or incorrect data being used by the models. The valuations, risk metrics, amortization results and loan loss reserve estimations produced by our internal models may be diÅerent from actual results, which could adversely aÅect our business results, cash Öows, fair value of net assets, business prospects and future earnings. Changes in any of our models or in any of the assumptions, judgments or estimates used in the models may cause the results generated by the model to be materially diÅerent. The diÅerent results could cause a revision of previously reported Ñnancial condition or results of operations, depending on when the change to the model, judgment or assumption is implemented. Any such changes may also cause diÇculties in comparisons of the Ñnancial condition or results of operations of prior or future periods. If our models are not reliable we could also make poor business decisions, including loan purchase decisions, guarantee fee pricing decisions, asset and liability management decisions, or other decisions, which could result in an adverse Ñnancial impact. Furthermore, any strategies we employ to attempt to manage the risks associated with our use of models may not be eÅective. See ""MD&A Ì CRITICAL ACCOUNTING POLICIES AND ESTIMATES Ì Valuation of Financial Instruments'' and ""MD&A Ì RISK MANAGEMENT Ì Interest-Rate Risk and Other Market Risks'' for more informa- tion on our use of models. Changes in our accounting policies, as well as estimates we make, could materially aÅect how we report our Ñnancial condition or results of operations. Our accounting policies are fundamental to understanding our Ñnancial condition and results of operations. We have identiÑed certain accounting policies and estimates as being ""critical'' to the presentation of our Ñnancial condition and results of operations because they require management to make particularly subjective or complex judgments about matters that are inherently uncertain and for which materially diÅerent amounts could be recorded using diÅerent assumptions or estimates. For a description of our critical accounting policies, see ""MD&A Ì CRITICAL ACCOUNTING POLICIES AND ESTIMATES.'' As new information becomes available and we update the assumptions underlying our estimates, we could be required to revise previously reported Ñnancial results if our results for accounting periods remain subject to change as a result of delays in the release of Ñnancial statements. From time to time, the Financial Accounting Standards Board, or FASB, and the SEC can change the Ñnancial accounting and reporting standards that govern the preparation of our Ñnancial statements. These changes are beyond our control, can be diÇcult to predict and could materially impact how we report our Ñnancial condition and results of operations. We could be required to apply a new or revised standard retroactively, which may result in the restatement of prior period Ñnancial statements by material amounts. A failure in our operational systems or infrastructure, or those of third parties, could impair our liquidity, disrupt our business, damage our reputation and cause losses. Shortcomings or failures in our internal processes, people or systems could lead to impairment of our liquidity, Ñnancial loss, disruption of our business, liability to customers, legislative or regulatory intervention or reputational damage. For example, our business is highly dependent on our ability to process a large number of transactions on a daily basis. The transactions we process have become increasingly complex and are subject to various legal and regulatory standards. Our Ñnancial, accounting, data processing or other operating systems and facilities may fail to operate properly or become disabled, adversely aÅecting our ability to process these transactions. The inability of our systems to accommodate an increasing volume of transactions or new types of transactions or products could constrain our ability to pursue new business initiatives. We also face the risk of operational failure or termination of any of the clearing agents, exchanges, clearing houses or other Ñnancial intermediaries we use to facilitate our securities and derivatives transactions. Any such failure or termination could adversely aÅect our ability to eÅect transactions, service our customers and manage our exposure to risk. 11 Freddie Mac Most of our key business activities are conducted in our principal oÇces located in McLean, Virginia. Despite the contingency plans and facilities we have in place, our ability to conduct business may be adversely impacted by a disruption in the infrastructure that supports our business and the communities in which we are located. Potential disruptions may include those involving electrical, communications, transportation or other services we use or that are provided to us. If a disruption occurs and our employees are unable to occupy our oÇces or communicate with or travel to other locations, our ability to service and interact with our customers or counterparties may suÅer and we may not be able to successfully implement contingency plans that depend on communication or travel. Our operations rely on the secure processing, storage and transmission of conÑdential and other information in our computer systems and networks. Although we take protective measures and endeavor to modify them as circumstances warrant, our computer systems, software and networks may be vulnerable to unauthorized access, computer viruses or other malicious code and other events that could have a security impact. If one or more of such events occur, this potentially could jeopardize conÑdential and other information, including nonpublic personal information and sensitive business data, processed and stored in, and transmitted through, our computer systems and networks, or otherwise cause interruptions or malfunctions in our operations or the operations of our customers or counterparties, which could result in signiÑcant losses or reputational damage. We may be required to expend signiÑcant additional resources to modify our protective measures or to investigate and remediate vulnerabilities or other exposures, and we may be subject to litigation and Ñnancial losses that are not fully insured. For a discussion of our material weaknesses related to our information technology and systems and our plans to remediate such weaknesses, see ""MD&A Ì RISK MANAGEMENT Ì Operational Risks Ì Internal Control Over Financial Reporting.'' We rely on third parties for certain functions that are critical to Ñnancial reporting, our Retained portfolio activity and mortgage loan underwriting. Any failures by those vendors could disrupt our business operations. We outsource certain key functions to external parties, including but not limited to (a) processing functions for trade capture, market risk management analytics, and asset valuation, (b) custody and recordkeeping for our investments portfolios, and (c) processing functions for mortgage loan underwriting. We may enter into other key outsourcing relationships in the future. If one or more of these key external parties were not able to perform their functions for a period of time, at an acceptable service level, or for increased volumes, our business operations could be constrained, disrupted or otherwise negatively impacted. Our use of vendors also exposes us to the risk of a loss of intellectual property or of conÑdential information or other harm. Financial or operational diÇculties of an outside vendor could also hurt our operations if those diÇculties interfere with the vendor's ability to provide services to us. Our risk management eÅorts may not eÅectively mitigate the risks we seek to manage. We could incur substantial losses and our business operations could be disrupted if we are unable to eÅectively identify, manage, monitor and mitigate operational risks, interest-rate and other market risks and credit risks related to our business. We have devoted signiÑcant resources to develop an enterprise risk management framework establishing governance over certain risks we face. However, our risk management policies, procedures and techniques may not be suÇcient to mitigate the risks we have identiÑed or to appropriately identify additional risks to which we are subject. See ""MD&A Ì RISK MANAGEMENT'' for a discussion of our approach to managing the risks we face. Our ability to hire, train and retain qualiÑed employees aÅects our business and operations. Our continued success depends, in large part, on our ability to hire and retain highly qualiÑed people. Our business is complex and many of our positions require speciÑc skills. Undesirable voluntary employee turnover strains existing resources and contributes to increased operational risk. Although voluntary employee turnover improved in 2006, if we experience turnover rates at or above the level experienced in 2005 or are unable to attract, train and retain talented people, our business and operations could be impaired or disrupted. Competition for highly qualiÑed personnel is intense and there can be no assurances that we will retain our key personnel or that we will be successful in attracting, training or retaining other highly qualiÑed personnel in the future. Furthermore, there is a risk that we may not have suÇcient personnel or personnel with suÇcient training in key roles. See ""MD&A Ì RISK MANAGEMENT Ì Operational Risks'' for a description of the impact of our staÇng and turnover. Legal and Regulatory Risks Developments aÅecting our legislative and regulatory environment could materially harm our business prospects or competitive position. Various developments or factors may aÅect our applicable legislative or regulatory environment, including any changes or developments aÅecting our charter, aÅordable housing goals, or regulatory capital requirements (including the 30 percent mandatory target capital surplus OFHEO imposed on us in January 2004); the interpretation of these requirements by our regulators; the adequacy of internal systems, controls and processes related to these requirements; the exercise or assertion of 12 Freddie Mac regulatory or administrative authority beyond current practice; the imposition of additional remedial measures; voluntary agreements with our regulators; or the enactment of proposed legislation. In August 2006, we announced that we would voluntarily limit the growth of our Retained portfolio, as described in ""BUSINESS Ì Business Activities Ì Investment and Funding Activities.'' HUD is reviewing certain of our investments and other assets and liabilities to ensure conformity with our public purpose, charter authorities and investment guidelines. In addition, the Treasury Department is reviewing its process for approving our debt oÅerings. We cannot predict the outcomes of these reviews or whether our business activities will be restricted as a result of these or other reviews. We are also exposed to the risk that weaknesses in our internal systems, controls and processes could aÅect the accuracy or timing of the data we provide to HUD or OFHEO or our compliance with legal requirements, and could ultimately lead to regulatory actions (by HUD, OFHEO or both) or other adverse impacts on our business (including our ability or intent to retain investments). Any assertions of non-compliance with existing or new statutory or regulatory requirements could result in Ñnes, penalties, litigation and damage to our reputation. Furthermore, we could be required, or may Ñnd it advisable, to change the nature or extent of our business activities if our various exemptions and special attributes were modiÑed or eliminated, new or additional fees or substantive regulation of our business activities were imposed, our relationship to the federal government were altered or eliminated, or our charter, the GSE Act, or other federal legislation aÅecting us were signiÑcantly amended. Any of these changes could have a material adverse eÅect on the scope of our activities, Ñnancial condition and results of operations. For example, such changes could (a) reduce the supply of mortgages available to us, (b) limit a signiÑcant revenue source by imposing restrictions on the size of our Retained portfolio, (c) make us less competitive by otherwise limiting our business activities or our ability to create new products, (d) increase our capital requirements, or (e) require us to make an annual contribution to an aÅordable housing fund equal to a speciÑed percentage of our average total mortgage portfolio. We cannot predict when or whether any potential legislation will be enacted or regulation will be promulgated. Any of the developments or factors described above could materially adversely aÅect: our ability to fulÑll our mission; our ability to meet our aÅordable housing goals; our ability or intent to retain investments; the size and growth of our mortgage portfolios; our future earnings, stock price and stockholder returns; the value of our assets; the rate of growth of the fair value of our assets; or our ability to recruit qualiÑed oÇcers and directors. We are making certain changes to our business to meet HUD's housing goals and subgoals, which may adversely aÅect our proÑtability. We are making signiÑcant adjustments to our mortgage sourcing and purchase strategies in an eÅort to meet our housing goals and subgoals, including changes to our underwriting guidelines and the expanded use of targeted initiatives to reach underserved populations. For example, we are purchasing loans and mortgage-related securities that oÅer lower expected returns on our investment and increase our exposure to credit losses. In addition, in order to meet future housing goals and subgoals, our purchases of goal-eligible loans need to increase as a percentage of total new mortgage purchases, which is causing us to forego other purchase opportunities that we would expect to be more proÑtable. If our current eÅorts to meet the goals and subgoals prove to be insuÇcient, we may need to take additional steps that could lead to a further reduction of service to portions of the conventional conforming mortgage market, and also a reduction in our proÑtability. In fact, for 2006, we reported to HUD that we did not meet one of the three home purchase subgoals. See ""REGULATION AND SUPERVISION Ì Department of Housing and Urban Development'' for additional information about HUD's regulation of our business. We are involved in legal proceedings that could result in the payment of substantial damages or otherwise harm our business. We are a party to various legal actions. In addition, certain of our former directors, oÇcers and employees are involved in legal proceedings for which they may be entitled to reimbursement by us for costs and expenses of the proceedings. The defense of these or any future claims or proceedings could divert management's attention and resources from the needs of the business. We may be required to make substantial payments in the event of adverse judgments or settlements of any such claims, investigations or proceedings. Any legal proceeding, even if resolved in our favor, could result in negative publicity or cause us to incur signiÑcant legal and other expenses. Furthermore, developments in, outcomes of, impacts of, and costs, expenses, settlements and judgments related to these legal proceedings may diÅer from our expectations and exceed any amounts for which we have reserved or require adjustments to such reserves. See ""NOTE 13: LEGAL CONTINGEN- CIES'' to our consolidated Ñnancial statements for information about our pending legal proceedings and related reserves. Legislation or regulation aÅecting the Ñnancial services industry generally may adversely aÅect our business activities. Our business activities may be aÅected by a variety of legislative and regulatory actions related to the activities of banks, savings institutions, insurance companies, securities dealers and other regulated entities that comprise a signiÑcant part of our customer base. Legislative or regulatory provisions that create or remove incentives for these entities either to sell 13 Freddie Mac mortgage loans to us or to purchase our securities could have a material adverse eÅect on our business results. Among the legislative and regulatory provisions applicable to these entities are capital requirements for federally insured depository institutions and regulated bank holding companies. For example, the Basel Committee on Banking Supervision, composed of representatives of certain central banks and bank supervisors, has developed a proposed set of risk-based capital standards for banking organizations. The U.S. banking regulators have proposed new capital standards for certain banking organizations that would incorporate the Basel Committee's proposed risk-based capital standards into existing requirements. If Ñnal rules adopted by the U.S. banking regulators revise the capital treatment of mortgage assets, decisions by U.S. banking organizations about whether to hold or sell such assets could be aÅected. However, the contents and timing of any Ñnal rules remain uncertain, as does the manner in which U.S. banking organizations may respond to them. The actions we expect to take in connection with the Interagency Guidance on Nontraditional Mortgage Product Risks are described in ""REGULATION AND SUPERVISION Ì OÇce of Federal Housing Enterprise Oversight Ì Nontradi- tional Mortgage Product Risks.'' On March 2, 2007, the federal Ñnancial institutions regulatory agencies issued for public comment a ""statement'' on subprime mortgage lending. If adopted, the statement would instruct lenders to apply underwriting standards similar to those in the Interagency Guidance on non-traditional products to hybrid ARMs. In addition, on February 27, 2007, we announced that we would implement stricter investment standards for certain subprime ARMs originated after September 1, 2007 and develop new mortgage products providing lenders with more choices to oÅer subprime borrowers. This initiative could reduce the number of subprime mortgages available to us for purchase, potentially reducing our proÑtability, and is likely to make it more diÇcult for us to achieve our housing goals and subgoals. In addition, our business could also be adversely aÅected by any modiÑcation, reduction or repeal of the federal income tax deductibility of mortgage interest payments. Competitive and Market Risks Changes in general business and economic conditions may adversely aÅect our business and earnings. Our business and earnings may be adversely aÅected by changes in general business and economic conditions, including changes in the markets for our portfolio investments or our mortgage-related and debt securities. These conditions include employment rates, Öuctuations in both debt and equity capital markets, the value of the U.S. dollar as compared to foreign currencies, and the strength of the U.S. economy and the local economies in which we conduct business. An economic downturn or increase in the unemployment rate could result in fewer mortgages for us to purchase, an increase in mortgage delinquencies or defaults and a higher level of credit-related losses than we estimated, which could reduce our earnings or reduce the fair value of our net assets. Various factors could cause the economy to slow down or even decline, including higher energy costs, higher interest rates, pressure on housing prices, reduced consumer or corporate spending, natural disasters such as hurricanes, terrorist activities, military conÖicts and the normal cyclical nature of the economy. A general decline in U.S. housing prices or changes in the U.S. housing market could negatively impact our business and earnings. The rate of home price appreciation in the U.S. declined in 2006 as the housing market slowed. This decline follows a decade of strong appreciation and particularly dramatic price increases in the past few years. Home price appreciation generally has increased the values of properties underlying the mortgages in our portfolio. A continued reversal of this strong home price appreciation in any of the geographic markets we serve could result in an increase in delinquencies or defaults and a higher level of credit-related losses, which could reduce our earnings. For more information, see ""MD&A Ì RISK MANAGEMENT Ì Credit Risks.'' If the conforming loan limits are decreased as a result of a decline in the index upon which such limits are based, we may face operational and legal challenges associated with changing our mortgage purchase commitments to conform with the lower limits and there could be fewer loans available for us to purchase. In October 2006, the FHFB reported that the national average price of a one-family residence had declined slightly, the Ñrst time this has occurred since its 1992-1993 survey. OFHEO announced that the conforming loan limits would be maintained at the 2006 limits for 2007 and deferred the decrease for one year. In addition, our business volumes are closely tied to the rate of growth in total outstanding U.S. residential mortgage debt and the size of the U.S. residential mortgage market. The rate of growth in total residential mortgage debt declined to 9 percent in 2006 from 14 percent in 2005. If the rate of growth in total outstanding U.S. residential mortgage debt were to continue to decline, there could be fewer mortgage loans available for us to purchase. A decline in the volume of loans available for us to purchase could reduce our earnings and margins, as we could face more competition to purchase a smaller number of loans. 14 Freddie Mac Competition from banking and non-banking companies may harm our business. We operate in a highly competitive environment and we expect competition to increase as Ñnancial services companies continue to consolidate to produce larger companies that are able to oÅer similar mortgage-related products at competitive prices. Increased competition in the secondary mortgage market and a decreased rate of growth in residential mortgage debt outstanding may make it more diÇcult for us to purchase mortgages to meet our mission objectives while providing favorable returns for our business. Furthermore, competitive pricing pressures may make our products less attractive in the market and negatively impact our proÑtability. We also compete for low-cost debt funding with Fannie Mae, the Federal Home Loan Banks and other institutions that hold mortgage portfolios. Competition for debt funding from these entities can vary with changes in economic, Ñnancial market and regulatory environments. Increased competition for low-cost debt funding may result in a higher cost to Ñnance our business, which could decrease our net income. We may face limited availability of Ñnancing, variation in our funding costs and uncertainty in our securitization Ñnancing. The amount, type and cost of our funding, including Ñnancing from other Ñnancial institutions and the capital markets, directly impacts our interest expense and results of operations and can therefore aÅect our ability to grow our assets. A number of factors could make such Ñnancing more diÇcult to obtain, more expensive or unavailable on any terms, both domestically and internationally (where funding transactions may be on terms more or less favorable than in the U.S.), including: ‚ adverse business or Ñnancial results or other adverse changes to our Ñnancial condition; ‚ speciÑc events that adversely impact our reputation; ‚ changes in the activities of our business partners; ‚ disruptions in the capital markets; ‚ speciÑc events that adversely impact the Ñnancial services industry; ‚ counterparty availability; ‚ changes in the preferences of the holders of our securities; ‚ changes in the breadth of our investor base; ‚ changes aÅecting the fair value of our assets; ‚ interest-rate Öuctuations, or rating agency actions; ‚ changes in our charter or regulatory oversight; ‚ changes to or developments in the legal, regulatory, accounting and tax environments governing our funding transactions, including the outcome of the Treasury Department's review of its process for approving our debt oÅerings; ‚ the general state of the U.S., Asian and other world economies, and factors aÅecting those economies; and ‚ public perception of any of the foregoing. Foreign investors, particularly in Asia, hold a signiÑcant portion of our debt securities and are an important source of funding for our business. Foreign investors' willingness to purchase and hold our debt securities can be inÖuenced by many factors, including changes in the world economies, changes in foreign currency exchange rates, regulatory and political factors, as well as the availability of and preferences for other investments. If foreign investors were to divest their holdings or reduce their purchases of our debt securities, our funding costs may increase. The willingness of foreign investors to purchase or hold our debt securities, and any changes to such willingness, may materially aÅect our liquidity, our business and results of operations. Foreign investors are also signiÑcant purchasers of mortgage-related securities and changes in the strength and stability of foreign demand for mortgage-related securities could aÅect the overall market for those securities and the returns available to us on our portfolio investments. Other GSEs also issue signiÑcant amounts of agency debt, which may negatively impact the prices we are able to obtain for our debt securities. An inability to issue debt securities at attractive rates in amounts suÇcient to fund our business activities and meet our obligations could have an adverse eÅect on our liquidity, Ñnancial condition and results of operations. See ""MD&A Ì LIQUIDITY AND CAPITAL RESOURCES Ì Liquidity Ì Debt Securities'' for a more detailed description of our debt issuance programs. We maintain secured intraday lines of credit to provide additional intraday liquidity to fund our activities through the Fedwire system. These lines of credit may require us to post collateral to third parties. In certain limited circumstances, these secured counterparties may be able to repledge the collateral underlying our Ñnancing without our consent. In addition, because these secured intraday lines of credit are uncommitted, we may not be able to continue to draw on them if and when needed. 15 Freddie Mac Our PCs and Structured Securities are also an integral part of our mortgage purchase program and any decline in the price performance of or demand for our PCs could have an adverse eÅect on the proÑtability of our securitization Ñnancing activities. There is a risk that our PC and Structured Securities support activities may not be suÇcient to support the liquidity and depth of the market for PCs. A reduction in our credit ratings could adversely aÅect our liquidity. Nationally recognized statistical rating organizations play an important role in determining, by means of the ratings they assign to issuers and their debt, the availability and cost of debt funding. We currently receive ratings from three nationally recognized statistical rating organizations for our unsecured borrowings. Our credit ratings are important to our liquidity. Actions by governmental entities or others could adversely aÅect our credit ratings. A reduction in our credit ratings could adversely aÅect our liquidity, competitive position, or the supply or cost of equity capital or debt Ñnancing available to us. A signiÑcant increase in our borrowing costs could cause us to sustain losses and impair our liquidity by requiring us to Ñnd other sources of Ñnancing. Fluctuations in interest rates could negatively impact our reported net interest income, earnings and fair value of net assets. Our portfolio investment activities and credit guarantee activities expose us to interest-rate and other market risks and credit risks. Changes in interest rates Ì up or down Ì could adversely aÅect our net interest yield. Although the yield we earn on our assets and our funding costs tend to move in the same direction in response to changes in interest rates, either can rise or fall faster than the other, causing our net interest yield to expand or compress. For example, when interest rates rise, our funding costs may rise faster than the yield we earn on our assets, causing our net interest yield to compress until the eÅect of the increase is fully reÖected in asset yields. Changes in the slope of the yield curve could also reduce our net interest yield. Changes in interest rates could reduce our GAAP net income materially, especially if actual conditions vary considerably from our expectations. For example, if interest rates rise or fall faster than estimated or the slope of the yield curve varies other than expected, we may incur signiÑcant losses. Changes in interest rates may also aÅect prepayment assumptions thus potentially impacting the fair value of our assets, including investments in our Retained portfolio, our derivative portfolio and our Guarantee asset. When interest rates fall, borrowers are more likely to prepay their mortgage loans by reÑnancing them at a lower rate. An increased likelihood of prepayment on the mortgages underlying our mortgage-related securities may adversely impact the performance of these securities. An increased likelihood of prepayment on the mortgage loans we hold may also negatively impact the performance of our Retained portfolio. Interest rates can Öuctuate for a number of reasons, including changes in the Ñscal and monetary policies of the federal government and its agencies, such as the Federal Reserve. Federal Reserve policies directly and indirectly inÖuence the yield on our interest- earning assets and the cost of our interest-bearing liabilities. The availability of derivative Ñnancial instruments (such as options and interest-rate and foreign-currency swaps) from acceptable counterparties of the types and in the quantities needed could also aÅect our ability to eÅectively manage the risks related to our investment funding. Our strategies and eÅorts to manage our exposures to these risks may not be as eÅective as they have been in the past. See ""MD&A Ì RISK MANAGEMENT Ì Interest-Rate Risk and Other Market Risks'' for a description of the types of market risks to which we are exposed and how we manage those risks. Higher credit losses and increased expected future credit costs could adversely aÅect our Ñnancial condition and/or results of operations. There can be no assurances that our risk management strategies will be eÅective to manage our credit risks or that our credit losses will not be higher than expected. Higher credit losses on our guarantees could require us to increase our allowances for credit losses through charges to earnings. Other credit exposures could also result in Ñnancial losses. Although we regularly review credit exposures to speciÑc customers and counterparties, default risk may arise from events or circumstances that are diÇcult to detect or foresee. In addition, concerns about, or default by, one institution could lead to signiÑcant liquidity problems, losses or defaults by other institutions. This risk may also adversely aÅect Ñnancial intermediaries, such as clearing agencies, clearinghouses, banks, securities Ñrms and exchanges with which we interact. These potential risks could ultimately cause liquidity problems or losses for us as well. Changes in the mortgage credit environment also aÅect our credit guarantee activities through the valuation of our Guarantee obligation. If expected future credit costs increase and we are not able to increase our guarantee fees due to competitive pressures or other factors, then the overall proÑtability of our new business would be lower and could result in losses on guarantees at their inception. Moreover, an increase in expected future credit costs generally increases the fair value of our existing Guarantee obligation. 16 Freddie Mac The loss of business volume from one or more key lenders could result in a decline in our market share and revenues. Our business depends on our ability to acquire a steady Öow of mortgage loans from the originators of those loans. We purchase a signiÑcant percentage of our single-family mortgages from several large mortgage originators. The mortgage industry has been consolidating and a decreasing number of large lenders originate most single-family mortgages. We could lose signiÑcant business volume and may be unable to replace it if one or more of our key lenders signiÑcantly reduces the volume of mortgages it delivers to us or is acquired or otherwise ceases to exist. The loss of business from any one of our key lenders could adversely aÅect our market share, our revenues and the performance of our mortgage-related securities. Negative publicity causing damage to our reputation could adversely aÅect our business prospects, earnings or capital. Reputation risk, or the risk to our earnings and capital from negative public opinion, is inherent in our business. Negative public opinion could adversely aÅect our ability to keep and attract customers or otherwise impair our customer relationships, adversely aÅect our ability to obtain Ñnancing, impede our ability to hire and retain qualiÑed personnel, hinder our business prospects or adversely impact the trading price of our securities. Perceptions regarding the practices of our competitors or our industry as a whole may also adversely impact our reputation. Adverse reputation impacts on third parties with whom we have important relationships may impair market conÑdence or investor conÑdence in our business operations as well. In addition, negative publicity could expose us to adverse legal and regulatory consequences, including greater regulatory scrutiny or adverse regulatory or legislative changes. These adverse consequences could result from our actual or alleged action or failure to act in any number of activities, including corporate governance, regulatory compliance, Ñnancial reporting and disclosure, purchases of products perceived to be predatory, safeguarding or using nonpublic personal information, or from actions taken by government regulators and community organizations in response to our actual or alleged conduct. Negative public opinion associated with our accounting restatement and material weaknesses in our internal control over Ñnancial reporting and related problems could continue to have adverse consequences. MARKET FOR THE COMPANY'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES Market Information Our common stock, par value $0.21 per share, is listed on the NYSE under the symbol ""FRE.'' From time to time, our common stock may be admitted to unlisted trading status on other national securities exchanges. Put and call options on our common stock are traded on U.S. options exchanges. At February 28, 2007, there were 661,430,516 shares outstanding of our common stock. On December 14, 2006, we announced our intent to withdraw our common stock from listing on NYSE Arca, Inc., formerly the PaciÑc Exchange. The decision to voluntarily withdraw listing from NYSE Arca was made to eliminate duplicative administrative requirements inherent with dual listings as a result of the NYSE Group's recent merger with Archipelago Holdings, the parent company of NYSE Arca. NYSE Arca will continue trading our common stock on an unlisted trading privilege basis. Table 4 sets forth the high and low sale prices of our common stock for the periods indicated. Table 4 Ì Quarterly Common Stock Information 2006 Quarter Ended December 31 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ September 30ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ June 30 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ March 31 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2005 Quarter Ended December 31 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ September 30ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ June 30 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ March 31 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (1) The principal market is the NYSE and prices are based on the Composite Tape. At February 28, 2007, the closing price for our common stock was $64.13 per share. Sale Prices(1) High Low $71.92 66.47 63.99 68.75 $67.49 66.91 67.87 73.91 $64.80 55.64 56.50 60.64 $54.85 54.50 58.51 59.74 17 Freddie Mac Holders As of February 28, 2007, we had 2,201 common stockholders of record. Dividends Table 5 sets forth the cash dividend per common share that we have declared for the periods indicated. Table 5 Ì Dividends Per Common Share Regular Cash Dividend Per Share 2007 Quarter Ended March 31 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2006 Quarter Ended December 31 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ September 30 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ June 30 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ March 31 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2005 Quarter Ended December 31 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ September 30 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ June 30 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ March 31 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $0.50 $0.50 0.47 0.47 0.47 $0.47 0.35 0.35 0.35 We have historically paid dividends to our stockholders in each quarter. Our board of directors will determine the amount of dividends, if any, declared and paid in any quarter after considering our capital position and earnings and growth prospects, among other factors. See ""NOTE 10: REGULATORY CAPITAL'' to our consolidated Ñnancial statements for additional information regarding dividend payments and potential restrictions on such payments and ""NOTE 9: STOCKHOLDERS' EQUITY'' to our consolidated Ñnancial statements for additional information regarding our preferred stock dividend rates. 18 Freddie Mac Stock Performance Graph The following graph compares the Ñve-year cumulative total stockholder return on our common stock with that of the Standard and Poor's, or S&P, 500 Financial Sector Index and the S&P 500 Index. On January 1, 2002, the composition of the S&P 500 Financial Sector Index was modiÑed. Historical data has been recalculated to reÖect this change. The graph assumes $100 invested in each of our common stock, the S&P 500 Financial Sector Index and the S&P 500 Index on December 31, 2001. Total return calculations assume annual dividend reinvestment. The graph does not forecast performance of our common stock. Comparative Cumulative Total Stockholder Return (in dollars) $175 $150 $125 $100 $75 $50 12/31/2001 12/31/2002 12/31/2003 12/31/2004 12/31/2005 12/31/2006 Freddie Mac S&P 500 Financials S&P 500 Freddie Mac S&P 500 Financials S&P 500 Issuer Purchases of Equity Securities At December 31, 2001 $100 100 100 2002 $92 86 78 2003 $92 112 100 2004 $118 124 111 2005 $107 131 116 2006 $115 156 134 Table 6 sets forth our common share repurchase activity during 2006. See ""MD&A Ì LIQUIDITY AND CAPITAL RESOURCES'' for additional information. Table 6 Ì Common Share Repurchase Activity in 2006 Period January - May ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ June ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ July ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ August ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ September ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ OctoberÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ NovemberÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ December ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total Number of Shares Purchased (in millions) Ì 8.6 4.1 12.2 0.6 2.9 4.3 Ì 32.7 Average Price Paid per Share $ Ì 58.05 57.47 59.56 63.99 68.74 69.06 Ì 61.06 Total Number of Shares Purchased as Part of a Publicly Announced Program(1) (in millions) Ì 8.6 4.1 12.2 0.6 2.9 4.3 Ì 32.7 Approximate Dollar Value of Shares That May Yet be Purchased Under the Program (in millions) $2,000 1,500 1,263 540 501 299 Ì Ì (1) On October 5, 2005, we announced our board of directors authorized us to repurchase up to $2 billion of outstanding shares of common stock. The repurchase program was completed in November 2006. 19 Freddie Mac Recent Sales of Unregistered Securities The securities we issue are ""exempted securities'' under the Securities Act and the Exchange Act. As a result, we do not Ñle registration statements with the SEC with respect to oÅerings of our securities. During 2006, we completed two preferred stock oÅerings, underwritten by syndicates of dealers headed by (a) Bear Stearns & Co. Inc. and UBS Securities LLC and (b) Lehman Brothers and Merrill Lynch, for aggregate oÅering proceeds of $1.5 billion and an aggregate underwriting discount of $15 million. See ""NOTE 9: STOCKHOLDERS' EQUITY'' to our consolidated Ñnancial statements for more information. We regularly provide stock compensation to our employees and members of our board of directors. We have three stock-based compensation plans under which grants are currently being made: (a) the Employee Stock Purchase Plan, or ESPP; (b) the 2004 Stock Compensation Plan, or 2004 Employee Plan; and (c) the 1995 Directors' Stock Compensation Plan, as amended and restated, or Directors' Plan. Prior to the stockholder approval of the 2004 Employee Plan, employee stock-based compensation was awarded in accordance with the terms of the 1995 Stock Compensation Plan, or 1995 Employee Plan. Although grants are no longer made under the 1995 Employee Plan, we currently have awards outstanding under this plan. We collectively refer to the 2004 Employee Plan and 1995 Employee Plan as the Employee Plans. During the year ended December 31, 2006, 914,368 stock options were exercised and 423,294 stock options were granted under our Employee Plans and Directors' Plan. Under our ESPP, 222,703 options to purchase stock were exercised and 226,266 options to purchase stock were granted. Further, for the year ended December 31, 2006, under the Employee Plans and Directors' Plan, 1,486,080 restricted stock units were granted and restrictions lapsed on 384,649 and 28,542 restricted stock units and restricted stock awards, respectively. See ""NOTE 11: STOCK-BASED COMPENSA- TION'' to our consolidated Ñnancial statements for more information. Transfer Agent and Registrar Computershare Trust Company, N.A. P.O. Box 43078 Providence, RI 02940-3078 Telephone: 781-575-2879 http://www.computershare.com NYSE Corporate Governance Listing Standards On October 9, 2006, our Chief Executive OÇcer submitted to the NYSE the certiÑcation required by Section 303A.12(a) of the NYSE Listed Company Manual regarding our compliance with the NYSE's corporate governance listing standards. 20 Freddie Mac FORWARD-LOOKING STATEMENTS We regularly communicate information concerning our business activities to investors, securities analysts, the news media and others as part of our normal operations. Some of these communications, including this Information Statement, contain ""forward-looking statements'' pertaining to our current expectations and objectives for Ñnancial reporting, remediation eÅorts, future business plans, results of operations, Ñnancial condition and market trends and developments. Forward-looking statements are often accompanied by, and identiÑed with, terms such as ""predict,'' ""ability,'' ""intent,'' ""indicator,'' ""trend,'' ""eÅorts,'' ""assumptions,'' ""judgments,'' ""models,'' ""developments,'' ""estimates,'' ""continue,'' ""pro- mote,'' ""aÅect,'' ""consider,'' ""enable,'' ""currently,'' ""priorities,'' ""remain,'' ""anticipate,'' ""initiative,'' ""ongoing,'' ""believe,'' ""expect,'' ""plan,'' ""targeted,'' ""depend,'' ""proposed,'' ""projections,'' ""until,'' ""attempt,'' ""forecasts,'' ""outlook,'' ""over time,'' ""future,'' ""seek,'' ""potential,'' ""objective,'' ""long-term,'' ""ultimately,'' ""goal,'' ""will,'' ""may,'' ""might,'' ""should,'' ""can,'' ""could,'' ""would,'' ""likely,'' ""if,'' ""typically,'' ""generally,'' ""new,'' ""uncertain'' and similar phrases. These statements are not historical facts, but rather represent our expectations based on current information, plans, estimates and projections. Forward-looking statements involve known and unknown risks, uncertainties and other factors, some of which are beyond our control. You should be careful about relying on any forward-looking statements and should also consider all risks, uncertainties and other factors described in this Information Statement in considering any forward-looking statements. Actual results may diÅer materially from those discussed as a result of various factors, including those factors described in the ""RISK FACTORS'' section of this Information Statement. Factors that could cause actual results to diÅer materially from the expectations expressed in these and other forward-looking statements by management include, among others: ‚ our ability to eÅectively and timely implement the remediation plan undertaken as a result of the restatement of our consolidated Ñnancial statements and the consent order entered into with OFHEO, including particular initiatives relating to technical infrastructure and controls over Ñnancial reporting; ‚ changes in applicable legislative or regulatory requirements, including enactment of GSE oversight legislation, changes to our charter, aÅordable housing goals, regulatory capital requirements, the exercise or assertion of regulatory or administrative authority beyond historical practice, or regulation of the subprime market; ‚ our ability to eÅectively implement our business strategies and manage the risks in our business, including our eÅorts to improve the supply and liquidity of, and demand for, our products; ‚ changes in our assumptions or estimates regarding rates of growth in our business, spreads we expect to earn, required capital levels, the timing and impact of capital transactions; ‚ our ability to eÅectively manage and implement changes, developments or impacts of accounting or tax standards and interpretations; ‚ the availability of debt Ñnancing and equity capital in suÇcient quantity and at attractive rates to support growth in our Retained portfolio, to reÑnance maturing debt and to meet regulatory capital requirements; ‚ changes in pricing or valuation methodologies, models, assumptions, estimates and/or other measurement techniques; ‚ volatility of reported results due to changes in fair value of certain instruments or assets; ‚ changes in general economic conditions; ‚ the rate of growth in total outstanding U.S. residential mortgage debt and the size of the U.S. residential mortgage market; ‚ preferences of originators in selling into the secondary market; ‚ borrower preferences for Ñxed-rate mortgages or ARMs; ‚ investor preferences for mortgage loans and mortgage-related and debt securities versus other investments; ‚ the occurrence of a major natural or other disaster in geographic areas in which portions of our Total mortgage portfolio are concentrated; ‚ other factors and assumptions described in this Information Statement, including in the sections titled ""BUSINESS,'' ""RISK FACTORS'' and ""MD&A;'' ‚ our assumptions and estimates regarding the foregoing and our ability to anticipate the foregoing factors and their impacts; and ‚ market reactions to the foregoing. We undertake no obligation to update forward-looking statements we make to reÖect events or circumstances after the date of this Information Statement or to reÖect the occurrence of unanticipated events. 21 Freddie Mac SELECTED FINANCIAL DATA(1) Income Statement Data Net interest incomeÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ Non-interest income (loss) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Net income before cumulative eÅect of changes in accounting principlesÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Cumulative eÅect of changes in accounting principles, net of taxes ÏÏÏÏ Net incomeÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Net income available to common stockholders ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ Earnings per common share before cumulative eÅect of changes in accounting principles: Basic ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ Diluted ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Earnings per common share after cumulative eÅect of changes in accounting principles: Basic ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ Diluted ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Dividends per common share ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ Weighted average common shares outstanding (in thousands): At or for the Year Ended December 31, 2006 2005 2004 2003 2002 (dollars in millions, except share-related amounts) 4,235 915 2,211 Ì 2,211 1,936 2.84 2.84 2.84 2.84 1.91 $ $ $ $ $ 5,370 199 2,189 (59) 2,130 1,907 2.84 2.83 2.76 2.75 1.52 $ $ $ $ $ 9,137 (3,039) $ 9,498 (244) $ 9,525 7,154 2,937 Ì 2,937 2,727 3.96 3.94 3.96 3.94 1.20 $ $ $ $ 4,816 Ì 4,816 4,600 6.69 6.68 6.69 6.68 1.04 10,090 Ì 10,090 9,851 14.22 14.17 14.22 14.17 0.88 $ $ $ $ Basic ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Diluted ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 680,856 682,664 691,582 693,511 689,282 691,521 687,094 688,675 692,727 695,116 Balance Sheet Data Total assetsÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 813,081 294,861 Senior debt due within one year ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 452,677 Senior debt due after one yearÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 6,400 Subordinated debt due after one year ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Miscellaneous liabilities(2) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 30,326 516 Minority interests in consolidated subsidiaries ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Stockholders' equity ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 28,301 Portfolio Balances(3) Retained portfolio (unpaid principal balances)(4) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 703,959 Total Guaranteed PCs and Structured Securities issued (unpaid $ 806,222 288,532 454,627 5,633 29,290 949 27,191 $ 795,284 282,303 443,772 5,622 30,662 1,509 31,416 $ 803,449 295,262 438,738 5,613 30,420 1,929 31,487 $ 752,249 244,429 415,662 5,605 52,914 2,309 31,330 $ 710,346 $ 653,261 $ 645,767 $ 567,366 principal balances)(5)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total mortgage portfolio (unpaid principal balances) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Ratios Return on average assets(6)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Return on common equity(7) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Return on total equity(8) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Dividend payout ratio on common stock(9)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Equity to assets ratio(10) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 1,477,023 1,826,720 1,335,524 1,684,546 1,208,968 1,505,531 1,162,068 1,414,700 1,090,624 1,316,703 0.3% 8.6 8.0 67.7 3.4 0.3% 7.7 7.3 56.4 3.7 0.4% 10.2 9.3 30.7 3.9 0.6% 17.2 15.3 15.6 4.0 1.4% 47.2 39.6 6.2 3.7 (1) EÅective January 1, 2006, we adopted the provisions of Statement of Financial Accounting Standards, or SFAS, No. 123(R), ""Share-based Payment'' and also changed our method of estimating prepayments for the purpose of amortizing premiums, discounts and deferred fees related to mortgage revenue bonds and commercial mortgage-backed securities held in the Retained portfolio. EÅective December 31, 2006, we adopted the provisions of SFAS No. 158, ""Employers' Accounting for DeÑned BeneÑt Pension and Other Postretirement Plans, an amendment of FASB Statements No. 87, 88, 106 and 132(R),'' or SFAS 158. EÅective January 1, 2005, we changed our method of accounting for interest expense related to callable debt instruments to recognize interest expense using an eÅective interest method over the contractual life of the debt and changed our method for determining gains and losses upon the re-sale of PCs and Structured Securities related to deferred items recognized in connection with our guarantee of those securities. See ""NOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES'' to our consolidated Ñnancial statements for more information regarding these accounting changes. EÅective January 1, 2003, we adopted the provisions of FASB Interpretation No. 45, ""Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others, an interpretation of FASB Statements No. 5, 57 and 107 and rescission of FASB Interpretation No. 34,'' or FIN 45, and FASB StaÅ Position FIN 45-2, ""Whether FASB Interpretation No. 45 Provides Support for Subsequently Accounting for a Guarantor's Liability at Fair Value.'' (2) Includes (a) Due to Participation CertiÑcate investors, (b) Accrued interest payable, (c) Guarantee obligation, (d) Derivative liabilities, at fair value, (e) Reserve for guarantee losses on Participation CertiÑcates and (f) Other liabilities, as presented on our consolidated balance sheets. (3) Excludes mortgage loans and mortgage-related securities traded, but not yet settled. (4) The Retained portfolio presented on our consolidated balance sheets diÅers from the Retained portfolio in this table because the consolidated balance sheet caption includes valuation adjustments and deferred balances. See ""MD&A Ì CONSOLIDATED BALANCE SHEETS ANALYSIS Ì Table 19 Ì Characteristics of Mortgage Loans and Mortgage-Related Securities in the Retained Portfolio'' for more information. (5) Excludes Structured Securities where we have resecuritized PCs and other previously issued Structured Securities. These excluded Structured Securities do not increase our credit-related exposure and consist of single-class Structured Securities backed by PCs, REMICs and principal-only strips. The notional balances of interest-only strips are excluded because this line item is based on unpaid principal balance. Also excluded from this line item are modiÑable and combinable REMIC tranches and interest and principal classes where the holder has the option to exchange the security tranches for other pre-deÑned security tranches. (6) Ratio computed as Net income divided by the simple average of beginning and ending Total assets. (7) Ratio computed as Net income available to common stockholders divided by the simple average of beginning and ending Stockholders' equity, net of Preferred stock, at redemption value. (8) Ratio computed as Net income divided by the simple average of beginning and ending Stockholders' equity. (9) Ratio computed as Common stock dividends declared divided by Net income available to common stockholders. (10) Ratio computed as the simple average of beginning and ending Stockholders' equity divided by the simple average of beginning and ending Total assets. 22 Freddie Mac MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS EXECUTIVE SUMMARY Our Business To achieve our objective for long-term growth of the fair value of our net assets, we focus on three long-term business drivers Ì the proÑtability of new investment and guarantee business, growth in our investment and total credit guarantee portfolios and market share. Competition, other market factors, our housing mission under our charter and the HUD aÅordable housing goals and subgoals require that we make trade-oÅs in our business that aÅect each of these drivers. Our purchases of mortgage loans beneÑting low- and moderate-income families and neighborhoods are an integral part of our mission and business, and we are committed to fulÑlling the needs of these borrowers and markets. Retained portfolio activities Through our Retained portfolio investment activities, we seek to produce long-term growth of the fair value of our net assets primarily by opportunistically purchasing mortgage assets that oÅer attractive investment returns while meeting the requirements of our charter and supporting the aÅordable housing goals and subgoals set for us by HUD. We estimate our expected investment returns using an option-adjusted spread approach. We select our investments based on these expected returns and our market expertise, regardless of the timing of the recognition of these returns in net income. During 2006, the unpaid principal balance of our Retained portfolio declined by 1 percent as relatively tight mortgage- to-debt option-adjusted spreads limited attractive investment opportunities and resulted in lower expected investment returns on new business. Also, as discussed in ""BUSINESS Ì Business Activities Ì Investment and Funding Activities,'' we began managing our Retained portfolio under a voluntary temporary growth limit eÅective July 1, 2006. We will keep this limit in place until we return to producing and publicly releasing quarterly Ñnancial statements prepared in conformity with GAAP. While operating under this limit, we continue to be selective about the new investments we make in order to achieve acceptable investment returns. Over the last several years, there has been a particularly strong demand for mortgage assets by investors. This demand was driven in part by the steep yield curve evident up until the second half of 2005. When short-term interest rates are low relative to mortgage interest rates, initial returns on mortgage-related investments are relatively high. A signiÑcant portion of our current Retained portfolio was acquired at attractive spreads when the slope of the yield curve was steep compared to historical levels. As a result, the initial net interest yields on our Ñxed-rate mortgage-related investments were relatively high. However, over the last three years, the net interest yield on those assets declined as our initial medium-term funding matured and was replaced with higher-coupon funding as the yield curve Öattened. In addition, throughout 2006 and 2005, new Ñxed-rate mortgage investments were acquired at lower initial net interest yields, which adversely aÅected the overall net interest yield of the Retained portfolio. While the natural decline of net interest yields of our Ñxed-rate mortgage investments is a driver of the decline in our net interest yield over the last three years, other factors have also contributed to the decline. For example, the increase of our issuances of callable debt put downward pressure on net interest yield in the near term; however, we expect this funding to reduce future rebalancing requirements and related costs over time. In addition, during 2006 and the latter part of 2005, while the yield curve was Öattening, we retired debt in order to take advantage of favorable funding spreads on our new debt issuances. While improving the spreads on our Retained portfolio had a positive impact on the fair value of our net assets, these debt retirements adversely impacted our net interest yields because retired lower-coupon debt was replaced at higher interest rates. During 2006, our average funding levels remained signiÑcantly below the London Interbank OÅered Rate, or LIBOR, with spreads relative to LIBOR for our Reference Notes» securities improving by 2 to 5 basis points along the interest-rate curve. Also, in 2005 and 2004, we increased our purchases of variable-rate non-agency mortgage-related securities, taking advantage of attractive spreads. While the net interest yields on variable-rate securities are less sensitive to changes in the yield curve, they generally have lower initial net interest yields than Ñxed-rate investments. Credit guarantee activities We seek to generate fair value growth through our credit guarantee activities by issuing guarantees that oÅer attractive long-term returns relative to anticipated credit costs. The securitization market is increasingly competitive and we have reduced our guarantee fees on new business in an eÅort to maintain our market share. In addition, during 2006, the residential mortgage market weakened and the rate of home price appreciation slowed. During 2006 and 2005, increases in the expected future credit costs associated with our credit guarantee activities increased the fair value of our Guarantee obligation, adversely impacting the fair value of our net assets. Also, as a result of the increase in expected future credit costs and competitive pressure on our guarantee fees, some of our new credit guarantee business was acquired below our normal expected return thresholds and we realized increased losses on certain 23 Freddie Mac guarantees at their inception. These trends have also contributed to a decline in the overall expected returns on our credit guarantee activities. During 2006, 2005 and 2004, the growth rates of our credit guarantee portfolio were 10.6 percent, 10.5 percent and 4.0 percent, respectively. For 2006, we estimate that our share of the total residential mortgage securitization market declined slightly due, in part, to lower purchase volumes of non-agency mortgage-related securities into our Retained portfolio. Also, our share of the GSE securitization market declined to approximately 43 percent in 2006 from approximately 45 percent in 2005 due to competitive pressures. The credit quality of our guarantee portfolio remains strong, with a weighted average current loan-to-value ratio of approximately 57 percent as of the end of 2006 as compared with 56 percent at the end of 2005, and the portfolio remains geographically well diversiÑed. In addition, our guarantee portfolio has beneÑted from several years of strong home price appreciation. However, as discussed in ""BUSINESS,'' the mortgages added to our portfolio in recent years do not have the beneÑt of signiÑcant home price appreciation and, in some markets, recent values of the properties underlying the mortgages have declined. As recently acquired credit guarantee business matures and enters its peak default years, we anticipate that default rates and loss severities will trend higher. As the residential mortgage market continues to grow, competition among loan originators and other market factors, such as relatively low interest rates and generally high home prices, have led to a higher proportion of variable-rate mortgage products and the proliferation of new mortgage products that oÅer borrowers a variety of payment options. We increased our purchases of these variable-rate and non-traditional mortgage products as they became more prevalent in the market. However, at December 31, 2006, long-term, Ñxed-rate mortgages comprised more than 80 percent of our credit guarantee portfolio. During 2006, interest-only mortgages comprised approximately 16 percent of our purchases and, at December 31, 2006, comprised approximately 5 percent of the total credit guarantee portfolio. Mortgages with optional payment terms, referred to as ""option ARMs,'' comprised approximately 2 percent of purchases and approximately 1 percent of our total credit guarantee portfolio. We generally seek higher compensation for the additional credit risk inherent in these products; however, our ability to do so has been limited due to competition for this business. Summary of 2006 Financial Results GAAP Results Net income was $2.2 billion in 2006, up 4 percent compared to $2.1 billion in 2005. In 2006, diluted earnings per common share increased by $0.09 reÖecting the increase in net income and the reduction in the diluted weighted average number of common shares outstanding, arising from our repurchase of approximately 32.7 million common shares during the year, partially oÅset by an increase in preferred dividends associated with our issuance of $1.5 billion in new preferred stock. Pre-tax income declined by $0.5 billion to $2.1 billion in 2006 from $2.6 billion in 2005. Net interest income declined to $4.2 billion in 2006 from $5.4 billion in 2005. While our Retained portfolio declined slightly year-over-year, the average balance of our interest-earning assets increased, as did the related average yields. Notwithstanding this improvement, net interest income declined as we replaced, at higher contractual interest rates, approximately $129 billion in long-term debt, which either matured or was repurchased during 2006. Derivative gains (losses), a component of non-interest income, includes another component of our investment returns; interest received or paid on interest rate swaps. In 2006, we recognized $92 million of interest income, as compared to $337 million of interest expense in 2005, an improvement of $429 million. This change primarily resulted from the impact of rising short-term interest rates, and partially oÅset the reduction in net interest income discussed above. Management and guarantee income increased to $1.7 billion in 2006 from $1.5 billion in 2005; however, our contractual guarantee fee rate declined modestly as the average balance of outstanding PCs increased by approximately 15 percent during 2006. Total non-interest expenses were unchanged year over year at $3.0 billion. Administrative expenses increased slightly to $1.6 billion in 2006 from $1.5 billion in 2005, primarily due to higher professional services costs related to improving technology and our internal control over Ñnancial reporting. Our administrative expenses declined as a percent of the average total mortgage portfolio to 9.3 basis points from 9.7 basis points in 2005. In 2006 and 2005, our provision for credit losses was $215 million and $251 million, respectively. The provision for credit losses in 2005 included $128 million related to properties aÅected by Hurricane Katrina, of which we reversed $82 million in 2006 because the related payment and delinquency experience on aÅected properties was better than expected. Absent the adjustments related to Hurricane Katrina in both years, from 2005 to 2006 our provision for credit losses increased by $174 million due to credit deterioration in our single-family credit guarantee portfolio as more loans transitioned through delinquency to foreclosure and the expected severity of losses on a per-property basis increased, driven 24 Freddie Mac 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 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 continue to have a signiÑcant number of material weaknesses and other internal control deÑciencies that have not been fully remediated and considerable challenges remain. Interest-Rate Risk Our interest-rate risk remains low. For 2006, PMVS-L and duration gap averaged 1 percent and zero months, respectively. Credit Risk See ""RISK MANAGEMENT Ì Credit Risks'' for information about our credit risks and our strategies for managing them. Legislative and Regulatory Matters We face a highly uncertain regulatory environment in light of GSE regulatory oversight legislation currently under consideration in Congress. We generate a signiÑcant portion of our net income through our Retained portfolio. Currently, we have in place a voluntary temporary growth limit on our Retained portfolio. GSE regulatory oversight legislation under consideration in the House of Representatives would give our regulator substantial authority to regulate the amount and composition of our portfolio investments and to require substantial reductions in those investments. This legislation also includes provisions that would increase the regulator's authority to require us to maintain higher minimum and risk-based capital levels and, for 2007 through 2011, require us to make an annual contribution to an aÅordable housing fund in an amount equal to 1.2 basis points of our average total mortgage portfolio. See ""REGULATION AND SUPERVISION Ì GSE Regulatory Oversight Legislation'' for more information regarding this bill. We cannot predict the prospects for the enactment, timing or content of any Ñnal legislation. The provisions of this legislation, individually and in certain combinations, could have a material adverse eÅect on our ability to fulÑll our mission, future earnings, stock price and stockholder returns, the rate of growth in our fair value, and our ability to recruit qualiÑed oÇcers and directors. 27 Freddie Mac CONSOLIDATED RESULTS OF OPERATIONS The following discussion of our consolidated results of operations should be read in conjunction with our consolidated Ñnancial statements, including the accompanying notes. Also see ""CRITICAL ACCOUNTING POLICIES AND ESTIMATES'' for more information concerning the most signiÑcant accounting policies and estimates applied in determining our reported Ñnancial position and results of operations. Table 7 Ì Summary Consolidated Statements of Income Net interest income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Non-interest income (loss): Management and guarantee income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Gains (losses) on Guarantee asset ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Income on Guarantee obligation ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Derivative gains (losses)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Hedge accounting gains (losses) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Gains (losses) on investment activity ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Gains (losses) on debt retirement ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Other ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Non-interest income (loss)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Non-interest expense: Administrative expenses ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Other ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Non-interest expense ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Income before income tax expense and cumulative eÅect of change in accounting principle ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Income tax beneÑt (expense) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Net income before cumulative eÅect of change in accounting principle, net of taxesÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Cumulative eÅect of change in accounting principle, net of tax ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Net incomeÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Year Ended December 31, 2004 2005 2006 (in millions) $5,370 $9,137 $4,235 1,382 1,672 1,450 (800) (1,064) (1,135) 920 867 (1,164) (1,357) (4,475) 732 2 (474) 466 346 915 22 (127) 206 149 199 743 (348) (327) 389 (3,039) (1,641) (1,535) (1,550) (1,406) (1,478) (821) (3,047) (3,013) (2,371) 2,556 (367) 2,189 (59) $2,130 3,727 (790) 2,937 Ì $2,937 2,103 108 2,211 Ì $2,211 Net Interest Income Table 8 summarizes our Net interest income and net interest yield and provides an attribution of changes in annual results to changes in interest rates or changes in volumes of our interest-earning assets and interest-bearing liabilities. Average balance sheet information is presented because we believe end-of-period balances are not representative of activity throughout the periods presented. For most components of the average balances, a daily weighted average balance was calculated for the period. When daily weighted average balance information was not available, a simple monthly average balance was calculated. 28 Freddie Mac Table 8 Ì Average Balance, Net Interest Income and Rate/Volume Analysis 2006 2005 2004 Year Ended December 31, Average Average Average Average Average Interest Income Balance(1)(2) (Expense)(1) Rate Interest Income Balance(1)(2) (Expense)(1) Rate (dollars in millions) Interest Income Average Balance(1)(2) (Expense)(1) Rate Interest-earning assets: Mortgage loans(3)(4) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Mortgage-related securities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total Retained portfolioÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Investments(5) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Securities purchased under agreements to resell and $ 63,870 650,059 713,929 57,705 Federal funds sold ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total interest-earning assets ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 28,577 $800,211 Interest-bearing liabilities: Short-term debt ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Long-term debt(6)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total debt securities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Due to Participation CertiÑcate investors ÏÏÏÏÏÏÏÏÏÏÏÏÏ Total interest-bearing liabilitiesÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Income (expense) related to derivatives ÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Impact of net non-interest-bearing funding ÏÏÏÏÏÏÏÏÏÏÏÏ Total funding of interest-earning assets ÏÏÏÏÏÏÏÏÏÏÏ Net interest income/yield ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Fully taxable-equivalent adjustments(7) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Net interest income/yield (fully taxable-equivalent basis) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $179,882 587,978 767,860 7,475 775,335 24,876 $800,211 $ 4,152 34,673 38,825 2,789 1,473 $ 43,087 $ (8,665) (28,218) (36,883) (387) (37,270) (1,582) Ì $(38,852) 4,235 $ 392 6.50% 5.33 5.44 4.83 5.15 5.38 (4.82) (4.80) (4.80) (5.18) (4.81) (0.20) 0.16 (4.85) 0.53 0.05 $ 61,248 611,452 672,700 53,252 25,344 $751,296 $192,497 524,270 716,767 10,399 727,166 24,130 $751,296 $ 4,037 29,684 33,721 1,773 833 $ 36,327 $ (6,102) (23,246) (29,348) (551) (29,899) (1,058) Ì $(30,957) 5,370 $ 339 6.59% 4.85 5.01 3.33 3.28 4.83 (3.17) (4.43) (4.09) (5.30) (4.11) (0.15) 0.14 (4.12) 0.71 0.05 $ 61,576 590,213 651,789 81,833 29,996 $763,618 $205,072 530,816 735,888 12,401 748,289 15,329 $763,618 $ 4,007 28,460 32,467 2,716 420 $ 35,603 $ (2,908) (22,950) (25,858) (708) (26,566) 100 Ì $(26,466) $ 9,137 267 6.51% 4.82 4.98 3.32 1.40 4.66 (1.42) (4.32) (3.51) (5.71) (3.55) 0.01 0.07 (3.47) 1.20 0.03 $ 4,627 0.58% $ 5,709 0.76% $ 9,404 1.23% 2006 vs. 2005 Variance Due to 2005 vs. 2004 Variance Due to Rate(8) Volume(8) Total Change Rate(8) Volume(8) Interest-earning assets: Mortgage loans ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Mortgage-related securities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total Retained portfolioÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Investments ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Securities purchased under agreements to resell and Federal funds soldÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total interest-earning assets ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Interest-bearing liabilities: Short-term debt ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Long-term debtÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total debt securities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Due to Participation CertiÑcate investors ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total interest-bearing liabilitiesÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Income (expense) related to derivatives ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total funding of interest-earning assets ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Net interest income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Fully taxable-equivalent adjustments ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Net interest income (fully taxable-equivalent basis) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ (56) 3,042 2,986 857 523 $ 4,366 $(2,986) (2,008) (4,994) 12 (4,982) (524) $(5,506) $(1,140) 30 $(1,110) $ 171 1,947 2,118 159 117 $ 2,394 $ 423 (2,964) (2,541) 152 (2,389) Ì $(2,389) $ 5 23 28 $ (in millions) $ 115 4,989 5,104 1,016 640 $ 6,760 $(2,563) (4,972) (7,535) 164 (7,371) (524) $(7,895) $(1,135) 53 $(1,082) $ $ 51 194 245 9 487 741 $(3,383) (581) (3,964) 48 (3,916) (1,158) $(5,074) $(4,333) 76 $(4,257) $ (21) 1,030 1,009 (952) (74) $ (17) $ 189 285 474 109 583 Ì $ 583 $ 566 (4) $ 562 Total Change $ $ 30 1,224 1,254 (943) 413 724 $(3,194) (296) (3,490) 157 (3,333) (1,158) $(4,491) $(3,767) 72 $(3,695) (1) Excludes mortgage loans and mortgage-related securities traded, but not yet settled. (2) For securities classiÑed as available-for-sale, we calculated average balances based on their unpaid principal balance plus their associated deferred fees and costs (e.g., premiums and discounts), but excluded the eÅects of mark-to-fair-value changes. For securities in the Retained portfolio classiÑed as trading, we calculated average balances excluding their mark-to-fair-value adjustments. For securities in the Cash and investments portfolio classiÑed as trading during 2004, we calculated average balances based on their fair values. (3) Non-accrual loans are included in average balances. (4) Loan fees included in mortgage loan interest income were $280 million, $371 million and $223 million for the years ended December 31, 2006, 2005 and 2004, respectively. (5) For 2006 and 2005, Investments consisted of Cash and cash equivalents and non-mortgage-related securities. For 2004, Investments also included Mortgage-related securities held in the Cash and investments portfolio. (6) Includes current portion of long-term debt. See ""NOTE 8: DEBT SECURITIES AND SUBORDINATED BORROWINGS'' to our consolidated Ñnancial statements for a reconciliation of Senior debt, due within one year on our consolidated balance sheets. (7) The determination of Net interest income/yield (fully taxable-equivalent basis), which reÖects fully taxable-equivalent adjustments to interest income, involves the conversion of tax-exempt sources of interest income to the equivalent amounts of interest income that would be necessary to derive the same net return if the investments had been subject to income taxes using our statutory tax rate of 35 percent. (8) Rate and volume changes are calculated on the individual Ñnancial statement line item level. Combined rate/volume changes were allocated to the individual rate and volume change based on their relative size. 29 Freddie Mac Table 9 summarizes components of our Net interest income. Table 9 Ì Net Interest Income 2006 Year Ended December 31, 2005(1) (in millions) $ 8,897 2004(1) $11,735 Contractual amounts of Net interest income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 8,059 Amortization expense, net:(2) Asset-related amortization expense, net ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Debt-related amortization expense, net ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total amortization expense, net ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (639) (1,603) (2,242) (1,023) (1,446) (2,469) (1,397) (1,301) (2,698) Income (expense) related to derivatives: Amortization of deferred balances in Accumulated other comprehensive income(3) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Accrual of periodic settlements of derivatives:(4) (1,620) (1,966) (1,814) Pay-Ñxed swapsÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Receive-Ñxed swaps(5) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Foreign-currency swaps ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Other ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total accrual of periodic settlements of derivatives ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total income (expense) related to derivatives ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (1,582) Net interest income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 4,235 392 Fully taxable-equivalent adjustments ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Net interest income (fully taxable-equivalent basis) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 4,627 Ì 502 (464) Ì 38 Ì 1,185 (277) Ì 908 (1,058) 5,370 339 $ 5,709 (427) 1,968 376 (3) 1,914 100 9,137 267 $ 9,404 (1) Certain amounts for 2005 and 2004 have been revised to conform with the 2006 presentation. (2) Represents amortization related to premiums, discounts, deferred fees and other adjustments to the carrying value of our Ñnancial instruments and the reclassiÑcation of previously deferred balances from Accumulated other comprehensive income, or AOCI, for certain derivatives in cash Öow hedge relationships related to individual debt issuances and mortgage purchase transactions. (3) Represents changes in fair value of derivatives in cash Öow hedge relationships that were previously deferred in AOCI and have been reclassiÑed to earnings as the associated hedged forecasted issuance of debt and mortgage purchase transactions aÅect earnings. (4) ReÖects the accrual of periodic cash settlements of all derivatives in qualifying hedge accounting relationships. (5) The accrual of periodic settlements of Receive-Ñxed swaps includes imputed interest on zero-coupon swaps. 2006 versus 2005 Net interest income and net interest yield on a fully taxable-equivalent basis decreased in 2006 as spreads on Ñxed-rate investments continued to narrow, driven by increases in long- and medium-term interest rates. The increase in our long-term debt interest costs reÖects the turnover of medium-term debt that we issued during the past few years to fund our investments in Ñxed-rate mortgage-related investments when the yield curve was steep (i.e. short- and medium-term interest rates were low as compared to long-term interest rates). As the yield curve Öattened during 2005 and 2006, we experienced increased funding costs associated with replacing maturing lower-cost debt used to fund existing Ñxed-rate mortgage investments. During 2006, net interest margins declined as a result of changes in interest rates on variable-rate assets acquired in 2004 and 2005 impacted our results. Also, we adjusted our funding mix in 2006 by increasing the proportion of callable debt outstanding, which we use to manage prepayment risk associated with our mortgage-related investments, and which generally has a higher interest cost than non-callable debt. In 2006, we considered the issuance of callable debt to be more cost eÅective than alternative interest-rate risk management strategies, primarily the issuance of non-callable bullet debt combined with the use of derivatives. We also reduced the balance of our short-term debt securities to approximately 23 percent of total outstanding debt as of December 31, 2006, from approximately 26 percent at the beginning of the year, to take advantage of the attractive funding spreads relative to LIBOR on our long-term debt. The impact of rising short-term rates on our short-term debt was largely oÅset by the impact of rising rates on our variable-rate assets in our Retained portfolio and our Cash and investments portfolio. Net interest income for 2006 also reÖected lower net interest income on derivatives in qualifying hedge accounting relationships. Net interest income associated with the accrual of periodic settlements declined as the benchmark LIBOR and the Euro Interbank OÅered Rate, or Euribor, interest rates increased during the year, adversely aÅecting net settlements on our receive-Ñxed swaps and foreign-currency swaps (primarily Euro-denominated). Net interest income was also aÅected by our decisions in March and December 2006 to discontinue hedge accounting treatment for a signiÑcant amount of our receive-Ñxed swaps and foreign-currency swaps, as discussed in ""NOTE 12: DERIVATIVES'' to our consolidated Ñnancial statements. The net interest expense related to these swaps is no longer a component of Net interest income, after hedge accounting was discontinued, but instead is recognized as a component of Derivative gains (losses). By the end of 2006, nearly all of our derivatives were not in hedge accounting relationships. EÅective January 1, 2006, we enhanced our process for forecasting interest rates and estimating prepayments used to amortize discounts, premiums and deferred fees for assets held in the Retained portfolio. This change in estimate resulted in a $93 million pre-tax reduction in Net interest income on mortgage-related securities. 30 Freddie Mac Enhancements to certain models used to estimate prepayment speeds on mortgage-related securities and our approach for estimating uncollectible interest on single-family mortgages greater than 90 days delinquent resulted in a net decrease in Retained portfolio interest income of $166 million (pre-tax) during the Ñrst quarter of 2005. 2005 versus 2004 Net interest income and net interest yield on a fully taxable-equivalent basis decreased in 2005 due to narrowing spreads on Ñxed-rate assets as the yield curve Öattened and the composition of our Retained portfolio changed toward a greater percentage of lower-yielding, variable-rate assets. The decline in Net interest income for 2005 also reÖected higher interest expense on derivatives in qualifying hedge accounting relationships. Net interest income associated with the accrual of periodic settlements related to our receive-Ñxed swaps and foreign-currency swaps declined as the benchmark LIBOR interest rate increased. Net interest income was also aÅected by our decision in 2004 to discontinue hedge accounting treatment for a signiÑcant amount of our pay-Ñxed swaps and receive-Ñxed swaps, as discussed in ""NOTE 12: DERIVATIVES'' to our consolidated Ñnancial statements. The net interest expense related to these swaps was no longer a component of Net interest income after hedge accounting was discontinued, but was recognized as a component of Non-interest income (loss) in Derivative gains (losses). Another factor in the decline in Net interest income for 2005 was our decision to cease the PC market-making and support activities conducted through our Securities Sales and Trading Group, or SS&TG, business unit and our external Money Manager program during the fourth quarter of 2004. By the end of 2004, we divested the trading portfolios related to our SS&TG business unit and our external Money Manager program in the Investments portfolio. This divestiture reduced the interest expense for funding the Investments portfolio as well as the hedging costs associated with it, which were reÖected in Gains (losses) on investment activity. Our investments in mortgage-related securities held by our SS&TG business unit and external Money Manager program were generally hedged by entering into forward sales of mortgage- related securities. For 2004, the valuation diÅerence between the trading securities and the related forward sale commitments resulted in a loss of $1,101 million in Gains (losses) on investment activity that was oÅset by Net interest income on the held position. Non-Interest Income (Loss) Management and Guarantee Income Table 10 provides summary information about Management and guarantee income. Management and guarantee income consists of contractual amounts due to us related to our management and guarantee fee as well as amortization of certain pre-2003 deferred fees, including credit and buy-down fees. Other guarantee-related revenue is deferred and recognized over time as a component of Income on Guarantee obligation. Table 10 Ì Management and Guarantee Income(1) 2006 Year Ended December 31, 2005 2004 Contractual management and guarantee feesÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Amortization of credit and buy-down fees included in Other liabilities(2) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total management and guarantee income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $1,613 59 $1,672 Amount Rate Rate Amount Amount (dollars in millions, rate in basis points) $1,303 79 $1,382 $1,431 19 $1,450 15.7 0.2 15.9 15.4 0.6 16.0 Rate 16.5 1.0 17.5 Unamortized balance of credit and buy-down fees included in Other liabilities, at period endÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 136 $ 186 $ 323 (1) Excludes amounts related to PCs we held in our Retained portfolio, which are reported in Net interest income. (2) A change in estimate resulted in a net pre-tax increase (decrease) in the Amortization of credit and buy down fees of $18 million and $(17) million for 2006 and 2005, respectively. See ""NOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES'' to our consolidated Ñnancial statements for further information. Management and guarantee income increased in both 2006 and 2005, primarily reÖecting increases in the average outstanding PC balances of 15 percent in each year. The average contractual management and guarantee fee rate decreased in both years from the prior years, reÖecting lower guarantee fee rates on new business and the liquidation of existing business with relatively higher guarantee fee rates. The continued decline in guarantee fee rates on new business is the result of competitive pricing pressures. Management and guarantee income includes the amortization of pre-2003 deferred credit fees and buy-down fees on our outstanding PCs. However, similar fees received after January 1, 2003 are primarily deferred and recognized over time as a component of Income on Guarantee obligation. Gains (Losses) on Guarantee Asset Upon issuance of a guarantee of securitized assets, we may record a Guarantee asset on our consolidated balance sheets representing the fair value of the guarantee fees we expect to receive over the life of the related PCs and Structured 31 Freddie Mac Securities. Subsequent changes in the fair value of the Guarantee asset are reported in current period income as Gains (losses) on Guarantee asset. The change in fair value of the Guarantee asset reÖects: ‚ reductions related to the contractual guarantee fees due that are considered a return of our recorded investment in the Guarantee asset; and ‚ changes in the fair value of expected future guarantee fees we expect to receive over the life of the related PC or Structured Security. As shown on ""Table 11 Ì Attribution of Change Ì Gains (Losses) on Guarantee Asset,'' contractual guarantee fees due represent Management and guarantee income realized in the current period related to PCs and Structured Securities held by third parties with an established Guarantee asset. A portion of contractual guarantee fees due is attributed to imputed interest income on the Guarantee asset. The fair value of expected future cash Öows is driven by changes in the expected interest and related discount rates that aÅect the estimated life of the mortgages underlying the outstanding PCs and Structured Securities and other economic factors that inÖuence the amount and timing of the future cash Öows. Our valuation methodology for the Guarantee asset, Ñrst implemented for 2005, uses market-based information to determine the fair value of future cash Öows associated with the Guarantee asset. Changes in the fair value of the Guarantee asset, which are recorded in current period earnings through Gains (losses) on Guarantee asset, reÖect the volatility associated with the market-based inputs used in our valuation. Changes in the estimated lives of the underlying mortgages also aÅect the fair value of the Guarantee asset. See ""CONSOLIDATED BALANCE SHEETS ANALYSIS Ì Table 25 Ì Changes in Guarantee Asset'' for additional information about the Guarantee asset. Table 11 Ì Attribution of Change Ì Gains (Losses) on Guarantee Asset Year Ended December 31, 2005 (in millions) Contractual guarantee fees dueÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $(1,475) $(1,270) 371 Portion of contractual guarantee fees due related to imputed interest income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (899) Return of investment on Guarantee asset ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (138) Change in fair value of future cash Öows ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Change in estimate(1)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (27) Gains (losses) on Guarantee asset ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ (800) $(1,064) 466 (1,009) 169 40 2006 $(1,086) 257 (829) (306) Ì $(1,135) 2004 (1) Represents a change in estimate resulting from enhancing our approach for determining the fair value of the Guarantee asset. See ""NOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES'' to our consolidated Ñnancial statements for further information. The reduction in our Guarantee asset attributable to the Return of investment on Guarantee asset increased during 2006, 2005 and 2004. The Return of investment on Guarantee asset increased as the outstanding PCs and Structured Securities have grown each year. Losses on the Guarantee asset decreased in 2006 as compared with 2005, due to increases in the fair value of the Guarantee asset consistent with the increase in mortgage interest rates during the year, which generally extends the life of the Guarantee asset. Losses on the Guarantee asset decreased in 2005 as compared with 2004, reÖecting the increase in mortgage interest rates during the year oÅset by the eÅect of the change in our valuation method. Income on Guarantee Obligation Upon issuance of a guarantee of securitized assets, we record a Guarantee obligation on our consolidated balance sheets representing the fair value of our obligation to perform under the terms of the guarantee. The Guarantee obligation consists of the following: ‚ performance and other related costs, which consist of: estimated default costs, including the unrecoverable principal and interest that will be incurred over the expected life of the underlying mortgages; estimated foreclosure-related costs; and estimated administrative and other costs related to our guarantee; and ‚ deferred guarantee income on newly-issued Guarantor Swap transactions, which represents the excess of compensa- tion received on issued guarantees and the fair value of the related Guarantee asset, as compared to the fair value of the corresponding Guarantee obligation. Compensation received includes cash, credit and buy-down fees received at the time of securitization. Credit fees vary with the relative credit quality of the underlying mortgages and buydown fees vary based on customer compensation payment preferences. The Guarantee obligation is amortized into income in relation to the decline in the unpaid principal balance on the mortgage loans underlying the PCs and Structured Securities. 32 Freddie Mac Table 12 provides information about the components of Income on Guarantee obligation. Table 12 Ì Income on Guarantee Obligation 2006 Year Ended December 31, 2005 (in millions) 2004 Amortization income related to: Performance and other related costs ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 584 283 Deferred guarantee income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Income on Guarantee obligation(1)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 867 Components of the Guarantee obligation, at period end: Unamortized balance of performance and other related costsÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $4,869 2,248 Unamortized balance of deferred guarantee incomeÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Ending Guarantee obligation(2) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $7,117 $ 616 304 $ 920 $3,743 1,798 $5,541 $ 537 195 $ 732 $2,738 1,327 $4,065 Liquidation rate for outstanding PCs and Structured Securities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 17% 24% 29% (1) Includes $170 million, $197 million and $128 million of amortization related to deferred credit and buydown fees received from counterparties in Guarantor Swap and similar transactions, or ""upfront fees,'' at December 31, 2006, 2005 and 2004, respectively. (2) Includes $1,391 million, $1,167 million and $940 million of unamortized upfront fees at December 31, 2006, 2005 and 2004, respectively. In 2006, Income on Guarantee obligation decreased as increasing mortgage interest rates resulted in lower liquidation rates on outstanding PCs and Structured Securities and lower rates of amortization. In 2005, Income on Guarantee obligation increased as compared with 2004 as the additions to the Guarantee obligation from new business more than oÅset the impact of lower PC and Structured Security liquidation rates caused by increases in mortgage interest rates. During 2006 and 2005, the growth in unamortized balances reÖects the increase in our portfolio of outstanding PCs and Structured Securities and increased expected credit costs associated with newly-issued guarantees. Derivative Overview Table 13 presents the notional amount for each of our hedge accounting classiÑcations and the corresponding impact of those positions on our consolidated Ñnancial statements. Table 13 Ì Summary of the EÅect of Derivatives on Selected Consolidated Financial Statement Captions Description Fair value hedges-open ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Cash Öow hedges-openÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ No hedge designationÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Subtotal ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Balance related to closed cash Öow hedges ÏÏÏÏ TotalÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Description Fair value hedges-open(4) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Cash Öow hedges-open(4)(5)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ No hedge designationÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ TotalÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Consolidated Balance Sheets December 31, 2006 Fair Value (Pre-Tax)(1) AOCI (Net of Taxes)(2) Notional Amount December 31, 2005 Fair Value (Pre-Tax)(1) AOCI (Net of Taxes)(2) $ Ì Ì 7,729 7,729 Ì $7,729 (in millions) $ Ì Ì Ì Ì (5,033) $(5,033) $115,146 668 567,558 683,372 Ì $683,372 $3,402 (26) 3,131 6,507 Ì $6,507 $ Ì 4 Ì 4 (6,291) $(6,287) 2006 Hedge Accounting Gains (Losses)(3) $ 2 Ì Ì $ 2 Consolidated Statements of Income Year Ended December 31, 2005 Derivative Gains (Losses) Hedge Accounting Gains (Losses)(3) (in millions) $ Ì (25) (1,332) $(1,357) $22 Ì Ì $22 2004 Hedge Accounting Gains (Losses)(3) $742 1 Ì $743 Derivative Gains (Losses) $ Ì 2 (4,477) $(4,475) Notional Amount $ Ì 70 757,127 757,197 Ì $757,197 Derivative Gains (Losses) $ Ì Ì (1,164) $(1,164) (1) The fair values of derivatives (netted by counterparty) are presented as Derivative assets, at fair value, and Derivative liabilities, at fair value, on our consolidated balance sheets. (2) Derivatives that meet speciÑc criteria may be accounted for as cash Öow hedges. Changes in the fair value of the eÅective portion of these open derivatives contracts are recorded in AOCI, net of taxes. Net deferred gains and losses on closed cash Öow hedges (i.e., where the derivative is either terminated or redesignated) are also included in AOCI, net of taxes, until the related forecasted transaction aÅects earnings or is determined to be probable of not occurring. (3) Hedge accounting gains (losses) arise when the fair value change of a derivative does not exactly oÅset the fair value change of the hedged item attributable to the hedged risk. For further information, see ""Hedge Accounting Gains (Losses)'' below and ""NOTE 12: DERIVATIVES'' to our consolidated Ñnancial statements. (4) For all derivatives in qualifying hedge accounting relationships, the accrual of periodic cash settlements is recorded in Net interest income on our consolidated statements of income and those amounts are not included in the table. For derivatives not in qualifying hedge accounting relationships, the accrual of periodic cash settlements is recorded in Derivative gains (losses) on our consolidated statements of income. (5) Derivative gains (losses) in each period include gains or losses reclassiÑed from AOCI, net of taxes, as a result of the termination of cash Öow hedge designations because we determined that the related forecasted transaction is probable of not occurring. 33 Freddie Mac Over the course of 2006, 2005 and 2004, we discontinued nearly all of our cash Öow hedge and fair value hedge accounting relationships. At December 31, 2006, the only derivatives in hedge accounting relationships were certain commitments to forward sell mortgage-related securities, which were designated in cash Öow hedge relationships. See ""NOTE 12: DERIVATIVES'' to our consolidated Ñnancial statements for additional information on our discontinuation of hedge accounting treatment. Derivatives that are not in qualifying hedge accounting relationships generally increase the volatility of reported Non-interest income (loss) because the fair value gains and losses on the derivatives are recognized in earnings without the oÅsetting recognition in earnings of the change in value of the economically hedged exposures. For derivatives designated in cash Öow hedge accounting relationships during 2006 and in prior years, the eÅective portion of the change in fair value of the derivative asset or derivative liability is presented in the stockholders' equity section of our consolidated balance sheets in AOCI, net of taxes. At December 31, 2006 and 2005, the net cumulative change in the fair value of all derivatives designated in cash Öow hedge relationships for which the forecasted transactions had not yet aÅected earnings (net of amounts previously reclassiÑed to earnings through each year end) was a loss of approximately $5.0 billion and $6.3 billion, respectively, on an after-tax basis. These amounts relate almost entirely to net deferred losses on closed cash Öow hedges. The majority of the closed cash Öow hedges relate to hedging the variability of cash Öows from forecasted issuances of debt. Fluctuations in prevailing market interest rates have no impact on the deferred portion of AOCI, net of taxes, relating to closed cash Öow hedges. The deferred amounts related to closed cash Öow hedges will be recognized into earnings as the hedged forecasted transactions aÅect earnings, unless it becomes probable that the forecasted transactions will not occur. If it is probable that the forecasted transactions will not occur, then the deferred amount associated with the forecasted transactions will be reclassiÑed into earnings immediately. At December 31, 2006, over 70 percent and 90 percent of the $5.0 billion net deferred losses in AOCI, net of taxes, relating to cash Öow hedges were linked to forecasted transactions occurring in the next 5 and 10 years, respectively. Over the next 10 years, the forecasted debt issuance needs associated with these hedges range from approximately $21.5 billion to $104.7 billion in any one quarter, with an average of $66.2 billion per quarter. Table 14 presents the scheduled amortization of the net deferred losses in AOCI at December 31, 2006, related to closed cash Öow hedges. The scheduled amortization is based on a number of assumptions. Actual amortization will diÅer from the scheduled amortization, perhaps materially, as we make decisions on debt funding levels or as changes in market conditions occur that diÅer from these assumptions. For example, for the scheduled amortization for cash Öow hedges related to future debt issuances, we assume that we will not repurchase the related debt and that no other factors aÅecting debt issuance probabilities will change. Table 14 Ì Scheduled Amortization to Income of Net Deferred Losses in AOCI Related to Closed Cash Flow Hedge Relationships Period of Scheduled Amortization to Income December 31, 2006 Amount (Pre-tax) Amount (After-tax) (in millions) 2007ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2008ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2009ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2010ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2011ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2012 to 2016ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Thereafter ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total net deferred losses in AOCI related to closed cash Öow hedge relationships ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $(1,466) (1,334) (1,109) (914) (723) (1,562) (635) $(7,743) $ (953) (867) (721) (594) (470) (1,016) (412) $(5,033) 34 Freddie Mac Derivative Gains (Losses) Table 15 provides a summary of the period-end notional amounts and the gains and losses related to derivatives that we used to manage interest-rate risk, but that were not accounted for in hedge accounting relationships. Table 15 Ì Derivatives Not in Hedge Accounting Relationships 2006 Year Ended December 31, 2005 2004 Notional or Contractual Amount Derivative Gains (Losses) Notional or Contractual Amount Derivative Gains (Losses) Notional or Contractual Amount Derivative Gains (Losses) (in millions) Call swaptions ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Put swaptions ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Receive-Ñxed swaps ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Pay-Ñxed swaps ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Futures ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Other(1) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Subtotal ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $194,200 29,725 222,631 217,565 22,400 70,606 757,127 $(1,128) (100) (290) 649 (248) (139) (1,256) $146,615 34,675 81,185 181,562 86,252 37,269 567,558 Accrual of periodic settlements: Receive-Ñxed swaps(2) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Pay-Ñxed swaps ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Other ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total accrual of periodic settlements ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (418) 541 (31) 92 $757,127 $(1,164) $567,558 $ (402) 202 (1,535) 612 63 40 (1,020) 426 (763) Ì (337) $(1,357) $189,945 25,175 25,572 95,043 129,110 157,618 622,463 $622,463 $ 386 (1,423) (396) (793) (213) (320) (2,759) 104 (1,826) 6 (1,716) $(4,475) (1) Consisted of basis swaps, certain option-based contracts, foreign-currency swaps, interest-rate caps, forward purchase and sale commitments, credit derivatives and swap guarantee derivatives not accounted for in hedge accounting relationships. 2004 and 2005 also included a prepayment management agreement which was terminated eÅective December 31, 2005. (2) The accrual of periodic settlements of Receive-Ñxed swaps includes imputed interest on zero-coupon swaps. Derivative gains (losses) reÖect the change in the fair value of and the accrual of periodic settlements of all derivatives not in hedge accounting relationships. From 2004 through 2006, we experienced signiÑcant periodic income volatility due to changes in the fair values of our derivatives and changes in the composition of our portfolio of derivatives not in hedge accounting relationships. A receive-Ñxed swap results in our receipt of a Ñxed interest-rate payment from our counterparty in exchange for a variable-rate payment to our counterparty. Conversely, a pay-Ñxed swap requires us to make a Ñxed interest-rate payment to our counterparty in exchange for a variable-rate payment from our counterparty. We use receive- and pay-Ñxed swaps to adjust the interest rate characteristics of our debt funding in order to more closely match changes in the interest-rate characteristics of our mortgage assets. Call and put swaptions are options to enter into receive- and pay-Ñxed swaps, respectively. We use swaptions and other option-based derivatives to adjust the characteristics of our debt in response to changes in the expected lives of mortgage-related assets in the Retained portfolio. Generally, receive-Ñxed swaps increase in value and pay-Ñxed swaps decrease in value when interest rates decrease (with the opposite being true when interest rates increase). The fair values of call and put swaptions are sensitive to changes in interest rates and are also driven by the market's expectation of potential changes in future interest rates (referred to as ""implied volatility''). Purchased swaptions generally become more valuable as implied volatility increases and less valuable as implied volatility decreases. Recognized losses on purchased options in any given period are limited to the premium paid to purchase the option plus any unrealized gains previously recorded. See ""CONSOLIDATED BALANCE SHEETS ANALYSIS Ì Derivative Assets and Liabili- ties, at Fair Value'' for information about changes in the notional amounts and the fair value of our derivatives. During 2006, fair value losses on our swaptions increased as implied volatility declined and both long-term and short- term swap interest rates increased. During 2006 and 2005, fair value changes of our pay-Ñxed and receive-Ñxed swaps were primarily driven by increases in long-term swap interest rates. An increase in the notional balance of our receive-Ñxed swaps not in qualifying hedge accounting relationships as a result of our discontinuation of hedge accounting treatment, combined with Öuctuations in swap interest rates throughout the year, reduced fair value losses recognized on our receive- Ñxed swaps during 2006. See ""NOTE 12: DERIVATIVES'' to our consolidated Ñnancial statements for additional information on our discontinuation of hedge accounting treatment. During 2004, losses on our put swaptions resulted from changes in swap interest rates and a decline in implied volatility of interest rates. Additionally, in 2004, a large portion of our pay-Ñxed swaps that were not in hedge accounting relationships was scheduled to begin on a future date. The net loss on our pay-Ñxed swaps in 2004 resulted from the overall decline in forward swap interest rates. 35 Freddie Mac The accrual of periodic settlements for derivatives not in qualifying hedge accounting relationships increased during 2006 compared to 2005 as short-term interest rates increased and the net income due to the receive variable-rate leg of our pay-Ñxed swaps was only partly oÅset by the net expense due to the pay variable-rate leg of our receive-Ñxed swaps. The expense associated with accrual of periodic settlements for derivatives not in qualifying hedge accounting relationships declined during 2005 compared to 2004 because interest accruals related to our pay-Ñxed and receive-Ñxed swaps largely oÅset one another during 2005, but only did so for the later part of 2004, following the discontinuation of hedge accounting for certain receive-Ñxed swaps in November 2004. Hedge Accounting Gains (Losses) Hedge accounting gains (losses) represent the extent to which diÅerences in the characteristics or terms of a derivative in a hedge accounting relationship and the hedged item result in fair value or cash Öow changes that are not exactly oÅset. Our net hedge ineÅectiveness gains in 2006 and 2005 were not signiÑcant. Net hedge ineÅectiveness gains in 2004 related primarily to fair value hedge accounting relationships where the derivative was valued using forward rates while the hedged debt was valued using spot rates. As discussed in ""NOTE 12: DERIVATIVES'' to our consolidated Ñnancial statements, a substantial portion of our derivatives in fair value hedge accounting relationships was reclassiÑed to no hedge designation during 2004 and 2006. Gains (Losses) on Investment Activity Table 16 summarizes the components of Gains (losses) on investment activity. Table 16 Ì Gains (Losses) on Investment Activity 2006 Year Ended December 31, 2004 2005 (in millions) Gains (losses) on trading securities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ (3) $(289) (95) Gains (losses) on PC residuals, at fair value ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Gains (losses) on sale of mortgage loans(1) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 92 546 Gains (losses) on sale of available-for-sale securities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Security impairments: (19) 86 22 Interest-only security impairments ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (147) Other security impairments ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (393) Total security impairments ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (540) (20) Total gains (losses) on investment activity ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $(474) Lower-of-cost-or-market adjustmentsÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (71) (300) (371) (10) $(127) $(1,071) 58 209 584 (66) (60) (126) (2) $ (348) (1) Represents mortgage loans sold in connection with securitization transactions. Gains (losses) on trading securities In 2006 and 2005, the increases in long-term interest rates resulted in losses on mortgage-related securities classiÑed as trading. However, these losses were signiÑcantly lower in 2006 than in 2005 as interest rates increased less in 2006 than in 2005. The losses in both years were partly oÅset by gains on interest-only mortgage-related securities classiÑed as trading, which generally increased in fair value as interest rates rose. Prior to 2005, our trading positions related primarily to our SS&TG business unit and external Money Manager program, both of which ceased operations in the fourth quarter of 2004. The trading activities of our SS&TG business unit resulted in valuation diÅerences, recorded as trading losses, that totaled $1,101 million in 2004, which were oÅset by net interest income on the trading securities held. Absent the SS&TG business unit, our trading gains (losses) netted to a $30 million gain in 2004. Gains (losses) on PC residuals, at fair value Gains (losses) on PC residuals relate to certain PCs and Structured Securities we hold in our Retained portfolio and represent the net fair value of the future cash inÖows and cash outÖows related to our guarantee of these securities. The fair value of PC residuals is aÅected by several factors including: (a) changes in interest rates, which aÅects the expected lives of the related PCs and Structured Securities; (b) default experience and loss severity trends related to our guarantees and (c) third party information with respect to fair value. The decrease in net losses on PC residuals in 2006 as compared to 2005 resulted from increasing interest rates in 2006 which increased the expected lives of related PCs and Structured Securities. In 2005, net losses on PC residuals included the eÅect of changes in the approach we used to estimate the fair values of our guarantee-related assets and liabilities, which resulted in net pre-tax losses of $78 million in the Ñrst quarter of 2005. In 2004, expected default costs declined due to continued home price appreciation and generated gains, partially oÅset by declines in mortgage interest rates which reduced the estimated fair value of future contractual guarantee fees related to securities we hold. 36 Freddie Mac Gains (losses) on sale of available-for-sale securities In 2006, gains on sales of available-for-sale securities included net gains of $188 million related to the sale of certain commercial mortgage-backed securities as discussed in ""Total security impairments.'' These gains were partly oÅset by net losses due primarily to the increase in interest rates during the year. In 2005, gains on sales of available-for-sale securities declined as the impact of rising interest rates was partly oÅset by an increase in the volume of resecuritization activity. Total security impairments Total security impairments in 2006, 2005 and 2004 included: ‚ $147 million, $71 million and $66 million, respectively, related to mortgage-related interest-only securities, primarily due to periodic declines in mortgage interest rates experienced during those years; ‚ $332 million, $115 million and $60 million, respectively, related to mortgage-related securities where we determined that a decline in fair value below amortized cost was other-than-temporary due to the deterioration of the credit quality of the underlying mortgage loans or because the impairment was interest-rate related and we did not have the intent to hold the security until the loss would be recovered; and ‚ $61 million, $185 million and $Ì million, respectively, related to impairments of certain commercial mortgage- backed securities which involved cash Öows from mixed pools of multifamily and non-residential commercial mortgages. In December 2005, HUD determined that these mixed-pool investments were not authorized under our charter and OFHEO subsequently directed us to divest these investments, which we did in 2006. Gains (Losses) on Debt Retirement We repurchase or call our outstanding debt securities from time to time to help support the liquidity and predictability of the market for our debt securities and to manage our mix of assets and liabilities. When we repurchase outstanding debt, we recognize a gain or loss related to the diÅerence between its fair value and its carrying value, including any remaining unamortized deferred items (e.g., premiums, discounts, issuance costs and hedging-related basis adjustments). When we exercise a call option on our callable debt, we recognize a gain or loss related to the diÅerence between its call price and its carrying value, including any remaining unamortized deferred items. In 2006 and 2005, we recognized net gains on debt retirements due primarily to the repurchases of outstanding debt trading at attractive prices to take advantage of favorable funding spreads relative to LIBOR on our new debt issuances. In 2004, we recognized net losses on debt retirements due primarily to the repurchase of outstanding debt to help preserve the liquidity and price performance of our debt securities as market interest rates declined, particularly in the early part of the year. Other Income Other income increased in 2006 as we recognized net foreign-currency gains on foreign-currency denominated debt as the U.S. dollar strengthened relative to the Euro during December 2006. We actively manage the foreign-currency risk associated with our foreign-currency denominated debt using derivatives, which were designated in fair value hedge accounting relationships until we voluntarily discontinued hedge accounting for those derivatives on December 1, 2006. After that date, we continued to manage our foreign-currency risk; however, translation gains and losses on our foreign- currency denominated debt were recorded in Other income and were substantially oÅset by net losses we recorded in Derivative gains (losses). In 2005, Other income included approximately $80 million of expense, net, related to certain errors not material to our consolidated Ñnancial statements with respect to income in previously reported periods. 37 Freddie Mac Non-Interest Expense Table 17 summarizes the components of Non-interest expense. Table 17 Ì Non-Interest Expense 2006 Year Ended December 31, 2005 (in millions) 2004 Administrative Expenses: Salaries and employee beneÑts ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 830 460 Professional services ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 61 Occupancy expense ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 290 Other administrative expensesÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 1,641 Total administrative expenses ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 215 Provision for credit losses ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 60 REO operations (income) expense ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 476 Losses on certain credit guarantees ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 407 Housing tax credit partnershipsÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 58 Minority interests in earnings of consolidated subsidiariesÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Other expenses ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 190 Total Non-interest expense ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $3,047 $ 805 386 58 286 1,535 251 40 234 320 96 537 $3,013 $ 758 588 60 144 1,550 143 (3) 33 281 129 238 $2,371 Administrative Expenses Salaries and employee beneÑts increased during each of the past three years primarily because we hired additional employees in support of our Ñnancial reporting and infrastructure-related activities. In an eÅort to recruit new talent and retain existing employees, we continued to experience increases in employee incentive compensation costs, such as employee stock compensation, special incentive awards and annual employee bonuses. The cessation of our SS&TG business unit and external Money Manager program activities during the fourth quarter of 2004 and related employee terminations partially oÅset other increases in Salaries and employee beneÑts during 2005. In 2006, professional services expense increased as we progressed with various initiatives to improve our Ñnancial accounting systems and continued our remediation activities. Professional services expense declined during 2005 in part because we were able to replace consultants with employees, increasing our Salaries and employee beneÑts expense as a consequence. Other administrative expenses are presented net of certain expenses that we defer related to software development activities. The net eÅect of these capitalized software costs, including the write-oÅ of previously capitalized amounts, was an increase (reduction) to Other administrative expenses totaling $15 million, $29 million and $(94) million in 2006, 2005 and 2004, respectively. In addition, Other administrative expenses increased in 2006 and 2005 compared to 2004 as a result of higher OFHEO regulatory assessments associated with its oversight responsibilities and charitable contributions, particularly associated with Hurricane Katrina. Provision for Credit Losses The provision for credit losses declined in 2006 as compared with 2005, which included an additional provision of $128 million for our estimate of incurred losses for loans aÅected by Hurricane Katrina. In 2006, we reversed $82 million of the provision for credit losses recorded in 2005 associated with Hurricane Katrina because the related payment and delinquency experience on aÅected properties was more favorable than expected. Absent the adjustments related to Hurricane Katrina, the provision for credit losses would have been $297 million, $123 million and $143 million in 2006, 2005 and 2004, respectively. We recorded additional reserves in 2006 related to our single-family portfolio reÖecting: ‚ increased estimates of incurred losses with respect to delinquent loans that are expected to experience higher default rates based on their year of origination; ‚ an observed increase in the transition rates of loans through delinquency to foreclosure and corresponding increases in the number of properties that we acquired as real estate owned; and ‚ increases in the expected severity of losses on a per-property basis, driven in part by the expectation of low or slower home price appreciation in certain areas. We expect that near-term credit losses, which include net charge-oÅs and REO expenses, will rise while still remaining below longer-term historical levels, as home price appreciation continues to slow signiÑcantly. Losses on Certain Credit Guarantees Losses on certain credit guarantees includes (a) losses recognized upon the issuance of PCs in Guarantor Swap transactions and (b) losses on non-performing loans repurchased from PC loan pools. 38 Freddie Mac We negotiate contracts with our customers in Guarantor Swap transactions based upon our view of the overall economics of the transaction, considering the volume and types of mortgage loans to be delivered to us and our estimates of the net present value of related future guarantee fees, credit costs and other associated cash Öows. However, the accounting for our guarantee-related assets and liabilities is not determined at the contract level, rather it is determined separately for each PC-related loan pool. We determine the initial fair value of the pool-level guarantee-related assets and liabilities using methodologies that employ direct market-based information that may diÅer from the estimates we use to negotiate the guarantee fee we charge customers. While our guarantee fees are subject to competitive pressure and we may enter into transactions for which our expectations of economic returns are below our normal return thresholds (e.g., to achieve our aÅordable housing goals or maintain our market share), we expect the vast majority of our Guarantor Swap transactions will generate positive economic returns over the lives of the related PCs. For each loan pool created, we compare the initial fair value of the related Guarantee obligation to the initial fair value of the related Guarantee asset and credit enhancement-related assets. If the Guarantee obligation is greater than the Guarantee asset, we immediately recognize a loss equal to the diÅerence with respect to that pool. If the Guarantee obligation is less than the Guarantee asset, no initial gain is recorded; rather, guarantee income equal to the diÅerence is deferred as an addition to the Guarantee obligation and is recognized as that liability is amortized. Accordingly, a Guarantor Swap transaction may result in some loan pools for which a loss is recognized immediately in earnings and other loan pools where guarantee income is deferred. We record these losses as Losses on certain credit guarantees. In 2006 and 2005, we realized losses of $350 million and $234 million, respectively, on certain Guarantor Swap transactions entered into during those years. The increase in these losses was driven by a combination of higher expected future credit costs and competitive pressure on guarantee fees. In addition, our Guarantee asset associated with certain non- traditional mortgage products, including interest-only loans and option ARMs, is subject to a lower market valuation than traditional mortgage products due to the lower liquidity or corresponding lack of observable market prices for the associated cash Öows. Losses on non-performing loans repurchased from the mortgage loan pools underlying PCs and Structured Securities held by third parties occur when the carrying value of the repurchased loan, net of any allocated loan loss reserve, exceeds the estimated fair value of the loan. Increases in market interest rates and declining market values for delinquent loans led to the recognition of losses of $126 million in 2006. Losses on certain credit guarantees increased during 2005 when compared to 2004, as a result of the initial application of our approach for determining the fair values of our guarantee-related assets and liabilities at inception. This approach uses more market-based information and is discussed in ""NOTE 2: TRANSFERS OF SECURITIZED INTERESTS IN MORTGAGE-RELATED ASSETS'' to our consolidated Ñnancial statements. We also realized losses in 2005 and to a lesser extent in 2006, as a result of our eÅorts to acquire business at competitive prices in order to meet the aÅordable housing goals and subgoals established by HUD. Housing Tax Credit Partnerships Operating losses of our housing tax credit partnerships, which are recorded as a component of Non-interest expense, have increased over the last three years as our investments in these partnerships have increased. The increased investment in housing tax credit partnerships generated related tax beneÑts, which consisted of tax credits and tax deductible operating losses. Tax beneÑts associated with our investments in housing tax credit partnerships reduced Income tax expense by $603 million, $476 million and $378 million for 2006, 2005 and 2004, respectively. See ""Income Tax Expense (BeneÑt)'' for additional information about the impact of these investments on our income tax expense. Other Expenses In April 2006, we reached an agreement in principle to settle the securities class action and shareholder derivative lawsuits relating to our restatement. The settlement became Ñnal in November 2006. In 2005, we recorded expenses of $339 million to increase our reserves for legal settlements, including this settlement, net of expected insurance proceeds. See ""NOTE 13: LEGAL CONTINGENCIES'' to our consolidated Ñnancial statements for more information. Income Tax Expense (BeneÑt) For 2006, 2005 and 2004, our eÅective tax rates were (5.1) percent, 14.4 percent and 21.2 percent, respectively. The decrease in the eÅective tax rate over the past three years is primarily due to the decline in pre-tax income, the 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. We expect tax credits resulting from our investments in housing tax credit partnerships to grow in the future. However, our ability to use all of the tax credits generated by existing or future investments in housing tax credit partnerships to reduce our federal income tax liability may be limited. 39 Freddie Mac Our eÅective tax rate for 2006 and 2004 also beneÑted from reductions to our tax reserves of $174 million and $94 million, respectively, due predominantly to a favorable U.S. Tax Court decision in 2006 and separate settlements with the Internal Revenue Service in both years. For additional information, see ""NOTE 14: INCOME TAXES'' to our consolidated Ñnancial statements. CONSOLIDATED BALANCE SHEETS ANALYSIS The following discussion of our consolidated balance sheets should be read in conjunction with our consolidated Ñnancial statements, including the accompanying notes. Also see ""CRITICAL ACCOUNTING POLICIES AND ESTIMATES'' for more information concerning our signiÑcant accounting policies. Table 18 Ì Summary Consolidated Balance Sheets December 31, 2006 2005 (in millions) Assets: Retained portfolio ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $700,543 79,973 Cash and investments ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 7,908 Derivative assets, at fair value ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 6,070 Guarantee asset, at fair valueÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 18,587 OtherÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total assetsÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $813,081 $709,384 67,792 7,097 5,083 16,866 $806,222 Liabilities and stockholders' equity: Liabilities: Total debt securities, netÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $753,938 7,117 Guarantee obligation ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Derivative liabilities, at fair value ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 179 23,030 OtherÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 784,264 Total liabilities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Minority interests in consolidated subsidiaries ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 516 Stockholders' equity: Preferred stock, at redemption value ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Common stock ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Additional paid-in capital ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Retained earnings ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ AOCI, net of taxes: 6,109 152 962 32,177 $748,792 5,541 590 23,159 778,082 949 4,609 152 924 31,559 Available-for-sale securities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Cash Öow hedge relationships ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ DeÑned beneÑt plansÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total AOCI, net of taxes ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Treasury stock, at cost ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total stockholders' equity ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (2,749) (5,033) (87) (7,869) (3,230) 28,301 Total liabilities and stockholders' equity ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $813,081 (2,485) (6,287) (1) (8,773) (1,280) 27,191 $806,222 Retained Portfolio As discussed in ""BUSINESS Ì Business Activities Ì Investment and Funding Activities,'' beginning July 1, 2006, we voluntarily limited the annual growth of our Retained portfolio. At December 31, 2006, the carrying value of the Retained portfolio was $700.5 billion, which was below the voluntary limit of $717.4 billion. 40 Freddie Mac Table 19 provides detail regarding the mortgage loans and mortgage-related securities in our Retained portfolio. Table 19 Ì Characteristics of Mortgage Loans and Mortgage-Related Securities in the Retained Portfolio Fixed Rate 2006 Variable Rate(2) December 31, Total Fixed Rate (in millions) 2005(1) Variable Rate(2) Total Mortgage loansÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 61,273 Guaranteed PCs and Structured Securities:(3) Single-family ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ MultifamilyÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total Guaranteed PCs and Structured Securities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 282,052 241 282,293 $ 4,574 $ 65,847 $ 56,458 $ 5,023 $ 61,481 71,828 141 71,969 353,880 382 354,262 299,167 247 299,414 61,766 144 61,910 360,933 391 361,324 Non-Freddie Mac mortgage-related securities: Agency mortgage-related securities:(4) Fannie Mae: Single-family ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ MultifamilyÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Ginnie Mae: Single-family ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ MultifamilyÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total agency mortgage-related securities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 25,805 987 707 13 27,512 17,640 2 231 Ì 17,873 Non-agency mortgage-related securities: 4,280 Single-family ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 23,768 Commercial mortgage-backed securitiesÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Mortgage revenue bonds(5) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 13,760 Manufactured housing(6)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 1,381 Total non-agency mortgage-related securities(7)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 43,189 Total unpaid principal balance of Retained portfolioÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $414,267 174,081 20,992 74 129 195,276 $289,692 Premiums, discounts, deferred fees, impairments of unpaid principal balances and other basis adjustments ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Net unrealized gains (losses) on mortgage-related securities, pre-tax ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Participation CertiÑcate residuals, at fair value ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Reserve for losses on mortgage loans held-for-investment ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total Retained portfolio per consolidated balance sheets ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 28,818 1,294 1,045 30 31,187 13,180 41 218 Ì 13,439 4,749 34,533 11,229 1,508 52,019 $439,078 181,678 8,954 92 172 190,896 $271,268 43,445 989 938 13 45,385 178,361 44,760 13,834 1,510 238,465 703,959 103 (4,046) 597 (70) $700,543 41,998 1,335 1,263 30 44,626 186,427 43,487 11,321 1,680 242,915 710,346 2,111 (3,551) 597 (119) $709,384 (1) Certain amounts for 2005 have been revised to conform with the 2006 presentation. (2) Variable-rate mortgage loans and mortgage-related securities include those with a contractual coupon rate that, prior to contractual maturity, is either scheduled to change or subject to change based on changes to the composition of the underlying collateral. Mortgage loans also include mortgages with balloon/reset provisions. (3) For Guaranteed PCs and Structured Securities we issue, we are subject to the credit risk associated with the underlying mortgage loan collateral. (4) Agency mortgage-related securities are generally not separately rated by nationally recognized statistical rating organizations, but are viewed as having a level of credit quality at least equivalent to non-agency mortgage-related securities rated AAA or equivalent. (5) Consists of obligations of states and political subdivisions. Approximately 67 percent and 66 percent of these securities were AAA-rated at December 31, 2006 and 2005, respectively. (6) At December 31, 2006 and 2005, 38 percent and 51 percent, respectively, of mortgage-related securities backed by manufactured housing were rated BBB¿ or above. For the same dates, 97 percent of these securities were supported by third-party credit enhancements (e.g., bond insurance) and other credit enhancements (e.g., deal structure through subordination). Approximately 30 percent and 33 percent of these securities were AAA-rated at December 31, 2006 and 2005, respectively. (7) Credit ratings for most non-agency mortgage-related securities are designated by at least two nationally recognized statistical rating organizations. At December 31, 2006 and 2005, approximately 96 percent and 98 percent, respectively, of total non-agency mortgage-related securities were AAA- rated. 41 Freddie Mac Table 20 provides additional detail regarding the fair value of mortgage-related securities in the Retained portfolio. Table 20 Ì Fair Value of Available-For-Sale and Trading Mortgage-Related Securities in the Retained Portfolio 2006 December 31, 2005 (in millions) 2004 Available-for-sale securities: Mortgage-related securities issued by: Freddie Mac ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $344,088 43,886 Fannie Mae ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Ginnie Mae ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 733 224,099 Other ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 13,925 Obligations of states and political subdivisions ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 626,731 Total available-for-sale mortgage-related securities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $351,447 43,306 1,115 231,356 11,241 638,465 $352,102 59,519 1,762 168,058 9,020 590,461 Trading securities: Mortgage-related securities issued by: Freddie Mac ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Fannie Mae ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Ginnie Mae ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total trading mortgage-related securitiesÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 6,573 802 222 7,597 Total fair value of available-for-sale and trading mortgage-related securities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $634,328 8,156 534 204 8,894 $647,359 11,398 385 59 11,842 $602,303 Issuers Greater than 10 Percent of Stockholders' Equity We held Fannie Mae securities in our Retained portfolio with a fair value of $44.7 billion, which represented 158 percent of Total stockholders' equity of $28.3 billion at December 31, 2006. In addition, we held at the individual trust level in our Retained portfolio securities issued by Countrywide Home Equity Loan Trust with a fair value of $3.3 billion, which represented 11.5 percent of Total stockholders' equity at December 31, 2006. No other individual issuer at the individual trust level exceeded 10 percent of Total stockholders' equity at December 31, 2006. Cash and Investments Table 21 provides additional detail regarding the non-mortgage-related securities in our Cash and investments portfolio. Table 21 Ì Cash and Investments Cash and cash equivalents ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $11,359 Investments: G3 2006 Fair Value Average Maturity (Months) December 31, 2005 Average Maturity Fair Value (Months) (dollars in millions) G3 $10,468 2004 Fair Value Average Maturity (Months) $35,253 G3 Available-for-sale securities: Non-mortgage-related securities: Asset-backed securities(1) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 32,122 Obligations of state and political subdivisions(1)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2,273 11,191 Commercial paper ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total available-for-sale non-mortgage-related securities(2) ÏÏÏÏÏÏÏÏÏÏ 45,586 19,778 Federal funds sold and Eurodollars ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 3,250 Securities purchased under agreements to resell ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 23,028 Subtotal ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 68,614 Total investments ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total Cash and investments per consolidated balance sheets ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $79,973 N/A 363 G3 G3 G3 N/A 282 G3 G3 G3 30,578 5,823 5,764 42,165 9,909 5,250 15,159 57,324 $67,792 N/A 303 Ì G3 G3 21,733 8,097 Ì 29,830 18,647 13,550 32,197 62,027 $97,280 (1) Consists primarily of securities that can be prepaid prior to their contractual maturity without penalty. (2) Credit ratings for most securities are designated by at least two nationally recognized statistical rating organizations. At December 31, 2006 and 2005, all of our available-for-sale non-mortgage-related securities were rated A or better. At December 31, 2004, 99.9% of these securities were rated A or better. The increase in the Cash and investments portfolio during 2006 compared to 2005 was in part driven by our decision to maintain higher levels of liquid investments to ensure that we could appropriately service our outstanding debt and PCs and Structured Securities while operating under the Federal Reserve Board's intraday overdraft policy, which was revised eÅective July 2006. The revised policy restricts the GSEs, among others, from maintaining intraday overdraft positions at the Federal Reserve. 42 Freddie Mac Derivative Assets and Liabilities, at Fair Value Table 22 summarizes the notional or contractual amounts and related fair value of our total derivative portfolio by product type. Table 22 Ì Total Derivative Portfolio December 31, 2006 2005 Notional or Contractual Amount(1) Fair Value(2) Notional or Contractual Amount(1) Fair Value(2) (in millions) Interest-rate swaps: Receive-ÑxedÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Pay-Ñxed ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Basis (Öoating to Öoating)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total interest-rate swaps ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Option-based: Call swaptions ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Put swaptions ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Other option-based derivatives(3) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total option-based ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ FuturesÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Foreign-currency swaps ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Interest-rate caps ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Subtotal ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Forward purchase and sale commitments ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Credit derivatives ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Swap guarantee derivatives ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total derivative portfolio ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $222,631 217,565 683 440,879 194,200 29,725 27,185 251,110 22,400 29,234 Ì 743,623 10,012 2,605 957 $757,197 $ (334) (1,352) Ì (1,686) 4,034 958 (15) 4,977 28 4,399 Ì 7,718 15 (1) (3) $ 7,729 $159,212 181,562 234 341,008 146,615 34,675 11,814 193,104 86,252 37,850 45 658,259 21,961 2,414 738 $683,372 $ 756 (991) Ì (235) 3,453 1,200 (7) 4,646 19 2,124 Ì 6,554 (44) (1) (2) $6,507 (1) Notional or contractual amounts are used to calculate the periodic amounts to be received and paid and generally do not represent actual amounts to be exchanged or directly reÖect our exposure to institutional credit risk. Notional or contractual amounts are not recorded as assets or liabilities on our consolidated balance sheets. (2) The fair value by derivative type presented in this table is shown prior to netting by counterparty. The fair value of derivatives presented on our consolidated balance sheets, however, is netted by counterparty, and is reported in the Derivative assets, at fair value and Derivative liabilities, at fair value captions. The total fair value of the derivative portfolio presented in this table equals the diÅerence between the fair value of the derivative assets and derivative liabilities presented on our consolidated balance sheets. The fair values for futures are directly derived from quoted market prices. Fair values of other derivatives are derived primarily from valuation models using market data inputs. (3) Primarily represents written options, including guarantees of stated Ñnal maturity of issued Structured Securities and written call options on PCs we issued. The carrying value of our derivative assets and liabilities on our consolidated balance sheets is equal to their fair value. The composition of our derivative portfolio will change from period to period as a result of derivative purchases, terminations or assignments prior to contractual maturity and expiration of the derivatives at their contractual maturity. We record changes in fair values of our derivatives in current income or, to the extent our accounting hedge relationships are eÅective, we defer those changes in AOCI or oÅset them with basis adjustments to the related hedged item. As a result, the increases or decreases in fair value by derivative categories will not correspond directly to Derivative gains (losses) or Hedge accounting gains (losses) on our consolidated statements of income. The fair value of the total derivative portfolio increased in 2006 due primarily to the increase in the fair value of foreign- currency swaps we use to economically hedge Euro-denominated debt as the U.S. dollar weakened relative to the Euro. Several factors contributed to the change in the composition of our derivative portfolio during 2006. We entered into additional pay-Ñxed swaps with relatively short maturities to oÅset our yield curve exposure in response to the continued Öattening of the yield curve and generally higher interest rates in 2006. We entered into additional receive-Ñxed swaps as a result of economic hedging activities related to our callable debt securities outstanding, which increased as a proportion of our total debt portfolio during 2006. We employ receive-Ñxed swaps to protect against a decline in interest rates until the speciÑed call date and between speciÑed call dates of our callable debt. We increased the notional balance of our call swaptions to manage the risk of further declines in market interest rates following the declines observed in the second half of the year. The notional balance of our futures declined in 2006 primarily because we continued to reduce our position in Eurodollar future contracts held for risk management purposes in response to movements in short-term rates. The notional balance of our foreign-currency swaps declined due to maturities of such swaps throughout 2006 that were not replaced by new contracts as the balance of our Euro-denominated debt securities declined during the year. 43 Freddie Mac Table 23 summarizes the changes in derivative fair values. Table 23 Ì Changes in Derivative Fair Values 2006 2005 (in millions) Beginning balance, at January 1 Ì Net asset (liability) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 6,507 $15,031 Net change in: Forward purchase and sale commitments ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Credit derivatives ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Swap guarantee derivatives ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Other derivatives:(1) 59 Ì (1) (35) 1 (1) Changes in fair value ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Fair value of new contracts entered into during the period(2) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Contracts realized or otherwise settled during the period ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Ending balance, at December 31 Ì Net asset (liability) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2,008 2,577 (3,421) (8,417) 2,522 (2,594) $ 7,729 $ 6,507 (1) Includes fair value changes for interest-rate swaps, option-based derivatives, futures, foreign-currency swaps and interest-rate caps. (2) Consists primarily of cash premiums paid or received on options and the initial value of interest-rate swaps after we have exercised related swaptions. Option premiums paid were $2,784 million and $2,248 million during 2006 and 2005, respectively. Table 24 shows the fair value for each derivative type and the maturity proÑle of our derivative positions. A positive fair value in Table 24 for each derivative type is the estimated amount, prior to netting by counterparty, that we would be entitled to receive if we terminated the derivatives of that type. A negative fair value for a derivative type is the estimated amount, prior to netting by counterparty, that we would owe if we terminated the derivatives of that type. See ""Table 36 Ì Derivative Counterparty Credit Exposure'' under ""RISK MANAGEMENT Ì Interest-Rate Risk and Other Market Risks'' for additional information regarding derivative counterparty credit exposure. Table 24 also provides the weighted average Ñxed rate of our pay-Ñxed and receive-Ñxed swaps. Table 24 Ì Derivative Fair Values and Maturities December 31, 2006 Fair Value(1) Total Fair Value Less than 1 Year 1 to 3 Years Greater than 3 and up to 5 Years In Excess of 5 Years (dollars in millions) Interest-rate swaps: Receive-Ñxed: SwapsÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Weighted average Ñxed rate(2) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Forward-starting swaps(3)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Weighted average Ñxed rate ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total receive-Ñxed ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Pay-Ñxed: SwapsÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Weighted average Ñxed rate(2) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Forward-starting swaps(3)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Weighted average Ñxed rate ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total pay-Ñxed ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total interest-rate swaps ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Option-based: Call swaptions ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Put swaptions ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Other option-based derivatives ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total option-based ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ FuturesÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Foreign-currency swaps ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Forward purchase and sale commitments ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Swap guarantee derivatives ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Subtotal ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ (373) 39 (334) 419 (1,771) (1,352) (1,686) 4,034 958 (15) 4,977 28 4,399 15 (3) 7,730 Credit derivatives ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ TotalÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (1) $ 7,729 $(149) 4.64% Ì Ì (149) $ (285) 4.81% Ì Ì (285) $ 106 5.01% Ì Ì 106 93 4.22% Ì Ì 93 (56) 12 Ì (5) 7 28 788 15 Ì $ 782 90 5.07% Ì Ì 90 (195) 703 Ì Ì 703 Ì 747 Ì Ì $1,255 3 5.08% Ì Ì 3 109 1,647 219 (1) 1,865 Ì 1,788 Ì Ì $3,762 $ (45) 5.33% 39 5.47% (6) 233 5.09% (1,771) 5.77% (1,538) (1,544) 1,672 739 (9) 2,402 Ì 1,076 Ì (3) $ 1,931 (1) Fair value is categorized based on the period from December 31, 2006 until the contractual maturity of the derivative. (2) Represents the notional weighted average rate for the Ñxed leg of the swaps. (3) Represents interest-rate swap agreements that are scheduled to begin on future dates which range from less than one year to ten years. 44 Freddie Mac Guarantee Asset See ""CONSOLIDATED RESULTS OF OPERATIONS Ì Non-Interest Income (Loss) Ì Gains (Losses) on Guarantee Asset'' for a description of the Guarantee asset. Table 25 summarizes changes in the Guarantee asset balance. Table 25 Ì Changes in Guarantee Asset December 31, 2006 2005 (in millions) Beginning balance ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $5,083 1,787 Additions, net of repurchases ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $4,516 1,631 Return of investment on Guarantee assetÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (1,009) 209 Changes in fair value of future cash Öows ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Gains (losses) on Guarantee asset ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (800) Ending balance ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $6,070 (899) (165) (1,064) $5,083 In 2006 and 2005, the primary drivers aÅecting the net increase in our Guarantee asset balance were our business volumes and changes in mortgage interest rates. Additions, net of repurchases, increased in 2006 primarily because net repurchases of PCs and Structured Securities into the Retained portfolio declined. When a PC or Structured Security is repurchased into the Retained portfolio, any related Guarantee asset becomes a component of the associated PC residual, therefore such repurchases reduce the balance of the Guarantee asset. Losses on Guarantee asset decreased as mortgage interest rates increased during 2006, which extended the expected lives of the PCs and Structured Securities and increased the fair value of the Guarantee asset. Total Debt Securities, Net Table 26 reconciles the par value of our debt securities to the amounts shown on our consolidated balance sheets. See ""LIQUIDITY AND CAPITAL RESOURCES'' for further discussion of our debt management activities. Table 26 Ì Reconciliation of the Par Value of Total Debt Securities to Our Consolidated Balance Sheets December 31, 2006 2005 (in millions) Total debt securities: Par value(1)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $787,970 Unamortized balance of discounts and premiums(2) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (41,769) Foreign-currency-related and hedging-related basis adjustments(3) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 7,737 Total debt securities, netÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $753,938 $780,382 (39,338) 7,748 $748,792 (1) Includes securities sold under agreements to repurchase and Federal funds purchased and swap collateral obligations. (2) Primarily represents unamortized discounts on zero-coupon debt securities. Also, includes accrued interest payable on swap collateral obligations. (3) Primarily represents deferrals related to the translation gain (loss) on foreign-currency denominated debt that was in hedge accounting relationships. 45 Freddie Mac Table 27 summarizes our Senior debt, due within one year. Table 27 Ì Senior Debt, Due Within One Year December 31, 2006 Average Outstanding During the Year Balance, Net(1) EÅective Rate(2) Balance, Net(3) EÅective Rate(4) Weighted Average Weighted Average Maximum Balance, Net Outstanding at Any Month End Reference Bills» securities and discount notes ÏÏÏÏÏÏÏÏÏÏÏÏÏ Medium-term Notes ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Securities sold under agreements to repurchase and Federal funds purchased ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Swap collateral obligations ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Hedging-related basis adjustments ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Short-term debt securities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Current portion of long-term debt ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Senior debt, due within one year ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $157,553 9,832 Ì 9,597 Ì 176,982 117,879 $294,861 5.14% 5.16 Ì 5.17 N/A 5.14 4.10 4.73 (dollars in millions) $165,270 4,850 81 9,705 4.76% 4.82 5.48 5.07 $182,946 9,832 2,200 11,528 December 31, 2005 Average Outstanding During the Year Balance, Net(1) EÅective Rate(2) Balance, Net(3) EÅective Rate(4) Weighted Average Weighted Average Reference Bills» securities and discount notes ÏÏÏÏÏÏÏÏÏÏÏÏÏ Medium-term Notes ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Securities sold under agreements to repurchase and Federal funds purchased ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Swap collateral obligations ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Hedging-related basis adjustments ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Short-term debt securities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Current portion of long-term debt ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Senior debt, due within one year ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $181,468 2,032 450 8,768 (5) 192,713 95,819 $288,532 4.00% 4.17 4.25 4.09 N/A 4.01 3.42 3.81 (dollars in millions) $181,878 850 267 10,374 3.11% 3.35 3.08 3.14 December 31, 2004 Average Outstanding During the Year Balance, Net(1) EÅective Rate(2) Balance, Net(3) EÅective Rate(4) Weighted Average Weighted Average Reference Bills» securities and discount notes ÏÏÏÏÏÏÏÏÏÏÏÏÏ Medium-term Notes ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Securities sold under agreements to repurchase and Federal funds purchased ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Swap collateral obligations ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Short-term debt securities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Current portion of long-term debt ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Senior debt, due within one year ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $180,198 162 Ì 16,279 196,639 85,664 $282,303 2.04% 2.51 Ì 2.24 2.05 3.33 2.44 (dollars in millions) $184,834 4,289 801 13,549 1.40% 1.31 1.37 1.36 Maximum Balance, Net Outstanding at Any Month End $194,578 2,032 1,000 13,533 Maximum Balance, Net Outstanding at Any Month End $212,715 5,320 3,046 16,279 (1) Represents par value, net of associated discounts, premiums and foreign-currency-related and hedging-related basis adjustments. Swap collateral obligations include the related accrued interest payable. (2) Represents the approximate weighted average eÅective rate for each instrument outstanding at the end of the period, which includes the amortization of discounts or premiums and issuance costs, but excludes the amortization of hedging-related basis adjustments. (3) Includes unamortized discounts or premiums and issuance costs. Issuance costs are reported in the Other assets caption on our consolidated balance sheets. (4) Represents the approximate weighted average eÅective rate during the period, which includes the amortization of discounts or premiums and issuance costs, but excludes the amortization of hedging-related basis adjustments. 46 Freddie Mac Guarantee Obligation See ""CONSOLIDATED RESULTS OF OPERATIONS Ì Non-Interest Income (Loss) Ì Income on Guarantee Obligation'' for a description of the components of the Guarantee obligation. Table 28 summarizes the changes in the Guarantee obligation balance. Table 28 Ì Changes in Guarantee Obligation December 31, 2006 2005 (in millions) Beginning balance ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $5,541 Transfer-out to the loan loss reserve(1) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (9) Additions, net of repurchases: Fair value of performance and other related costs of newly-issued guarantees ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Deferred guarantee income of newly-issued guarantees ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 1,719 733 Amortization income related to: (584) Performance and other related costs ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (283) Deferred guarantee incomeÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Income on Guarantee obligation ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (867) Ending balance ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $7,117 $4,065 (10) 1,629 777 (616) (304) (920) $5,541 Components of the Guarantee obligation, at period end: Unamortized balance of performance and other related costs ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $4,869 2,248 Unamortized balance of deferred guarantee income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Ending Guarantee obligation ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $7,117 $3,743 1,798 $5,541 (1) Represents portions of the Guarantee obligation recognized through Guarantor Swap transactions or upon the sale of PCs and Structured Securities that correspond to incurred credit losses reclassiÑed to Reserve for guarantee losses on Participation CertiÑcates at initial recognition of a Guarantee obligation. The Guarantee obligation increased in 2006 due to business volume and a decline in the rate of amortization. Generally increasing mortgage interest rates resulted in lower liquidation rates on outstanding PCs and Structured Securities. Total Stockholders' Equity The balance of Total stockholders' equity increased in 2006 primarily as a result of Net income, partially oÅset by preferred and common stock dividends declared during 2006. 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. The repurchase of outstanding shares of common stock and the issuance of non-cumulative, perpetual preferred stock during 2006 resulted in a net reduction of $0.5 billion to the balance of Total stockholders' equity. 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. See ""LIQUIDITY AND CAPITAL RESOURCES Ì Capital Resources Ì Core Capital'' for additional information. The balance of AOCI at December 31, 2006 was a net loss of approximately $7.9 billion, net of taxes, compared to a net loss of $8.8 billion, net of taxes, at December 31, 2005. The reduction in the net loss in AOCI was primarily the result of the amortization of deferred losses in Net interest income related to closed cash Öow hedge relationships, partially oÅset by an increase in unrealized losses on available-for-sale securities primarily driven by the increase in interest rates during 2006. CONSOLIDATED FAIR VALUE BALANCE SHEETS ANALYSIS Our consolidated fair value balance sheets include the estimated fair values of Ñnancial instruments recorded on our consolidated balance sheets prepared in accordance with GAAP, as well as oÅ-balance sheet Ñnancial instruments that represent our assets or liabilities that are not recorded on our GAAP consolidated balance sheets. These oÅ-balance sheet items predominantly consist of: (a) the unrecognized Guarantee asset and Guarantee obligation associated with our PCs issued through our Guarantor Swap program prior to the implementation of FIN 45, (b) certain commitments to purchase mortgage loans and (c) certain credit enhancements on manufactured housing asset-backed securities. The fair value balance sheets also include certain assets and liabilities that are not Ñnancial instruments (such as property and equipment and real estate owned, which are included in Other assets) at their carrying value in accordance with GAAP. During 2006 and 2005, our fair value results were impacted by several improvements in our approach for estimating the fair value of certain Ñnancial instruments. See ""OFF-BALANCE SHEET ARRANGEMENTS'' and ""CRITICAL ACCOUNTING POLICIES AND ESTIMATES'' as well as ""NOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES'' and ""NOTE 16: FAIR VALUE DISCLOSURES'' to our consolidated Ñnancial statements for more information on fair values. 47 Freddie Mac In conjunction with the preparation of our consolidated fair value balance sheets, we use a number of Ñnancial models. See ""RISK MANAGEMENT Ì Operational Risks'' and ""RISK MANAGEMENT Ì Interest-Rate Risk and Other Market Risks'' for information concerning the risks associated with these models. Table 29 Ì Summary Consolidated Fair Value Balance Sheets(1) December 31, 2006 2005 Carrying Amount(2) Fair Value Carrying Amount(2) Fair Value Total assets ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $813.1 Total liabilities and minority interests ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Net assets attributable to stockholders: Preferred stockholders ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Common stockholders ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total net assets ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total liabilities and net assets ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $784.8 6.1 22.2 28.3 $813.1 (in billions) $811.3 $779.5 5.8 26.0 31.8 $811.3 $806.2 $779.0 4.6 22.6 27.2 $806.2 $805.2 $774.3 4.1 26.8 30.9 $805.2 (1) The summary consolidated fair value balance sheets do not purport to present our net realizable, liquidation or market value as a whole. Furthermore, amounts we ultimately realize from the disposition of assets or settlement of liabilities may vary signiÑcantly from the fair values presented. (2) Carrying amounts equal the amounts reported on our GAAP consolidated balance sheets. Key Components of Changes in Fair Value of Net Assets Changes in the fair value of net assets from period to period result from returns (measured on a fair value basis) and capital transactions and are primarily attributable to changes in a number of key components: Core spread income Core spread income on the Retained portfolio is a fair value estimate of the net current period accrual of income from the spread between mortgage-related investments and debt, calculated on an option-adjusted basis. OAS is an estimate of the yield spread between a given Ñnancial instrument and a benchmark (LIBOR, agency or Treasury) yield curve, after consideration of potential variability in the instrument's cash Öows resulting from any options embedded in the instrument, such as prepayment options. Changes in mortgage-to-debt OAS The fair value of our net assets can be signiÑcantly aÅected from period to period by changes in the net OAS between the mortgage and agency debt sectors. The fair value impact of changes in OAS for a given period represents an estimate of the net unrealized increase or decrease in fair value of net assets arising from net Öuctuations in OAS during that period. We do not attempt to hedge or actively manage the basis risk represented by the impact of changes in mortgage-to-debt OAS because we generally hold a substantial portion of our mortgage assets for the long term and we do not believe that periodic increases or decreases in the fair value of net assets arising from Öuctuations in OAS will signiÑcantly aÅect the long-term value of the Retained portfolio. Our estimate of the eÅect of changes in OAS excludes the impact of other market risk factors we actively manage, or economically hedge, to keep interest-rate risk exposure within prescribed limits. Asset-liability management return Asset-liability management return represents the estimated net increase or decrease in the fair value of net assets resulting from net exposures related to the market risks we actively manage. We do not hedge all of the interest-rate risk that exists at the time a mortgage is purchased or that arises over its life. The market risks to which we are exposed as a result of our Retained portfolio activities that we actively manage include duration and convexity risks, yield curve risk and volatility risk. We seek to manage these risk exposures within prescribed limits as part of our overall portfolio management strategy. Taking these risk positions and managing them within prudent limits is an integral part of our strategy to optimize the risk/ reward proÑle of our investment activity and produce fair value growth. We expect that the residual risk positions we take and manage under our integrated risk management framework will produce fair value returns that contribute to meeting our fair value growth objectives, although those positions may result in a net increase or decrease in fair value for a given period. During 2006, our duration and convexity risk level as measured by our PMVS was below the risk limits set by management and the board of directors. See ""RISK MANAGEMENT Ì Interest-Rate Risk and Other Market Risks'' for more information. Core guarantee fees, net Core guarantee fees, net represents a fair value estimate of the annual income of the credit guarantee portfolio, based on current portfolio characteristics and market conditions. This estimate considers both contractual guarantee fees collected 48 Freddie Mac over the life of the credit guarantee portfolio and credit-related delivery fees collected up-front when pools are formed, and associated costs and obligations, which include default costs. Change in the fair value of the credit guarantee portfolio Change in the fair value of the credit guarantee portfolio represents the estimated impact on the fair value of the credit guarantee business resulting from additions to the portfolio (net diÅerence between the fair values of the Guarantee asset and Guarantee obligation recorded when pools are formed) plus the eÅect of changes in interest rates, projections of the future credit outlook and other market factors (e.g., impact of the passage of time on cash Öow discounting). In 2005, we changed our method for estimating the fair values of the Guarantee asset and Guarantee obligation. See ""NOTE 2: TRANSFERS OF SECURITIZED INTERESTS IN MORTGAGE-RELATED ASSETS'' to our consolidated Ñnancial statements for additional information. We generally do not hedge changes in the fair value of our existing credit guarantee portfolio, with two exceptions discussed below. While periodic changes in the fair value of the credit guarantee portfolio may have a signiÑcant impact on the fair value of net assets, we believe that changes in the fair value of our existing credit guarantee portfolio are not the best indication of long-term fair value expectations because such changes do not reÖect our expectation that, over time, replacement business will largely replenish guarantee fee income lost because of prepayments. However, to the extent that projections of the future credit outlook are realized our fair value results may be aÅected. We hedge interest-rate exposure related to net buy-ups (up-front payments we made that increase the guarantee fee that we will receive over the life of the pool) and Öoat (expected gains or losses resulting from our mortgage security program remittance cycles). These value changes are excluded from our estimate of the changes in fair value of the credit guarantee portfolio, so that it reÖects only the impact of changes in interest rates and other market factors on the unhedged portion of the projected cash Öows from the credit guarantee business. The fair value changes associated with net buy-ups and Öoat are considered in asset-liability management return (described above) because they relate to hedged positions. Fee income Fee income includes miscellaneous fees, such as resecuritization fees, fees generated by our automated underwriting service and delivery fees on some mortgage purchases. Discussion of Fair Value Results 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. Estimated impact of changes in mortgage-to-debt OAS on fair value results For the years ended December 31, 2006 and 2005, we estimate that on a pre-tax basis the increases in the fair value of net assets attributable to common stockholders, before capital transactions included decreases of approximately $0.9 billion and $2.7 billion, respectively, due to a net widening of mortgage-to-debt OAS. We believe disclosing the estimated impact of changes in mortgage-to-debt OAS on the fair value of net assets is helpful to understanding our current period fair value results in the context of our long-term fair value return expectation. Our long-term expectation is to generate returns, before capital transactions, over time on the average fair value of net assets attributable to common stockholders in the low- to mid-teens. However, period-to-period returns may Öuctuate substantially due to market conditions. These market conditions include changes in interest rates and other market factors that aÅect certain components of our fair value changes, including those which we do not attempt to hedge or actively manage, speciÑcally, the change in mortgage-to-debt OAS with respect to our Retained portfolio and the change in the fair value of the single-family guarantee portfolio. Our estimate of the periodic increases or decreases in the fair value of net assets associated with Öuctuations in option- adjusted spreads provides insight into a component of our fair value results that we do not believe will signiÑcantly aÅect the long-term fair value of the Retained portfolio. This belief is based on our expectation that diÅerences between the prepayments forecasted by our models and the actual prepayments we will experience are not likely to be signiÑcant. How we estimate the impact of changes in mortgage-to-debt OAS on fair value results The impact of changes in OAS on fair value should be understood as an estimate rather than a precise measurement. To estimate the impact of OAS changes, we use models that involve the forecast of interest rates and prepayment behavior and other inputs. We also make assumptions about a variety of factors, including macroeconomic and security-speciÑc data, 49 Freddie Mac interest-rate paths, cash Öows and prepayment rates. We use these models and assumptions in running our business, and we rely on many of the models in producing our Ñnancial statements and measuring, managing and reporting interest-rate and other market risks. The use of diÅerent estimation methods or the application of diÅerent assumptions could result in a materially diÅerent estimate of OAS impact. We revised the method we previously used to report the impact that changes in OAS have on our 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. An integral part this framework includes the attribution of fair value changes to assess the performance of our investment activities. On a daily basis, all interest rate sensitive assets, liabilities and derivatives are modeled using our proprietary prepayment and interest rate models. Management uses interest-rate risk statistics generated from this process, along with daily market movements, coupon accruals and price changes, to estimate and attribute returns into various risk factors commonly used in the Ñxed income industry to quantify and understand sources of fair value return. One important risk factor is the change in fair value due to changes in mortgage-to-debt OAS. The method previously used to estimate the impact of mortgage-to-debt OAS changes on fair value was performed on a monthly basis and excluded certain portions of the investment portfolio. The new methodology estimates the impact of mortgage-to-debt OAS changes on fair value on a daily basis and includes all Ñnancial instruments. On a pre-tax basis for 2006 and 2005, the reported OAS impacts using our new methodology were reductions in fair value of $0.9 billion and $2.7 billion, respectively. Using our previous methodology, the OAS impacts were pre-tax reductions in fair value of $0.6 billion and $2.0 billion, respectively. Understanding our estimate of the impact of changes in mortgage-to-debt OAS on fair value results A number of important qualiÑcations apply to our disclosed estimates. The estimated impact of the change in option- adjusted spreads on the fair value of our net assets in any given period does not depend on other components of the change in fair value. Although the fair values of our Ñnancial instruments will generally move toward their par values as the instruments approach maturity, investors should not expect that the eÅect of past changes in OAS will necessarily reverse through future changes in OAS. To the extent that actual prepayment or interest rate distributions diÅer from the forecasts contemplated in our models, changes in values reÖected in mortgage-to-debt OAS may not be recovered in fair value returns at a later date. When the OAS on a given asset widens, the fair value of that asset will typically decline, all other things being equal. However, we believe such OAS widening has the eÅect of increasing the likelihood that, in future periods, we will recognize income at a higher spread on this existing asset. The reverse is true when the OAS on a given asset tightens Ì current period fair values for that asset typically increase due to the tightening in OAS, while future income recognized on the asset is more likely to be earned at a reduced spread. Although a widening of OAS is generally accompanied by lower current period fair values, it can also provide us with greater opportunity to purchase new assets for our Retained portfolio at the wider mortgage-to-debt OAS. For these reasons, our estimate of the impact of the change in OAS provides information regarding one component of the change in fair value for the particular period being evaluated. However, results for a single period should not be used to extrapolate long-term fair value returns. We believe the potential fair value return of our business over the long term depends primarily on our ability to add new assets at attractive mortgage-to-debt OAS and to eÅectively manage over time the risks associated with these assets, as well as the risks of our existing portfolio to ensure that we realize anticipated returns on our business. In other words, to capture the fair value returns we expect, we have to apply accurate estimates of future prepayment rates and other performance characteristics at the time we purchase assets, and then manage successfully the range of market risks associated with a debt-funded mortgage portfolio over the life of these assets. LIQUIDITY AND CAPITAL RESOURCES Liquidity Our business activities require that we maintain adequate liquidity to make payments upon the maturity or repurchase of our debt securities, purchase mortgage loans, mortgage-related securities and other investments, make payments of principal and interest on our debt securities and on our guaranteed PCs and Structured Securities, make net payments on derivative instruments, fund our general operations and pay dividends on our preferred and common stock. We fund our cash requirements primarily by issuing short-term and long-term debt. Other sources of cash include: ‚ receipts of principal and interest payments on securities we hold or mortgage loans we have securitized and sold; ‚ sales of securities we hold; 50 Freddie Mac ‚ borrowings against mortgage-related securities and other investment securities we hold; ‚ other cash Öows from operating activities, including guarantee activities; and ‚ issuances of common and preferred stock. We measure our cash position on a daily basis, netting uses of cash with sources of cash. We manage the net cash position over a rolling forecasted 120-day period, with the goal of providing the amount of debt funding needed to cover expected net cash outÖows without adversely aÅecting our overall funding levels. We maintain alternative sources of liquidity to allow normal operations for 120 days without relying upon the issuance of unsecured debt consistent with industry practices of sound liquidity management. Our daily liquidity management activities are consistent with the liquidity component of our commitment with OFHEO to maintain alternative sources of liquidity to allow normal operations for 90 days without relying upon issuance of unsecured debt. See ""RISK MANAGEMENT AND DISCLOSURE COMMIT- MENTS'' for further information. The Federal Reserve Board revised its payments system risk policy, eÅective in July 2006, to restrict or eliminate daylight overdrafts by GSEs in connection with their use of the Fedwire system. The revised policy also includes a requirement that the GSEs fully fund their accounts in the system to the extent necessary to cover payments on their debt and mortgage-related securities each day, before the Federal Reserve Bank of New York, acting as Ñscal agent for the GSEs, will initiate such payments. We have taken actions to fully fund our account as necessary, such as opening lines of credit with third parties. Certain of these lines of credit require that we post collateral that, in certain limited circumstances, the secured party has the right to repledge to other third parties, including the Federal Reserve Bank. As of December 31, 2006, we pledged approximately $20.2 billion of securities to these secured parties. These lines of credit, which provide additional intraday liquidity to fund our activities through the Fedwire system, are uncommitted intraday loan facilities. As a result, while we expect to continue to use these facilities, we may not be able to draw on them if and when needed. See ""NOTE 5: RETAINED PORTFOLIO AND CASH AND INVESTMENTS PORTFOLIO'' to our consolidated Ñnancial statements for further information. We believe that the revisions to the Federal Reserve Board's policies will not have a material adverse eÅect on our liquidity. To fund our business activities, we depend on the continuing willingness of investors to purchase our debt securities. Any change in applicable legislative or regulatory exemptions, including those described in ""REGULATION AND SUPERVISION,'' could adversely aÅect our access to some debt investors, thereby potentially increasing our debt funding costs. However, because of our Ñnancial performance and our regular and signiÑcant participation as an issuer in the capital markets, our sources of liquidity have remained adequate to meet our needs and we anticipate that they will continue to be so. Under our charter, the Secretary of the Treasury has discretionary authority to purchase our obligations up to a maximum of $2.25 billion principal balance outstanding at any one time. However, we do not rely on this authority as a source of liquidity to meet our obligations. Depending on market conditions and the mix of derivatives we employ in connection with our ongoing risk management activities, our derivative portfolio can be either a net source or a net use of cash. For example, depending on the prevailing interest-rate environment, interest-rate swap agreements could cause us either to make interest payments to counterparties or to receive interest payments from counterparties. Purchased options require us to pay a premium while written options allow us to receive a premium. We are required to pledge collateral to third parties in connection with secured Ñnancing and daily trade activities. In accordance with contracts with certain derivative counterparties, we post collateral to those counterparties for derivatives in a net loss position, after netting by counterparty, above agreed-upon posting thresholds. See ""NOTE 5: RETAINED PORTFOLIO AND CASH AND INVESTMENTS PORTFOLIO'' to our consolidated Ñnancial statements for informa- tion about assets we pledge as collateral. We are involved in various legal proceedings, including those discussed in ""NOTE 13: LEGAL CONTINGENCIES'' to our consolidated Ñnancial statements, which may result in a use of cash. Debt Securities We fund our operating cash needs and Ñnance our purchases of mortgage loans, mortgage-related securities and non- mortgage-related securities held in our Retained portfolio and Cash and investments portfolio primarily through the issuance of short-term and long-term debt. Table 30 summarizes the par value of the debt securities we issued, based on settlement dates, during 2006 and 2005. We seek to maintain a variety of consistent, active funding programs that promote high-quality coverage by market makers and reach a broad group of institutional and retail investors. By diversifying our investor base and the types of debt securities we oÅer, we believe we enhance our ability to maintain continuous access to the debt markets under a variety of market conditions. 51 Freddie Mac Table 30 Ì Debt Security Issuances by Product, at Par Value(1) Year Ended December 31, 2006 2005 (in millions) Short-term debt: Reference Bills» securities and discount notesÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $593,444 8,532 Medium-term Notes Ì Callable ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 1,550 Medium-term Notes Ì Non-callable ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 603,526 Total short-term debt ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Long-term debt: Medium-term Notes Ì Callable(2) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Medium-term Notes Ì Non-callable(3) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ U.S. dollar Reference Notes» securities Ì Non-callable(4) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Freddie SUBS» securities(5)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total long-term debt ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 106,777 17,721 55,000 3,299 182,797 Total debt securities issuedÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $786,323 $826,253 1,745 360 828,358 87,047 33,624 48,146 Ì 168,817 $997,175 (1) Excludes securities sold under agreements to repurchase and Federal funds purchased, swap collateral obligations and securities sold but not yet purchased. (2) Includes $100 million and $Ì million of Medium-term Notes Ì Callable issued for the years ended December 31, 2006 and 2005, respectively, which were accounted for as debt exchanges. (3) Includes $1,000 million and $Ì million of Medium-term Notes Ì Non-callable issued for the years ended December 31, 2006 and 2005, respectively, which were accounted for as debt exchanges. (4) Includes $Ì million and $3,396 million of U.S. dollar Reference Notes» securities issued for the years ended December 31, 2006 and 2005, respectively, which were accounted for as debt exchanges. (5) Includes $1,549 million of Freddie SUBS» securities issued for the year ended December 31, 2006, which were accounted for as debt exchanges. Short-Term Debt. We fund our operating cash needs primarily by issuing Reference Bills» securities and other discount notes, which are short-term instruments with maturities of one year or less that are sold on a discounted basis, paying only principal at maturity. Our Reference Bills» securities program consists of large issues of short-term debt that we auction to dealers on a regular schedule. We issue discount notes with maturities ranging from one day to one year in response to investor demand and our cash needs. Short-term debt also includes certain Medium-term Notes that have original maturities of one year or less. Long-Term Debt. We issue long-term debt primarily through our Medium-term Notes program and our Reference Notes» securities program. Medium-term Notes. We issue a variety of Ñxed- and variable-rate Medium-term Notes, including callable and non-callable Ñxed-rate securities, zero-coupon securities and variable-rate securities, with various maturities ranging up to 30 years. Medium-term Notes with original maturities of one year or less are classiÑed as short-term debt. Medium- term Notes typically contain call provisions, eÅective as early as three months or as distant as 10 years after the securities are issued. Reference Notes» Securities. Through our Reference Notes» securities program, we sell large issues of long-term debt that provide investors worldwide with a high-quality, liquid investment vehicle. Reference Notes» securities are regularly issued, non-callable Ñxed-rate securities, which we currently issue with original maturities ranging from two through ten years. We primarily issue securities denominated in U.S. dollars. We have also issued 4Reference Notes» securities denominated in Euros, but did not issue any such securities in 2006 or 2005. We hedge our exposure to changes in foreign-currency exchange rates by entering into swap transactions that convert foreign-currency denomi- nated obligations to U.S. dollar-denominated obligations. See ""RISK MANAGEMENT Ì Interest-Rate Risk and Other Market Risks Ì Sources of Interest-Rate Risk and Other Market Risks'' for more information. The investor base for our debt is predominantly institutional. However, we also conduct weekly oÅerings of FreddieNotes» securities, a Medium-term Notes program designed to meet the investment needs of retail investors. Subordinated Debt. In December 2006, we issued approximately $2.0 billion of Freddie SUBS» securities, including approximately $1.5 billion issued in exchange for previously issued Freddie SUBS» securities. In addition, we called approximately $1.0 billion of previously issued Freddie SUBS» securities in August 2006 and issued approximately $1.25 billion of Freddie SUBS» securities in June 2006. We did not issue, call or repurchase any Freddie SUBS» securities during 2005 and 2004. Our issuance of subordinated debt in the form of Freddie SUBS» securities supports our risk management and disclosure commitments with OFHEO (described in ""RISK MANAGEMENT AND DISCLOSURE COMMITMENTS''). Debt Retirement Activities. We repurchase or call our outstanding debt securities from time to time to help support the liquidity and predictability of the market for our debt securities and to manage interest rate risk associated with our assets and liabilities. When our debt securities become seasoned or European call options on our debt securities expire, they may become less liquid, which could cause their price to decline. By repurchasing debt securities, we help preserve the 52 Freddie Mac liquidity of our debt securities and improve their price performance, which helps to reduce our funding costs over the long- term. Our repurchase activities also help us manage the funding mismatch, or duration gap, created by changes in interest rates. For example, when interest rates decline, the expected lives of the mortgage-related securities held in our Retained portfolio decrease, reducing the need for long-term debt. We use a number of diÅerent means to shorten the eÅective weighted average lives of our outstanding debt securities and thereby manage the duration gap, including retiring long-term debt through repurchases or calls; changing our debt funding mix between short- and long-term debt; or using derivative instruments, such as entering into receive-Ñxed swaps or terminating or assigning pay-Ñxed swaps. From time to time, we may also enter into transactions in which we exchange newly issued debt securities for similar outstanding debt securities held by investors. These transactions are accounted for as debt exchanges. See ""CONSOLIDATED RESULTS OF OPERATIONS Ì Non-Interest Income (Loss) Ì Gains (Losses) on Debt Retirement'' for more information. Table 31 provides the par value, based on settlement dates, of debt securities we repurchased, called and exchanged during 2006 and 2005. Table 31 Ì Debt Security Repurchases, Calls and Exchanges Repurchases of outstanding 4Reference Notes» securities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Repurchases of outstanding Medium-term NotesÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Calls of callable Medium-term Notes ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Calls of callable Freddie SUBS» securitiesÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Exchanges of U.S. dollar Reference Notes» securities and Medium-term Notes ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Exchanges of Freddie SUBS» securities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Year Ended December 31, 2006 2005 (in millions) $ 5,210 28,560 26,559 1,000 1,074 1,480 $ Ì 11,663 36,236 Ì 3,043 Ì Credit Ratings. Our ability to access the capital markets and other sources of funding, as well as our cost of funds, are highly dependent upon our credit ratings. Table 32 indicates our credit ratings at March 1, 2007. Table 32 Ì Freddie Mac Credit Ratings Nationally Recognized Statistical Rating Organization Moody's Standard & Poor's Fitch Senior long-term debt(1) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Short-term debt(2) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Subordinated debt ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Preferred stockÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ AAA A-1° AA¿ AA¿ Aaa P-1 Aa2 Aa3 AAA F-1° AA¿ AA¿ (1) Includes Medium-term Notes, U.S. dollar Reference Notes» securities and 4Reference Notes» securities. (2) Includes Reference Bills» securities and discount notes. In addition to the ratings described in Table 32, S&P provides a ""Risk-To-The-Government'' rating that measures our ability to meet our debt obligations and the value of our franchise in the absence of any implied government support. Our ""Risk-To-The-Government'' rating was AA¿ at March 1, 2007. Moody's also provides a ""Bank Financial Strength'' rating that represents Moody's opinion of our intrinsic safety and soundness and, as such, excludes certain external credit risks and credit support elements. Ratings under this measure range from A, the highest, to E. Our ""Bank Financial Strength'' rating was A¿ at March 1, 2007. Equity Securities See ""Capital Resources Ì Core Capital'' and ""MARKET FOR THE COMPANY'S COMMON EQUITY, RE- LATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES'' for information about issuances and repurchases of our equity securities. Cash and Investments Portfolio We maintain a cash and investments portfolio that is important to our Ñnancial management and our ability to provide liquidity and stability to the mortgage market. At December 31, 2006, the investments in this portfolio consisted of liquid non-mortgage-related securities that we could sell or Ñnance to provide us with an additional source of liquidity to fund our business operations. We also use the portfolio to help manage recurring cash Öows and meet our other cash management needs. In addition, we use the portfolio to hold capital on a temporary basis until we can deploy it into Retained portfolio investments or credit guarantee opportunities. We may also sell or Ñnance the securities in this portfolio to maintain capital reserves to meet mortgage funding needs, provide diverse sources of liquidity or help manage the interest-rate risk inherent in mortgage-related assets. The non-mortgage-related securities in the Cash and investments portfolio consist principally of asset-backed securities and other marketable assets that can be readily converted to cash. For additional information on our Cash and investments portfolio, see ""CONSOLIDATED BALANCE SHEETS ANALYSIS Ì Cash and Investments.'' The non-mortgage- 53 Freddie Mac related investments in this portfolio may expose us to institutional credit risk and the risk that the investments could decline in value due to market-driven events such as credit downgrades or changes in interest rates and other market conditions. See ""RISK MANAGEMENT Ì Credit Risks Ì Institutional Credit Risk'' for more information. Contractual Obligations Table 33 provides aggregated information about the listed categories of our contractual obligations. These contractual obligations aÅect our short- and long-term liquidity and capital resource needs. The table includes information about undiscounted future cash payments due under these contractual obligations, aggregated by type of contractual obligation, including the contractual maturity proÑle of our debt securities and other liabilities reported on our consolidated balance sheet and our operating leases at December 31, 2006. The timing of actual future payments may diÅer from those presented due to a number of factors, including discretionary debt repurchases. Our contractual obligations include other purchase obligations that are enforceable and legally binding. For purposes of this table, purchase obligations are included through the termination date speciÑed in the respective agreements, even if the contract is renewable. Many of our purchase agreements for goods or services include clauses that would allow us to cancel the agreement prior to the expiration of the contract within a speciÑed notice period; however, this table includes such obligations without regard to such termination clauses (unless we have provided the counterparty with actual notice of our intention to terminate the agreement). In addition, in Table 33, the amounts of future interest payments on debt securities outstanding at December 31, 2006 are based on the contractual terms of our debt securities at that date. These amounts were determined using the key assumptions that (a) variable-rate debt continues to accrue interest at the contractual rates in eÅect at December 31, 2006 until maturity and (b) callable debt continues to accrue interest until its contractual maturity. The amounts of future interest payments on debt securities presented do not reÖect certain factors that will change the amounts of interest payments on our debt securities after December 31, 2006, such as (a) changes in interest rates, (b) the call or retirement of any debt securities, (c) the issuance of new debt securities and (d) other factors. Accordingly, the amounts presented in the table do not represent a forecast of our future cash interest payments or interest expense. Table 33 excludes the following items: ‚ future payments related to our Guarantee obligation, because the amount and timing of such payments are generally contingent upon the occurrence of future events and are therefore uncertain; ‚ future contributions to our Pension Plan, as we have not yet determined whether a contribution is required for 2007. See ""NOTE 15: EMPLOYEE BENEFITS'' to our consolidated Ñnancial statements for additional information about contributions to our Pension Plan; ‚ future cash settlements on derivative agreements not yet accrued, because the amount and timing of such payments are dependent upon changes in the underlying Ñnancial instruments and are therefore uncertain; and ‚ future dividends on the preferred stock we issued, because dividends on these securities are non-cumulative. In addition, the classes of preferred stock issued by our two consolidated real estate investment trust, or REIT, subsidiaries pay dividends and are cumulative. However, dividends on the REIT preferred stock are excluded because the timing of these payments is dependent upon declaration by the boards of the REITs. 54 Freddie Mac Table 33 Ì Contractual Obligations by Year at December 31, 2006 Total 2007 2008 2009 2010 2011 Thereafter (in millions) Long-term debt securities(1) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $609,083 $117,972 $ 98,313 $63,231 $46,681 $55,208 $227,678 Short-term debt securities(1) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 178,887 Ì Interest payable(2)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 140,167 50,060 Other liabilities reÖected on our consolidated balance sheet: 178,887 26,095 Ì 11,589 Ì 14,516 Ì 17,029 Ì 20,878 Due to Participation CertiÑcate investors ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Other contractual liabilities(3)(4) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 11,123 2,704 11,123 1,711 Ì 556 Ì 178 Ì 78 Ì 41 Ì 140 Purchase obligations: Purchase commitments(5) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Other purchase obligations ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Operating lease obligations ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Ì 21 48 Total speciÑed contractual obligations ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $952,352 $345,909 $119,845 $80,486 $61,306 $66,859 $277,947 9,856 247 18 9,856 418 114 Ì 82 16 Ì 19 12 Ì 35 13 Ì 14 7 (1) Represents par value. Callable debt is included in this table at its contractual maturity. For additional information about our debt securities, see ""NOTE 8: DEBT SECURITIES AND SUBORDINATED BORROWINGS'' to our consolidated Ñnancial statements. (2) Includes estimated future interest payments on our short-term and long-term debt securities. Also includes accrued interest payable recorded on our consolidated balance sheet, which consists primarily of the accrual of interest on short-term and long-term debt as well as the accrual of periodic cash settlements of derivatives, netted by counterparty. (3) Other contractual liabilities primarily represents future cash payments due under our contractual obligations to make delayed equity contributions to low-income housing tax credit partnerships that are unconditional and legally binding. (4) Accrued obligations related to our deÑned beneÑt plans, deÑned contribution plans and executive deferred compensation plan are included in the Total and 2007 columns. However, the timing of payments due under these obligations is uncertain. See ""NOTE 15: EMPLOYEE BENEFITS'' to our consolidated Ñnancial statements for additional information. (5) Purchase commitments represents our obligations to purchase mortgage loans and mortgage-related securities from third parties. The majority of purchase commitments included in this caption are accounted for as derivatives in accordance with SFAS No. 133, ""Accounting for Derivative Instruments and Hedging Activities,'' or SFAS 133. Capital Resources 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 at attractive long-term returns. See ""NOTE 10: REGULATORY CAPITAL'' to our consolidated Ñnancial statements for more information regarding our regulatory capital requirements and OFHEO's capital monitoring framework. As appropriate, we will consider opportunities to return excess capital to shareholders (through dividends and share repurchases) and optimize our capital structure to lower our cost of capital. We assess and project our capital adequacy relative to our regulatory requirements as well as our economic risks. This includes targeting a level of additional capital above each of our capital requirements to help support ongoing compliance and to accommodate future uncertainties. We evaluate the adequacy of our targeted additional capital in light of changes in our business and risk exposures. We develop an annual capital plan that is approved by our board of directors and updated periodically. This plan provides projections of capital adequacy, taking into consideration our business plans, forecasted earnings, economic risks and regulatory requirements. Capital Adequacy We estimate as of December 31, 2006 that we exceeded each of our regulatory capital requirements, including the 30 percent mandatory target capital surplus, based on our most recent submissions to OFHEO. See ""NOTE 10: REGULATORY CAPITAL'' to our consolidated Ñnancial statements for further information regarding our regulatory capital requirements and OFHEO's capital monitoring framework. Core Capital During 2006 and 2005, we added approximately $0.2 billion and $1.0 billion, respectively, to Core capital primarily from Net income of $2.2 billion and $2.1 billion, respectively, partly oÅset by the payment of common and preferred stock dividends totaling $1.6 billion and $1.3 billion, respectively. In addition, 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. In accordance with OFHEO's capital monitoring framework, we obtained OFHEO's approval for both the common stock repurchases and preferred stock redemption described above. 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. 55 Freddie Mac Our board of directors approved a dividend per common share of $0.50 for the fourth quarter of 2006 and the Ñrst quarter of 2007, an increase over the $0.47 per share common dividend that was paid for each of the Ñrst three quarters of 2006 and the fourth quarter of 2005. Our common dividend per share was $0.35 for each of the Ñrst three quarters of 2005 and $0.30 for the fourth quarter of 2004. Our board of directors will determine the amount of future dividends, if any, after considering factors such as our capital position, and our earnings and growth prospects. For the fourth quarter of 2004 through the Ñrst quarter of 2007, our board of directors also approved quarterly preferred stock dividends that were consistent with the contractual rates and terms of the preferred stock. See ""NOTE 9: STOCKHOLDERS' EQUITY'' to our consolidated Ñnancial statements for information regarding our outstanding issuances of preferred stock. RISK MANAGEMENT We are exposed to risks that include interest-rate and other market risks, operational risks and credit risks, among others, including those described in ""RISK FACTORS.'' We manage risk through a framework, approved by our board of directors, that recognizes primary risk ownership and management by our business areas. Within this framework, our executive management committees and divisions responsible for independent risk oversight, which include Enterprise Risk Oversight, Corporate Compliance and Internal Audit, monitor performance against our risk management strategies and established risk limits, identify and assess potential issues, and provide oversight regarding changes in business processes and activities. Oversight of risk management is also provided by our board of directors and its committees. Together, these groups assess the adequacy and eÅectiveness of the risk management functions across the company. While we consider both our day-to-day and long-term management of interest-rate and other market risks and credit risks to be satisfactory, we identiÑed weaknesses in prior years in our overall risk governance framework. We created an executive management enterprise risk committee in June 2006 to provide a company-wide view of risk and have formed Ñve subcommittees to focus on credit, market, models, operational and regulatory risks. Our board of directors has also assigned primary responsibility for oversight of enterprise risk management to the Governance, Nominating and Risk Oversight Committee of the board of directors. We have taken steps to strengthen our capacity in four important areas: risk governance, risk identiÑcation, risk measurement and assessment and related education and communication. Accordingly, we believe we have reduced the severity of the deÑciencies in our risk governance framework so that they no longer represent a signiÑcant deÑciency in our internal control over Ñnancial reporting. Operational Risks Operational risks are inherent in all of our business activities and can become apparent in various ways, including accounting or operational errors, business interruptions, fraud, failures of the technology used to support our business activities and other operational challenges from failed or inadequate internal controls. We face a number of signiÑcant operational risks, including material weaknesses and other signiÑcant deÑciencies in our internal control over Ñnancial reporting. These operational risks may expose us to Ñnancial loss, may delay or interfere with our ability to return to and sustain timely Ñnancial reporting, or may result in other adverse consequences. Governance over the management of our operational risks takes place through the enterprise risk management framework described above. Business areas retain primary responsibility for identifying, assessing and reporting their operational risks. Our business processes are highly dependent on our use of technology and business and Ñnancial models. We face challenges in the areas of system security, change management and information technology application and general controls. See ""Internal Control Over Financial Reporting'' for more information concerning material weaknesses related to our systems. In recent years, we have strengthened our processes to validate model assumptions, code, theory and the system applications that utilize our models. We are currently improving our model oversight processes and enhancing our staÇng both within the business areas and in our risk oversight functions. We continue to make signiÑcant investments to build new Ñnancial reporting systems and move to more eÅective and eÇcient business processing systems. Until those systems are implemented, we continue to remain more reliant on end-user computing systems than is desirable and we are challenged to eÅectively and timely deliver integrated production systems. Reliance on certain of these end-user computing systems increases the risk of errors in some of our core operational processes and increases our dependency on monitoring controls. In the near term, we are mitigating this risk by improving our documentation and controls over these systems and placing certain key end-user systems into a change management process controlled by our information technology group. Our eÅorts to develop and deploy new Ñnancial reporting and business process systems have limited our Öexibility to release new products and other business initiatives in response to competitive market forces. We manage this risk through a management committee that monitors key projects and allocates resources to development eÅorts. 56 Freddie Mac We outsource certain key functions to external parties, including (a) processing functions for trade capture, market risk management analytics and asset valuation, (b) custody and recordkeeping and (c) processing functions for mortgage loan underwriting. In addition, we use a process of delegated underwriting for the single-family mortgages we purchase or securitize. We also expect to implement a process of delegated underwriting for certain multifamily mortgages we purchase or securitize. See ""Credit Risks Ì Mortgage Credit Risk Ì Underwriting Requirements and Quality Control Standards'' for information about how we mitigate the risks associated with delegated underwriting. We mitigate the risk from our use of external parties by engaging in active vendor management, such as establishing detailed vendor requirements, reviewing business continuity plans, monitoring quality assurance processes and using third party reviews of our vendors. In recognition of the importance of the accuracy and reliability of our valuation of Ñnancial instruments, we engage in an ongoing internal review of our valuations. We perform analysis of internal valuations on a monthly basis to conÑrm the reasonableness of the valuations. This analysis is performed by a group that is independent of the business area responsible for valuing the positions. Our veriÑcation and validation procedures depend on the nature of the security and valuation methodology being reviewed and may include: comparisons with external pricing sources, comparisons with observed trades, independent veriÑcation of key valuation model inputs and independent security modeling. Results of the monthly veriÑcation process, as well as any changes in our valuation methodologies, are reported to a management committee that is responsible for reviewing and approving the approaches used in our valuations to ensure that they are well controlled and eÅective, and result in reasonable fair values. We are also exposed to the risk that our business processes could be adversely aÅected by inadequate staÇng, which strains existing resources and increases the risk that an error or fraud will not be detected. This risk is of particular concern for us because of high voluntary employee turnover rates experienced in 2005, critical vacancies and recent changes in our senior management. During 2006, we Ñlled some important vacancies such as Chief Financial OÇcer, General Counsel, General Auditor, Corporate Controller and Principal Accounting OÇcer and Chief Information OÇcer. While we have made progress in our eÅorts to reduce voluntary employee turnover rates and to build a strong management team by Ñlling several senior positions, we need to continue to recruit additional qualiÑed people into key positions across the organization in order to achieve our remediation objectives. See ""Internal Control Over Financial Reporting'' for more information concerning staÇng adequacy risk related to Ñnancial reporting. In addition to the particular risks and challenges we are facing, we experience ongoing risks that are similar to those of other large Ñnancial institutions. For example, we are exposed to the risk that a catastrophic event, such as a terrorist event or natural disaster, could result in a signiÑcant business disruption and an inability to process transactions through normal business processes. To mitigate this risk, we maintain and test business continuity plans and have established backup facilities for critical business processes and systems away from, although in the same metropolitan area as, our main oÇces. In 2006, we established out-of-region capabilities for clearing and treasury services. However, we can make no assurances that these measures will be suÇcient to respond to the full range of catastrophic events that might occur. Internal Control Over Financial Reporting Improving internal control over Ñnancial reporting and mitigating the risks presented by material weaknesses and signiÑcant deÑciencies in our Ñnancial reporting processes continue to be top corporate priorities. During 2006, we developed a comprehensive plan for returning to quarterly Ñnancial reporting. The comprehensive plan includes mitigation and remediation of identiÑed material weaknesses and signiÑcant deÑciencies; strengthening of our Ñnancial close process; implementation of critical systems initiatives; and completion of a review of our system of internal controls related to the processing and recording of Ñnancial transactions. We have made progress implementing changes to our accounting, Ñnancial reporting and operational infrastructure that have improved our internal control environment, including outsourcing the custody and recordkeeping functions for our Retained portfolio and Cash and investments portfolio, implementing a new accounting sub-ledger for our Cash and investments portfolio and upgrading our general ledger system. However, certain key initiatives, including the implementa- tion of a new sub-ledger for our Retained portfolio, were not completed by year-end as originally planned and will continue to be part of our remediation eÅorts in 2007. As a result of our eÅorts, we made signiÑcant progress toward the remediation of our material weaknesses, as described below. However, each of the material weaknesses identiÑed in prior years persisted throughout 2006 and they continue to present challenges for us in 2007. We also made progress in the remediation of the signiÑcant deÑciencies in our internal control and we have mitigated some of them so that they have been reduced to control deÑciencies in our internal control over Ñnancial reporting. For example, we enhanced our risk governance framework thereby reducing the severity of the weaknesses that existed in this area. We also improved our processes for identifying security impairments and the governance of and change management 57 Freddie Mac processes related to the amortization of deferred premiums, discounts and deferred fees for assets held in our Retained portfolio. While we have made progress in our remediation eÅorts, our material weaknesses and remaining signiÑcant deÑciencies will continue to pose signiÑcant risks to our Ñnancial reporting processes until adequately remediated. The material weaknesses that aÅected us through December 31, 2006 and continue to present challenges for us, as well as our related remediation activities, are described below: Integration among our systems, business units and external service providers. Our systems and processes related to our operational and Ñnancial accounting systems, business units and external service providers are not adequately integrated. This inadequate integration increases the risk of error in our Ñnancial reporting due to: (a) the potential failure to correctly pass information between systems and processes; (b) incompatibility of data between systems; (c) incompatible systems; or (d) a lack of clarity in process ownership. To compensate for this weakness, we have implemented mitigating controls, including extensive manual procedures to perform data validation and Ñnancial analytics. We have also enhanced the communication and coordination between our business units. Our remediation eÅorts are targeted to address risks posed by (a) the hand-oÅ of data between systems, business units and various data owners, (b) the reliance on end-user computing solutions or (c) reliance on simplifying assumptions in the applications of our accounting policies. We have also formalized internal guidance for controls over the hand-oÅ of data at all stages of our Ñnancial close processes, end-user computing solutions and the use of simplifying assumptions in our accounting policies. Our remediation plans include identifying areas that require attention, evaluating our application of the new internal guidance for the hand-oÅ of data and remediating any control deÑciencies identiÑed. We have also undertaken an initiative to more clearly link the application of our accounting policies to our systems and our end-user computing solutions. We have undertaken an initiative to redesign our Ñnancial close process to make timely Ñnancial reporting possible. Our remediation eÅorts currently focus on implementing enhancements to our current Ñnancial close process, while addressing our objective of long-term sustainability in our processes. We have deÑned and begun monitoring performance metrics to evaluate our progress in achieving close targets, with a focus on accuracy and timeliness. Information technology general controls as they relate to change management. Our controls over managing the introduction of program and data changes need improvement. Weaknesses in these controls include a lack of consistent standards and inadequate testing of changes prior to deployment; an environment and processes that increase the diÇculties of establishing and maintaining internal control; and issues arising from inherent system limitations. We are implementing new change management processes so that changes to our system applications and new system implementations are properly designed and approved, fully tested and meet the requirements of the business. We are also focused on promoting an environment of accountability for adhering to change management processes and providing our staÅ with the tools and training to implement system changes appropriately. Information technology general controls as they relate to security administration, management and technology. Our controls over information systems security administration and management functions need to improve in the following areas: (a) granting and revoking user access rights; (b) segregation of duties; (c) monitoring user access rights; and (d) periodic review of the appropriateness of access rights. Weaknesses in these controls could allow unauthorized users to access, enter, delete or change data in these systems, as well as increase the possibility that entries could be duplicated or omitted inadvertently. Our remediation eÅorts include reviewing the design of our existing controls against industry standards, establishing new procedures to secure data and restrict access to appropriate users, and the development of new tools to monitor access to data and the types of access granted to speciÑc users. We are also centralizing the responsibility for granting user access to key system applications and enhancing our automation of controls designed to prevent unauthorized or inappropriate levels of system access. Monitoring of results within Ñnancial operations and reporting functions. The controls we use to monitor the results of our Ñnancial reporting process, such as the performance of Ñnancial analytics and account reconciliations, failed to identify certain issues that required adjustments to our Ñnancial results prior to our reporting them. Our remediation eÅorts have included a detailed evaluation and redesign of our Ñnancial analytics and reconciliation procedures, and the implementation of regular, structured reviews of monthly Ñnancial results and accounting matters. We are continuing to identify additional Ñnancial analytics improvements that we need to make. Additionally, we need to continue to execute the new controls for a period of time in order to assess their eÅectiveness. StaÇng adequacy. During 2006, we made progress in our eÅorts to build a strong management team by Ñlling several key senior management positions. However, we must continue to recruit additional qualiÑed people into leadership and key 58 Freddie Mac staÅ positions in targeted functions within the company to achieve our objectives for the remediation of our internal control deÑciencies. Our employee voluntary turnover rate was higher in 2005 than prior years, but voluntary turnover in 2006 was signiÑcantly lower than 2005. Undesirable voluntary turnover strains existing resources and contributes to increased operational risk. Furthermore, our standards of performance need to be enforced in order to create a more eÅective culture of accountability. Our remediation activities are focused on addressing staÇng issues in targeted areas across the company by identifying and Ñlling critical vacancies, addressing staÅ development and training needs, and eliminating key person dependencies in critical roles. Additionally, we are taking steps to build a culture of accountability that supports operational risk management decision-making and promotes the urgency to identify and address deÑciencies in our internal controls. For example, risk management accountability has been formally included as a performance objective for all our employees. We are also reinforcing accountability through staÅ training that raises the awareness of risks in our business and highlights the importance of maintaining eÅective internal controls. Management risk and control self-assessment process. We do not currently have a self-assessment process for our internal control over Ñnancial reporting in order to reliably enable management to identify deÑciencies in our internal control, evaluate the eÅectiveness of internal control or modify our control procedures in response to changes in risk in a timely manner. Our remediation activities are focused on an in-depth assessment of the design of internal control over Ñnancial reporting in our existing business processes and the development of a self-assessment process that will provide management with a more timely and reliable tool to identify changes to our processes, risks, and controls in order to identify and remediate control deÑciencies. The new management self-assessment process will be implemented under an enhanced risk governance structure designed to identify and escalate risk issues and control deÑciencies in a timely manner. Our objective for this new process is to allow us to assess the design and eÅectiveness of our internal control over Ñnancial reporting in a manner consistent with the requirements of the Sarbanes-Oxley Act of 2002. In addition to these material weaknesses, we identiÑed a number of signiÑcant deÑciencies in our internal control over Ñnancial reporting that, although not determined to be material weaknesses as of the end of the year, still present risks of error in our Ñnancial statements and disclosures. These signiÑcant deÑciencies include: ‚ deÑciencies in our processes related to the valuation of our guarantee-related assets and liabilities; ‚ deÑciencies in our controls over the accuracy and completeness of data received from external counterparties or passed between our business processes and used in our transaction processing and Ñnancial reporting systems; ‚ over-reliance on end-user computing solutions with insuÇcient development, documentation and change controls; ‚ deÑciencies in our new product implementation process; and ‚ deÑciencies in our procedures for monitoring our use of simplifying assumptions in the application of our accounting policies, and our excessive reliance on such assumptions. The excessive use of simplifying assumptions increases the risk that insigniÑcant diÅerences, when compared to a stricter application of our accounting policies, could become consequential over time and result in errors that are not detected (e.g., if the underlying transaction volume aÅected by a simplifying assumption increases). As we continue our remediation activities, we may identify additional material weaknesses, signiÑcant deÑciencies or other operational issues in our internal controls or conclude that signiÑcant deÑciencies we have already identiÑed should be regarded as material weaknesses, either individually or in the aggregate. Improvements to the processes and controls we put in place to remediate our control deÑciencies need to operate for a period of time to enable us to evaluate their eÅectiveness. The material weaknesses and signiÑcant deÑciencies in our internal control over Ñnancial reporting adversely aÅect our ability to record, process, summarize and report Ñnancial data in a timely manner. Based on the continued existence of material weaknesses at December 31, 2006, our Chief Executive OÇcer and Chief Financial OÇcer have concluded that our internal control over Ñnancial reporting was not eÅective at December 31, 2006. In order to compensate for the material weaknesses and other deÑciencies in our internal controls, we continue to perform extensive veriÑcation and validation procedures to provide reasonable assurance that our consolidated Ñnancial statements are prepared in accordance with GAAP. Therefore, in view of the additional procedures we performed, we believe that these weaknesses do not prevent us from preparing and issuing our consolidated Ñnancial statements in conformity with GAAP. Our resumption of interim Ñnancial reporting will depend on continued progress with our remediation eÅorts; however, our objective is to return to quarterly reporting during the second half of 2007. We will begin the process of registering our common stock with the SEC after resuming timely quarterly reporting. 59 Freddie Mac Disclosure Controls and Procedures Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that the information required to be disclosed by a company in its Ñnancial reports is accumulated and communicated to its senior management team as appropriate to allow timely decisions regarding required disclosure. Full evaluation of our disclosure controls and procedures has been delayed as our resources are focused on the remediation of our internal control over Ñnancial reporting. Interest-Rate Risk and Other Market Risks Our interest-rate risk management objective is to serve our housing mission by protecting shareholder value in all interest-rate environments. Our disciplined approach to interest-rate risk management is essential to maintaining a strong and durable capital base and uninterrupted access to debt and equity capital markets. Sources of Interest-Rate Risk and Other Market Risks Our Retained portfolio activities expose us to interest-rate risk and other market risks arising primarily from the uncertainty as to when borrowers will pay the outstanding principal balance of mortgage loans and mortgage-related securities held in the Retained portfolio, known as prepayment risk, and the resulting potential mismatch in the timing of our receipt of cash Öows on our assets versus the timing of our obligation to make payments on our liabilities. For the vast majority of our mortgage-related investments, the mortgage borrower has the option to make unscheduled payments of additional principal or to completely pay oÅ a mortgage loan at any time before its scheduled maturity date (without having to pay a prepayment penalty) or to hold the mortgage loan to its stated maturity. Our credit guarantee activities also expose us to interest-rate risk because changes in interest rates can cause Öuctuations in the fair value of our existing credit guarantee portfolio. We generally do not hedge these changes in fair value except for interest-rate exposure related to net buy-ups and Öoat. Float, which arises from timing diÅerences between when the borrower pays us and when we reduce the PC balance, can lead to signiÑcant interest expense if the interest rate paid to a PC investor is higher than the reinvestment rate we earn on payments received from mortgage borrowers. The types of interest-rate risk and other market risks to which we are exposed are described below. Duration Risk and Convexity Risk. Duration is a measure of a Ñnancial instrument's price sensitivity to changes in interest rates. Convexity is a measure of how much a Ñnancial instrument's duration changes as interest rates change. Our convexity risk primarily results from prepayment risk. We actively manage duration risk and convexity risk through asset selection and structuring (that is, by identifying or structuring mortgage-related securities with attractive prepayment and other characteristics), by issuing a broad range of both callable and non-callable debt instruments and by using interest-rate derivatives. Managing the impact of duration risk and convexity risk is the principal focus of our daily market risk management activities. These risks are encompassed in our PMVS and duration gap risk measures, discussed in greater detail below. We use prepayment models to determine the estimated duration and convexity of mortgage assets for our PMVS and duration gap measures. Expected results can be aÅected by diÅerences between prepayments forecasted by the models and actual prepayments. Yield Curve Risk. Yield curve risk is the risk that non-parallel shifts in the yield curve (such as a Öattening or steepening) will adversely aÅect shareholder value. Because changes in the shape, or slope, of the yield curve often arise due to changes in the market's expectation of future interest rates at diÅerent points along the yield curve, we evaluate our exposure to yield curve risk by examining potential reshaping scenarios at various points along the yield curve. Our yield curve risk under a speciÑed yield curve scenario is reÖected in our PMVS-Yield Curve, or PMVS-YC, disclosure. Volatility Risk. Volatility risk is the risk that changes in the market's expectation of the magnitude of future variations in interest rates will adversely aÅect shareholder value. Implied volatility is a key determinant of the value of an interest-rate option. Since mortgage assets generally include the borrower's option to prepay a loan without penalty, changes in implied volatility aÅect the value of mortgage assets. We manage volatility risk through asset selection and by maintaining a consistently high percentage of option-embedded liabilities relative to our mortgage assets. We monitor volatility risk by measuring exposure levels on a daily basis and we maintain internal limits on the amount of volatility risk exposure that is acceptable to us. Basis Risk. Basis risk is the risk that interest rates in diÅerent market sectors will not move in tandem and will adversely aÅect shareholder value. This risk arises principally because we generally hedge mortgage-related investments with debt securities. We do not actively manage the basis risk arising from funding Retained portfolio investments with our debt securities, also referred to as mortgage-to-debt option-adjusted spread risk. See ""CONSOLIDATED FAIR VALUE BALANCE SHEETS ANALYSIS Ì Key Components of Changes in Fair Value of Net Assets Ì Changes in mortgage- to-debt OAS '' for additional information. We also incur basis risk when we use LIBOR- or Treasury-based instruments in our risk management activities. 60 Freddie Mac Foreign-Currency Risk. Foreign-currency risk is the risk that Öuctuations in currency exchange rates (e.g., foreign currencies to the U.S. dollar) will adversely aÅect shareholder value. We are exposed to foreign-currency risk because we have debt denominated in currencies other than the U.S. dollar, our functional currency. We eliminate virtually all of our foreign-currency risk by entering into swap transactions that eÅectively convert foreign-currency denominated obligations into U.S. dollar-denominated obligations. Portfolio Market Value Sensitivity and Measurement of Interest-Rate Risk We employ a risk management strategy that seeks to substantially match the duration characteristics of our assets and liabilities. To accomplish this, we employ an integrated strategy encompassing asset selection and structuring and asset and liability management. Through our asset selection process, we seek to purchase mortgage assets with desirable prepayment expectations based on our evaluation of their yield-to-maturity, option-adjusted spreads and credit characteristics. Through this selection process and the restructuring of mortgage assets, we seek to retain cash Öows with more stable risk and investment return characteristics while selling oÅ the cash Öows that do not meet our investment proÑle. Through our asset and liability management process, we mitigate interest-rate risk by issuing a wide variety of debt products. The prepayment option held by mortgage borrowers drives the fair value of our mortgage assets such that the combined fair value of our mortgage assets and non-callable debt will decline if interest rates move signiÑcantly in either direction. We mitigate much of our exposure to changes in interest rates by funding a signiÑcant portion of our mortgage portfolio with callable debt. When interest rates change, our option to redeem this debt oÅsets a large portion of the fair value change driven by the mortgage prepayment option. At December 31, 2006, approximately 50 percent of our Ñxed- rate mortgage assets were funded and economically hedged with callable debt. However, because the mortgage prepayment option is not fully hedged by callable debt, the combined fair value of our mortgage assets and debt will be aÅected by changes in interest rates. To further reduce our exposure to changes in interest rates, we hedge a signiÑcant portion of the remaining prepayment risk with option-based derivatives. These derivatives primarily consist of call swaptions, which tend to increase in value as interest rates decline, and put swaptions, which tend to increase in value as interest rates increase. With the addition of these option-based derivatives, the fair value of net assets becomes relatively stable over a wide range of interest rates because a greater portion of our prepayment risk has been hedged. The fair value of net assets is further stabilized by our ongoing portfolio rebalancing, primarily involving interest-rate swaps. Although we do not hedge all of our exposure to changes in interest rates, these exposures are generally well understood, are subject to established limits, and are monitored and controlled through our disciplined risk management process. See ""CONSOLIDATED FAIR VALUE BALANCE SHEETS ANALYSIS Ì Key Components of Changes in Fair Value of Net Assets Ì Changes in mortgage-to-debt OAS'' for further information. We measure our exposure to key interest-rate risks every day against both internal management limits and limits set by our board of directors. Throughout 2006, our interest-rate risk remained low and well below management and board limits. PMVS and Duration Gap. Our primary interest-rate risk measures are PMVS and duration gap. PMVS is measured in two ways, one measuring the estimated sensitivity of our portfolio market value (as deÑned below) to parallel moves in interest rates (PMVS-L) and the other to nonparallel movements (PMVS-YC). Our PMVS and duration gap estimates are determined using models that involve our best judgment of interest-rate and prepayment assumptions. In addition, in the case of PMVS, daily calculations are based on an estimate of the fair value of our net assets attributable to common stockholders. Accordingly, while we believe that PMVS and duration gap are useful risk management tools, they should be understood as estimates rather than as precise measurements. While PMVS and duration gap estimate the exposure of the fair value of net assets attributable to common stockholders (measured as the fair value of total net assets less the fair value of preferred stock) to changes in interest rates, they do not capture the potential impact of certain other market risks, such as changes in volatility, basis, prepayment model, mortgage-to-debt option-adjusted spreads and foreign-currency risk. The impact of these other market risks can be signiÑcant. See ""Sources of Interest-Rate Risk and Other Market Risks'' discussed above and ""CONSOLIDATED FAIR VALUE BALANCE SHEETS ANALYSIS Ì Key Components of Changes in Fair Value of Net Assets Ì Changes in mortgage-to-debt OAS '' for further information. ‚ PMVS-L shows the estimated loss in pre-tax portfolio market value, expressed as a percentage of our after-tax fair value of net assets attributable to common stockholders, from an immediate adverse 50 basis point parallel shift in the level of LIBOR rates (i.e., when the yield at each point on the LIBOR yield curve increases or decreases by 50 basis points). 61 Freddie Mac ‚ PMVS-YC shows the estimated loss in pre-tax portfolio market value, expressed as a percentage of our after-tax fair value of net assets attributable to common stockholders, from an immediate adverse 25 basis point change in the slope (up and down) of the LIBOR yield curve. The 25 basis point change in slope for the PMVS-YC measure is obtained by shifting the two-year and ten-year LIBOR rates by an equal amount (12.5 basis points), but in opposite directions. LIBOR rate shifts between the two-year and ten-year points are interpolated. ‚ Duration gap estimates the net sensitivity of the fair value of our Ñnancial instruments to movements in interest rates. Duration gap is presented in units expressed as months. A duration gap of zero implies that the change in value of assets from an instantaneous rate move will be accompanied by an equal and oÅsetting move in the value of debt and derivatives thus leaving the net fair value of equity unchanged. However, because duration does not capture convexity exposure (the amount by which duration itself changes as rates move), actual changes in fair value from interest-rate changes may diÅer from those implied by duration gap alone. For that reason, we believe duration gap is most useful when used in conjunction with PMVS. The 50 basis point shift and 25 basis point change in slope of the LIBOR yield curve used for our PMVS measures represent events that are expected to have an approximately 5 percent probability of occurring over a one-month time horizon. We believe that our PMVS measures represent conservative measures of interest-rate risk because these assumed scenarios are unlikely, and because the scenarios assume instantaneous shocks, therefore these PMVS measures do not consider the eÅects on fair value of any rebalancing actions that we would typically take to reduce our risk exposure. The expected loss in portfolio market value, which is the numerator in the fraction used to calculate the PMVS percentages, is an estimate of the sensitivity to changes in interest rates of the fair value of all interest-earning assets and interest-bearing liabilities and derivatives on a pre-tax basis. When we calculate the expected loss in portfolio market value and duration gap, we also take into account the cash Öows related to certain credit guarantee-related items, including net buy-ups and expected gains or losses due to net interest from Öoat. In making these calculations, we do not consider the sensitivity to interest-rate changes of the following assets and liabilities: ‚ Credit guarantee portfolio. We do not consider the sensitivity of the fair value of the credit guarantee portfolio to changes in interest rates except for the guarantee-related items mentioned above (i.e., net buy-ups and Öoat), because we believe the expected beneÑts from replacement business provide an adequate hedge against interest-rate changes. ‚ Other assets with minimal interest-rate sensitivity. We do not include other assets, primarily non-Ñnancial instruments such as Ñxed assets and REO, because of the minimal impact they would have on both PMVS and duration gap. These two categories of assets and liabilities are included in our estimate of the after-tax fair value of net assets attributable to common stockholders, which is the denominator of the fraction used to calculate the PMVS-L and PMVS-YC percentages. PMVS Results. Table 34 provides estimated point-in-time PMVS-L and PMVS-YC results at December 31, 2006 and 2005. Table 34 also provides PMVS-L estimates assuming an immediate 100 basis point shift in the LIBOR yield curve. Because we do not hedge all prepayment option risk, the duration of our mortgage assets changes more rapidly as changes in interest rates increase. Accordingly, as shown in Table 34, the PMVS-L results based on a 100 basis point shift in the LIBOR curve are disproportionately higher than the PMVS-L results based on a 50 basis point shift in the LIBOR curve. Table 34 Ì Portfolio Market Value Sensitivity Assuming Shifts of the LIBOR Yield Curve Portfolio Market Value Sensitivity PMVS-YC 25 bps PMVS-L 50 bps 100 bps Potential Pre-Tax Loss in Portfolio Market Value (in millions) PMVS-YC 25 bps PMVS-L 50 bps 100 bps At: December 31, 2006 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ December 31, 2005 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Ì% Ì% 1% 1% 2% 3% $27 $26 $146 $236 $560 $798 Derivatives have enabled us to keep our interest-rate risk exposure at consistently low levels in a wide range of interest- rate environments. By keeping PMVS-L and PMVS-YC low, we have been able to reduce the exposure of the fair value of our stockholders' equity to adverse changes in interest rates. Table 35 shows that the low PMVS-L risk levels for the periods presented would generally have been higher if we had not used derivatives to manage our interest-rate risk exposure. 62 Freddie Mac Table 35 Ì Derivative Impact on Portfolio Market Value Sensitivity Before Derivatives After Derivatives EÅect of Derivatives At December 31, 2006 PMVS-L (50 bps) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ At December 31, 2005 PMVS-L (50 bps) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2% 2% 1% 1% (1)% (1)% Duration Gap Results. Our estimated average duration gap for the months of December 2006 and 2005 was zero months. The disclosure in our Monthly Volume Summary reports, which are available on our website at www.freddiemac.com, reÖects the average of the daily PMVS-L, PMVS-YC and duration gap estimates for a given reporting period (a month, quarter or year). Use of Derivatives and Interest-Rate Risk Management Use of Derivatives. We use derivatives primarily to: ‚ hedge forecasted issuances of debt and synthetically create callable and non-callable funding; ‚ regularly adjust or rebalance our funding mix in order to more closely match changes in the interest-rate characteristics of our mortgage assets; and ‚ hedge foreign-currency exposure (see ""Sources of Interest-Rate Risk and Other Market Risks Ì Foreign-Currency Risk.'') Hedge Forecasted Debt Issuances and Create Synthetic Funding. We typically commit to purchase mortgage investments on an opportunistic basis for a future settlement, typically ranging from two weeks to three months after the date of the commitment. To facilitate larger and more predictable debt issuances that contribute to lower funding costs, we use interest-rate derivatives to economically hedge the interest-rate risk exposure from the time we commit to purchase a mortgage to the time the related debt is issued. We also use derivatives to synthetically create the substantive economic equivalent of various debt funding structures. For example, the combination of a series of short-term debt issuances over a deÑned longer-term period and a pay-Ñxed swap with the same maturity as the last issuance is the substantive economic equivalent of a long-term Ñxed-rate debt instrument of comparable maturity. Similarly, the combination of non-callable debt and a call swaption, or option to enter into a receive-Ñxed swap, with the same maturity as the non-callable debt, is the substantive economic equivalent of callable debt. These derivatives strategies increase our funding Öexibility and allow us to better match asset and liability cash Öows, often reducing overall funding costs. Adjust Funding Mix. We generally use interest-rate swaps to mitigate contractual funding mismatches between our assets and liabilities. We also use swaptions and other option-based derivatives to adjust the contractual funding of our debt in response to changes in the expected lives of mortgage-related assets in the Retained portfolio. As market conditions dictate, we take rebalancing actions to keep our interest-rate risk exposure within management-set limits. In a declining interest-rate environment, we typically enter into receive-Ñxed swaps or purchase Treasury-based derivatives to shorten the duration of our funding to oÅset the declining duration of our mortgage assets. In a rising interest-rate environment, we typically enter into pay-Ñxed swaps or sell Treasury-based derivatives in order to lengthen the duration of our funding to oÅset the increasing duration of our mortgage assets. Types of Derivatives. The derivatives we use to hedge interest-rate and foreign-currency risk are common in the Ñnancial markets. We principally use the following types of derivatives: ‚ LIBOR- and Euribor-based interest-rate swaps; ‚ LIBOR- and Treasury-based exchange-traded futures; ‚ LIBOR- and Treasury-based options (including swaptions); and ‚ Foreign-currency swaps. In addition to swaps, futures and options, our derivative positions include the following: Forward Purchase and Sale Commitments. We routinely enter into forward purchase and sale commitments for mortgage loans and mortgage-related securities. Most of these commitments are derivatives subject to the requirements of SFAS 133. Swap Guarantee Derivatives. We guarantee the payment of principal and interest on (a) multifamily mortgage loans that are originated and held by state and municipal housing Ñnance agencies to support tax-exempt multifamily housing revenue bonds, (b) tax-exempt multifamily housing revenue bonds that support pass-through certiÑcates issued by third parties and (c) Freddie Mac pass-through certiÑcates which are backed by tax-exempt multifamily housing revenue bonds and related taxable bonds and/or loans. In connection with some of these guarantees, we may also guarantee the sponsor's or 63 Freddie Mac the borrower's performance as a counterparty on any related interest-rate swaps used to mitigate interest-rate risk. Guarantees of these interest-rate swaps entered into after June 30, 2003 are treated as derivatives and are reported as swap guarantee derivatives. Credit Derivatives. See ""Credit Risks Ì Mortgage Credit Risk Ì Mortgage Credit Risk Management Strategies'' for more information. Derivative-Related Risks Our use of derivatives exposes us to derivative market liquidity risk and counterparty credit risk. Derivative Market Liquidity Risk. Derivative market liquidity risk is the risk that we may not be able to enter into or exit out of derivative transactions at a reasonable cost. A lack of suÇcient capacity or liquidity in the derivatives market could limit our risk management activities, increasing our exposure to interest-rate risk. To help maintain continuous access to derivative markets, we use a variety of products and transact with many diÅerent derivative counterparties. In addition to over-the-counter, or OTC, derivatives, we also use exchange-traded derivatives, asset securitization activities, callable debt and short-term debt to rebalance our portfolio. We limit our duration and convexity exposure to each counterparty. At December 31, 2006, the largest single uncollateralized exposure of our 27 approved OTC counterparties listed in ""Table 36 Ì Derivative Counterparty Credit Exposure'' was related to a AAA-rated counterparty, constituting $403 million, or 60 percent, of the total uncollateralized exposure of our OTC interest-rate swaps, option-based derivatives and foreign-currency swaps. Derivative Counterparty Credit Risk. Counterparty credit risk arises from the possibility that the derivative counterparty will not be able to meet its contractual obligations. Exchange-traded derivatives, such as futures contracts, do not measurably increase our counterparty credit risk because changes in the value of open exchange-traded contracts are settled daily through a Ñnancial clearinghouse established by each exchange. OTC derivatives, however, expose us to counterparty credit risk because transactions are executed and settled between us and the counterparty. When an OTC derivative has a market value above zero at a given date (i.e., it is an asset reported as Derivative assets, at fair value on our consolidated balance sheets), then the counterparty could potentially be obligated to deliver cash, securities or a combination of both having that market value to satisfy its obligation to us under the derivative. We actively manage our exposure to counterparty credit risk using several tools, including: ‚ review of external rating analyses; ‚ strict standards for approving new derivative counterparties; ‚ ongoing monitoring of our positions with each counterparty; ‚ master netting agreements and collateral agreements; and ‚ stress-testing to evaluate potential exposure under possible adverse market scenarios. On an ongoing basis, we review the credit fundamentals of all of our derivative counterparties to conÑrm that they continue to meet our internal standards. We assign internal ratings, credit capital and exposure limits to each counterparty based on quantitative and qualitative analysis, which we update and monitor on a regular basis. We conduct additional reviews when market conditions dictate or events aÅecting an individual counterparty occur. Derivative Counterparties. Our use of OTC interest-rate swaps, option-based derivatives and foreign-currency swaps is subject to rigorous internal credit and legal reviews. Our derivative counterparties carry external credit ratings among the highest available from major rating agencies. All of these counterparties are major Ñnancial institutions and are experienced participants in the OTC derivatives market. Master Netting and Collateral Agreements. We use master netting and collateral agreements to reduce our credit risk exposure to our active OTC derivative counterparties for interest-rate swaps, option-based derivatives and foreign-currency swaps. See ""NOTE 17: CONCENTRATION OF CREDIT AND OTHER RISKS'' to our consolidated Ñnancial statements for additional information. Table 36 summarizes our exposure to counterparty credit risk in our derivatives, which represents the net positive fair value of derivative contracts and related accrued interest after netting by counterparty as applicable (i.e., net amounts due to us under derivative contracts). This table is useful in understanding the counterparty credit risk related to our derivative portfolio. 64 Freddie Mac Table 36 Ì Derivative Counterparty Credit Exposure December 31, 2006 Rating(1) Number of Counterparties(2) Notional Amount Total Exposure at Fair Value(3) Weighted Average Contractual Maturity (in years) AAAÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ AA ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ AA¿ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ A° ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ A¿ ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Subtotal(5) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Other derivatives(6) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Forward purchase and sale commitmentsÏÏÏÏ Credit derivatives ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Swap guarantee derivatives ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total derivatives ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2 8 12 4 1 27 $ 3,408 269,126 278,993 142,332 210 694,069 49,554 10,012 2,605 957 $757,197 $ 411 2,134 6,264 1,393 1 10,203 Ì 24 Ì Ì $10,227 Rating(1) Number of Counterparties(2) Notional Amount Total Exposure at Fair Value(3) Weighted Average Contractual Maturity (in years) Collateral Posting Threshold Mutually agreed upon $10 million or less $10 million or less $1 million or less $1 million or less Collateral Posting Threshold Mutually agreed upon $10 million or less $10 million or less $1 million or less $1 million or less $1 million or less Exposure, Net of Collateral(4) (dollars in millions) $411 92 161 7 1 672 Ì 24 Ì Ì $696 December 31, 2005 Exposure, Net of Collateral(4) (dollars in millions) $ 93 16 73 2 5 1 190 Ì 35 Ì Ì $225 1.6 4.7 5.2 6.1 5.0 5.2 2.7 4.3 5.8 5.8 4.0 6.0 5.3 AAAÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ AA ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ AA¿ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ A° ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ A ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ A¿ ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Subtotal(5) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Other derivatives(6) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Forward purchase and sale commitmentsÏÏÏÏ Credit derivative ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Swap guarantee derivatives ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total derivatives ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2 7 8 5 2 1 25 $ 3,102 148,135 156,058 227,842 24,879 210 560,226 98,033 21,961 2,414 738 $683,372 $ 93 619 2,499 5,297 364 3 8,875 Ì 35 Ì Ì $8,910 (1) We use the lower of S&P and Moody's ratings to manage collateral requirements. In this table, the rating of the legal entity is stated in terms of the S&P equivalent. (2) Based on legal entities. AÇliated legal entities are reported separately. (3) For each counterparty, this amount includes derivatives with a net positive fair value (recorded as Derivative assets, at fair value), including the related accrued interest receivable/payable (net) (recorded in Accounts and other receivables, net or Accrued interest payable). (4) Total Exposure at Fair Value less collateral held as determined at the counterparty level. (5) Consists of OTC derivative agreements for interest-rate swaps, option-based derivatives (excluding written options), foreign-currency swaps and purchased interest-rate caps. Written options do not present counterparty credit exposure, because we receive a one-time up-front premium in exchange for giving the holder the right to execute a contract under speciÑed terms, which generally puts us in a liability position. (6) Consists primarily of exchange-traded contracts and written options. Over time, our exposure to individual counterparties for OTC interest-rate swaps, option-based derivatives and foreign- currency swaps varies depending on changes in fair values, which are aÅected by changes in period-end interest rates, the implied volatility of interest rates, foreign-currency exchange rates and the amount of derivatives held. Our uncollateralized exposure to counterparties for these derivatives, after applying netting agreements and collateral, increased to $672 million at December 31, 2006 from $190 million at December 31, 2005. This increase was primarily due to a signiÑcant increase in uncollateralized exposure to AAA-rated counterparties, which typically are not required to post collateral given their low risk proÑle. At December 31, 2006, the uncollateralized exposure to non-AAA-rated counterparties was primarily due to uncollateralized exposure below the applicable counterparty collateral posting threshold as well as market movements during the time period between when a derivative was marked to fair value and the date we received the related collateral. Collateral is typically transferred within one business day based on the values of the related derivatives. As indicated in Table 36, approximately 93 percent of our counterparty credit exposure for OTC interest-rate swaps, option-based derivatives and foreign-currency swaps was collateralized at December 31, 2006. If all of our counterparties for these derivatives had defaulted simultaneously on December 31, 2006, our maximum loss for accounting purposes would have been approximately $672 million. Our economic loss, as measured by our potential additional uncollateralized exposure, may be higher than the uncollateralized exposure of our derivatives if we were not able to replace the defaulted derivatives in a timely fashion. We monitor the risk that our uncollateralized exposure to each of our OTC counterparties for interest-rate swaps, option-based derivatives and foreign-currency swaps will increase under certain adverse market 65 Freddie Mac conditions by performing daily market stress tests. These tests evaluate the potential additional uncollateralized exposure we would have to each of these derivative counterparties assuming changes in the level and implied volatility of interest rates and changes in foreign-currency exchange rates over a brief time period. To date, we have not incurred any credit losses on OTC derivative counterparties or set aside speciÑc reserves for institutional credit risk exposure. We do not believe such reserves are necessary, given our counterparty credit risk management policies and collateral requirements. OTC Forward Purchase and Sale Commitments Treated as Derivatives. Because the typical maturity of our OTC commitments is less than one year, we do not require master netting and collateral agreements for the counterparties of these commitments. However, we monitor the credit fundamentals of our OTC commitments counterparties on an ongoing basis to ensure that they continue to meet our internal risk-management standards. As indicated in Table 36, the exposure to OTC commitments counterparties of $24 million and $35 million at December 31, 2006 and 2005, respectively, was uncollateralized. Credit Risks Our credit guarantee portfolio is subject primarily to two types of credit risk: mortgage credit risk and institutional credit risk. Mortgage credit risk is the risk that a borrower will fail to make timely payments on a mortgage or security we own or guarantee. Institutional credit risk is the risk that a counterparty that has entered into a business contract or arrangement with us will fail to meet its obligations. See ""PORTFOLIO BALANCES AND ACTIVITIES Ì Table 47 Ì Total Mortgage Portfolio and Total Guaranteed PCs and Structured Securities Issued Based on Unpaid Principal Balances'' for more information on the composition of our Total mortgage portfolio. Mortgage Credit Risk Mortgage Credit Risk Management Strategies. Mortgage credit risk is primarily inÖuenced by the credit proÑle of the borrower on the mortgage, the features of the mortgage itself, the type of property securing the mortgage and the general economy. To manage our mortgage credit risk, we focus on three key areas: underwriting requirements and quality control standards; portfolio diversiÑcation; and portfolio management activities, including loss mitigation and the use of credit enhancements. While we have historically focused on obtaining credit enhancements at the time of mortgage purchase, we are continuing to expand our capabilities in this area to allow more active and ongoing credit portfolio rebalancing and risk transfers. Underwriting Requirements and Quality Control Standards. All mortgages that we purchase for our Retained portfolio or guarantee have an inherent risk of default. We seek to manage the underlying risk by adequately pricing for the risk we assume using our underwriting and quality control processes. We use a process of delegated underwriting for the single-family mortgages we purchase or securitize. In this process, we provide originators with a series of mortgage underwriting standards and the originators represent and warrant to us that the mortgages sold to us meet these requirements. We subsequently review a sample of these loans and, if we determine that any loan is not in compliance with our contractual standards, we may require the seller/servicer to repurchase that mortgage or make us whole in the event of a default. We provide originators with written standards and/or automated underwriting software tools, such as Loan Prospector» and other quantitative credit risk management tools that are designed to evaluate single-family mortgages and monitor the related mortgage credit risk for loans we may purchase. Loan Prospector» generates a credit risk classiÑcation by evaluating information on signiÑcant indicators of mortgage default risk, such as loan-to-value ratios, credit scores and other mortgage and borrower characteristics. These statistically-based risk assessment tools increase our ability to distinguish among single-family loans based on their expected risk, return and importance to our mission. In many cases, underwriting standards are tailored under contracts with individual customers. We have been expanding the share of mortgages we purchase that were underwritten by our seller/servicers using alternative automated underwriting systems or agreed-upon underwriting standards that diÅer from our system or guidelines. We regularly monitor the performance of mortgages purchased using these systems and standards, and if they underperform mortgages originated using Loan Prospector», we may seek additional guarantee fee compensation for future purchases of similar mortgages. The percentage of our single-family mortgage purchase volume evaluated using Loan Prospector» prior to purchase has declined over the last three years. As part of our post-purchase quality control review process, we use Loan Prospector» to evaluate the credit quality of virtually all single-family mortgages that were not evaluated by Loan Prospector» prior to purchase. Loan Prospector» risk classiÑcations inÖuence both the price we charge to guarantee loans and the loans we review in quality control. For multifamily mortgage loans, we use an intensive pre-purchase underwriting process for the mortgages we purchase, unless the mortgage loans have signiÑcant credit enhancements. Our underwriting process includes assessments of the local 66 Freddie Mac market, the borrower, the property manager, the property's historical and projected Ñnancial performance and the property's physical condition, which may include a physical inspection of the property. In addition to our own inspections, we rely on third-party appraisals and environmental and engineering reports. Beginning in 2007, we also expect to begin a program of delegated underwriting for certain multifamily mortgages we purchase or securitize. Credit Enhancements. Our charter requires that single-family mortgages with loan-to-value ratios above 80 percent at the time of purchase must be covered by one or more of the following: (a) primary mortgage insurance; (b) a seller's agreement to repurchase or replace any mortgage in default (for such period and under such circumstances as we may require); or (c) retention by the seller of at least a 10 percent participation interest in the mortgages. In addition, for some mortgage loans, we elect to share the default risk by transferring a portion of that risk to various third parties through a variety of other credit enhancements. In many cases, the lender's or third party's risk is limited to a speciÑc level of losses at the time the credit enhancement becomes eÅective. At December 31, 2006 and 2005, credit-enhanced single-family mortgages and mortgage-related securities represented approximately 16 percent and 17 percent of the $1,541 billion and $1,395 billion, respectively, unpaid principal balance of the Total mortgage portfolio, excluding non-Freddie Mac mortgage-related securities and that portion of issued Structured Securities that is backed by Ginnie Mae CertiÑcates. We exclude non-Freddie Mac mortgage-related securities because they expose us primarily to institutional credit risk. We exclude that portion of Structured Securities backed by Ginnie Mae CertiÑcates because the incremental credit risk to which we are exposed is considered de minimis. See ""CONSOLI- DATED BALANCE SHEETS ANALYSIS Ì Table 19 Ì Characteristics of Mortgage Loans and Mortgage-Related Securities in the Retained Portfolio'' for additional information about our non-Freddie Mac mortgage-related securities. Our ability and desire to expand or reduce the portion of our Total mortgage portfolio with credit enhancements will depend on our evaluation of the credit quality of new business purchase opportunities, the risk proÑle of our portfolio and the future availability of eÅective credit enhancements at prices that permit an attractive return. While the use of credit enhancements reduces our exposure to mortgage credit risk, it increases our exposure to institutional credit risk. Primary mortgage insurance is the most prevalent type of credit enhancement protecting our Total mortgage portfolio and is typically provided on a loan-level basis for certain single-family mortgages. Primary mortgage insurance transfers varying portions of the credit risk associated with a mortgage to a third-party insurer. The amount of insurance we obtain on any mortgage depends on our requirements and on our assessment of risk. We may from time to time agree with the insurer to reduce the amount of coverage that is in excess of our charter's minimum requirement and may also furnish certain services to the insurer in exchange for fees paid by the insurer. As is the case with credit enhancement agreements generally, these agreements often improve the overall value of purchased mortgages and thus may allow us to oÅer lower guarantee fees to sellers. The second most prevalent type of credit enhancement that we use is pool insurance. Pool insurance provides insurance on a pool of loans up to a stated aggregate loss limit. In addition to a pool-level loss coverage limit, some pool insurance contracts may have limits on coverage at the loan level. For pool insurance contracts that expire before the completion of the contractual term of the mortgage loan, we seek to ensure that the contracts cover the period of time during which we believe the mortgage loans are most likely to default. As of December 31, 2006 and 2005, in connection with PCs and Structured Securities backed by single-family mortgage loans, we had maximum coverage totaling $30.7 billion and $27.5 billion, respectively, in primary mortgage insurance. Other forms of credit enhancements on single-family mortgage loans include indemniÑcation agreements (under which we may require a lender to reimburse us for credit losses realized on mortgages), government guarantees, collateral (including cash or high-quality marketable securities) pledged by a lender, excess interest and subordinated security structures. As of December 31, 2006 and 2005, in connection with PCs and Structured Securities backed by single-family mortgage loans, we had maximum coverage totaling $8.9 billion and $5.6 billion, respectively, in recourse to lenders and $3.2 billion and $3.4 billion, respectively, in other credit enhancements. We occasionally use credit enhancements to mitigate risk on multifamily mortgages. The types of credit enhancements used for multifamily mortgage loans include recourse, third-party guarantees or letters of credit, cash escrows, subordinated participations in mortgage loans or structured pools, sharing of losses with sellers, and cross-default and cross- collateralization provisions. Cross-default and cross-collateralization provisions typically work in tandem. With a cross- default provision, if the loan on a property goes into default, we have the right to declare speciÑed other mortgage loans of the same borrower or certain of its aÇliates to be in default and to foreclose those other mortgages. In cases where the borrower agrees to cross-collateralization, we have the additional right to apply excess proceeds from the foreclosure of one mortgage to amounts owed to us by the same borrower or its speciÑed aÇliates relating to other multifamily mortgage loans we own. We also receive similar credit enhancements for multifamily PC Guarantor Swaps; for tax-exempt multifamily housing revenue bonds that support pass-through certiÑcates issued by third parties for which we provide our guarantee of the 67 Freddie Mac payment of principal and interest; for Freddie Mac pass-through certiÑcates that are backed by tax-exempt multifamily housing revenue bonds and related taxable bonds and/or loans; and for multifamily mortgage loans that are originated and held by state and municipal agencies to support tax-exempt multifamily housing revenue bonds for which we provide our guarantee of the payment of principal and interest. Portfolio DiversiÑcation. A key characteristic of our credit risk portfolio is diversiÑcation along a number of critical risk dimensions. We continually monitor a variety of mortgage loan characteristics such as product mix, loan-to-value ratios and geographic concentrations, which may aÅect the default experience on our overall mortgage portfolio. As part of our risk management practices, we have adopted a set of limits on our purchases and holdings of certain types of newer nontraditional mortgage products that are deemed to have higher risks or lack suÇcient historical experience to conÑdently forecast performance expectations over a full housing cycle. These newer loan products include interest-only loans and option ARMs, loans with high loan-to-value ratios, and mortgages originated with limited or no underwriting documentation. To improve our ability to fulÑll our mission, we have increased our participation in nontraditional mortgage market products. To that end, we issue Structured Securities backed by mortgage loans or mortgage-related securities using collateral pools transferred to trusts that were speciÑcally created for the purpose of issuing the securities. These trusts issue various senior interests, subordinated interests or both. We purchase senior interests of the trusts and simultaneously issue and guarantee Structured Securities backed by these interests. We refer to these Structured Securities as Structured Transactions. Although Structured Transactions generally have underlying mortgage loans with higher risk characteristics, they may aÅord us credit protection from losses due to the structure employed and other credit enhancement features. Product mix aÅects the credit risk proÑle of our Total mortgage portfolio. In general, 15-year amortizing Ñxed-rate mortgages exhibit the lowest default rate among the types of mortgage loans we securitize and purchase, due to the accelerated rate of principal amortization on these mortgages and the credit proÑles of borrowers who seek and qualify for them. The next lowest rate of default is associated with 30-year amortizing Ñxed-rate mortgages. In a rising interest environment, balloon/reset mortgages and ARMs typically default at a higher rate than Ñxed-rate mortgages, although default rates for diÅerent types of ARMs may vary. In the low interest rate environment experienced during 2006, 2005 and 2004, this trend was reversed with ARMs exhibiting lower default rates than Ñxed-rate mortgages. Table 37 provides the distribution of our Total mortgage portfolio. Table 37 Ì Product Distribution(1)(2) Unpaid Principal Balances related to: Guaranteed PCs and Structured Securities: December 31, 2006 2005 (dollars in millions) Single-family ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Multifamily ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Structured Securities backed by non-Freddie Mac mortgage-related securities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Mortgage loans in the Retained portfolio: Single-Family ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Multifamily ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total Unpaid Principal Balance ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $1,442,306 8,415 26,302 20,640 45,207 $1,542,870 $1,294,521 14,503 26,500 20,396 41,085 $1,397,005 Product Distribution Single-family 30-year amortizing Ñxed-rate(3) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 15-year amortizing Ñxed-rate ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ ARMs/Variable-rate ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Option ARMsÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Interest OnlyÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Balloon/Resets ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Other ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total single-familyÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Multifamily Conventional(4) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total multifamilyÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 63% 19 7 1 5 1 1 97% 3% 3% 100% 59% 23 8 1 2 2 1 96% 4% 4% 100% (1) Based on unpaid principal balances. (2) Excludes non-Freddie Mac mortgage-related securities held in our Retained portfolio other than those that underlie Freddie Mac Structured Securities. (3) Includes 40-year and 20-year Ñxed-rate mortgages. (4) Also includes Structured Transactions backed by multifamily collateral. 68 Freddie Mac During the past several years, there was a rapid proliferation of nontraditional mortgage product types designed to address a variety of borrower and lender needs, including issues of aÅordability and reduced income documentation requirements. While features of these products have been on the market for some time, their prevalence in the market and our Total mortgage portfolio increased in 2006 and 2005. See ""REGULATION AND SUPERVISION Ì OÇce of Federal Housing Enterprise Oversight Ì Nontraditional Mortgage Product Risks'' and ""RISK FACTORS Ì Legal and Regulatory Risks.'' We expect each of these products to default more often than traditional products and we consider this when determining our credit and guarantee fees. Our purchases of interest-only and option ARM mortgage products increased in 2006, representing approximately 18 percent of our Total mortgage portfolio purchases as compared to 11 percent in 2005. Despite this recent increase in purchases, these products represent a small percentage of the unpaid principal balance of our Total mortgage portfolio. At December 31, 2006 and 2005, interest-only and option ARMs collectively represented approximately 6 percent and 3 percent, respectively, of the unpaid principal balance of the Total mortgage portfolio. We will continue to monitor the growth of these products in our portfolio and, if appropriate, may seek credit enhancements to further manage the incremental risk. Interest-only and option ARM loans. These mortgages are designed to allow borrowers to have Öexibility in their payment terms. Interest-only mortgages allow the borrower to pay only interest for a Ñxed period of time before the loan begins to amortize. Option ARM loans permit a variety of repayment options, which include minimum, interest only, fully amortizing 30-year and fully amortizing 15-year payments. Minimum payment option loans allow the borrower to make monthly payments that are less than the interest accrued for the period. The unpaid interest, known as negative amortization, is added to the principal balance of the loan, which increases the outstanding loan balance. The amount of option ARM mortgages within our Total mortgage portfolio was 1 percent for both 2006 and 2005 and the amount of related negative amortization in both years was not material. We also hold securities issued by third parties where the underlying collateral may include interest-only and option ARM mortgage products. Delinquencies on total interest-only and option ARM products increased to 0.41 percent in 2006 from 0.08 percent in 2005. Mortgages generally have a lower rate of delinquency in the year in which they are originated. We generally mitigate credit risk inherent in these securities through a guarantee from the third party issuer or the underlying structure of the security. For additional information about the credit quality and credit risk management of non- Freddie Mac securities we hold see ""Institutional Credit Risk Ì Non-Freddie Mac Mortgage-Related Securities'' and ""CONSOLIDATED BALANCE SHEETS ANALYSIS Ì Retained Portfolio.'' Subprime loans. Participants in the mortgage market often characterize loans based upon their overall credit quality at the time of origination, generally considering them to be prime or subprime. There is no universally accepted deÑnition of subprime. The subprime segment of the mortgage market primarily serves borrowers with poorer credit payment histories and such loans typically have a mix of credit characteristics that indicate a higher likelihood of default and higher loss severities than prime loans. Such characteristics might include a combination of high loan-to-value ratios, low FICO scores or originations using lower underwriting standards such as limited or no documentation of a borrower's income. The subprime market helps certain borrowers by increasing the availability of mortgage credit. While we do not characterize the single-family loans underlying the PCs and Structured Securities in our credit guarantee portfolio as either prime or subprime, we believe that, based on lender-type, underwriting practice and product structure, the number of loans underlying these securities that are subprime is not signiÑcant. Also included in our credit guarantee portfolio are Structured Securities backed by non-agency mortgage-related securities where the underlying collateral was identiÑed as being subprime by the original issuer. At December 31, 2006 and 2005, the Structured Securities backed by subprime mortgages constituted approximately 0.1 percent and 0.2 percent, respectively of our credit guarantee portfolio. With respect to our Retained portfolio, we do not believe that any meaningful amount of the agency securities we hold is backed by subprime mortgages. However, at December 31, 2006 and 2005, we held approximately $124 billion and $139 billion, respectively, of non-agency mortgage-related securities backed by subprime loans. These securities include signiÑcant credit enhancement based on their structure and more than 99.9 percent of these securities were rated AAA at December 31, 2006. We announced on February 27, 2007 that we would implement stricter investment standards for certain subprime ARMs with short adjustment periods originated after September 1, 2007. First, we will only buy ARMs, and mortgage- related securities backed by those loans, for which borrowers have been qualiÑed at the fully-indexed and fully-amortizing rate in order to help protect these borrowers from the payment shock that could occur when the interest rates on their ARMs increase. Second, we will limit the use of low-documentation underwriting for these types of mortgages to help ensure that borrowers have the income necessary to aÅord their homes. 69 Freddie Mac Table 38 Ì Characteristics of Single-Family Total Mortgage Portfolio(1) Purchases During the Year Ended December 31, 2005 2004 2006 Ending Balance December 31, 2005 2006 2004 Original Loan-to-Value, or LTV, Ratio Range(2) Less than 60%ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Above 60% to 70% ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Above 70% to 80% ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Above 80% to 90% ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Above 90% to 100% ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ TotalÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Weighted average original loan-to-value ratio ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Estimated Current LTV Ratio Range(3)(4) Less than 60% ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Above 60% to 70% ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Above 70% to 80% ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Above 80% to 90% ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Above 90% to 100% ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Above 100% ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Weighted average estimated current LTV ratio ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Credit Score(5) 19% 21% 23% 16 14 50 54 7 7 6 6 100% 100% 100% 16 46 8 7 24% 25% 26% 17 16 44 46 8 7 6 7 100% 100% 100% 17 42 9 6 73% 71% 71% 70% 70% 70% 53% 56% 52% 18 17 18 18 6 8 2 3 Ì 1 100% 100% 100% 19 18 7 3 1 57% 56% 58% 740 and aboveÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 700 to 739 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 660 to 699 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 620 to 659 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Less than 620 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Not Available ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 42% 44% 41% 23 24 19 19 10 10 4 5 Ì Ì 100% 100% 100% 24 20 11 4 Ì 45% 45% 44% 23 23 18 18 9 9 4 4 1 1 100% 100% 100% 23 18 9 4 2 Weighted average credit score ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 720 722 719 725 725 723 Loan Purpose Purchase ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Cash-out reÑnance ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Other reÑnanceÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 53% 44% 40% 35 32 21 15 100% 100% 100% 27 33 37% 32% 28% 29 29 39 34 100% 100% 100% 27 45 Property Type 1 unit ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2-4 units ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 97% 97% 97% 3 3 100% 100% 100% 3 97% 97% 97% 3 3 100% 100% 100% 3 Occupancy Type Primary residenceÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Second/vacation home ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Investment ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 89% 91% 92% 5 6 4 5 100% 100% 100% 4 4 92% 93% 94% 4 5 3 3 100% 100% 100% 3 3 (1) Purchases and ending balances are based on the unpaid principal balance of the single-family mortgage portfolio (excluding certain Structured Securities that are backed by non-Freddie Mac mortgage-related securities). Such purchases included in the data totaled $358 billion, $396 billion and $360 billion at December 31, 2006, 2005 and 2004, respectively. Such ending balances included in the data totaled $1,482 billion, $1,333 billion and $1,203 billion at December 31, 2006, 2005 and 2004, respectively. (2) Our charter requires that mortgage loans purchased with loan-to-value ratios above 80 percent be covered by mortgage insurance or other credit enhancements. (3) Current market values are estimated by adjusting the value of the property at origination based on changes in the market value of homes since origination. Estimated current LTV excludes Structured Transactions and option ARMs. Estimated current LTV ratio range is not applicable to purchases made during the year. (4) 2005 and 2004 ratios have been revised to conform to the current year presentation. (5) Credit score data are as of mortgage loan origination. Loan-to-Value Ratios. An important safeguard against credit losses for mortgage loans in our single-family, non- credit-enhanced portfolio is provided by the borrowers' equity in the underlying properties. Mortgage loans with higher loan- to-value ratios (and therefore lower levels of borrower equity) at the time of purchase are also protected by credit enhancements, because our charter requires that loans with loan-to-value ratios above 80 percent at the time of purchase be covered by mortgage insurance or certain other credit protections. The likelihood of single-family mortgage default depends not only on the initial credit quality of the loan, but also on events that occur after origination. Accordingly, we monitor changes in home prices across the country and the impact of 70 Freddie Mac these home price changes on the underlying loan-to-value ratio of mortgages in our portfolio. While home prices rose signiÑcantly over the previous 10 years, this growth has slowed signiÑcantly in 2006 and home prices have declined in some parts of the United States. Home price appreciation over the past several years has increased the values of properties underlying the mortgages in our portfolio. We monitor regional geographic markets for changes in these trends, particularly with respect to new loans originated in regional markets that have had signiÑcant home price appreciation, and we may seek to reinsure a portion of this risk should we determine that the possibility of such changes warrants action. Historical experience has shown that defaults are less likely to occur on mortgages with lower estimated current loan-to-value ratios. In the event of a default, lower loan-to-value ratios generally reduce the total amount of loss, thereby mitigating credit losses. Credit Score. Credit scores are a useful measure for assessing the credit quality of a borrower. Credit scores are numbers reported by credit repositories, based on statistical models, that summarize an individual's credit record and predict the likelihood that a borrower will repay future obligations as expected. FICO» scores, developed by Fair, Isaac and Co., Inc., are the most commonly used credit scores today. FICO» scores are ranked on a scale of approximately 300 to 850 points. Statistically, consumers with higher credit scores are more likely to repay their debts as expected than those with lower scores. At December 31, 2006, 2005 and 2004, the weighted average credit score for the Total mortgage portfolio (based on the credit score at origination) remained high at 725, 725 and 723, respectively, indicating borrowers with strong credit quality. Loan Purpose. Mortgage loan purpose indicates how the borrower intends to use the funds from a mortgage loan. The three general categories are: purchase, cash-out reÑnance and other reÑnance. In a purchase transaction, funds are used to acquire a property. In a cash-out reÑnance transaction, in addition to paying oÅ an existing Ñrst mortgage lien, the borrower obtains additional funds that may be used for other purposes, including paying oÅ subordinate mortgage liens and providing unrestricted cash proceeds to the borrower. In other reÑnance transactions, the funds are used to pay oÅ an existing Ñrst mortgage lien and may be used in limited amounts for certain speciÑed purposes; such reÑnances are generally referred to as ""no cash-out'' or ""rate and term'' reÑnances. Other reÑnance transactions also include reÑnance mortgages for which the delivery data provided was not suÇcient for us to determine whether the mortgage was a cash-out or a no cash-out reÑnance transaction. The portion of our single-family mortgage purchases that were reÑnance-related declined in 2006 as interest rates increased during the year. Given similar loan characteristics (e.g., loan-to-value ratios), purchase transactions have the lowest likelihood of default followed by no cash-out reÑnances and then cash-out reÑnances. As a practical matter, however, no cash-out reÑnances tend to have lower loan-to-value ratios, borrowers with higher credit scores and better overall performance than purchase transactions. Property Type. Single-family mortgage loans are deÑned as mortgages secured by housing with up to four living units. Mortgages on one-unit properties tend to have lower credit risk than mortgages on multiple-unit properties. Occupancy Type. Borrowers may purchase a home as a primary residence, second/vacation home or investment property that is typically a rental property. Mortgage loans on properties occupied by the borrower as a primary or secondary residence tend to have a lower credit risk than mortgages on investment properties. Geographic Concentration. Because our business involves purchasing mortgages from every geographic region in the U.S., we maintain a geographically diverse mortgage portfolio. This diversiÑcation generally mitigates credit risks arising from changing local economic conditions. Our Total mortgage portfolio's geographic distribution was relatively stable from 2004 to 2006, and remains broadly diversiÑed across these regions. See ""NOTE 17: CONCENTRATION OF CREDIT AND OTHER RISKS'' to our consolidated Ñnancial statements for more information concerning the distribution of our Total mortgage portfolio by geographic region. Loss Mitigation Activities. Loss mitigation activities are a key component of our strategy for managing and resolving troubled assets and lowering credit losses. Our single-family loss mitigation strategy emphasizes early intervention in delinquent mortgages and providing alternatives to foreclosure. Other single-family loss mitigation activities include providing our single-family servicers with default management tools designed to help them manage non-performing loans more eÅectively and support fulÑllment of our mission by assisting borrowers in retaining home ownership. Foreclosure alternatives are intended to reduce the number of delinquent mortgages that proceed to foreclosure and, ultimately, mitigate our total credit losses by eliminating a portion of the costs related to foreclosed properties and avoiding the credit loss in REO. Repayment plans, the most common type of foreclosure alternative, mitigate our credit losses because they assist borrowers in returning to compliance with the original terms of their mortgages. Forbearance agreements, the second most common type of foreclosure alternative, provide a temporary suspension of the foreclosure process to allow additional time for the borrower to return to compliance with the original terms of the borrower's mortgage or to implement another foreclosure alternative. Loan modiÑcations, the third most common type of foreclosure alternative, involve changing the terms of a mortgage, such as the loan term. The total number of loans with foreclosure alternatives was approximately 59,100, 60,000 and 48,300 for the years ended December 31, 2006, 2005 and 2004, respectively. In 2005, the total number of 71 Freddie Mac loans with foreclosure alternatives increased as forbearance agreements were extended to single-family borrowers aÅected by Hurricane Katrina in an eÅort to mitigate the risk of default and foreclosure and assist impacted borrowers. In 2006, the number of loans with foreclosure alternatives declined slightly as loans previously subject to forbearance either resumed payments, paid-oÅ or defaulted. However, the number of loans with foreclosure alternatives in the North Central region of the U.S., which has been adversely aÅected by a downturn in the automotive industry, increased. We require multifamily seller/servicers to closely manage mortgage loans they have sold us in order to mitigate potential losses. For loans over $1 million, servicers must generally submit an annual assessment of the mortgaged property to us based on the servicer's analysis of Ñnancial and other information about the property and, except for certain higher performing loans, an inspection of the property. We evaluate these assessments internally and may direct the servicer to take speciÑc actions to reduce the likelihood of delinquency or default. If a loan defaults despite this intervention, we may oÅer a foreclosure alternative to the borrower. For example, we may modify the terms of a multifamily mortgage loan, which gives the borrower an opportunity to bring the loan current and retain ownership of the property. Because multifamily seller/servicers are an important part of our loss mitigation process, we rate their performance regularly and conduct on-site reviews of their servicing operations to conÑrm compliance with our standards. Within our Total mortgage portfolio, our pricing reÖects our expectation that some mortgage loans will become non- performing due to changes in general economic conditions, the Ñnancial status of individual borrowers or other factors. Table 39 summarizes our non-performing assets. Table 39 Ì Non-Performing Assets Troubled debt restructuring: Reperforming or less than 90 days delinquent(1)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Serious delinquencies(2) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total troubled debt restructuring ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Other serious delinquencies(3) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Non-accrual multifamily loans(4) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Subtotal(5) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ REO, net(6) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ TotalÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Detail of other serious delinquencies:(7) Retained and repurchased mortgage loans(2)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Loans underlying outstanding PCs and Structured Securities(8) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Loans underlying outstanding Structured Transactions(9) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total serious delinquencies(3) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2006 $2,633 470 3,103 5,700 Ì 8,803 743 $9,546 $2,982 1,721 997 $5,700 Based on unpaid principal balance December 31, 2004 (in millions) 2005 2003 $1,807 490 2,297 6,318 27 8,642 741 $9,383 $ 1,874 496 2,370 7,470 21 9,861 795 $10,656 $2,108 497 2,605 6,438 1 9,044 629 $9,673 $2,889 2,100 1,449 $6,438 2002 $1,776 388 2,164 6,830 47 9,041 594 $9,635 (1) Includes previously delinquent loans whose terms have been modiÑed. (2) Includes single-family loans 90 days or more delinquent. We fully reserve current period accruals for mortgages greater than 120 days delinquent. For serious delinquencies in restructurings, we also fully reserve all uncollected interest after a mortgage becomes 90 days delinquent. (3) Includes single-family loans 90 days or more delinquent and not in troubled debt restructurings. For multifamily loans, the population includes all loans 60 days or more delinquent but less than 90 days delinquent. Also included are multifamily loans greater than 90 days past due but where principal and interest are being paid to us under the terms of a credit enhancement agreement. For more information about delinquency rates, see ""Table 6.3 Ì Delinquency Performance'' in ""NOTE 6: LOAN LOSS RESERVES'' to our consolidated Ñnancial statements. (4) Non-accrual mortgage loans are loans for which interest income is recognized only on a cash basis and only include multifamily loans that are 90 days or more delinquent. No single-family mortgage loans in our Retained portfolio are classiÑed as non-accrual, since we generally begin establishing reserves for current accruals after 90 days delinquency. (5) For the year ended December 31, 2006, $481 million was included in Net interest income and Management and guarantee income related to these mortgage loans. The amount of forgone net interest income and additional management and guarantee income that we would have recorded had these loans been current is $34 million for the year ended December 31, 2006. (6) For more information about REO balances, see ""NOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES'' and ""NOTE 7: REAL ESTATE OWNED'' to our consolidated Ñnancial statements. (7) Detail of other serious delinquencies is not available for 2004, 2003 and 2002. (8) Includes mortgages greater than 90 days, but generally less than 120 days, delinquent. Once a loan is delinquent for 120 days it is generally repurchased out of the security and becomes part of our Retained portfolio. (9) Consists of mortgages 90 days or more delinquent that underlie the non-agency securities that back our Structured Transactions. Total non-performing assets declined during 2006 as many of the mortgages aÅected by Hurricane Katrina in 2005 have resumed payments following the forbearance period we oÅered and others were modiÑed from their original terms to help borrowers avoid foreclosure. Many of these loans were reported as serious delinquencies at the end of 2005, but have been reclassiÑed to troubled debt restructuring in 2006, as a result of loss mitigation activities. In addition, the increase in the REO balance is attributable to lower turnover caused by slower disposition of properties in the North Central region as well as an increase in market values of the new REO inventory due to appreciation in all regions over the last few years. The increase in troubled debt restructurings and serious delinquencies from 2004 to 2005 was in part a result of the eÅects of Hurricane Katrina as well as increases in the North Central region. 72 Freddie Mac Other Credit Risk Management Activities. To compensate us for unusual levels of risk in some mortgage products, we may charge incremental fees above a base guarantee fee calculated based on credit risk factors such as the mortgage product type, loan purpose, loan-to-value ratio, and other loan or borrower attributes. In addition, we occasionally use Ñnancial incentives and credit derivatives, as described below, in situations where we believe they will beneÑt our credit risk management strategy. These arrangements are intended to reduce our credit-related expenses, thereby improving our overall returns. In some cases, we provide Ñnancial incentives in the form of lump sum payments to selected seller/servicers if they deliver a speciÑed volume or percentage of mortgage loans meeting speciÑed credit risk standards over a deÑned period of time. These Ñnancial incentives may also take the form of a fee payable to us by the seller if the mortgages delivered to us do not meet certain credit standards. We have also entered into credit derivatives, including risk-sharing agreements. Under these risk-sharing agreements, default losses on speciÑc mortgage loans delivered by sellers are compared to default losses on reference pools of mortgage loans with similar characteristics. Based upon the results of that comparison, we remit or receive payments based upon the default performance of the speciÑed mortgage loans. These agreements are accounted for as credit derivatives rather than Ñnancial guarantees, in part, because we may make payments to the seller/servicer under these agreements (depending upon actual default experience over the lives of the mortgages). The total notional amount of mortgage loans subject to these agreements was approximately $1.9 billion and $2.4 billion at December 31, 2006 and 2005, respectively. In addition, the total notional amount of mortgage loans in other credit derivatives was approximately $0.7 billion and $Ì billion at December 31, 2006 and 2005, respectively. All credit derivatives were classiÑed as no hedge designation. The fair value of these credit derivatives was not material at either December 31, 2006 or 2005. Although these arrangements are part of our overall credit risk management strategy, we have not treated them as credit enhancements for purposes of describing our Total mortgage portfolio characteristics because the risk-sharing and credit derivative agreements may result in us making payments to the seller/servicer. Delinquencies. We report single-family delinquency information based on the number of single-family mortgages that are 90 days or more past due or in foreclosure. For multifamily loans, we report the delinquency when payment is 60 days or more past due. Delinquencies on mortgage loans underlying Structured Transactions may be categorized as delinquent on a diÅerent schedule than other mortgage loans due to variances in industry practice. We include all the single-family loans that we own and those that are collateral for our PCs and Structured Securities, including those with signiÑcant credit enhancement, in the calculation of delinquency information; however, we exclude that portion of Structured Securities that is backed by Ginnie Mae CertiÑcates and certain Structured Transactions where delinquency data on the underlying mortgage-related securities is not available. The Structured Transactions we have excluded represented 0.06 percent, 0.04 percent and 0.07 percent of our Total mortgage portfolio at December 31, 2006, 2005 and 2004, respectively, and these securities were shadow rated AAA at the initial securitization. Shadow ratings are credit assessments performed by a rating agency at time of origination, but are not published nor subsequently monitored. Multifamily delinquencies may include mortgage loans where the borrowers are not paying as agreed, but principal and interest are being paid to us under the terms of a credit enhancement agreement. Table 40 presents delinquency information for the single-family loans underlying our Total mortgage portfolio. Table 40 Ì Single-Family Ì Delinquency Rates Ì By Region(1) Northeast(2) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Southeast(2) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ North Central(2) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Southwest(2)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ West(2) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total non-credit-enhanced Ì all regions(3) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total credit-enhanced Ì all regions(3) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total credit-enhanced and non-credit-enhanced Ì all regions(3)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ December 31, 2005 2004 2006 0.24% 0.22% 0.24% 0.38 0.30 0.30 0.32 0.64 0.26 0.11 0.12 0.30 0.25 1.86 2.46 0.53% 0.69% 0.73% 0.31 0.27 0.26 0.15 0.24 2.75 (1) Region Designation: West (AK, AZ, CA, GU, HI, ID, MT, NV, OR, UT, WA); Northeast (CT, DE, DC, MA, ME, MD, NH, NJ, NY, PA, RI, VT, VA, WV); North Central (IL, IN, IA, MI, MN, ND, OH, SD, WI); Southeast (AL, FL, GA, KY, MS, NC, PR, SC, TN, VI); Southwest (AR, CO, KS, LA, MO, NE, NM, OK, TX, WY). Beginning in 2005, Puerto Rico and Virgin Islands were reclassiÑed from Northeast to Southeast. (2) Based on mortgage loans in the Retained portfolio and Total Guaranteed PCs and Structured Securities Issued, excluding that portion of Structured Securities that is backed by Ginnie Mae CertiÑcates and Structured Transactions. (3) Based on mortgage loans in the Retained portfolio and Total Guaranteed PCs and Structured Securities Issued, excluding that portion of Structured Securities that is backed by Ginnie Mae CertiÑcates. Our total single-family delinquency rate has declined over the past three years, with some regional variation, reÖecting generally strong economic conditions and strong, but recently slowing, home price appreciation. 73 Freddie Mac Both our total credit-enhanced and total non-credit-enhanced delinquency rates improved in 2006. Many of the loans in the Southwest and Southeast regions that were aÅected by Hurricane Katrina, and were delinquent at the end of 2005, resumed payments following the forbearance period we oÅered and others were modiÑed from their original terms to help borrowers avoid foreclosure. Excluding the loans aÅected by Hurricane Katrina, our total non-credit-enhanced delinquency rate at December 31, 2006 was unchanged from December 31, 2005. However, the total non-credit-enhanced delinquency rate for the North Central region rose in 2006, primarily due to a regional economic downturn. In addition to the improvement attributable to loans aÅected by Hurricane Katrina, our total credit-enhanced delinquency rate declined as the number of loans added to the portfolio increased. The delinquency rates on new loans are generally lower than more seasoned loans and we expect that delinquency rates for these loans will increase as they age. Our multifamily delinquency rate remained very low at 0.05 percent, zero percent and 0.06 percent at the end of 2006, 2005 and 2004, respectively. Hurricane Katrina has not aÅected our reported multifamily delinquency rate because the contractual terms of certain aÅected mortgage loans, with unpaid principal balances totaling $149 million at December 31, 2006, were modiÑed. Table 41 Ì Single-Family Mortgages By Year of Origination Ì Percentage of Mortgage Portfolio and Non-Credit- Enhanced Delinquency Rates(1) Year of Origination Pre-1999 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 1999ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2000ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2001ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2002ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2003ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2004ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2005ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2006ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ At December 31, (1) Excludes Structured Transactions. Percent of Single-Family UPB Balance 3% 1 G1 3 9 26 16 23 19 100% 2006 Non-Credit- Enhanced Delinquency Rate 0.57% 0.67 1.83 0.60 0.32 0.15 0.22 0.19 0.09 0.25% December 31, 2005 Percent of Single-Family UPB Balance 5% 1 G1 4 11 34 21 24 Ì 100% Non-Credit- Enhanced Delinquency Rate 0.70% 0.89 2.09 0.75 0.38 0.17 0.21 0.08 Ì 0.30% Percent of Single-Family UPB Balance 7% 2 1 6 16 44 24 Ì Ì 100% 2004 Non-Credit- Enhanced Delinquency Rate 0.61% 0.78 1.94 0.59 0.26 0.06 0.03 Ì Ì 0.24% Our single-family portfolio was aÅected by heavy reÑnance volumes in recent years. At December 31, 2006, approximately 58 percent of our single-family mortgage portfolio consisted of mortgage loans originated in 2006, 2005 or 2004. Mortgage loans originated in 2003 and earlier, which represent approximately 42 percent of our single-family mortgage portfolio, have delinquency rates that are generally higher than the overall portfolio delinquency rate due to the natural aging of the loans and, in some instances, the weaker credit quality of these loans. The Ñrst year delinquency rate associated with new originations increased in each of the last three years due to a number of factors, including the expansion of credit terms under which loans are underwritten and an increase in our purchases of variable-rate and non-traditional mortgage products that have higher inherent credit risk than traditional Ñxed-rate mortgage products. 74 Freddie Mac Table 42 Ì Single-Family Ì Delinquency Rates Ì By Product 2006 Non-Credit-Enhanced, December 31, 2005 2004 Percent of Number of Single- Family Loans Percent of Number of Single- Family Loans Percent of Number of Single- Family Loans Delinquency Rate Delinquency Rate Delinquency Rate Conventional: 30-year amortizing Ñxed rate(1)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 15-year amortizing Ñxed rateÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ ARMs/Variable rate ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Interest Only ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Balloon/Resets ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total Mortgage Loans, PCs and Structured Securities ÏÏÏÏÏÏÏÏÏÏÏ Structured Transactions ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total Mortgage Portfolio ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 55% 34 6 3 1 99 1 100% 0.31% 0.14% 0.26% 0.30% 0.19% 0.25% 0.26% 0.25% Number of single-family loans (in millions)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 9.22 52% 38 6 1 2 99 1 100% 8.67 0.40% 0.19% 0.23% 0.04% 0.19% 0.30% 0.08% 0.30% 49% 42 7 Ì 2 100 Ì 100% 8.19 0.36% 0.12% 0.17% Ì 0.12% 0.24% Ì 0.24% 2006 Credit-Enhanced(2), December 31, 2005 2004 Percent of Number of Single- Family Loans Percent of Number of Single- Family Loans Percent of Number of Single- Family Loans Delinquency Rate Delinquency Rate Delinquency Rate Conventional: 30-year amortizing Ñxed rate(1)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 15-year amortizing Ñxed rateÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ ARMs/Variable rate ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Interest Only ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Balloon/Resets ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ FHA/VAÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Rural Housing Service and other federally guaranteed loans ÏÏÏÏ Total Mortgage Loans, PCs and Structured Securities ÏÏÏÏÏÏÏÏÏÏÏ Structured Transactions(3) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total Mortgage Portfolio ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 76% 7 6 3 1 2 1 96 4 100% 1.32% 0.64% 1.24% 1.05% 0.98% 2.99% 2.65% 1.30% 14.82% 1.86% Number of single-family loans (in millions)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 1.94 73% 9 7 2 1 2 1 95 5 100% 1.91 1.74% 0.81% 1.08% 0.23% 0.91% 4.03% 3.34% 1.61% 19.19% 2.46% 71% 11 7 Ì 1 2 1 93 7 100% 1.99 1.69% 0.53% 0.81% Ì 0.63% 3.88% 3.20% 1.53% 19.24% 2.75% 2006 Total, December 31, 2005 2004 Percent of Number of Single- Family Loans Percent of Number of Single- Family Loans Delinquency Rate Percent of Number of Single- Family Loans Delinquency Rate Delinquency Rate Conventional: 30-year amortizing Ñxed rate(1)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 15-year amortizing Ñxed rateÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ ARMs/Variable rate ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Interest Only ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Balloon/Resets ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ FHA/VAÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Rural Housing Service and other federally guaranteed loans ÏÏÏÏ Total Mortgage Loans, PCs and Structured Securities ÏÏÏÏÏÏÏÏÏÏÏ Structured Transactions(3) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total Mortgage Portfolio ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 60% 29 6 3 1 G 1 G 1 99 1 100% 0.54% 0.16% 0.44% 0.44% 0.25% 2.99% 2.65% 0.42% 7.71% 0.53% Number of single-family loans (in millions)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Net Charge-oÅs (dollars in millions) Mortgage Loans, PCs and Structured Securities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Structured Transactions(3) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total Mortgage Portfolio ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 11.16 $ 141 1 $ 142 56% 33 6 1 2 G 1 G 1 98 2 100% 10.58 $ 101 Ì $ 101 0.72% 0.22% 0.40% 0.10% 0.25% 4.03% 3.34% 0.53% 10.79% 0.69% 53% 36 7 Ì 2 G1 G1 98 2 100% 10.18 $ 140 Ì $ 140 0.71% 0.15% 0.31% Ì 0.17% 3.88% 3.20% 0.48% 16.01% 0.73% (1) Includes 40-year and 20-year Ñxed-rate mortgages. (2) Credit-enhanced loans are primarily those mortgage loans for which a third party has primary default risk. The total credit-enhanced unpaid principal balance as of December 31, 2006, 2005 and 2004 was $266 billion, $253 billion and $248 billion, respectively, for which the maximum coverage of third party primary liability was $58 billion, $53 billion and $52 billion, respectively. (3) Structured Transactions generally have underlying mortgage loans with higher risk characteristics but provide inherent credit protection from losses due to the structure employed, including subordination, excess interest, overcollateralization and other features. 75 Freddie Mac Credit Loss Performance. Table 43 provides detail on our credit loss performance, including REO activity, charge-oÅs and credit losses. Table 43 Ì Credit Loss Performance REO REO balances: 2006 Year Ended December 31, 2005 (dollars in millions) 2004 Single-family ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ MultifamilyÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ $ 734 9 743 $ $ 611 18 629 $ $ 740 1 741 REO activity (number of properties):(1) Beginning property inventory, at January 1 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Properties acquired ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Properties disposed ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Ending property inventory, at December 31 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Average holding period (in days)(2) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 8,070 16,387 (15,672) 8,785 9,604 15,861 (17,395) 8,070 9,170 18,489 (18,055) 9,604 175 186 177 (61) $ 1 (60) $ (40) $ Ì (40) $ (1) 4 3 REO operations income (expense): Single-family ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ MultifamilyÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ CHARGE-OFFS Single-family: Foreclosure alternatives, gross ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Recoveries(3)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Foreclosure alternatives, net ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ REO acquisitions, gross ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Recoveries(3)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ REO acquisitions, net ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Single-family totals: Charge-oÅs, grossÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Recoveries(3)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Single-family charge-oÅs, net ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Multifamily: Charge-oÅs, grossÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Recoveries(3)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Multifamily charge-oÅs, net ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ $ $ (50) $ (44) $ 11 (39) (258) 155 (103) (308) 166 (142) (5) Ì (5) 23 (21) (242) 162 (80) (286) 185 (101) (8) Ì (8) Total Charge-oÅs: Charge-oÅs, grossÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (313) (294) Recoveries: Related to primary mortgage insuranceÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Not related to primary mortgage insurance ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total recoveries(3) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Charge-oÅs, net ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ CREDIT LOSSES(4) Single-family ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ MultifamilyÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ In basis points:(5) Single-family ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ MultifamilyÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 112 54 166 (147) $ 119 66 185 (109) $ (203) $ (4) (207) $ (141) $ (8) (149) $ $ $ $ (1.4) Ì (1.4) (1.1) Ì (1.1) (47) 21 (26) (253) 139 (114) (300) 160 (140) Ì Ì Ì (300) 85 75 160 (140) (141) 4 (137) (1.1) Ì (1.1) (1) Includes single-family and multifamily REO properties. (2) Represents weighted average holding period for single-family and multifamily properties based on number of REO properties disposed. (3) Includes recoveries of charge-oÅs primarily resulting from foreclosure alternatives and REO acquisitions on loans where a share of default risk has been assumed by mortgage insurers, servicers, or other third parties through credit enhancements. Recoveries of charge-oÅs through credit enhancements are limited in some instances to amounts less than the full amount of the loss. (4) Equal to REO operations income (expense) plus Charge-oÅs, net. (5) Calculated as credit losses divided by the average Total mortgage portfolio, excluding non-Freddie Mac mortgage-related securities and that portion of Structured Securities that is backed by Ginnie Mae CertiÑcates. Table 44 and Table 45 provide detail by region for two credit performance statistics, REO activity and charge-oÅs. Regional REO acquisition and charge-oÅ trends generally follow a pattern that is similar to, but lags, that of regional delinquency trends. Increases in the volume of REO properties in the North Central region were driven by impacts to borrowers aÅected by an economic downturn and weakening housing markets within the region. 76 Freddie Mac Table 44 Ì REO Activity By Region(1) 2006 Year Ended December 31, 2005 (number of properties) 2004 REO Inventory Beginning property inventory ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Properties acquired by region: NortheastÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ SoutheastÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ North Central ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Southwest ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ WestÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total properties acquired ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Properties disposed by region: NortheastÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ SoutheastÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ North Central ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Southwest ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ WestÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total properties disposed ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Ending property inventory ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 8,070 9,604 9,170 1,253 3,970 7,237 3,497 430 16,387 (1,260) (4,132) (6,294) (3,441) (545) (15,672) 8,785 1,306 4,504 5,790 3,412 849 15,861 (1,384) (5,221) (5,715) (3,820) (1,255) (17,395) 8,070 1,500 5,499 5,787 3,926 1,777 18,489 (1,562) (5,596) (5,111) (3,605) (2,181) (18,055) 9,604 (1) See ""Table 40 Ì Single-Family Ì Delinquency Rates Ì By Region'' for a description of these regions. Table 45 Ì Single-Family Charge-oÅs and Recoveries By Region(1)(2) Year Ended December 31, 2006 Charge-oÅs, gross Recoveries Charge-oÅs, net Charge-oÅs, gross Northeast ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Southeast ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ North CentralÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Southwest ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ West ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 22 72 133 73 8 $308 $ (9) (42) (66) (44) (5) $(166) $ 13 30 67 29 3 $142 $ 21 76 102 68 19 $286 2005 Recoveries (in millions) $ (10) (54) (66) (44) (11) $(185) Charge-oÅs, net Charge-oÅs, gross Recoveries Charge-oÅs, net 2004 $ 11 22 36 24 8 $101 $ 24 84 92 66 34 $300 $ (10) (49) (49) (35) (17) $(160) $ 14 35 43 31 17 $140 (1) See ""Table 40 Ì Single-Family Ì Delinquency Rates Ì By Region'' for a description of these regions. (2) Includes recoveries of charge-oÅs primarily resulting from foreclosure alternatives and REO acquisitions on loans where a share of default risk has been assumed by mortgage insurers, servicers, or other third parties through credit enhancements. Recoveries of charge-oÅs through credit enhancements are limited in some instances to amounts less than the full amount of the loss. Single-family charge-oÅs, gross, increased in 2006 primarily due to a modest increase in the volume of REO properties acquired at foreclosure, as noted in Table 44. We maintain two loan loss reserves Ì Reserve for losses on mortgage loans held-for-investment and Reserve for guarantee losses on Participation CertiÑcates Ì at levels we deem adequate to absorb probable incurred losses on mortgage loans held-for-investment in the Retained portfolio and certain mortgages underlying PCs held by third parties. See ""CRITICAL ACCOUNTING POLICIES AND ESTIMATES Ì Credit Losses,'' ""NOTE 1: SUMMARY OF SIG- NIFICANT ACCOUNTING POLICIES'' and ""NOTE 6: LOAN LOSS RESERVES'' to our consolidated Ñnancial statements for further information. Table 46 summarizes our loan loss reserves activity for both of our reserves in total. 77 Freddie Mac Table 46 Ì Loan Loss Reserves Activity Total loan loss reserves:(1) Beginning balance ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Provision (beneÑt) for credit losses ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Charge-oÅs, grossÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Recoveries(2) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Charge-oÅs, net ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Adjustment for change in accounting(3) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Transfers-outÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Other transfers, net(4) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Ending balanceÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Charge-oÅs, net to Total mortgage portfolio(5)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Coverage ratio (reserves to charge-oÅs, net) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2006 2005 Year Ended December 31, 2004 (dollars in millions) 2003 2002 $ 414 215 (313) 166 (147) Ì (71) 9 $ 420 $ 264 251 (294) 185 (109) Ì (11) 19 $ 414 $ 299 143 (300) 160 (140) Ì (20) (18) $ 264 $ 265 (5) (224) 145 (79) 110 (11) 19 $ 299 $ 224 122 (171) 99 (72) Ì (9) Ì $ 265 1.0 bps 2.9 0.8 bps 3.8 1.1 bps 1.9 0.7 bps 3.8 0.7 bps 3.7 (1) Includes Reserves for loans held-for-investment in the Retained portfolio and Reserves for guarantee losses on Participation CertiÑcates. (2) Includes recoveries of charge-oÅs primarily resulting from foreclosure alternatives and REO acquisitions on loans where a share of default risk has been assumed by mortgage insurers, servicers or third parties through credit enhancements. Recoveries of charge-oÅs through credit enhancements are limited in some instances to amounts less than the full amount of the loss. (3) On January 1, 2003, $110 million of recognized Guarantee obligation attributable to estimated incurred losses on outstanding PCs or Structured Securities was reclassiÑed to Reserve for guarantee losses on Participation CertiÑcates. (4) Represents the portion of the Guarantee obligation recognized through Guarantor Swap transactions or upon the sale of PCs and Structured Securities that corresponds to incurred credit losses reclassiÑed to Reserve for guarantee losses on Participation CertiÑcates upon initial recognition of a Guarantee obligation. In addition, the amount includes an increase (reduction) of loan loss reserves of $9 million and $(31) million in 2005 and 2004, respectively, related to prior period adjustments for which the related income was recorded in Other income. (5) Calculated using the average Total mortgage portfolio, excluding non-Freddie Mac mortgage-related securities and that portion of Structured Securities that is backed by Ginnie Mae CertiÑcates. Our total loan loss reserves increased in 2006 as additional reserves we recorded to reÖect incurred losses related to our single-family portfolio were partly oÅset by the reversal of $82 million of the Provision for credit losses recorded in 2005 associated with Hurricane Katrina. The increase in loan loss reserves during 2005 was primarily related to our estimate of incurred losses associated with Hurricane Katrina which was $128 million at December 31, 2005. See ""CONSOLIDATED RESULTS OF OPERATIONS Ì Non-Interest Expense Ì Provision for Credit Losses,'' for additional information. Credit Risk Sensitivity. Our credit risk sensitivity analysis assesses the assumed increase in the present value of expected single-family mortgage portfolio credit losses over ten years as the result of an estimated immediate 5 percent decline in home prices nationwide, followed by a return to more normal growth in home prices based on historical experience. We use an internally developed Monte Carlo simulation-based model to generate our credit risk sensitivity analyses. The Monte Carlo model uses a simulation program to generate numerous potential interest-rate paths that, in conjunction with a prepayment model, are used to estimate mortgage cash Öows along each path. In the credit risk sensitivity analysis, we adjust the home-price assumption used in the base case to estimate the level and sensitivity of potential credit costs resulting from a sudden decline in home prices. Our credit risk sensitivity results are presented in ""RISK MANAGEMENT AND DISCLOSURE COMMITMENTS.'' Institutional Credit Risk Our primary institutional credit risk exposure, other than counterparty credit risk exposure relating to derivatives, arises from agreements with the following entities: mortgage loan insurers; mortgage seller/servicers; issuers, guarantors or third party providers of credit enhancements on non-Freddie Mac mortgage-related securities held in our Retained portfolio; mortgage investors and originators; and issuers, guarantors and insurers of investments held in our Cash and investments portfolio. See ""RISK MANAGEMENT Ì Interest-Rate Risk and Other Market Risks Ì Use of Derivatives and Interest- Rate Risk Management'' for information concerning counterparty credit risk exposure relating to derivatives. Mortgage Loan Insurers. We have institutional credit risk relating to the potential insolvency or non-performance of mortgage insurers that insure mortgages we purchase or guarantee. We manage this risk by establishing eligibility standards for mortgage insurers and by regularly monitoring our exposure to individual mortgage insurers. We also monitor the mortgage insurers' credit ratings, as provided by nationally recognized statistical rating organizations, and we periodically review the methods used by the nationally recognized statistical rating organizations. We also perform periodic on-site reviews of mortgage insurers to conÑrm compliance with our eligibility requirements and to evaluate their management and control practices. In addition, state insurance authorities regulate mortgage insurers. See ""NOTE 17: CONCENTRATION OF CREDIT AND OTHER RISKS'' to our consolidated Ñnancial statements for additional information. Mortgage Seller/Servicers. We are exposed to institutional credit risk arising from the insolvency of or non- performance by our mortgage seller/servicers, including non-performance of their repurchase obligations arising from the representations and warranties made to us for loans they underwrote and sold to us. The servicing fee charged by mortgage 78 Freddie Mac servicers varies by mortgage product. We generally require our single-family servicers to retain a minimum percentage fee for mortgages serviced on our behalf, typically 0.25 percent of the unpaid principal balance of the mortgage loans. However, on an exception basis, we allow a lower or no minimum servicing amount. The credit risk associated with servicing fees relates to whether we could transfer the applicable servicing rights to a successor servicer and recover amounts owed to us by the defaulting servicer in the event the current servicer is unable to fulÑll its responsibilities. In order to manage the credit risk associated with our mortgage seller/servicers, we require them to meet minimum Ñnancial capacity standards, insurance and other eligibility requirements. We do not believe we have any signiÑcant exposure to seller/servicers identiÑed as primarily subprime lenders that are not currently in compliance with our Ñnancial monitoring standards. We institute remedial actions against seller/servicers that fail to comply with our standards. These actions may include transferring mortgage servicing to other qualiÑed servicers or terminating our relationship with the seller/servicer. We conduct periodic operational reviews of our single-family mortgage seller/servicers to help us better understand their control environment and its impact on the quality of loans sold to us. We use this information to determine the terms of business we conduct with a particular seller/servicer. We manage the credit risk associated with our multifamily seller/servicers by establishing eligibility requirements for participation in our multifamily programs. These seller/servicers must also meet our standards for originating and servicing multifamily loans. We conduct regular quality control reviews of our multifamily mortgage seller/servicers to determine whether they remain in compliance with our standards. Non-Freddie Mac Mortgage-Related Securities. Investments for our Retained portfolio expose us to institutional credit risk on non-Freddie Mac mortgage-related securities to the extent that servicers, issuers, guarantors, or third parties providing credit enhancements become insolvent or do not perform. See ""CONSOLIDATED BALANCE SHEETS ANALYSIS Ì Table 19 Ì Characteristics of Mortgage Loans and Mortgage-Related Securities in the Retained Portfolio'' for more information concerning our Retained portfolio. Our non-Freddie Mac mortgage-related securities portfolio consists of both agency and non-agency mortgage-related securities. Agency mortgage-related securities, which are securities issued or guaranteed by Fannie Mae or Ginnie Mae, present minimal institutional credit risk due to the high credit quality of Fannie Mae and Ginnie Mae. Agency mortgage- related securities are generally not separately rated by nationally recognized statistical rating organizations, but are viewed as having a level of credit quality at least equivalent to non-agency mortgage-related securities rated AAA (based on the S&P rating scale or an equivalent rating from other nationally recognized statistical rating organizations). At December 31, 2006, we held approximately $45 billion of agency securities, representing approximately 2 percent of our Total mortgage portfolio. Non-agency mortgage-related securities expose us to institutional credit risk if the nature of the credit enhancement relies on a third party to cover potential losses. However, most of our non-agency mortgage-related securities rely primarily on subordinated tranches to provide credit loss protection and therefore expose us to limited counterparty risk. In those instances where we desire further protection, we may choose to mitigate our exposure with bond insurance or by purchasing additional subordination. Bond insurance exposes us to the risks related to the bond insurer's ability to satisfy claims. At December 31, 2006, a signiÑcant portion of the bond insurers providing coverage for non-agency mortgage-related securities held by us were rated AAA or equivalent by at least one nationally recognized statistical rating organization. At December 31, 2006, we held approximately $238 billion of non-agency mortgage-related securities. Of this amount, 96.2 percent was rated AAA or equivalent. We manage institutional credit risk on non-Freddie Mac mortgage-related securities by only purchasing securities that meet our investment guidelines and performing ongoing analysis to evaluate the creditworthiness of the issuers and servicers of these securities and the bond insurers that guarantee them. To assess the creditworthiness of these entities, we may perform additional analysis, including on-site visits, veriÑcation of loan documentation, review of underwriting or servicing processes and similar due diligence measures. In addition, we regularly evaluate our investments to determine if any impairment in fair value requires an impairment loss recognition in earnings, warrants divestiture or requires a combination of both. See ""RISK FACTORS Ì Legal and Regulatory Risks'' for more information. Mortgage Investors and Originators. We are exposed to pre-settlement risk through the purchase, sale and Ñnancing of mortgage loans and mortgage-related securities with mortgage investors and originators. The probability of such a default is generally remote over the short time horizon between the trade and settlement date. We manage this risk by evaluating the creditworthiness of our counterparties and monitoring and managing our exposures. In some instances, we may require these counterparties to post collateral. Cash and Investments Portfolio. Institutional credit risk also arises from the potential insolvency or non-performance of issuers or guarantors of investments held in our Cash and investments portfolio. Instruments in this portfolio are investment grade at the time of purchase and primarily short-term in nature, thereby substantially mitigating institutional 79 Freddie Mac credit risk in this portfolio. We regularly evaluate these investments to determine if any impairment in fair value requires an impairment loss recognition in earnings, warrants divestiture or requires a combination of both. OFF-BALANCE SHEET ARRANGEMENTS We enter into certain business arrangements that are not recorded on our consolidated balance sheets or may be recorded in amounts that diÅer from the full contract or notional amount of the transaction. Most of these arrangements relate to our Ñnancial guarantee and securitization activity for which we record guarantee-related assets and obligations, but the related securitized assets are owned by third parties. See ""CRITICAL ACCOUNTING POLICIES AND ESTIMATES Ì Issuances and Transfers of PCs and Structured Securities'' for more discussion of oÅ-balance sheet arrangements. These oÅ-balance sheet arrangements may expose us to potential losses in excess of the amounts recorded on our consolidated balance sheets. Guarantee of PCs and Structured Securities As discussed in ""BUSINESS Ì Business Activities Ì Credit Guarantee Activities,'' we guarantee the payment of principal and interest on issued PCs or Structured Securities. Mortgage-related assets that back PCs and Structured Securities held by third parties are not reÖected as our assets, unless we retained or repurchased an interest in the PCs that back Structured Securities that were issued and sold to third parties. We manage the risks of our credit guarantee activity carefully, sharing the risk in some cases with third parties through the use of primary loan-level mortgage insurance, pool insurance and other credit enhancements. ""NOTE 4: FINANCIAL GUARANTEES'' of our consolidated Ñnancial statements provides information about our guarantees, including details related to credit protections and maximum coverages that we obtain through credit enhancements. Also, see ""RISK MANAGEMENT Ì Credit Risks'' for more information. Credit guarantee activity also occurs through the Guarantor Swap program in the form of mortgage swap transactions. In a mortgage swap transaction, a mortgage lender delivers mortgages to us in exchange for our guaranteed PCs that represent undivided interests in those same mortgages. We receive various forms of consideration in exchange for providing our guarantee on issued PCs, including (a) the contractual right to receive a management and guarantee fee, (b) delivery or credit fees for higher-risk mortgages and (c) other forms of credit enhancements received from counterparties or mortgage loan insurers. Credit guarantee activity also occurs through our Cash Window and our MultiLender Swap program. Single-family mortgage loans we purchase for cash through the Cash Window are typically either retained by us in our Retained portfolio or pooled together with other single-family mortgage loans we purchase in connection with PC swap-based transactions in our MultiLender Program executed with various lenders. We may issue such PCs to these lenders in exchange for the mortgage loans we purchase from them or, to the extent these loans are pooled with loans purchased for cash, we may sell them to third parties for cash consideration through an auction. In addition to the issuance and transfer of PCs to third parties, we also sell PCs from our Retained portfolio in resecuritized form. We issue single- and multi-class Structured Securities that are backed by securities held in our Retained portfolio and subsequently transfer such Structured Securities to third parties in exchange for cash, PCs or other mortgage- related securities. We generally earn resecuritization fees in connection with the creation of Structured Securities and can earn an ongoing management and guarantee fee for certain issued Structured Securities. Our principal credit risk exposure on Structured Securities relates only to that portion of resecuritized assets that consists of non-Freddie Mac mortgage- related securities. For information about our purchase, securitization and resecuritization activities, see ""PORTFOLIO BALANCES AND ACTIVITIES.'' Our maximum potential exposure to credit losses relating to our outstanding guaranteed mortgage-related securities held by third parties is primarily represented by the unpaid principal balance of those securities, which was $1,123 billion as of December 31, 2006. Based on our historical credit losses, which in 2006 averaged approximately 1.4 basis points of the balance of guaranteed securities outstanding (including those owned in our Retained portfolio), we do not believe that the maximum exposure is representative of our actual exposure on these guarantees. The maximum exposure does not take into consideration the recovery we would receive through exercising our rights to the collateral backing the underlying loans nor the available credit enhancements, which includes recourse and primary insurance with third parties. The accounting policies and fair value estimation methodologies we apply to our credit guarantee activities signiÑcantly aÅect the volatility of our reported earnings. See ""CONSOLIDATED RESULTS OF OPERATIONS Ì Non-Interest Income (Loss)'' for an analysis of the eÅects on our consolidated statements of income related to our credit guarantee activities. See ""CONSOLIDATED BALANCE SHEETS ANALYSIS'' for a description of our Guarantee asset and Guarantee obligation. The accounting for our securitization transactions and the signiÑcant assumptions used to determine 80 Freddie Mac the gains or losses from such transfers that are accounted for as sales are discussed in ""NOTE 2: TRANSFERS OF SECURITIZED INTERESTS IN MORTGAGE-RELATED ASSETS'' to our consolidated Ñnancial statements. Other We extend other guarantees and provide indemniÑcation to counterparties for breaches of standard representations and warranties in contracts entered into in the normal course of business based on an assessment that the risk of loss would be remote. See ""NOTE 4: FINANCIAL GUARANTEES'' to our consolidated Ñnancial statements for additional information. We are a party to numerous entities that are considered to be variable interest entities, or VIEs, in accordance with FASB Interpretation No. 46 (Revised December 2003), ""Consolidation of Variable Interest Entities (revised Decem- ber 2003), an interpretation of APB No. 51,'' or FIN 46(R). These variable interest entities include low-income multifamily housing tax credit partnerships, certain Structured Transactions and certain asset-backed investment trusts. See ""NOTE 3: VARIABLE INTEREST ENTITIES'' to our consolidated Ñnancial statements for additional information related to our signiÑcant variable interests in these VIEs. As part of our credit guarantee business, we routinely enter into forward purchase and sale commitments for mortgage loans and mortgage-related securities. Some of these commitments are accounted for as derivatives with their fair values reported as either Derivative assets, at fair value or Derivative liabilities, at fair value on our consolidated balance sheets. See ""RISK MANAGEMENT Ì Interest-Rate Risk and Other Market Risks'' for further information. Certain non- derivative commitments are related to commitments arising from mortgage swap transactions and commitments to purchase certain multifamily mortgage loans that will be classiÑed as held-for-investment. These non-derivative commitments totaled $264.4 billion and $178.8 billion at December 31, 2006 and 2005, respectively. Such commitments are not accounted for as derivatives and are not recorded on our consolidated balance sheets. CRITICAL ACCOUNTING POLICIES AND ESTIMATES The preparation of Ñnancial statements in accordance with GAAP requires us to make a number of judgments, estimates and assumptions that aÅect the reported amounts of our assets, liabilities, income, and expenses. Certain of our accounting policies, as well as estimates we make, are critical to the presentation of our Ñnancial condition and results of operations. They often require management to make diÇcult, complex or subjective judgments and estimates, at times, regarding matters that are inherently uncertain. The accounting policies discussed in this section are particularly critical to understanding our consolidated Ñnancial statements. Actual results could diÅer from our estimates and diÅerent judgments and assumptions related to these policies and estimates could have a material impact on the consolidated Ñnancial statements. Our critical accounting policies and estimates relate to: (a) valuation of Ñnancial instruments; (b) issuances and transfers of PCs and Structured Securities; (c) derivative instruments and hedging activities; (d) credit losses; (e) amortization of cost basis adjustments using the eÅective interest method; and (f) impairment recognition on investments in securities. For additional information about these and other signiÑcant accounting policies, including recently issued accounting pronouncements, see ""NOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES'' to our consolidated Ñnancial statements. Valuation of Financial Instruments A signiÑcant portion of our assets and liabilities are Ñnancial instruments that are recorded on our consolidated Ñnancial statements at estimated fair value. The estimation of fair value applies to instruments that are complex in nature and requires signiÑcant management judgments and assumptions. These judgments and assumptions, as well as changes in market conditions, may have a material eÅect on our GAAP consolidated balance sheets and statements of income as well as our consolidated fair value balance sheets. Fair value is deÑned as the amount at which an asset or liability could be exchanged in a current transaction between willing parties, other than in a forced or liquidation sale. The selection of a method to estimate fair value for each type of Ñnancial instrument depends on both the reliability and availability of relevant market data. The amount of judgment involved in estimating the fair value of a Ñnancial instrument is aÅected by a number of factors, such as the type of 81 Freddie Mac instrument, the liquidity of the markets for the instrument and the contractual characteristics of the instrument. We estimate fair value according to the following hierarchy of sources: ‚ quoted market prices for identical and similar instruments; ‚ industry standard models that consider market inputs such as yield curves, duration, volatility factors and prepayment speeds; and ‚ internally developed models that consider inputs based on management's judgment of market-based assumptions. We use quoted market prices when they are available and reliable. Financial instruments with active markets and readily available market prices are valued based on independent price quotations obtained from third party sources, such as pricing services, dealer marks or direct market observations. Independent price quotations obtained from pricing services are valuations estimated by a service provider using market information. Dealer marks are prices obtained from dealers that generally make markets in the relevant products and are an indication of the price at which the dealer would consider transacting in normal market conditions. Market observable prices are prices that are retrieved from sources in which market trades are executed, such as electronic trading platforms. When quoted market prices are not readily available, we utilize models, including industry-standard models and internally developed models. These models use market inputs such as interest rate curves, market volatilities and pricing spreads. We maximize the use of market inputs to the extent available. Certain complex Ñnancial instruments have signiÑcant data inputs that cannot be validated by reference to the market. These instruments are typically illiquid or unique in nature and require the use of management's judgment of market-based assumptions. The use of diÅerent pricing models or assumptions could produce materially diÅerent estimates of fair value. Fair value aÅects our statement of income in the following ways: ‚ For certain Ñnancial instruments that are recorded in the GAAP consolidated balance sheets at fair value, changes in fair value are recognized in current period earnings. These include: Ì securities and PC residuals classiÑed as trading, which are recorded in Gains (losses) on investment activity; Ì derivatives in a fair value hedge accounting relationship and the related adjustments to the hedged items, which are recorded in Hedge accounting gains (losses); Ì derivatives with no hedge designation, which are recorded in Derivative gains (losses); and Ì the Guarantee asset, which is recorded in Gains (losses) on Guarantee asset. ‚ For other Ñnancial instruments that are recorded in the GAAP consolidated balance sheets at fair value, changes in fair value are deferred, net of tax, in AOCI. These include: Ì securities and PC residuals classiÑed as available-for-sale, which are initially measured at fair value with deferred gains and losses recognized in AOCI. These deferred gains and losses aÅect earnings over time through amortization, sale or impairment recognition; and Ì changes in derivatives that are designated in cash Öow hedge accounting relationships. ‚ Our Guarantee obligation is initially measured at fair value, but is not remeasured at fair value on a periodic basis. This obligation aÅects earnings over time through amortization to Income on Guarantee obligation. ‚ Mortgage loans that are held-for-sale are recorded at the lower-of-cost-or-market with changes in fair value recorded through earnings in Gains (losses) on investment activity. We periodically evaluate our valuation methodologies and may change them to improve our fair value estimates, to accommodate market developments or to compensate for changes in data availability and reliability or other operational constraints. At December 31, 2006 and 2005, the fair values for approximately 99 percent of our mortgage-related securities were based on prices obtained from third parties or were determined using models with signiÑcant market inputs. The fair values for the remainder of our mortgage-related securities are obtained from internal models with few or no market inputs. The majority of the fair values for our non-mortgage-related securities are based on prices obtained from third parties. For some of these securities, where the interest rates frequently reset, the carrying value is presumed to be a reasonable approximation of fair value. The majority of our derivative positions are valued using internally developed models that use market inputs because few of the derivative contracts we use are listed on exchanges. At December 31, 2006 and 2005, approximately 65 percent and 68 percent, respectively, of the gross fair value of our derivatives portfolio related to interest-rate and foreign-currency swaps that did not have embedded options. These derivatives were valued using a discounted cash Öow model that projects future cash Öows and discounts them at the spot rate related to each cash Öow. The remaining 35 percent and 32 percent, respectively, of our derivatives portfolio was valued based on prices obtained from third parties or using models with signiÑcant market inputs. The fair values for all of our debt securities are based on prices obtained from third parties or are determined using models with signiÑcant market inputs. 82 Freddie Mac See ""RISK MANAGEMENT Ì Interest-Rate Risk and Other Market Risks'' for discussion of market risks and our interest-rate sensitivity measures, PMVS and duration gap. Issuances and Transfers of PCs and Structured Securities We issue PCs and Structured Securities to third parties in several diÅerent ways. In general, we account for such transfers as sales of Ñnancial assets or as Ñnancial guarantee transactions. We evaluate whether transfers of PCs or Structured Securities qualify as sales based upon the requirements of SFAS No. 140, ""Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities, a replacement of FASB Statement No. 125,'' or SFAS 140. If a transfer of PCs or Structured Securities qualiÑes as a sale, we recognize a gain or loss on the sale immediately in earnings. The gain or loss is calculated as cash received less the recognized carrying value of interests sold and the fair value of liabilities incurred upon sale. If we determine that a transfer of PCs or Structured Securities does not qualify as a sale, we account for the transfer as a secured borrowing pursuant to SFAS 140 or as a Ñnancial guarantee transaction pursuant to the provisions of FIN 45. Many of the transfers of PCs and Structured Securities that we make are accounted for as Ñnancial guarantee transactions pursuant to FIN 45. For such transactions, we recognize a Guarantee obligation at the inception of an executed guarantee. We also recognize the fair value of any consideration received in such transactions. For transfers of PCs and Structured Securities to third parties, the fair value measurements involve our best estimate with respect to key assumptions. These key assumptions include expected credit losses, exposure to credit losses that could be greater than expected, prepayment rates, forward yield curves and discount rates. We believe that these assumptions are comparable to those used by other market participants. The use of diÅerent pricing models or assumptions could produce materially diÅerent results. See ""NOTE 2: TRANSFERS OF SECURITIZED INTERESTS IN MORTGAGE- RELATED ASSETS'' to our consolidated Ñnancial statements for further discussion of the approach we use to determine fair values. Derivative Instruments and Hedging Activities The determination of whether a derivative qualiÑes for hedge accounting requires signiÑcant judgment and has a signiÑcant impact on how such instruments are accounted for in our consolidated Ñnancial statements. As described more fully in ""NOTE 12: DERIVATIVES'' to our consolidated Ñnancial statements, by December 31, 2006 we had discontinued substantially all of our hedge accounting relationships. We report the change in fair value of derivatives that are not designated in hedge accounting relationships on our consolidated statements of income in the period in which the change in value occurs. We record the change in fair value of derivatives that are in cash Öow hedge accounting relationships, to the extent these relationships are eÅective, as a separate component of AOCI and reclassify this amount into earnings when the hedged item or forecasted transaction aÅects earnings. We record the change in fair value of derivatives in fair value hedge relationships each period in earnings along with the change in fair value of the hedged item attributable to the hedged risk. The determination of whether a derivative qualiÑes for hedge accounting requires judgment about the application of SFAS 133, as amended by SFAS No. 138, ""Accounting for Certain Derivative Instruments and Certain Hedging Activities, an amendment of FASB Statement No. 133,'' and SFAS No. 149, ""Amendment of Statement 133 on Derivative Instruments and Hedging Activities,'' collectively referred to as SFAS 133. SFAS 133 requires contemporaneous documentation of our hedge relationships, including identiÑcation of the hedged item, the hedging instrument, the nature of the hedged risk and the method used to assess the eÅectiveness of the hedge relationship. Derivatives previously designated as cash Öow hedges generally have hedged interest-rate risk related to the forecasted issuances of debt. For these hedging relationships to qualify for hedge accounting both at inception and over the life of the derivative, we must estimate the probable future level of certain types of debt issuances. These estimates are based on our expectation of future funding needs and the future mix of debt issuances. Our expectations about future funding are based upon projected growth and historical activity. If these estimates had been lower, a smaller notional amount of the derivatives would have been eligible for designation as cash Öow hedges and potentially material amounts that were deferred and reported in AOCI would have been reported as Derivative gains (losses) on our consolidated statements of income in the period in which they occurred. If estimated future fundings do not occur, or are probable of not occurring, potentially material amounts that were deferred and reported in AOCI would be immediately recognized in Derivative gains (losses) on our consolidated statements of income. We believe that the forecasted issuances of debt previously hedged in cash Öow hedging relationships are probable of occurring, therefore we may continue to include previously deferred amounts in AOCI. For a more detailed description of our use of derivatives and summaries of derivative positions, see ""CONSOLIDATED RESULTS OF OPERATIONS Ì Derivative Overview'' and ""NOTE 12: DERIVATIVES'' to our consolidated Ñnancial statements. 83 Freddie Mac Credit Losses We maintain a Reserve for losses on mortgage loans held-for-investment to provide for incurred credit losses from our mortgage loan portfolio. We also maintain a Reserve for guarantee losses on Participation CertiÑcates to provide for losses incurred on mortgages underlying PCs or Structured Securities held by third parties that we guarantee. We use the same methodology to determine our Reserve for losses on mortgage loans held-for-investment and our Reserve for guarantee losses on Participation CertiÑcates, as the relevant factors aÅecting credit risk are the same. The Reserve for losses on mortgage loans held-for-investment and the Reserve for guarantee losses on Participation CertiÑcates are collectively referred to as the loan loss reserves. To calculate the loan loss reserves for the single-family loan portfolio, we aggregate homogenous loans into pools based on common underlying characteristics, using statistically based models to evaluate relevant factors aÅecting loan collectibility, and determine the best estimate of loss. To calculate loan loss reserves for the multifamily loan portfolio, we use models, evaluate certain larger loans for impairment, and review repayment prospects and collateral values underlying individual loans. We regularly evaluate the underlying estimates and models we use when determining the loan loss reserves and update our assumptions to reÖect our own historical experience and our current view of overall economic conditions and other relevant factors. Determining the adequacy of the loan loss reserves is a complex process that is subject to numerous estimates and assumptions requiring judgment. Key estimates and assumptions that impact our loan loss reserves include: ‚ loss severity trends; ‚ default experience; ‚ expected proceeds from credit enhancements; ‚ collateral valuation; and ‚ identiÑcation and impact assessment of macroeconomic factors. No single statistic or measurement determines the adequacy of the loan loss reserves. We exercise a signiÑcant amount of judgment in selecting the above factors. Changes in one or more of the estimates or assumptions used to calculate the loan loss reserves could have a material impact on the loan loss reserves and provisions for credit losses. We believe the level of our loan loss reserves is reasonable based on internal reviews of the factors and methodologies used. An independent management group reviews the level of loan loss reserves, as well as the factors and methodologies that give rise to the estimate, and submits the best point estimate for review by senior management. This review process provides consistent implementation and disclosure. Loan loss reserves associated with Hurricane Katrina in 2005 were established based on preliminary estimates that were higher than current estimates. We have revised these estimates based on additional information about property damage and recoveries. During 2006, our revised estimates of incurred losses related to Hurricane Katrina resulted in a reduction of $82 million in the loan loss reserves originally recorded in 2005 for loans aÅected by the hurricane. Amortization of Cost Basis Adjustments Using the EÅective Interest Method We recognize interest income on certain mortgage-related and non-mortgage-related investments, using the retrospec- tive eÅective interest method in accordance with SFAS No. 91, ""Accounting for Nonrefundable Fees and Costs Associated with Originating or Acquiring Loans and Initial Direct Costs of Leases, an amendment of FASB Statements No. 13, 60, and 65 and a rescission of FASB Statement No. 17,'' or SFAS 91. Deferred items, including premiums, discounts and other basis adjustments, are amortized into interest income over the estimated lives of the securities using the retrospective eÅective interest method. SFAS 91 allows estimates of principal prepayments for pools of assets containing similar characteristics where prepayments are probable and the timing and amount of prepayments can be reasonably estimated. Most of our mortgage-related and non-mortgage-related investments meet this requirement. Therefore, we recalculate the constant eÅective yield at each period end using our current estimate of principal prepayments. Adjustments that result from applying the updated eÅective yield as if it had been in eÅect since the acquisition of the securities are recognized through interest income. For certain other investments in mortgage-related securities classiÑed as available-for-sale, interest income is recognized using the prospective eÅective interest method in accordance with Emerging Issues Task Force Issue No. 99-20, ""Recognition of Interest Income and Impairment on Purchased BeneÑcial Interests and BeneÑcial Interests That Continue to Be Held by a Transferor in Securitized Financial Assets,'' or EITF 99-20. Under this method, changes in the eÅective yield due to changes in estimated lives are recognized as adjustments to interest income in future periods rather than as 84 Freddie Mac catch up adjustments in the current period. We speciÑcally apply such guidance to beneÑcial interests (including undivided interests which are similar to beneÑcial interests) in securitized Ñnancial assets that: ‚ can contractually be prepaid or otherwise settled in such a way that we may not recover substantially all of our recorded investment (such as interest-only securities); or ‚ were not of high credit quality at the date that we acquired them. Determination of the eÅective yield requires signiÑcant judgment in estimating expected prepayment behavior, which is inherently uncertain. Estimates of future prepayments are derived from market sources and our internal prepayment models. Judgment is involved in making initial determinations about prepayment expectations and in changing those expectations over time in response to changes in market conditions, such as interest rates and other macroeconomic factors. The eÅects of future changes in market conditions may be material. We believe that the above assumptions are comparable to those used by other market participants. However, the use of diÅerent assumptions in our prepayment models could have resulted in materially diÅerent income recognition results. See ""NOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES'' to our consolidated Ñnancial statements for more information on interest income recognition on securities. Impairment Recognition on Investments in Securities We recognize impairment losses on available-for-sale securities through the income statement when we have concluded that a decrease in the fair value of a security is not temporary. For securities accounted for under EITF 99-20, an impairment loss is recognized when there is both a decline in fair value below the carrying amount and an adverse change in expected cash Öows. Determination of whether an adverse change has occurred involves judgment about expected prepayments and credit events. We review securities not accounted for under EITF 99-20 for potential impairment whenever the security's fair value is less than its amortized cost. This review considers a number of factors, including the severity of the decline in fair value, credit ratings, the length of time the investment has been in an unrealized loss position, and the likelihood of sale in the near term. We recognize impairment losses when quantitative and qualitative factors indicate that it is likely that we will not fully recover the unrealized loss. One of the factors we consider is our intent and ability to hold the investment until a point in time at which recovery can be reasonably expected to occur. We apply signiÑcant judgment in determining whether impairment loss recognition is appropriate. We believe our judgments are reasonable. However, diÅerent judgments could have resulted in materially diÅerent impairment loss recognition. See ""NOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES'' to our consolidated Ñnancial statements for more information on impairment recognition on securities. Accounting Changes and Recently Issued Accounting Pronouncements See ""NOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES'' to our consolidated Ñnancial statements for more information concerning our accounting policies and recently issued accounting pronouncements, including those that we have not yet adopted, that will likely aÅect our consolidated Ñnancial statements. PORTFOLIO BALANCES AND ACTIVITIES Total Mortgage Portfolio Our Total mortgage portfolio includes the unpaid principal balances of mortgage loans and mortgage-related securities held in our Retained portfolio and the unpaid principal balances of guaranteed PCs and Structured Securities held by third parties. Guaranteed PCs and Structured Securities held by third parties are considered outstanding and are not included on our consolidated balance sheets. 85 Freddie Mac Table 47 provides information about our Total mortgage portfolio at December 31, 2006 and 2005. Table 47 Ì Total Mortgage Portfolio and Total Guaranteed PCs and Structured Securities Issued Based on Unpaid Principal Balances(1)(2) Outstanding Guaranteed PCs and Structured Securities(3)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Retained portfolio: PCs and Structured Securities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Non-Freddie Mac mortgage-related securities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Mortgage loans ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total Retained portfolio(4) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total mortgage portfolio ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ December 31, 2006 2005 Amounts (dollars in millions) $1,122,761 354,262 283,850 65,847 703,959 $1,826,720 % of Total Mortgage Portfolio 61% 19 16 4 39 100% Amounts (dollars in millions) $ 974,200 361,324 287,541 61,481 710,346 $1,684,546 % of Total Mortgage Portfolio 58% 21 17 4 42 100% (1) Excludes mortgage loans and mortgage-related securities traded, but not yet settled. (2) The 2006 amounts exclude the eÅect of credit-related impairments on mortgage-related securities in our Retained portfolio. The 2005 amounts have been revised to conform with the current year presentation. (3) Represents Guaranteed PCs and Structured Securities held by third parties. (4) The Retained portfolio presented in this table diÅers from the Retained portfolio presented on our consolidated balance sheets because the amounts presented on our consolidated balance sheets include valuation adjustments and deferred balances. See ""CONSOLIDATED BALANCE SHEETS ANALYSIS Ì Table 19 Ì Characteristics of Mortgage Loans and Mortgage-Related Securities in the Retained Portfolio'' for a reconciliation of the Retained portfolio amounts shown in this table to the amounts shown under such caption on our consolidated balance sheets. See ""Table 50 Ì Guaranteed PCs and Structured Securities Issued and Outstanding'' for more information concerning outstanding guaranteed PCs and Structured Securities. Also see ""CONSOLIDATED BALANCE SHEETS ANALYSIS Ì Table 19 Ì Characteristics of Mortgage Loans and Mortgage-Related Securities in the Retained Portfolio'' for more information concerning the non-Freddie Mac mortgage-related securities in our Retained portfolio. Table 48 presents the distribution of unsecuritized mortgage loans held in our Retained portfolio. Table 48 Ì Mortgage Loans Held in the Retained Portfolio(1) Single-family: Conventional Fixed-rate ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Variable-rateÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total conventional ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ FHA/VA Ì Fixed-rateÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Rural Housing Service and other federally guaranteed loans ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total single-familyÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Multifamily: Conventional Fixed-rate ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Variable-rateÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total conventional ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Rural Housing Service ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total multifamily ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total mortgagesÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (1) Based on unpaid principal balances. Excludes mortgage loans traded, but not yet settled. December 31, 2006 2005 (in millions) $18,427 1,233 19,660 196 784 20,640 41,863 3,341 45,204 3 45,207 $65,847 $18,532 903 19,435 255 706 20,396 36,961 4,121 41,082 3 41,085 $61,481 86 Freddie Mac Table 49 summarizes purchases into our Total mortgage portfolio. Table 49 Ì Total Mortgage Portfolio Activity Detail(1) New business purchases:(2) Single-family mortgage purchases: 2006 % of Purchase Amounts Amounts Year Ended December 31, 2005 % of Purchase Amounts Amounts (dollars in millions) 2004 % of Purchase Amounts Amounts Conventional: 30-year amortizing Ñxed-rate(3) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $251,143 21,556 15-year amortizing Ñxed-rate ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ ARMs/Variable-rate(4) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 18,854 Interest Only(5) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 58,176 Option ARMs(6) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Ì Balloon/Resets(7)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 419 FHA/VA(8) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 946 176 Rural Housing Service and other federally guaranteed loans ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total single-family ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 351,270 Multifamily: Conventional ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total multifamily ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 13,031 13,031 Total mortgage purchases ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 364,301 Non-Freddie Mac mortgage-related securities purchased for Structured Securities: Ginnie Mae CertiÑcates ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Structured Transactions(9) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total Non-Freddie Mac mortgage-related securities purchased for Structured Securities ÏÏÏÏÏÏÏÏÏÏÏÏ 48 8,592 8,640 Total single-family and multifamily mortgage purchases and total non-Freddie Mac mortgage-related 67% 6 5 16 Ì Ì Ì Ì 94 4 4 98 Ì 2 2 $272,702 40,963 35,677 26,516 3,918 1,720 Ì 177 381,673 11,172 11,172 392,845 37 14,331 14,368 67% 10 9 7 1 Ì Ì Ì 94 3 3 97 Ì 3 3 $220,867 72,754 50,187 818 Ì 9,658 319 209 354,812 12,712 12,712 367,524 85 7,205 7,290 59% 19 14 Ì Ì 3 Ì Ì 95 3 3 98 Ì 2 2 securities purchased for Structured Securities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $372,941 100% $407,213 100% $374,814 100% Non-Freddie Mac mortgage-related securities purchased into the Retained portfolio: Agency securities: Fannie Mae: Single-family: Fixed-rate ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ Variable-rate ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total Fannie Mae ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 4,259 8,014 12,273 Ginnie Mae: Single-family: Fixed-rate ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total Ginnie Mae ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total agency mortgage-related securities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Ì Ì 12,273 Non-agency securities: Single-family Single-family: Fixed-rate ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Variable-rate ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total single-family ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Commercial mortgage-backed securities: Fixed-rate ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Variable-rate ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total commercial mortgage-backed securities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 718 96,906 97,624 2,534 13,432 15,966 Mortgage revenue bonds: Single-family: Fixed-rate ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Variable-rate ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 3,062 Ì Multifamily: Fixed-rate ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Variable-rate ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total mortgage revenue bonds ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 116 Ì 3,178 Total non-agency mortgage-related securities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 116,768 Total non-Freddie Mac mortgage-related securities purchased into the Retained portfolio ÏÏÏÏÏÏÏ 129,041 Total new business purchases ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $501,982 Mortgage purchases with credit enhancements ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Mortgage liquidations(10) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $339,814 Mortgage liquidations rate(10)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Freddie Mac securities repurchased into the Retained portfolio: 17% 20% Single-family: Fixed-rate ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 76,378 27,146 Variable-rate ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Multifamily: Variable-rate ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Ì Total Freddie Mac securities repurchased into the Retained portfolio ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $103,524 $ 2,854 3,368 6,222 64 64 6,286 2,154 148,600 150,754 10,343 4,497 14,840 2,374 27 434 5 2,840 168,434 174,720 $581,933 17% $384,674 26% $106,682 29,805 Ì $136,487 $ 756 3,282 4,038 Ì Ì 4,038 1,294 101,620 102,914 8,841 2,037 10,878 1,499 Ì 414 31 1,944 115,736 119,774 $494,588 19% $401,029 28% $ 72,147 23,942 146 $ 96,235 (1) Based on unpaid principal balances. Excludes mortgage loans and mortgage-related securities traded but not yet settled. (2) 2004 data includes certain mortgage-related securities that have been transferred from the Investments caption to the Retained portfolio caption on our consolidated balance sheets. (3) Includes 40-year and 20-year Ñxed-rate mortgages. (4) Includes ARMs with 1-, 3-, 5-, 7- and 10-year initial Ñxed-rate periods. (5) Represents loans where the borrower pays interest only for a period of time before the borrower begins making principal payments. 87 Freddie Mac (6) Includes mortgage loans we purchased that underlie whole-loan REMICs except for $83 million of mortgage loan purchases that collateralize the non-guaranteed portion of whole-loan REMICs. (7) Mortgages whose terms require lump sum principal payments on contractually determined future dates unless the borrower qualiÑes for and elects an extension of the maturity date at an adjusted interest rate. (8) Excludes FHA/VA loans that back Structured Transactions. (9) Includes $6,908 million, $14,331 million and $5,653 million at December 31, 2006, 2005 and 2004, respectively, of option ARM loans. (10) Based on total mortgage portfolio. Excludes the eÅect of sales of non-Freddie Mac mortgage-related securities. Our new business purchases consist of mortgage loans and non-Freddie Mac mortgage-related securities that are purchased for our Retained portfolio and serve as collateral for our issued PCs and Structured Securities. We generate a signiÑcant portion of our mortgage purchase volume through several key mortgage lenders that have entered into unique business arrangements with us. See ""BUSINESS Ì Business Activities Ì Credit Guarantee Activities'' for information about these relationships and consequent risks. During 2006 and 2005, we increased purchases of adjustable-rate (i.e., ARMs/Variable-rate and option ARMs) and interest-only mortgage loans and non-Freddie Mac mortgage-related securities because these products generally oÅered more attractive option-adjusted spreads than Ñxed-rate products. Guaranteed PCs and Structured Securities Guaranteed PCs and Structured Securities Issued represent the unpaid principal balances of the mortgage-related securities we issue or otherwise guarantee. Table 50 presents the distribution of underlying mortgage assets for total PCs and Structured Securities issued and outstanding. Table 50 Ì Guaranteed PCs and Structured Securities Issued and Outstanding December 31, 2006 2005 Total Issued PCs Outstanding PCs Total Issued PCs Outstanding PCs and Structured Securities(2) and Structured Securities(1) and Structured Securities(2) and Structured Securities(1) PCs and Structured Securities Single-family: Conventional: 30-year Ñxed-rate(3) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 15-year Ñxed-rate ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ ARMs/Variable-rate ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Option ARMs ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Balloons/ResetsÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ FHA/VA(4) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Rural Housing Service and other federally guaranteed loans ÏÏÏÏÏÏÏÏÏÏ Total single-family ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 956,842 290,314 169,254 2,808 21,551 1,398 139 1,442,306 $ 763,563 202,747 116,910 303 20,508 1,267 139 1,105,437 $ 810,897 321,176 131,294 3,830 26,321 849 154 1,294,521 (in millions) Multifamily: Conventional: Fixed-rateÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Variable-rate ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total multifamily ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Structured Securities backed by non-Freddie Mac mortgage-related securities: Ginnie Mae CertiÑcates(5) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Structured Transactions(6) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total Structured Securities backed by non-Freddie Mac mortgage- 3,449 4,966 8,415 1,510 24,792 3,208 4,825 8,033 1,481 7,810 10,149 4,354 14,503 2,021 24,479 $614,112 220,225 88,898 414 24,973 823 154 949,599 9,902 4,210 14,112 1,900 8,589 related securities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 26,302 $1,477,023 9,291 $1,122,761 26,500 $1,335,524 10,489 $974,200 (1) Based on unpaid principal balances. Excludes mortgage loans and mortgage-related securities traded, but not yet settled. (2) Represents PCs and Structured Securities held by third parties. (3) Issued balances include $42 million and $Ì million of 40-year Ñxed-rate mortgages at December 31, 2006 and 2005, respectively; and $66,779 million and $67,937 million of 20-year Ñxed-rate mortgages at December 31, 2006 and 2005, respectively. (4) Excludes FHA and VA loans that are collateral for Structured Transactions. (5) Represents Ginnie Mae CertiÑcates that are backed by FHA/VA loans. (6) Represents Structured Securities backed by non-agency securities that include $1,122 million and $1,520 million of Ñxed-rate, $4,019 million and $3,472 million of ARMs/variable-rate, $2,648 million and $3,566 million of FHA/VA, $9 million and $12 million of the Rural Housing Service and other federally guaranteed loans and $12 million and $19 million of second mortgages, which are mortgage loans that are subordinate to a superior mortgage lien on the property, at December 31, 2006 and 2005, respectively. 88 Freddie Mac Table 51 provides further detail regarding both issued and outstanding Guaranteed PCs and Structured Securities. Table 51 Ì Single-Class and Multi-Class PCs and Other Structured Securities Based on Unpaid Principal Balances(1) December 31, 2006 PCs and Structured Securities in Retained Portfolio PCs and Structured Securities Outstanding (held by third parties) (in millions) Total Guaranteed PCs and Structured Securities Issued PCs and Structured Securities: Single-class(2) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Multi-class(3)(4) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Other(5) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total PCs and Structured Securities(6) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ December 31, 2005 PCs and Structured Securities: Single-class(2) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Multi-class(3)(4)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Other(5) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total PCs and Structured Securities(6) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $194,057 160,205 Ì $354,262 $202,970 158,354 Ì $361,324 $ 624,383 491,696 6,682 $1,122,761 $529,901 437,668 6,631 $974,200 $ 818,440 651,901 6,682 $1,477,023 $ 732,871 596,022 6,631 $1,335,524 (1) Excludes Freddie Mac mortgage-related securities traded, but not yet settled. (2) Includes PCs not backing Structured Securities and single-class Structured Securities backed by PCs and Ginnie Mae CertiÑcates. (3) Includes that portion of multi-class Structured Securities that are backed by PCs and non-agency mortgage-related securities. Also includes multi- class Structured Securities backed by Ginnie Mae CertiÑcates. (4) Principal-only strips backed by Freddie Mac mortgage-related Securities held in the Retained portfolio are classiÑed as multi-class for the purpose of this table. (5) See ""NOTE 4: FINANCIAL GUARANTEES'' to our consolidated Ñnancial statements for a discussion of our guarantees of principal and interest related to these securities. (6) PCs and Structured Securities Issued exclude $1,240,221 million and $961,777 million at December 31, 2006 and 2005, respectively, of Structured Securities backed by resecuritized PCs and other previously issued Structured Securities. These excluded Structured Securities, which do not increase our credit related exposure, consist of single-class Structured Securities backed by PCs, REMICs, and principal-only strips. The notional balances of interest-only strips are excluded because this table is based on unpaid principal balances. Also excluded are modiÑable and combinable REMIC tranches and interest and principal classes, where the holder has the option to exchange the security tranches for other pre-deÑned security tranches. 89 Freddie Mac Table 52 provides settlement detail for the mortgage-related securities that we issued during the past three years. Table 52 Ì Total Guaranteed PCs and Structured Securities Issued(1) 2006 Year Ended December 31, 2005 (in millions) 2004 Total Guaranteed PCs and Structured Securities Issuance Detail: Single-family: Conventional:(2) 30-year amortizing Ñxed-rate(3) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 15-year amortizing Ñxed-rate ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ ARMs/Variable-Rate ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Interest Only ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Option ARMs ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Balloon/Resets ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ FHA/VA ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Rural Housing Service and other federally guaranteed loans ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total single-familyÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $250,616 21,542 18,819 58,112 Ì 410 946 8 350,453 $272,910 41,037 35,666 26,487 3,918 1,817 Ì 10 381,845 $220,137 72,358 50,226 818 Ì 9,737 319 48 353,643 Multifamily: ConventionalÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total multifamily ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 930 930 1,654 1,654 4,175 4,175 Non-Freddie Mac mortgage-related securities purchased for Structured Securities: Ginnie Mae CertiÑcates ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Structured Transactions(4)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total Non-Freddie Mac mortgage-related securities purchased for Structured Securities ÏÏÏÏÏÏÏ Total Guaranteed PCs and Structured Securities Issued ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 48 8,592 8,640 $360,023 37 14,331 14,368 $397,867 85 7,205 7,290 $365,108 Resecuritization Activity: Multi-class ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Single-class ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total activity ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $169,396 219,493 $388,889 208,450 204,984 $413,434 $215,506 72,686 $288,192 (1) Based on unpaid principal balances. Excludes Freddie Mac mortgage-related securities traded, but not yet settled. (2) The single-family product detail in this table does not agree to similar detail in ""Table 49 Ì Total Mortgage Portfolio Activity Detail'' due to timing diÅerences associated with mortgage loan purchases into the Retained portfolio and sales from the Retained portfolio. SpeciÑcally, we report mortgage loans in Table 49 when we purchase them into the Retained portfolio whereas we report mortgage loans in Table 52 when we sell them from the Retained portfolio to create PCs and Structured Securities. (3) Includes 40-year and 20-year Ñxed-rate mortgages. (4) Represents Structured Securities backed by non-agency securities that are backed by a mixture of prime, FHA/VA and subprime mortgage loans, including $6,908 million, $14,331 million and $5,653 million at December 31, 2006, 2005 and 2004, respectively, of Option ARMs. 90 Freddie Mac QUARTERLY SELECTED FINANCIAL DATA In our opinion, Ñnancial data for each quarter and full-year 2006 and 2005 reÖects all adjustments, consisting of normal recurring adjustments, necessary for a fair statement of the results of operations for such periods. See ""NOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Ì Estimates'' and ""Ì Changes in Accounting Princi- ples'' for more information concerning some of these adjustments. Net interest incomeÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Non-interest income (loss) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Non-interest expenseÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Income tax beneÑt (expense) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Net income (loss)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Earnings (loss) per common share: Basic(1) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Diluted(1) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Net interest income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Non-interest income (loss)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Non-interest expense ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Income tax beneÑt (expense)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Net income before cumulative eÅect of change in accounting principle ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Cumulative eÅect of change in accounting principle, net of taxes ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Net income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Earnings per common share before cumulative eÅect of change in accounting principle: Basic(1) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Diluted(1)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Earnings per common share after cumulative eÅect of change in accounting principle: Basic(1) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Diluted(1)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 1Q 2Q 2006 3Q (in millions, except share-related amounts) $ 959 $ 973 4Q $1,131 1,347 (584) 115 $2,009 $1,172 979 (714) (40) $1,397 (868) (827) 21 (543) (922) 12 $ (715) $ (480) Full-Year $ 4,235 915 (3,047) 108 $ 2,211 $ 2.81 $ 2.80 $ 1.93 $ 1.93 $(1.17) $(1.17) $(0.85) $(0.85) $ $ 2.84 2.84 4Q 2Q 2005 3Q (in millions, except share-related amounts) $ 1,363 423 (729) (177) 880 Ì 880 $1,237 346 (761) (138) 684 Ì $ 684 $1,269 (278) (583) (68) 340 Ì $ 340 $ Full-Year $ 5,370 199 (3,013) (367) 2,189 (59) $ 2,130 $ 0.41 $ 0.41 $ 0.41 $ 0.41 $ 1.19 $ 1.19 $ 1.19 $ 1.19 $ 0.90 $ 0.90 $ 0.90 $ 0.90 $ $ $ $ 2.84 2.83 2.76 2.75 1Q $1,501 (292) (940) 16 285 (59) $ 226 $ 0.34 $ 0.33 $ 0.25 $ 0.25 (1) Earnings (loss) per share is computed independently for each of the quarters presented. Due to the use of weighted average common shares outstanding when calculating earnings (loss) per share, the sum of the four quarters may not equal the full-year amount. Earnings (loss) per share amounts may not recalculate using the amounts in this table due to rounding. 91 Freddie Mac RISK MANAGEMENT AND DISCLOSURE COMMITMENTS In October 2000, we announced our voluntary adoption of a series of commitments designed to enhance market discipline, liquidity and capital. In September 2005, we entered into a written agreement with OFHEO that updated these commitments and set forth a process for implementing them. The letters between the company and OFHEO dated September 1, 2005 constituting the written agreement are available on the Investor Relations page of our website at www.freddiemac.com/investors/reports.html#commit. As noted in these letters, disclosures may be aÅected by situations where current Ñnancial statements are not available. The status of our commitments at December 31, 2006 follows: Description Status 1. Periodic Issuance of Subordinated Debt: ‚ We will issue Freddie SUBS» securities for public secondary market trading that are rated by no less than two nationally recognized statistical rating organizations. ‚ Freddie SUBS» securities will be issued in an amount such that the sum of Total capital (Core capital plus general allowance for losses) and the outstanding balance of ""Qualifying subordinated debt'' will equal or exceed the sum of 0.45 percent of outstanding PCs and Structured Securities we guaranteed and 4 percent of total on-balance sheet assets. Qualifying subordinated debt is discounted by one-Ñfth each year during the instrument's last Ñve years before maturity; when the remaining maturity is less than one year, the instrument is entirely excluded. We will take reasonable steps to maintain outstanding subordinated debt of suÇcient size to promote liquidity and reliable market quotes on market values. ‚ Each quarter we will submit to OFHEO calculations of the quantity of qualifying Freddie SUBS» securities and Total capital as part of our quarterly capital report. ‚ Every six months, we will submit to OFHEO a subordinated debt management plan that includes any issuance plans for the six months following the date of the plan. 2. Liquidity Management and Contingency Planning: ‚ We will maintain a contingency plan providing for at least three months' liquidity without relying upon the issuance of unsecured debt. We will also periodically test the contingency plan in consultation with OFHEO. 3. Interest-Rate Risk Disclosures: ‚ We will provide public disclosure of our duration gap, PMVS-L and PMVS-YC interest-rate risk sensitivity results on a monthly basis. See ""RISK MANAGEMENT Ì Interest-Rate Risk and Other Market Risks Ì Portfolio Market Value Sensitivity and Measurement of Interest-Rate Risk'' for a description of these metrics. ‚ Consistent with promoting the liquidity of our securities, in December 2006 we issued approximately $2.0 billion of Freddie SUBS» securities, including approximately $1.5 billion issued in exchange for previously issued Freddie SUBS» securities. In addition, we called approximately $1.0 billion of previously issued Freddie SUBS» securities in August 2006 and issued approximately $1.25 billion of Freddie SUBS» securities in June 2006. We did not issue, call or repurchase any Freddie SUBS» securities during 2005 and 2004. Our ability to issue additional subordinated debt may be limited until we return to regular Ñnancial reporting. ‚ All Freddie SUBS» securities issued in 2006 were rated by no less than two nationally recognized statistical rating organizations. ‚ We reported to OFHEO that at December 31, 2006, we had $42.6 billion in Total capital plus qualifying subordinated debt, resulting in a surplus of $5.0 billion. During 2006, we submitted our quarterly Total capital plus qualifying subordinated debt reports to OFHEO. ‚ We have submitted our semi-annual subordinated debt management plans to OFHEO. ‚ We have in place a liquidity contingency plan, upon which we report to OFHEO on a weekly basis. We periodically test this plan in accordance with our agreement with OFHEO. ‚ For the twelve months ended December 31, 2006, our duration gap averaged zero month, PMVS-L averaged 1 percent and PMVS-YC averaged zero percent. Our 2006 monthly average duration gap, PMVS results and related disclosures are provided in our Monthly Volume Summary which is available on our website, www.freddiemac.com/investors/volsum. 92 Freddie Mac Description Status 4. Credit Risk Disclosures: ‚ We will make quarterly assessments of the impact on expected credit losses from an immediate 5 percent decline in single-family home prices for the entire U.S. We will disclose the impact in present value terms and measure our losses both before and after receipt of private mortgage insurance claims and other credit enhancements. ‚ Our quarterly credit risk sensitivity estimates are as follows: As of: 12/31/06 09/30/06 06/30/06 03/31/06 12/31/05 Before Receipt of Credit Enhancements(1) After Receipt of Credit Enhancements(2) Net Present NPV Value, or NPV(3) Ratio(4) Value, or NPV(3) Ratio(4) Net Present NPV (dollars in millions) $1,128 $1,071 $1,018 $ 915 $ 873 (dollars in millions) 7.6 bps 7.4 bps 7.2 bps 6.6 bps 6.5 bps $770 $724 $686 $598 $564 5.2 bps 5.0 bps 4.9 bps 4.3 bps 4.2 bps 5. Public Disclosure of Risk Rating: ‚ We will seek to obtain a rating, that will be continuously monitored by at least one nationally recognized statistical rating organization, assessing ""risk-to-the-government'' or independent Ñnancial strength. (1) Assumes that none of the credit enhancements currently covering our mortgage loans has any mitigating impact on our credit losses. (2) Assumes we collect amounts due from credit enhancement providers after giving eÅect to certain assumptions about counterparty default rates. (3) Based on single-family Total mortgage portfolio, excluding Structured Securities backed by Ginnie Mae CertiÑcates. (4) Calculated as the ratio of net present value of increase in credit losses to the single- family Total mortgage portfolio, deÑned in footnote (3) above. ‚ At March 1, 2007, our ""risk-to-the-government'' rating from S&P was ""AA¿'' and Moody's Bank Financial Strength Rating for us was ""A¿''. 93 Freddie Mac CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA 94 Freddie Mac REPORT OF INDEPENDENT AUDITORS To the Board of Directors and Stockholders of Freddie Mac: In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of income, of cash Öows, and of stockholders' equity present fairly, in all material respects, the Ñnancial position of Freddie Mac, a stockholder-owned government-sponsored enterprise (the ""company''), and its subsidiaries at December 31, 2006 and 2005, and the results of their operations and their cash Öows for each of the three years in the period ended December 31, 2006, in conformity with accounting principles generally accepted in the United States of America. These Ñnancial statements are the responsibility of the company's management. Our responsibility is to express an opinion on these Ñnancial statements based on our audits. We conducted our audits of these statements in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the Ñnancial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the Ñnancial statements, assessing the accounting principles used and signiÑcant estimates made by management, and evaluating the overall Ñnancial statement presentation. We believe that our audits provide a reasonable basis for our opinion. We have also audited in accordance with auditing standards generally accepted in the United States of America the supplemental consolidated fair value balance sheets of the company as of December 31, 2006 and 2005. As described in ""NOTE 16: FAIR VALUE DISCLOSURES,'' the supplemental consolidated fair value balance sheets have been prepared by management to present relevant Ñnancial information that is not provided by the historical-cost consolidated balance sheets and is not intended to be a presentation in conformity with generally accepted accounting principles. In addition, the supplemental consolidated fair value balance sheets do not purport to present the net realizable, liquidation, or market value of the company as a whole. Furthermore, amounts ultimately realized by the company from the disposal of assets or amounts required to settle obligations may vary signiÑcantly from the fair values presented. In our opinion, the supplemental consolidated fair value balance sheets referred to above present fairly, in all material respects, the information set forth therein as described in ""NOTE 16: FAIR VALUE DISCLOSURES.'' As discussed in ""NOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES,'' the company changed its method of accounting for deÑned beneÑt plans as of December 31, 2006, its method of accounting for interest expense related to callable debt instruments as of January 1, 2005, and its method for determining gains and losses on sales of certain guaranteed securities as of October 1, 2005. McLean, Virginia March 20, 2007 95 Freddie Mac FREDDIE MAC CONSOLIDATED STATEMENTS OF INCOME Year Ended December 31, 2006 2004 2005 (dollars in millions, except share- related amounts) Interest income Mortgage loansÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Mortgage-related securities in the Retained portfolio ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Cash and investments ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total interest incomeÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 4,152 34,673 4,262 43,087 $ 4,037 29,684 2,606 36,327 $ 4,007 28,460 3,136 35,603 Interest expense Short-term debt ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Long-term debt ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total interest expense on debt securitiesÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Due to Participation CertiÑcate investors ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total interest expense ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Income (expense) related to derivatives ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Net interest income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Non-interest income (loss) Management and guarantee income (includes interest on Guarantee asset of $466, $371 and $257) ÏÏÏÏ Gains (losses) on Guarantee asset ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Income on Guarantee obligation ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Derivative gains (losses)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Hedge accounting gains (losses) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Gains (losses) on investment activity ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Gains (losses) on debt retirement ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Resecuritization fees ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Other income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Non-interest income (loss) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Non-interest expense Salaries and employee beneÑtsÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Professional services ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Occupancy expense ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Other administrative expenses ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total administrative expenses ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Provision for credit losses ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Real estate owned, or REO, operations income (expense)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Losses on certain credit guarantees ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Housing tax credit partnerships ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Minority interests in earnings of consolidated subsidiaries ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Other expenses ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Non-interest expense ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Income before income tax expense and cumulative eÅect of change in accounting principle ÏÏÏÏÏÏÏÏÏÏÏ Income tax beneÑt (expense) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Net income before cumulative eÅect of change in accounting principleÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Cumulative eÅect of change in accounting principle, net of tax beneÑt of $32 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Net income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (8,665) (28,218) (36,883) (387) (37,270) (1,582) 4,235 1,672 (800) 867 (1,164) 2 (474) 466 129 217 915 (830) (460) (61) (290) (1,641) (215) (60) (476) (407) (58) (190) (3,047) 2,103 108 2,211 Ì 2,211 $ (6,102) (23,246) (29,348) (551) (29,899) (1,058) 5,370 1,450 (1,064) 920 (1,357) 22 (127) 206 125 24 199 (805) (386) (58) (286) (1,535) (251) (40) (234) (320) (96) (537) (3,013) 2,556 (367) 2,189 (59) $ 2,130 Preferred stock dividends ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Amount allocated to participating stock option holders ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Net income available to common stockholdersÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (270) (5) $ 1,936 $ (223) Ì 1,907 (2,908) (22,950) (25,858) (708) (26,566) 100 9,137 1,382 (1,135) 732 (4,475) 743 (348) (327) 159 230 (3,039) (758) (588) (60) (144) (1,550) (143) 3 (33) (281) (129) (238) (2,371) 3,727 (790) 2,937 Ì 2,937 (210) Ì 2,727 $ $ Basic earnings per common share: Earnings before cumulative eÅect of change in accounting principle ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Cumulative eÅect of change in accounting principle, net of taxesÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Basic earnings per common share ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Diluted earnings per common share: Earnings before cumulative eÅect of change in accounting principle ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Cumulative eÅect of change in accounting principle, net of taxesÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Diluted earnings per common share ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ $ $ $ $ $ 2.84 $ Ì $ $ 2.84 2.84 $ Ì $ $ 2.84 $ 2.84 (0.09) $ $ 2.76 $ 2.83 (0.08) $ $ 2.75 3.96 Ì 3.96 3.94 Ì 3.94 Weighted average common shares outstanding (in thousands) Basic ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Diluted ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Dividends per common share ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 680,856 682,664 1.91 $ 691,582 693,511 1.52 $ 689,282 691,521 1.20 $ The accompanying notes are an integral part of these Ñnancial statements. 96 Freddie Mac FREDDIE MAC CONSOLIDATED BALANCE SHEETS December 31, 2006 2005 (in millions, except share-related amounts) Assets Retained portfolio Mortgage loans: Held-for-investment, at amortized costÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Reserve for losses on mortgage loans held-for-investment ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Held-for-sale, at lower-of-cost-or-market ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Mortgage loans, net of reserve ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 63,780 (70) 1,908 65,618 $ 60,009 (119) 1,538 61,428 Mortgage-related securities: Available-for-sale, at fair value (includes $20,463 and $168, respectively, pledged as collateral that may be repledged) ÏÏÏ Trading, at fair valueÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Participation CertiÑcate residuals, at fair value ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total mortgage-related securities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Retained portfolio ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Cash and investments Cash and cash equivalents ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Investments: 626,731 7,597 597 634,925 700,543 638,465 8,894 597 647,956 709,384 11,359 10,468 Non-mortgage-related securities: Available-for-sale, at fair value ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Securities purchased under agreements to resell and Federal funds sold ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Cash and investments ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Accounts and other receivables, net ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Derivative assets, at fair value ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Guarantee asset, at fair valueÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Real estate owned, net ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Other assets ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total assetsÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 45,586 23,028 79,973 7,461 7,908 6,070 743 10,383 $813,081 Liabilities and stockholders' equity Debt securities, net Senior debt: Due within one year ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Due after one yearÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Subordinated debt, due after one year ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total debt securities, net ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Due to Participation CertiÑcate investors ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Accrued interest payableÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Guarantee obligation ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Derivative liabilities, at fair value ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Reserve for guarantee losses on Participation CertiÑcates ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Other liabilities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total liabilitiesÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $294,861 452,677 6,400 753,938 11,123 8,345 7,117 179 350 3,212 784,264 Commitments and contingencies (Notes 1, 3, 4, 13 and 14) Minority interests in consolidated subsidiaries ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Stockholders' equity Preferred stock, at redemption value ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Common stock, $0.21 par value, 726,000,000 shares authorized, 725,863,886 shares and 725,882,280 shares issued, respectively, and 661,254,178 shares and 692,717,422 shares outstanding, respectively ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Additional paid-in capital ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Retained earnings ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Accumulated other comprehensive income (loss), or AOCI, net of taxes, related to: Available-for-sale securities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Cash Öow hedge relationships ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ DeÑned beneÑt plansÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total AOCI, net of taxes ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Treasury stock, at cost, 64,609,708 shares and 33,164,858 shares, respectively ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total stockholders' equityÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total liabilities and stockholders' equityÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 516 6,109 152 962 32,177 (2,749) (5,033) (87) (7,869) (3,230) 28,301 $813,081 (2,485) (6,287) (1) (8,773) (1,280) 27,191 $806,222 42,165 15,159 67,792 6,373 7,097 5,083 629 9,864 $806,222 $288,532 454,627 5,633 748,792 10,607 7,611 5,541 590 295 4,646 778,082 949 4,609 152 924 31,559 The accompanying notes are an integral part of these Ñnancial statements. 97 Freddie Mac FREDDIE MAC CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY 2006 Year Ended December 31, 2005 2004 Shares Amount Shares Amount Shares Amount (in millions) Preferred stock, at redemption value Balance, beginning of year ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Preferred stock issuances ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Preferred stock, end of year ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Common stock, par value Balance, beginning of year ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Common stock, end of year ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Additional paid-in capital Balance, beginning of year ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Stock-based compensation ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Income tax beneÑt from employee stock option exercises ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Preferred stock issuance costs ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Common stock issuances ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Real Estate Investment Trust, or REIT, preferred stock repurchase ÏÏÏÏÏÏÏÏÏÏ Additional paid-in capital, end of yearÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Retained earnings Balance, beginning of year ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Cumulative eÅect of change in accounting principle, net of taxes ÏÏÏÏÏÏÏÏÏÏÏÏ Balance, beginning of year, as adjusted ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Net income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Preferred stock dividends declared ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Common stock dividends declared ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Retained earnings, end of year ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ AOCI, net of taxes Balance, beginning of year ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Changes in unrealized gains (losses) related to available-for-sale securities, net of reclassiÑcation adjustments ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Changes in unrealized gains (losses) related to cash Öow hedge relationships, net of reclassiÑcation adjustmentsÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Changes in minimum pension liability ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Changes in other comprehensive income, net of taxes, net of reclassiÑcation adjustments ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Adjustment to initially apply Statement of Financial Accounting Standard, or SFAS, No. 158, net of taxÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ AOCI, net of taxes, end of yearÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Treasury stock, at cost Balance, beginning of year ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Common stock issuances ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Common stock repurchases ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Treasury stock, end of year ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total stockholders' equity ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 92 40 132 726 726 33 (1) 33 65 Comprehensive income (loss) Net income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Changes in other comprehensive income, net of taxes, net of reclassiÑcation adjustments ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total comprehensive income (loss) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 92 Ì 92 726 726 $ 4,609 1,500 6,109 152 152 924 60 9 (15) (15) (1) 962 31,559 (13) 31,546 2,211 (270) (1,310) 32,177 (8,773) (264) 1,254 (2) 988 (84) (7,869) 50 (1,280) 35 (2) (2,000) Ì 33 (3,230) $28,301 $ 2,211 988 $ 3,199 $ 4,609 Ì 4,609 152 152 873 67 6 Ì (13) (9) 924 30,728 Ì 30,728 2,130 (223) (1,076) 31,559 (3,593) (6,824) 1,637 7 (5,180) Ì (8,773) (1,353) 73 Ì (1,280) $27,191 $ 2,130 (5,180) $(3,050) 92 Ì 92 726 726 37 (2) Ì 35 $ 4,609 Ì 4,609 152 152 814 56 20 Ì (17) Ì 873 28,837 Ì 28,837 2,937 (210) (836) 30,728 (1,498) (2,010) (87) 2 (2,095) Ì (3,593) (1,427) 74 Ì (1,353) $31,416 $ 2,937 (2,095) 842 $ The accompanying notes are an integral part of these Ñnancial statements. 98 Freddie Mac FREDDIE MAC CONSOLIDATED STATEMENTS OF CASH FLOWS 2006 Year Ended December 31, 2005 (in millions) 2004 Cash Öows from operating activities Net income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Adjustments to reconcile net income to net cash provided by operating activities: $ 2,211 $ 2,130 $ 2,937 Cumulative eÅect of change in accounting principle, net ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Hedge accounting gains ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Unrealized losses (gains) on derivatives not in hedge accounting relationships, net ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Asset related amortization Ì premiums, discounts and hedging basis adjustments ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Debt related amortization Ì premiums and discounts on certain debt securities and hedging basis adjustments ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Net discounts paid on retirements of debtÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (Gains) losses on debt retirement ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Provision for credit losses ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Housing tax credit partnership losses ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Losses on investment activity ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Decrease in deferred income taxes ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Purchases of held-for-sale mortgages ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Sales of held-for-sale mortgages ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Repayments of held-for-sale mortgages ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Net proceeds of trading securities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Change in accounts and other receivables, net ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Change in amounts due to Participation CertiÑcate investors, net ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Change in accrued interest payable ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Change in income taxes payableÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Change in Guarantee asset ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Change in Guarantee obligation ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Change in Participation CertiÑcate residuals, at fair value ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Other, net ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Net cash provided by operating activities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Cash Öows from investing activities Purchases of available-for-sale securities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Proceeds from sales of available-for-sale securities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Proceeds from maturities of available-for-sale securities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Purchases of held-for-investment mortgages ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Repayments of held-for-investment mortgages ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Proceeds from sales of REO ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Net (increase) decrease in securities purchased under agreements to resell and Federal funds soldÏÏÏÏÏÏÏ Derivative premiums and terminations, net ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Investments in housing tax credit partnerships ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Net cash used for investing activities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Cash Öows from Ñnancing activities Proceeds from issuance of short-term debt ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Repayments of short-term debtÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Proceeds from issuance of long-term debtÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Repayments of long-term debt ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Repayments of minority interest in consolidated subsidiaries ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Repurchase of REIT preferred stock ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Proceeds from the issuance of preferred stock ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Proceeds from issuance of common stock ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Repurchases of common stock ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Payment of cash dividends on preferred stock and common stock ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Tax beneÑt from the exercise of stock-based awards ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Payments of housing tax credit partnerships notes payable ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Increase (decrease) in cash overdraft ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Net cash (used for) provided by Ñnancing activities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Net increase (decrease) in cash and cash equivalents ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Cash and cash equivalents at beginning of year ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Cash and cash equivalents at end of year ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Supplemental cash Öow information Cash paid (received) for: InterestÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Derivative interest carry, net ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Income taxes ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Non-cash investing and Ñnancing activities: Held-for-sale mortgages securitized and retained as available-for-sale securities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Transfers from mortgage loans to REO ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Investments in housing tax credit partnerships Ñnanced by notes payableÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Transfers from held-for-sale mortgages to held-for-investment mortgages ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Transfers from held-for-investment mortgages to held-for-sale mortgages ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Transfers from Retained portfolio PCs to held-for-investment mortgages ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 59 (22) 1,014 791 9,129 (5,207) (206) 260 320 343 (1,452) (26,763) 23,662 118 2,598 661 (3,077) 282 607 (567) 1,413 112 42 6,247 (414,063) 94,961 249,857 (12,826) 11,897 1,380 17,038 932 (127) (50,951) 857,361 (862,176) 153,504 (125,959) (436) (142) Ì 60 Ì (1,299) Ì (940) (54) 19,919 (24,785) 35,253 10,468 $ Ì (2) 1,253 26 11,176 (7,430) (466) 215 407 494 (1,074) (18,352) 18,722 104 1,085 (1,040) 434 734 (282) (987) 1,540 6 446 9,220 (386,394) 86,745 305,317 (15,410) 10,466 1,212 (7,869) (97) (161) (6,191) 750,201 (766,598) 177,361 (159,204) (469) (27) 1,485 35 (2,000) (1,580) 4 (1,382) 36 (2,138) 891 10,468 11,359 $ $ 34,399 325 1,250 $ 26,797 (590) 1,212 13 1,603 324 123 950 1,316 175 1,517 1,095 291 Ì 1,372 Ì (743) 2,758 1,302 5,748 (3,085) 327 143 281 738 (346) (31,698) 30,965 162 38,672 1,870 529 (235) 773 (830) 1,173 (170) (19) 51,252 (276,573) 85,583 176,432 (12,270) 11,256 1,552 (11,615) (193) (69) (25,897) 826,020 (841,638) 187,779 (183,541) (405) Ì Ì 57 Ì (1,046) $ $ Ì (498) 28 (13,244) 12,111 23,142 35,253 23,902 325 363 272 1,733 1,184 198 Ì 1,716 The accompanying notes are an integral part of these Ñnancial statements. 99 Freddie Mac NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES We are a stockholder-owned government-sponsored enterprise, or GSE, established by Congress in 1970 to provide a continuous Öow of funds for residential mortgages. Our obligations are ours alone and are not insured or guaranteed by the U.S. government, or any other agency or instrumentality of the U.S. We play a fundamental role in the U.S. housing Ñnance system, linking the domestic mortgage market and the global capital markets. Our participation in the secondary mortgage market includes providing our credit guarantee for residential mortgages originated by mortgage lenders and investing in mortgage loans and mortgage-related securities that we hold in our Retained portfolio. Through our credit guarantee activities, we securitize mortgage loans by issuing Mortgage Participation CertiÑcates, or PCs, to third-party investors. We also resecuritize mortgage-related securities that are issued by us or the Government National Mortgage Association, or Ginnie Mae, as well as non-agency entities. We also guarantee multifamily mortgage loans that support housing revenue bonds issued by third parties and we guarantee other mortgage loans held by third parties. Securitized mortgage-related assets that back PCs and Structured Securities that are held by third parties are not reÖected as our assets. In return for providing our guarantee on issued PCs and Structured Securities, we may earn a management and guarantee fee that is paid to us over the life of the related PCs and Structured Securities. Our obligation to guarantee the payment of principal and interest on issued PCs and Structured Securities usually results in the recognition of a Guarantee asset and Guarantee obligation. Our Ñnancial reporting and accounting policies conform to U.S. generally accepted accounting principles, or GAAP. Certain amounts in prior periods have been reclassiÑed to conform to the current presentation. We evaluate the materiality of identiÑed errors in the Ñnancial statements using both an income statement, or ""rollover,'' and a balance sheet, or ""iron- curtain,'' approach, based on relevant quantitative and qualitative factors. Our approach is consistent with the Securities and Exchange Commission's StaÅ Accounting Bulletin No. 108, ""Considering the EÅects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements,'' or SAB 108, which is eÅective for the year ended December 31, 2006. Estimates The preparation of Ñnancial statements requires us to make estimates and assumptions that aÅect (a) the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the Ñnancial statements and (b) the reported amounts of revenues and expenses and gains and losses during the reporting period. Actual results could diÅer from those estimates. Our estimates and judgments include the following: ‚ estimating fair value for Ñnancial instruments (See ""NOTE 16: FAIR VALUE DISCLOSURES'' for a discussion of our fair value estimates); ‚ determining the expected future cash Öows (including the timing and amounts of prepayments) of mortgage-related assets in the Retained portfolio for the purpose of amortizing deferred amounts and assessing when securities are other-than-temporarily impaired; ‚ assessing the reserves for credit losses on mortgage loans and guarantee losses on PCs; ‚ assessing our legal and tax contingencies; ‚ estimating the expected timing and amounts of future issuances of non-callable debt; and ‚ determining other matters that aÅect the reported amounts and disclosure of contingencies in the Ñnancial statements. Net income for 2006 was increased by approximately $8 million (after-tax), or $0.01 per diluted common share, due primarily to changes in estimates related to the amortization of discounts, premiums and deferred fees for assets held in the Retained portfolio and enhancements to our approach for certain valuations including the Guarantee asset and Guarantee obligation. EÅective January 1, 2006, we enhanced our process for forecasting interest rates and estimating prepayments used to amortize discounts, premiums and deferred fees for assets held in the Retained portfolio. This change resulted in a $49 million (after-tax) reduction in Net income for 2006, including the eÅect of the amortization of deferred credit fees. Also, eÅective January 1, 2006, we enhanced our approach for Guarantee asset and Guarantee obligation valuations primarily with respect to applying dealer prices in estimating the fair value of our guarantee-related assets. We also enhanced our approach for applying loan characteristics in the valuation of our Guarantee obligation. These changes resulted in a $57 million (after-tax) increase in Net income for 2006. In 2005, Net income was reduced by approximately $206 million (after-tax), or $0.30 per diluted common share, related to the implementation of enhancements to our approach for Guarantee asset and Guarantee obligation valuations, the 100 Freddie Mac estimation of reserves for uncollectible interest, and models used to estimate prepayment behavior of mortgage assets, all of which were recorded as changes in accounting estimates. In 2004, Net income was decreased by approximately $56 million (after-tax), or $0.08 per diluted common share, as the result of a change in estimate related to enhancements to certain assumptions and calculations in the amortization process for deferred fees recorded as basis adjustments on assets in our Retained portfolio. Table 1.1 shows the pre-tax impact of the changes in estimates in our consolidated statements of income: Table 1.1 Ì Summary of Change in Estimates (Pre-Tax) Interest income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Non-interest income (loss) Management and guarantee income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Gains (losses) on Guarantee asset ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Gains (losses) on investment activity ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Other income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total Non-interest income (loss) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total pre-tax impact of changes in estimatesÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Year ended December 31, 2005 2004 2006 (in millions) $(93) $(166) $(86) 18 40 47 Ì 105 $ 12 (17) (27) (78) (27) (149) $(315) Ì Ì Ì Ì Ì $(86) Changes in Accounting Principles At December 31, 2006, we adopted Statement of Financial Accounting Standards, or SFAS, No. 158, ""Employers' Accounting for DeÑned BeneÑt Pension and Other Postretirement Plans, an amendment of FASB Statements No. 87, 88, 106, and 132(R),'' or SFAS 158, which requires the recognition of our pension and other postretirement plans' overfunded or underfunded status in the statement of Ñnancial position beginning December 31, 2006. See ""Recently Adopted Accounting Standards'' for additional information. Table 1.2 summarizes the incremental eÅect of applying SFAS 158 on individual line items on our consolidated balance sheets. Table 1.2 Ì Change in Accounting for DeÑned BeneÑt Plans Ì Impact on Financial Statements December 31, 2006 Prior to Adoption of SFAS 158 EÅect of Adopting SFAS 158 As Reported (in millions) Consolidated Balance Sheet Line Items(1) Assets: Other assets ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total assetsÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 10,432 813,130 Liabilities and stockholders' equity: Other liabilities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ AOCI, net of taxes: DeÑned beneÑt plansÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total liabilities and stockholders' equity ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 3,177 (3) 813,130 $(49) (49) 35 (84) (49) $ 10,383 813,081 3,212 (87) 813,081 (1) Allocation between Other assets and Other liabilities on our consolidated balance sheets depends upon whether the deÑned beneÑt plans are either overfunded (impacting Other assets) or underfunded (impacting Other liabilities). Included in the Other assets line on our consolidated balance sheets is a Deferred tax asset of $45 million based on the amount reclassiÑed into AOCI, net of taxes at December 31, 2006. EÅective January 1, 2006, we made a change to our method of amortization for certain types of non-agency securities resulting in a $13 million (after-tax) reduction to the opening balance of retained earnings. EÅective January 1, 2005, we changed our method of accounting for interest expense related to callable debt instruments to recognize interest expense using an eÅective interest method over the contractual life of the debt. For periods prior to 2005, we amortized premiums, discounts, deferred issuance costs and other basis adjustments into interest expense using an eÅective interest method over the estimated life of the debt. We implemented this change in accounting method to facilitate improved Ñnancial reporting, particularly to promote the comparability of our Ñnancial reporting with that of our primary competitor. The change in accounting method also reduced the operational complexity associated with determining the estimated life of callable debt. The cumulative eÅect of this change was a $59 million (after-tax) reduction in net income for 2005. Table 1.3 summarizes the pro forma net income and related basic and diluted earnings per common share, had the amortization of premiums, discounts, deferred issuance costs and other basis adjustments related to callable debt based on the contractual maturity been in eÅect for the year ended December 31, 2004. 101 Freddie Mac Table 1.3 Ì Pro Forma Information Ì Change in Accounting for Interest Expense Related to Callable Debt Year Ended December 31, 2004 (in millions, except share-related amounts) As reported: Net income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Basic earnings per common share ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Diluted earnings per common shareÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Pro forma: Net income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Basic earnings per common share ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Diluted earnings per common shareÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $2,937 $ 3.96 $ 3.94 $2,910 $ 3.92 $ 3.90 Beginning October 1, 2005, we changed our method for determining gains and losses upon the resale of PCs and Structured Securities related to deferred items recognized in connection with our guarantee of those securities. This change in accounting principle was facilitated by system changes that now allow us to apply and track these deferred items relative to the speciÑc portions of the purchased PCs and Structured Securities. The lack of certain historical data precluded us from calculating the cumulative eÅect of the change. We were not able to determine the pro forma eÅects of applying the new method retroactively. See ""NOTE 2: TRANSFERS OF SECURITIZED INTERESTS IN MORTGAGE- RELATED ASSETS'' for additional information. Consolidation and Equity Method of Accounting The consolidated Ñnancial statements include our accounts and those of our subsidiaries. All material intercompany transactions have been eliminated in consolidation. For each entity with which we are involved, we determine whether the entity should be considered our subsidiary and included in our consolidated Ñnancial statements. We consolidate (a) all variable interest entities, or VIEs, in which we are the primary beneÑciary and (b) entities in which we hold more than 50 percent of the voting rights or have the ability to exercise control over the entity. We are considered the primary beneÑciary and must consolidate a VIE when we absorb a majority of expected losses or expected residual returns, or both. In addition to the VIEs that are consolidated, we have signiÑcant variable interest in certain other VIEs that are not consolidated because we are not the primary beneÑciary. See ""NOTE 3: VARIABLE INTEREST ENTITIES'' for more information. We consolidate entities when we hold more than 50 percent of the voting rights or have the ability to exercise control over the entity. Accordingly, we consolidate our two majority-owned REITs, Home Ownership Funding Corporation and Home Ownership Funding Corporation II. The equity and net earnings attributable to the minority shareholder interests in our consolidated subsidiaries are reported separately on our consolidated balance sheets as Minority interests in consolidated subsidiaries and in the consolidated statements of income as Minority interests in earnings of consolidated subsidiaries. We use the equity method of accounting for VIEs when we are not the primary beneÑciary and for entities that are not VIEs over which we have the ability to exercise signiÑcant inÖuence, but not control. Under the equity method of accounting, we report our recorded investment as part of Other assets on our consolidated balance sheets and recognize our share of the entity's net income or losses in the consolidated statements of income as Non-interest income/expense, with an oÅset to the recorded investment on our consolidated balance sheets. Losses are recognized up to the amount of investment recorded. We regularly invest as a limited partner in qualiÑed low-income housing tax credit, or LIHTC, partnerships that are eligible for federal tax credits. Most of these are VIEs. We are the primary beneÑciary and consolidate certain of these partnerships as described further in ""NOTE 3: VARIABLE INTEREST ENTITIES.'' Our recorded investment in those partnerships that are not consolidated is accounted for under the equity method and reported as part of Other assets on our consolidated balance sheets. Our share of partnership income or loss is reported in our consolidated statements of income as Non-interest expense Ì Housing tax credit partnerships. Our obligations to make delayed equity contributions that are unconditional and legally binding are recorded at their present value in Other liabilities on the consolidated balance sheets. To the extent our cost basis in qualiÑed LIHTC partnerships diÅers from the book basis reÖected at the partnership level, the diÅerence is amortized over the life of the tax credits and included in our share of earnings (losses) from housing tax credit partnerships. We periodically review these investments for impairment and adjust them to fair value when a decline in market value below the recorded investment is deemed to be other-than-temporary. Impairment losses are included in our consolidated statements of income as part of Non-interest expense Ì Housing tax credit partnerships. Cash and Cash Equivalents and Statements of Cash Flows Highly liquid investment securities that have an original maturity of three months or less and are used for cash management purposes are accounted for as cash equivalents. In addition, cash collateral we obtained from counterparties to 102 Freddie Mac derivative contracts where we are in a net unrealized gain position is recorded as Cash and cash equivalents. The vast majority of the Cash and cash equivalents balance is interest-bearing in nature. In the consolidated statements of cash Öows, cash Öows related to the acquisition and termination of derivatives other than forward commitments are generally classiÑed in investing activities, without regard to whether the derivatives are designated as a hedge of another item. Cash Öows from commitments accounted for as derivatives that result in the acquisition or sale of mortgage securities or mortgage loans are classiÑed in either: (a) operating activities for trading securities or mortgage loans classiÑed as held-for-sale, or (b) investing activities for available-for-sale securities or mortgage loans classiÑed as held-for-investment. Cash Öows related to mortgage loans classiÑed as held-for-sale are classiÑed in operating activities until the loans have been securitized and retained as available-for-sale PCs, at which time the cash Öows are classiÑed as investing activities. Cash Öows related to guarantee fees, including buy-up and buy-down payments, are classiÑed as operating activities, along with the cash Öows related to the collection and distribution of payments on the mortgage loans underlying PCs. Buy-up and buy-down payments are discussed further below in ""Swap-Based Issuances of PCs and Structured Securities.'' Transfers of PCs and Structured Securities that Qualify as Sales Upon completion of a transfer of a Ñnancial asset that qualiÑes as a sale under SFAS No. 140, ""Accounting for Transfers and Servicing of Financial Assets and Extinguishment of Liabilities, a replacement of FASB Statement No. 125,'' or SFAS 140, we de-recognize all assets sold and recognize all assets obtained and liabilities incurred. Upon sale, we recognize the fair value of our obligation to guarantee the payment of principal and interest of PCs and Structured Securities transferred in sale transactions. The portion of such obligation that relates to our non-contingent obligation to stand ready to perform under our guarantee is recognized as a Guarantee obligation, while the portion of the obligation that relates to estimated incurred losses on securitized assets is recognized for consolidated balance sheet purposes as Reserve for guarantee losses on Participation CertiÑcates. The resulting gain (loss) on sale of transferred PCs and Structured Securities is reÖected in our consolidated statements of income as a component of Gains (losses) on investment activity. In recording a sales transaction, we also continue to carry on our consolidated balance sheets any retained interests in securitized Ñnancial assets. Such retained interests include our right to receive management and guarantee fees on PCs or Structured Securities, which is classiÑed on our consolidated balance sheets as a Guarantee asset. The carrying amount of all such retained interests is determined by allocating the previous carrying amount of the transferred assets between assets sold and the retained interests based upon their relative fair values at the date of transfer. Other retained interests include PCs or Structured Securities that are not transferred to third parties upon the completion of a securitization or resecuritization transaction. Swap-Based Issuances of PCs and Structured Securities We issue PCs and Structured Securities through cash-based sales transactions and through various swap-based exchanges. In the case of PC-based swaps, we issue such securities to third parties through Guarantor and MultiLender Swap transactions. Guarantor Swaps are transactions in which Ñnancial institutions transfer mortgage loans to us in exchange for PCs we issue that are backed by such mortgage loans. MultiLender Swaps are similar to Guarantor Swaps, except that formed pools include loans that are contributed by more than one other party or by us. In Guarantor and MultiLender Swaps, as in sales transactions, in return for providing our guarantee, we earn a guarantee fee that is paid to us over the life of an issued PC. It is also common for buy-up or buy-down payments to be exchanged between our counterparties and us upon the issuance of a PC. Buy-ups are upfront payments made by us that increase the guarantee fee we will receive over the life of the PC. Buy-downs are upfront payments that are made to us that decrease (i.e., partially prepay) the guarantee fee we will receive over the life of the PC. We may also receive upfront, cash-based payments as additional compensation for our guarantee of mortgage loans, referred to as credit fees. As additional consideration received on swap-based exchanges, we may receive various types of seller-provided credit enhancements related to the underlying mortgage loans. We also issue and transfer Structured Securities to third parties in exchange for PCs and non-Freddie Mac mortgage-related securities. We recognize the fair value of our contractual right to receive guarantee fees as a Guarantee asset at the inception of an executed guarantee. Additionally, at inception of an executed guarantee, we recognize a Guarantee obligation at the greater of (a) fair value or (b) the contingent liability amount required by SFAS No. 5, ""Accounting for Contingencies,'' or SFAS 5. Similar to transfers of PCs and Structured Securities that qualify as sales, that portion of our estimated guarantee liability that relates to our non-contingent obligation to stand ready to perform under a PC guarantee is recognized as Guarantee obligation, while that portion of such estimated guarantee liability that relates to our contingent obligation to make payments under our guarantee is recognized on our consolidated balance sheets as Reserve for guarantee losses on Participation CertiÑcates. Credit enhancements received in connection with Guarantor Swaps and other similar exchange transactions of PCs are measured at fair value and recognized as follows: (a) pool insurance is recognized as an Other asset; (b) recourse and/or indemniÑcations that are provided by counterparties to Guarantor Swap transactions are recognized as 103 Freddie Mac Other assets; and (c) primary mortgage insurance is recognized at inception as a component of the recognized Guarantee obligation. Because Guarantee asset, Guarantee obligation and credit enhancement-related assets that are recognized at the inception of an executed Guarantor Swap are valued independently of each other, net diÅerences between these recognized assets and liabilities may exist at inception. If the amount of the Guarantee asset plus the credit enhancement-related assets is greater than the total amount of the Guarantee obligation, the diÅerence between such amounts is deferred on our consolidated balance sheets as a component of Guarantee obligation and referred to as deferred guarantee income. If the amount of the Guarantee asset and the credit enhancement-related assets is less than the total amount of the Guarantee obligation, the diÅerence between such amounts is expensed immediately to earnings as a component of Non-interest expense Ì Other expenses. Additionally, cash payments that are made or received in connection with buy-ups and buy- downs are recognized as adjustments of recognized deferred guarantee income. Likewise, credit fees that we receive at inception are also recognized as adjustments of recognized deferred guarantee income. We account for a portion of PCs that we issue through our MultiLender Swap Program in the same manner as transfers that are accounted for as sales. The remaining portion of such PC issuances is accounted for in a manner consistent with the accounting for PCs issued through the Guarantor Swap program. For Structured Securities that we issue to third parties in exchange for PCs and non- Freddie Mac mortgage-related securities, we generally do not recognize any incremental Guarantee asset or Guarantee obligation. Rather, we defer and amortize into income on a straight-line basis that portion of the transaction fee that we receive that relates to the estimated fair value of our future administrative responsibilities for issued Structured Securities. In cases where we retain portions of Structured Securities issued in such transactions, a portion of the received transaction fee is deferred as a carrying value adjustment of retained Structured Securities. The balance of transaction fees received, which relates to compensation earned in connection with structuring-related services we rendered to third parties, is recognized immediately in earnings as Non- interest income Ì Resecuritization fees. Purchases of PCs or Structured Securities The purchase of a PC or Structured Security prompts the extinguishment of the corresponding, recognized Guarantee obligation. We de-recognize an extinguished Guarantee obligation against earnings as a component of Gains (losses) on investment activity. Correspondingly, the recognized Guarantee asset is reclassiÑed on our consolidated balance sheets as a component of PC residuals. PC residuals are remeasured at fair value, including the fair value of the inherent credit obligation associated with the purchased PC or Structured Security. The unamortized balance of deferred guarantee income is extinguished as a basis adjustment to the recognized value of purchased PCs. Such basis adjustments are subsequently amortized into earnings as Interest income pursuant to the requirements of SFAS No. 91, ""Accounting for Nonrefundable Fees and Costs Associated with Originating or Acquiring Loans and Initial Direct Costs of Leases, an amendment of FASB Statements No. 13, 60 and 65 and a rescission of FASB Statement No. 17,'' or SFAS 91, using the eÅective interest method. Subsequent Measurement of Recognized Guarantee-Related Assets and Liabilities Deferred Guarantee Income Deferred guarantee income is amortized into earnings at a rate that is commensurate with the observed rate of decline in the unpaid principal balance of securitized mortgage loans. Periodic amortization of recognized deferred guarantee income is reÖected in earnings as a component of Income on Guarantee obligation. Recognized Guarantee Asset We generally account for a Guarantee asset like a debt instrument classiÑed as trading under SFAS 115, ""Accounting for Certain Investments in Debt and Equity Securities,'' or SFAS 115. Changes in the fair value of the recognized Guarantee asset are reÖected in earnings as a component of Gains (losses) on Guarantee asset. Cash collections of our contractual guarantee fee reduce the value of the Guarantee asset. All guarantee-related compensation that is received over the life of the loan in cash is reÖected in earnings as a component of Management and guarantee income. Recognized Guarantee Obligation We amortize the recognized Guarantee obligation into earnings commensurate with the observed decline in the unpaid principal balance of securitized mortgage loans. Periodic amortization of a recognized Guarantee obligation is reÖected in earnings as a component of Income on Guarantee obligation. Separately, the subsequent measurement of our contingent obligation to make guarantee payments is further discussed below in ""Reserves for Losses on Mortgage Loans Held-for- Investment and Losses on PCs.'' 104 Freddie Mac Recognized Credit Enhancements Credit enhancements that are separately recognized as Other assets are amortized into earnings as Non-interest expense. Such assets are amortized over related contract terms at the greater of amounts calculated by amortizing recognized credit enhancements (a) commensurate with the observed decline in the unpaid principal balance of covered mortgage loans or (b) on a straight-line basis over a credit enhancement's contract term. Recurring insurance premiums are recorded at the amount paid and amortized over their contractual life and, if provided quarterly, then the amortization period is three months. PC Residuals PC residuals relate to certain PCs or Structured Securities that we hold as investments and represent the fair value of the expected future cash Öows associated with the guarantee contracts (including cash Öows related to Management and guarantee fees and our Guarantee obligation) that are inherent within such securities. We recognize a PC residual in connection with PCs or Structured Securities that we hold that (a) were previously transferred to third parties as part of transactions that were accounted for either as sales or in a manner described above for Guarantor Swap transactions (such that a Guarantee asset and Guarantee obligation were previously established for held PCs or Structured Securities), or (b) were formed from mortgage loans purchased through our Cash Window, referred to as ""Cash Window Purchases,'' and that were never transferred to third parties. Similar to our recognized Guarantee asset, a PC residual is accounted for like a debt security and is classiÑed as either available-for-sale or trading under SFAS 115. PC residuals relating to PCs or Structured Securities that were transferred to third parties and for which a Guarantee asset and Guarantee obligation was recognized are accounted for like debt securities that are classiÑed as trading. PC residuals relating to PCs held in portfolio that were formed from Cash Window Purchases and that were never transferred to third parties are generally accounted for like debt securities that are classiÑed as available-for-sale. PC residuals are subsequently carried at fair value considering the future inherent credit obligation. All changes in the fair value of PC residuals that are designated as trading are reÖected in earnings as a component of Gains (losses) on investment activity. All changes in the fair value of PC residuals that are accounted for as available-for-sale are reÖected as a component of Accumulated other comprehensive income (loss), net of taxes, or AOCI, a component of Stockholders' equity. All cash received over the life of the underlying loans with respect to the Guarantee asset component of the PC residuals is reÖected in earnings as a component of Net interest income. Due to Participation CertiÑcate Investors Timing diÅerences between our receipt of scheduled and unscheduled principal and interest payments from seller/ servicers on mortgages underlying PCs and the subsequent pass through of those payments on PCs owned by third-party investors result in the liability Due to Participation CertiÑcate investors. In those cases, the PC balance is not reduced for payments of principal received from seller/servicers in a given month until the Ñrst day of the next month and we do not release the cash received (principal and interest) to the PC investor until the Ñfteenth day of that next month. We generally invest the principal and interest amounts we receive in short-term investments from the time the cash is received until the time we pay the PC investor. Interest income resulting from investment of principal and interest payments from seller/ servicers is reported in interest income. For unscheduled principal prepayments, these timing diÅerences result in an expense accrual upon prepayment of the underlying mortgage. This is because the related PCs continue to bear interest due to the PC investor at the PC coupon rate from the date of prepayment until the date the PC security balance is reduced, while generally no interest is received from the mortgage on that prepayment amount during that period. The expense recognized upon prepayment is reported in Interest expense Ì Due to Participation CertiÑcate investors. We report PC coupon interest amounts relating to our investment in PCs consistent with GAAP applied by third party investors in PCs. Accordingly, the PC coupon interest on prepayments of a mortgage pending remittance on PCs held by us is reported as both Interest Income Ì Mortgage-related securities in the Retained portfolio and Interest expense Ì Due to Participation CertiÑcate investors. Scheduled and unscheduled principal payments received by us that relate to our investment in PCs are reported as a reduction to our investment in PCs on our consolidated balance sheets. Mortgage Loans Mortgage loans that we intend to sell are classiÑed as held-for-sale. If we decide to retain a loan, the loan is transferred to the held-for-investment portfolio. Loans transferred to the held-for-investment portfolio are transferred at lower of cost or market. Lower-of-cost-or-market valuation adjustments relating to these loans are treated as basis adjustments and are subsequently amortized into interest income over the estimated lives of the mortgages using the eÅective interest method. 105 Freddie Mac We recognize interest on mortgage loans on an accrual basis, except when we believe the collection of principal or interest is doubtful. See ""Non-Performing Loans'' for additional information. Held-for-sale mortgages are reported at lower-of-cost-or-market, on a portfolio basis, with gains and losses reported in Gains (losses) on investment activity. Premiums and discounts on loans classiÑed as held-for-sale are not amortized during the period that such loans are classiÑed as held-for-sale. For a description of how we determine the fair value of our held- for-sale mortgage loans, see ""NOTE 16: FAIR VALUE DISCLOSURES.'' Mortgage loans that we have the ability and intent to hold for the foreseeable future or to maturity are classiÑed as held- for-investment. These mortgage loans are reported at their outstanding principal balances, net of deferred fees (including premiums and discounts). These deferred items are amortized into interest income over the estimated lives of the mortgages using the eÅective interest method. We use actual prepayment experience and estimates of future prepayments to determine the constant yield needed to apply the eÅective interest method. For purposes of estimating future prepayments, the mortgages are aggregated by similar characteristics such as origination date, coupon and maturity. Reserves for Losses on Mortgage Loans Held-for-Investment and Losses on PCs We maintain a reserve for losses on mortgage loans held-for-investment to provide for credit losses inherent in that portfolio. We also maintain a reserve for guarantee losses on PCs to provide for credit losses inherent in mortgages underlying PCs or Structured Securities held by third parties. The reserve for losses on mortgage loans held-for-investment and the reserve for guarantee losses on PCs and Structured Securities held by third parties are collectively referred to as ""loan loss reserves.'' Increases in loan loss reserves are reÖected in earnings as a component of the Provision for credit losses. Decreases in loan loss reserves are reÖected through (a) charging-oÅ such balances (net of recoveries) when realized losses are recorded or (b) a reduction in the Provision for credit losses. Upon sale of PCs or Structured Securities, we re-establish a Guarantee obligation, which includes the consideration of inherent credit losses. Also, upon sale, we recognize incurred losses as a component of Gains (losses) on investment activity. Single-family loan portfolio Ì We estimate credit losses on homogeneous pools of single-family loans using statisti- cally-based models that evaluate a variety of factors. The homogeneous pools of single-family mortgage loans are determined based on common underlying characteristics, including year of origination, loan-to-value ratio and geographic region. In determining the loan loss reserves for impaired single-family loans at the balance sheet date, we evaluate factors including: ‚ the year of loan origination; ‚ geographic location; ‚ actual and estimated amounts for loss severity trends for similar loans; ‚ default experience; ‚ expected proceeds from credit enhancements; ‚ pre-foreclosure real estate taxes and insurance; and ‚ estimated costs should the underlying property ultimately be foreclosed upon and sold. Our best estimate of each of these factors is used to estimate the amount of our probable loss at the balance sheet date. Favorable trends in these factors decrease our estimate of probable losses, while negative trends increase our estimate. We frequently validate and update the models and factors to capture changes in actual loss experience, as well as changes in underwriting practices and in our loss mitigation strategies. We also consider macroeconomic and other factors including regional housing trends, applicable home price indices, unemployment and employment dislocation trends, consumer credit statistics, recent changes in credit underwriting practices, the extent of third party insurance, and other measurable factors that inÖuence the quality of the portfolio at the balance sheet date. We then adjust the loan loss reserves to the level required based on our best assessment of these factors. Multifamily loan portfolio Ì We estimate credit losses on the multifamily loan portfolio based on all available evidence, including adequacy of third-party credit enhancements, evaluation of the repayment prospects, and fair value of collateral underlying the individual loans. The review of the repayment prospects and value of collateral underlying individual loans is based on property-speciÑc and market-level risk characteristics including apartment vacancy rates, apartment rental rates, and property sales information. Loans individually evaluated for impairment include loans that become 60 days past due for principal and interest, certain loans with observable collateral deÑciencies and loans whose contractual terms were modiÑed due to credit concerns. When loan loss reserves for individual loans are established, consideration is given to all available evidence, such as the present value of discounted expected future cash Öows, fair value of collateral, and credit enhancements. 106 Freddie Mac Non-Performing Loans Non-performing loans consist of: (a) loans whose terms have been modiÑed due to previous delinquency or risk of delinquency and, therefore, are now considered part of our impaired loan population, referred to as ""troubled debt restructurings,'' (b) serious delinquencies and (c) non-accrual loans. Serious delinquencies are those single-family loans that are 90 days or more past due or in foreclosure, and multifamily loans that are more than 60 days but less than 90 days past due. This category also includes multifamily loans that are 90 days or more past due but where principal and interest are being paid to us under the terms of a credit enhancement agreement. Non-performing loans generally accrue interest in accordance with their contractual terms unless they are in non-accrual status. Non-accrual loans are loans where interest income is recognized on a cash basis, and only include multifamily loans 90 days or more past due. For non-accrual loans, any existing accruals are reversed against interest income unless they are both well secured and in the process of collection. For single-family retained and repurchased mortgage loans, interest income is accrued; however, we begin to fully reserve for accrued interest on these loans after a mortgage becomes 90 days past due. For single-family loans underlying outstanding PCs and Structured Securities held by third parties, we reserve for lost interest using a statistically based model. Impaired loans include single-family loans, both performing and non-performing, that are troubled debt restructurings and delinquent loans purchased from PC pools whose fair value was less than acquisition cost at the date of purchase. Multifamily impaired loans are deÑned as performing and non-performing troubled debt restructurings, loans 60 days or more past due (except for certain credit-enhanced loans) and certain mortgage loans with real estate collateral values less than the outstanding unpaid principal balances. See ""Table 6.2 Ì Impaired Loans'' in ""NOTE 6: LOAN LOSS RESERVES'' for further discussion. We have the option to purchase mortgage loans out of PC pools under certain circumstances, such as to resolve an existing or impending delinquency or default. Our general practice is to purchase the mortgage loans out of pools after the loans are 120 days delinquent. Loans that are purchased from PC pools held by third parties are recorded on our consolidated balance sheets at fair value at the date of purchase and are subsequently carried at amortized cost. Loans purchased out of PC pools held in the Retained portfolio are recorded on our consolidated balance sheets at the adjusted cost basis. Increases in market interest rates and declining market values for delinquent loans resulted in all loans purchased out of PC pools during 2006 being classiÑed as impaired loans. We record realized losses on certain guaranteed loans when the fair value is less than the unpaid principal balance, net of related reserves, as of the date of our repurchase. For loans that later re-perform, a portion of the valuation discount applied when the loan was repurchased will be accreted back into income over the estimated life of the loan. Charge-OÅs The loan loss reserves are reduced for charge-oÅs when a loss is speciÑcally identiÑed. For both single-family and multifamily mortgages where the original terms of the mortgage loan agreement are modiÑed for economic or legal reasons related to the borrower's Ñnancial diÇculties, losses are recorded at the time of modiÑcation and the loans are subsequently accounted for as troubled debt restructurings. For mortgages that are foreclosed upon and thus transferred to Real estate owned, net, or REO, or are involved in a pre-foreclosure sale, losses at the time of transfer or pre-foreclosure sale are charged-oÅ against Reserve for losses on mortgage loans held-for-investment. For transfers to REO, losses arise when the carrying basis of the loan (including accrued interest) exceeds the fair value of the foreclosed property (after deduction for estimated selling costs and consideration of third-party insurance or other credit enhancements). REO gains arise and are recognized immediately in earnings when the fair market value of the acquired asset (after deduction for estimated disposition costs) exceeds the carrying value of the mortgage (including accrued interest). REO gains and losses subsequent to foreclosure are included in REO operations income (expense). Investments in Securities Investments in securities consist primarily of mortgage-related securities. We classify securities as ""available-for-sale'' or ""trading.'' We currently do not classify any securities as ""held-to-maturity'' although we may elect to do so in the future. Securities classiÑed as available-for-sale and trading are reported at fair value with changes in fair value included in AOCI and Gains (losses) on investment activity, respectively. See ""NOTE 16: FAIR VALUE DISCLOSURES'' for more information on how we determine the fair value of securities. We record forward purchases and sales of securities that are speciÑcally exempt from the requirements of SFAS No. 133, ""Accounting for Derivative Instruments and Hedging Activities,'' or SFAS 133, on a trade date basis. Securities underlying forward purchases and sales contracts that are not exempt from the requirements of SFAS 133 are recorded on the contractual settlement date with a corresponding commitment recorded on the trade date. 107 Freddie Mac We often retain Structured Securities created through resecuritizations of mortgage-related securities held by us. The new Structured Securities we acquire in these transactions are classiÑed as available-for-sale or trading based upon the predominant classiÑcation of the mortgage-related security collateral we contributed. For most of our investments in securities, interest income is recognized using the retrospective eÅective interest method. Deferred items, including premiums, discounts and other basis adjustments, are amortized into interest income over the estimated lives of the securities. We use actual prepayment experience and estimates of future prepayments to determine the constant yield needed to apply the eÅective interest method. We recalculate the constant eÅective yield based on changes in estimated prepayments as a result of changes in interest rates and other factors. When the constant eÅective yield changes, an adjustment to interest income is made for the amount of amortization that would have been recorded if the new eÅective yield had been applied since the mortgage assets were acquired. For certain securities investments, interest income is recognized using the prospective eÅective interest method. We speciÑcally apply this accounting to beneÑcial interests in securitized Ñnancial assets that (a) can contractually be prepaid or otherwise settled in such a way that we may not recover substantially all of our recorded investment (such as interest-only strips) or (b) are not of high credit quality at the acquisition date. We recognize as interest income (over the life of these securities) the excess of all estimated cash Öows attributable to these interests over their principal amount using the eÅective yield method. We update our estimates of expected cash Öows periodically and recognize changes in calculated eÅective yield on a prospective basis. We review securities for potential impairment on an ongoing basis. We consider a number of factors, including the severity of the decline in fair value, credit ratings, the length of time the investment has been in an unrealized loss position and the likelihood of sale in the near term. We also recognize impairment when qualitative factors indicate that it is likely we will not recover the unrealized loss. When evaluating these factors, we consider our intent and ability to hold the investment until a point in time at which recovery of the unrealized loss can be reasonably expected to occur. Impairment losses on manufactured housing securities exclude the eÅects of separate Ñnancial guarantee contracts that are not embedded in the securities because the beneÑts of such contracts are not recognized until claims become probable of recovery under the contracts. We resecuritize securities held in the Retained portfolio and we typically retain the majority of the cash Öows from resecuritization transactions in the form of Structured Securities. Certain securities in the Retained portfolio have a high probability of being resecuritized and therefore, for those in an unrealized loss position, we may not have the intent to hold for a period of time suÇcient to recover those unrealized losses. In that case, the impairment is deemed other-than-temporary. For certain securities meeting the criteria of (a) or (b) in the preceding paragraph, other- than-temporary impairment is deÑned as occurring whenever there is an adverse change in estimated future cash Öows coupled with a decline in fair value below the amortized cost basis. When a security is deemed to be other-than-temporarily impaired, the cost basis of the security is written down to fair value, with the loss recorded to Gains (losses) on investment activity. Based on the new cost basis, the adjusted deferred amounts related to the impaired security are amortized over the security's remaining life in a manner consistent with the amount and timing of the future estimated cash Öows. The security cost basis is not changed for subsequent recoveries in fair value. Gains and losses on the sale of securities are included in Gains (losses) on investment activity, including those gains (losses) reclassiÑed into earnings from AOCI. We use the speciÑc identiÑcation method for determining the cost of a security in computing the gain or loss. Repurchase and Resale Agreements We enter into repurchase and resale agreements primarily as an investor or to Ñnance our security positions. Such transactions are accounted for as purchases and sales when the transferor relinquishes control over transferred securities and as secured Ñnancings when the transferor does not relinquish control. Our policy is to take possession of securities purchased under agreements to resell and reverse dollar roll transactions. Debt Securities Issued Debt securities that we issue are classiÑed as either due within one year or due after one year, based on their remaining contractual maturity. The classiÑcation of interest expense on debt securities as either short-term or long-term is based on the original contractual maturity of the debt security. Deferred items, including premiums, discounts, issuance costs and hedging-related basis adjustments, are amortized and reported through interest expense using the eÅective interest method over the contractual life of the related indebtedness. The balance of deferred items remaining when debt is extinguished prior to its contractual maturity is reÖected in earnings in the period of extinguishment as a component of Gains (losses) on debt retirement. Prior to 2005, for callable debt, deferred items were amortized over the period during which the related indebtedness was expected to be outstanding and changes in the expected life were reÖected prospectively as an adjustment 108 Freddie Mac to the eÅective yield on the debt. Amortization of hedging-related basis adjustments is initiated upon the termination of the related hedge relationship. Amortization of premiums, discounts and issuance costs begins at the time of debt issuance. Premiums, discounts and hedging-related basis adjustments are reported as a component of Debt securities, net. Issuance costs are reported as a component of Other assets. Debt securities denominated in a foreign currency are translated into U.S. dollars using foreign exchange spot rates at the balance sheet dates and any translation gains or losses are reported in Non-interest income (loss) Ì Other income. Contemporaneous transfers of cash between us and a creditor in connection with the issuance of a new debt obligation and satisfaction of an existing debt obligation are accounted for as extinguishments, with recognition of any gains or losses in earnings if the debt instruments have substantially diÅerent terms. If the debt instruments do not have substantially diÅerent terms, the transaction is accounted for as an exchange rather than an extinguishment and the fees associated with the new debt obligation, along with the existing unamortized premium or discount, concession fees and hedge gains and losses on the existing debt obligation, are considered a basis adjustment on the new debt obligation and are amortized as an adjustment of interest expense over the remaining term of the new debt obligation. Derivatives Derivatives are reported at their fair value on our consolidated balance sheets. The fair value of derivatives is generally reported net by counterparty, provided that a legally enforceable master netting agreement exists. Derivatives in a net unrealized gain position are reported as Derivative assets, at fair value. Similarly, derivatives in a net unrealized loss position are reported as Derivative liabilities, at fair value. At December 31, 2006 nearly all of our derivatives were not designated in hedge accounting relationships. For those derivatives not designated as an accounting hedge, fair value gains and losses are reported as Derivative gains (losses) in the consolidated statements of income. For purchase and sale commitments of securities classiÑed as trading, fair value gains and losses are reported as Gains (losses) on investment activity on our consolidated statements of income. Subject to certain qualifying conditions, we may designate a derivative as either a hedge of the cash Öows of a variable- rate instrument or forecasted transaction, referred to as a cash Öow hedge; a hedge of the fair value of a Ñxed-rate instrument, referred to as a fair value hedge; or a foreign-currency fair value or cash Öow hedge, referred to as a foreign- currency hedge. In order to be designated as an accounting hedge, the derivative must be expected to be highly eÅective in oÅsetting the changes in cash Öows or fair value of the hedged item resulting from the hedged risk. In addition, the documentation of the hedging designation must include identiÑcation of the hedged item, the hedging instrument, the risk exposure and corresponding risk management objective, how eÅectiveness will be assessed and how ineÅectiveness will be measured. For a derivative accounted for as a cash Öow hedge, we report changes in the fair value of these instruments in AOCI to the extent the hedge is eÅective. The remaining ineÅective portion is reported as Hedge accounting gains (losses). In general, we recognize the associated amounts reported in AOCI as Net interest income during the period or periods in which the hedged item aÅects earnings. Deferred amounts linked to interest payments on long-term debt are recorded as long- term debt interest expense and amounts not linked to interest payments on long-term debt are recorded in Income (expense) related to derivatives. Amounts reported in AOCI related to changes in the fair value of commitments to purchase or sell securities that are designated as cash Öow hedges are recognized as basis adjustments to the assets held which are amortized in earnings as interest income using the eÅective interest method and, for assets sold, as Gains (losses) on investment activity. If the hedged item in a cash Öow hedge is the forecasted issuance of debt and the occurrence of the forecasted transaction becomes probable of not occurring, the amount in AOCI is reclassiÑed to earnings immediately. If we expect at any time that continued reporting of a net loss in AOCI would lead to recognizing a net loss on the combination of a hedging instrument and the hedged transaction (and related asset acquired or liability incurred) in one or more future periods, the loss is reclassiÑed immediately into earnings for the amount that is not expected to be recovered. For a derivative accounted for as a fair value hedge, we report changes in the fair value of the derivative as Hedge accounting gains (losses) along with the changes in the fair value of the hedged item attributable to the risk being hedged. Any diÅerence between these two amounts results in ineÅectiveness recognized in the income statement. When the hedge is terminated or redesignated, the fair value adjustment to the carrying amount of the hedged asset or liability is amortized to earnings as a component of the hedged item's interest income or expense over the remaining life of the hedged item using the eÅective interest method. If a derivative no longer qualiÑes as a cash Öow or fair value hedge, or if we voluntarily terminate the hedging relationship, we discontinue hedge accounting prospectively. We continue to carry the derivative on our consolidated balance sheets at fair value and record further fair value gains and losses as Derivative gains (losses) in our consolidated statements of income until the derivative is terminated or redesignated. 109 Freddie Mac The periodic interest cash Öows related to derivative contracts currently accrued, which are derived primarily from interest-rate swap contracts and include imputed interest on zero-coupon swaps, are classiÑed as Income (expense) related to derivatives for derivatives in hedge relationships and as Derivative gains (losses) for derivatives not in hedge accounting relationships. Real Estate Owned REO is initially recorded at fair value, net of estimated disposition costs and is subsequently carried at the lower-of- cost-or-market. Amounts we expect to receive from third-party insurance or other credit enhancements are recorded when the asset is acquired. The receivable is adjusted when the actual claim is Ñled, and is a component of Accounts and other receivables, net on our consolidated balance sheets. Material development and improvement costs relating to REO are capitalized. Operating expenses on the properties, net of any rental or other income, are included in REO operations income (expense). Estimated declines in REO fair value that result from ongoing valuation of the properties are provided for and charged to REO operations income (expense) when identiÑed. Any gains and losses on REO dispositions are included in REO operations income (expense). Income Taxes We use the asset and liability method of accounting for income taxes pursuant to SFAS No. 109, ""Accounting for Income Taxes.'' Under this method, deferred tax assets and liabilities are recognized based upon the expected future tax consequences of existing temporary diÅerences between the Ñnancial reporting and the tax reporting basis of assets and liabilities using enacted statutory tax rates. To the extent tax laws change, deferred tax assets and liabilities are adjusted, when necessary, in the period that the tax change is enacted. Valuation allowances are recorded to reduce deferred tax assets when it is more likely than not that a tax beneÑt will not be realized. For all periods presented, no such valuation allowance was deemed necessary by our management. Reserves are recorded for income tax contingencies and related contingent interest where the potential for loss is probable and reasonably estimable in accordance with SFAS 5. Income tax expense includes (a) deferred tax expense, which represents the net change in the deferred tax asset or liability balance during the year plus any change in a valuation allowance and (b) current tax expense, which represents the amount of tax currently payable to or receivable from a tax authority plus amounts accrued for expected tax deÑciencies (including tax and related interest and penalties). Income tax expense excludes the tax eÅects related to adjustments recorded to equity as well as the tax eÅects of the cumulative eÅect of changes in accounting principles. Stock-Based Compensation We record compensation expense for stock-based compensation awards based on the grant-date fair value of the award and expected forfeitures. Compensation expense is recognized over the period during which an employee is required to provide service in exchange for the stock-based compensation award. The recorded compensation expense is accompanied by an adjustment to Additional paid-in capital on our consolidated balance sheets. The vesting period for stock-based compensation awards is generally three to Ñve years for options, restricted stock and restricted stock units. The vesting period for the option to purchase stock under the Employee Stock Purchase Plan, or ESPP, is three months. See ""NOTE 11: STOCK-BASED COMPENSATION'' for additional information. The fair value of options to purchase shares of our common stock, including options issued pursuant to the ESPP, is estimated using a Black-Scholes option pricing model, taking into account the exercise price and an estimate of the expected life of the option, the market value of the underlying stock, expected volatility, expected dividend yield, and the risk-free interest rate for the expected life of the option. The fair value of restricted stock and restricted stock unit awards is based on the fair value of our common stock on the grant date. Incremental compensation expense related to the modiÑcation of awards is based on a comparison of the fair value of the modiÑed award with the fair value of the original award before modiÑcation. We generally expect to settle our stock- based compensation awards in shares. In limited cases, an award may be cash-settled upon a contingent event such as involuntary termination. These awards are accounted for as an equity award until the contingency becomes probable of occurring, when the award is reclassiÑed from equity to a liability. We initially measure the cost of employee service received in exchange for a stock-based compensation award of liability instruments based on the fair value of the award at the grant date. The fair value of that award is remeasured subsequently at each reporting date through the settlement date. Changes in the fair value during the service period are recognized as compensation cost over that period. Excess tax beneÑts are recognized in Additional paid-in capital. Cash retained as a result of the excess tax beneÑts is presented in the consolidated statements of cash Öows as Ñnancing cash inÖows. The write-oÅ of deferred tax assets relating to unrealized tax beneÑts associated with recognized compensation costs reduces Additional paid-in capital to the extent there are excess tax beneÑts from previous stock-based awards remaining in Additional paid-in capital, with any remainder reported as part of income tax expense. 110 Freddie Mac Earnings Per Common Share Because we have participating securities, we use the ""two-class'' method of computing earnings per common share. The ""two-class'' method is an earnings allocation formula that determines earnings per share for common stock and participating securities based on dividends declared and participation rights in undistributed earnings. Our participating securities consist of vested options to purchase common stock that earn dividend equivalents at the same rate when and as declared on common stock. Basic earnings per common share is computed as net income available to common stockholders divided by the weighted average common shares outstanding for the period. Diluted earnings per common share is determined using the weighted average number of common shares during the period, adjusted for the dilutive eÅect of common stock equivalents. Dilutive common stock equivalents reÖect the assumed net issuance of additional common shares pursuant to certain of our stock- based compensation plans that could potentially dilute earnings per common share. Comprehensive Income Comprehensive income is the change in equity, on a net of tax basis, resulting from transactions and other events and circumstances from non-owner sources during a period. It includes all changes in equity during a period, except those resulting from investments by stockholders. We deÑne comprehensive income as consisting of net income plus changes in the unrealized gains and losses on available-for-sale securities, the eÅective portion of derivatives accounted for as cash Öow hedge relationships, changes in the minimum pension liability, and changes in components of pension liability that receive deferred expense recognition. Reportable Segments We have one business segment for Ñnancial reporting purposes under SFAS No. 131, ""Disclosures About Segments of an Enterprise and Related Information,'' or SFAS 131, for all periods presented on our consolidated Ñnancial statements. Recently Adopted Accounting Standards Accounting for Stock-Based Compensation Ì EÅective January 1, 2006, we adopted SFAS 123(R), ""Share-Based Payment,'' or SFAS 123(R), which requires compensation expense for stock options and other share-based payments to be measured based on the instruments' grant-date fair value, and for the expense to be recorded based on the fair value reduced by expected forfeitures. We adopted this standard by using the modiÑed prospective method of transition which requires the provisions of SFAS 123(R) to be applied to new awards as well as awards modiÑed, repurchased or cancelled after the eÅective date. In adopting SFAS 123(R), we recognized compensation expense for stock-based compensation awards net of estimated forfeitures. Previously, the eÅects of forfeitures were recorded as they occurred. The eÅect of adopting SFAS 123(R) did not have a material impact on our consolidated Ñnancial statements. Accounting Changes and Error Corrections Ì On January 1, 2006, we adopted SFAS No. 154, ""Accounting Changes and Error Corrections, a replacement of APB Opinion No. 20 and FASB Statement No. 3,'' or SFAS 154. SFAS 154 changes the requirements for the accounting for and reporting of a change in accounting principle. It applies to all voluntary changes in accounting principle and changes required by an accounting pronouncement in the instance that the pronouncement does not include speciÑc transition provisions. APB Opinion No. 20, ""Accounting Changes,'' or APB 20, requires that the cumulative eÅect of most voluntary changes in accounting principles be included in net income in the period of adoption. The new statement requires retrospective application to prior periods' Ñnancial statements of a voluntary change in accounting principle, unless it is impracticable to determine either period-speciÑc eÅects or the cumulative eÅect of the change. SFAS 154 is eÅective for accounting changes and corrections of errors made in Ñscal years beginning after December 15, 2005. Our adoption of SFAS 154 did not have a material impact on our consolidated Ñnancial statements. Accounting for Employers' DeÑned BeneÑt Pension and Other Postretirement Plans Ì On December 31, 2006, we adopted SFAS 158. In accordance with this standard, on December 31, 2006, we recorded the funded status of each of our deÑned beneÑt pension and postretirement plans as an asset or liability on our consolidated balance sheet with a corresponding oÅset, net of taxes, recorded in AOCI within Stockholders' Equity. See ""Table 1.2 Ì Change in Accounting for DeÑned BeneÑt Plans Ì Impact on Financial Statements.'' EÅective December 31, 2008, SFAS 158 also requires our deÑned beneÑt plan assets and obligations to be measured as of the date of our consolidated balance sheet. We expect that the eÅect of implementing the change in measurement date from September 30 to December 31 will not be material to our Ñnancial condition or our results of operations. Determining Variability in Applying FASB Interpretation No. 46(R) Ì EÅective July 1, 2006, we adopted FASB StaÅ Position No. FIN 46(R)-6, ""Determining the Variability to Be Considered in Applying FASB Interpretation No. 46(R),'' or FSP FIN 46(R)-6. The adoption of FSP FIN 46(R)-6 was not material to our Ñnancial condition or results of operations. 111 Freddie Mac Recently Issued Accounting Standards, Not Yet Adopted Accounting for Certain Hybrid Instruments Ì In February 2006, the FASB issued SFAS No. 155, ""Accounting for Certain Hybrid Financial Instruments, an amendment of FASB Statements No. 133 and 140,'' or SFAS 155, with further guidance provided in Derivatives Implementation Group (DIG) Issue B-40 ""Embedded Derivatives: Application of Paragraph 13(b) to Securitized Interests in Prepayable Financial Assets,'' or DIG B-40. These statements amend SFAS 133 and SFAS 140. The objective of these statements is to simplify the accounting for certain hybrid Ñnancial instruments, permitting fair value measurement for any hybrid Ñnancial instrument with an embedded derivative that otherwise would require bifurcation. In addition, these statements establish a requirement to evaluate interests in securitized Ñnancial assets to identify instruments that are freestanding derivatives or that are hybrid Ñnancial instruments that contain an embedded derivative requiring bifurcation. SFAS 155 is eÅective for all Ñnancial instruments acquired or issued after the beginning of an entity's Ñrst Ñscal year that begins after September 15, 2006. Because SFAS 155 is to be adopted prospectively, it will not result in a cumulative eÅect of a change in accounting principle. In connection with the adoption of this accounting standard, we will elect to measure, at fair value, newly acquired interests in securitized Ñnancial assets that contain embedded derivatives requiring bifurcation with periodic market adjustments reÖected in the income statement. We expect the amount of our securities that will be impacted by SFAS 155 will be minimal. Fair Value Measurements Ì In September 2006, the FASB issued SFAS No. 157, ""Fair Value Measurements,'' or SFAS 157. This statement deÑnes fair value, establishes a framework for measuring fair value in GAAP and expands disclosures about fair value measurements. SFAS 157 applies under other accounting pronouncements that require or permit fair value measurements but does not change existing guidance as to whether or not a Ñnancial asset or liability is carried at fair value. SFAS 157 is eÅective for Ñnancial statements issued for Ñscal years beginning after November 15, 2007 with earlier adoption permitted. We do not plan to elect early adoption and are currently evaluating the eÅect of SFAS 157 on our Ñnancial position and results of operations. We do not believe the implementation will likely result in a material diÅerence to our fair value measurements. The Fair Value Option for Financial Assets and Financial Liabilities Ì In February 2007, the FASB issued SFAS No. 159, ""The Fair Value Option for Financial Assets and Financial Liabilities, Including an amendment of FASB Statement No. 115,'' or SFAS 159. This statement permits companies to choose to measure certain Ñnancial assets and liabilities at fair value with changes in fair value recognized in earnings as they occur. The objective is to improve Ñnancial reporting by providing entities with the opportunity to measure both assets and liabilities at fair value without having to apply complex hedge accounting provisions. SFAS 159 is eÅective as of the beginning of an entity's Ñrst Ñscal year beginning after November 15, 2007, with earlier adoption permitted. We do not plan to elect early adoption and are still evaluating how we will adopt SFAS 159. We have not yet determined the impact, if any, on our consolidated Ñnancial statements of adopting this standard. Accounting for Uncertainty in Income Taxes Ì In June 2006, the Financial Accounting Standards Board, or FASB, issued Interpretation No. 48, ""Accounting for Uncertainty in Income Taxes, an interpretation of FASB Statement No. 109,'' or FIN 48. FIN 48 provides a single model to address accounting for uncertainty in tax positions and clariÑes the accounting for income taxes by prescribing a minimum recognition threshold a tax position is required to meet before being recognized in the Ñnancial statements. FIN 48 also provides guidance on derecognition, measurement, classiÑcation, interest and penalties, accounting in interim periods, disclosure and transition. FIN 48 is eÅective for Ñscal years beginning after December 15, 2006. We will adopt FIN 48 as of January 1, 2007, as required. The cumulative eÅect of adopting FIN 48 will be recorded to retained earnings. We do not anticipate this interpretation will have a material impact on our retained earnings. We have determined that adoption of FIN 48 will result in an overall increase to our retained earnings primarily as a result of a gain contingency for which we have not recognized a Ñnancial statement beneÑt. 112 Freddie Mac NOTE 2: TRANSFERS OF SECURITIZED INTERESTS IN MORTGAGE-RELATED ASSETS Securitization Transactions We Executed As discussed in ""NOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES,'' we issue two types of mortgage-related securities: PCs and Structured Securities. Table 2.1 below presents the unpaid principal balances of issued PCs and Structured Securities. Table 2.1 Ì Guaranteed PCs and Structured Securities Issued Based on Unpaid Principal Balances(1) December 31, 2006 2005 (in millions) Guaranteed PCs and Structured Securities Issued: Held by third parties ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $1,122,761 354,262 Held in the Retained portfolio ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total Guaranteed PCs and Structured Securities issued(2)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $1,477,023 $ 974,200 361,324 $1,335,524 (1) Excludes mortgage loans and mortgage-related securities traded, but not yet settled. Due to timing diÅerences in our receipt of principal and interest payments from mortgage servicers and subsequent pass-through of payments to PC investors, the unpaid principal balances of the underlying mortgage loans do not equal the unpaid principal balances of issued PCs and Structured Securities. See ""NOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Ì Due to Participation CertiÑcate Investors'' for more information. (2) As further discussed in ""NOTE 4: FINANCIAL GUARANTEES,'' we guarantee certain mortgage-related securities issued by third parties. Guaranteed PCs and Structured Securities exclude $1,240.2 billion and $961.8 billion at December 31, 2006 and 2005, respectively, of Structured Securities backed by resecuritized PCs and other previously issued Structured Securities. These excluded Structured Securities do not increase our credit-related exposure and consist of single-class and multi-class Structured Securities backed by PCs, Real Estate Mortgage Investment Conduits, or REMICs, and principal-only strips. The notional balance of interest-only strips is excluded because this table is based on unpaid principal balances. Also excluded are modiÑable and combinable REMIC tranches and interest and principal classes where the holder has the option to exchange the security tranches for other pre-deÑned security tranches. At December 31, 2006 and 2005, approximately 94 percent and 92 percent, respectively, of issued PCs and Structured Securities (excluding securities we issued that are backed by Ginnie Mae CertiÑcates) had a corresponding Guarantee asset, Guarantee obligation or PC residual recognized on our consolidated balance sheets. With respect to such securities held by third parties at December 31, 2006 and 2005, 95 percent and 93 percent, respectively, had a related Guarantee asset and Guarantee obligation established. Of those issued PCs and Structured Securities that had a corresponding Guarantee asset, Guarantee obligation or PC residual at December 31, 2006 and 2005, 57 percent and 50 percent, respectively, were issued in Ñnancial guarantee transactions, while the rest of those securities were issued as a result of sales or secured borrowing transactions. Gains and Losses on Transfers of PCs and Structured Securities that are Accounted for as Sales We recognized net pre-tax gains of approximately $86 million, $364 million and $356 million for the years ended December 31, 2006, 2005 and 2004, respectively, on transfers of PCs and Structured Securities that were accounted for as sales under SFAS 140. In connection with the derivation of such gains (losses) upon sale prior to October 1, 2005, we had consistently applied a methodology for determining the order in which to record extinguishments of unamortized deferred guarantee income, buy-down fees and credit fees as adjustments to the carrying value of the repurchased securities. Beginning October 1, 2005, we changed our methodology for determining gains (losses) upon the re-sale of PCs and Structured Securities related to unamortized deferred guarantee income, buy-down fees and credit fees. Our methodology now applies a speciÑc identiÑcation method of associating the extinguished deferred guarantee income, buy-down fees and credit fees to the speciÑc portions of purchased PCs and Structured Securities and relieves those carrying value adjustments through gains (losses) when the speciÑc portion of the PC or Structured Security is re-sold. This change in accounting principle was facilitated by system changes that allow us to apply and track the carrying value adjustments to the speciÑc portions of the purchased PCs and Structured Securities. Valuation of Recognized Guarantee Asset, Guarantee Obligation and PC Residuals Recognized Guarantee asset Our approach for estimating the fair value of the Guarantee asset makes use of third-party market data as practicable. For approximately 75 percent of the fair value of the Guarantee asset, the valuation approach involves obtaining dealer quotes on proxy securities with collateral similar to aggregated characteristics of our portfolio, eÅectively equating the Guarantee asset with current, or ""spot,'' market values for excess servicing interest-only, or IO, securities, which trade at a discount to trust IO security prices. We consider excess servicing securities to be comparable to the Guarantee asset, in that they represent an IO-like income stream, have less liquidity than trust IO securities and do not have matching principal- only securities. The remaining 25 percent of the fair value of the Guarantee asset related to underlying loan products for which comparable market prices were not readily available. This portion of the Guarantee asset was valued using an expected 113 Freddie Mac cash Öow approach with market input assumptions extracted from the dealer quotes provided on the more liquid products, reduced by an estimated liquidity discount. For 2004, we calculated the Guarantee asset fair value using an expected cash Öow approach. SpeciÑcally, Monte Carlo projections were used to forecast Guarantee asset-related future cash Öows. The forecasted cash Öows were then discounted using factors that were derived from modeled forward interest rates for each scenario path, to which we then applied a trailing average option-adjusted spread of up to 24 months that was based on trust IO security prices. Recognized Guarantee obligation Our approach for estimating the fair value of the Guarantee obligation makes use of third-party market data as practicable. We divided the credit aspects of our Guarantee obligation portfolio into three primary components: performing loans, non-performing loans and manufactured housing. For each component, we developed a speciÑc valuation approach for capturing its unique characteristics. For performing loans, we use capital markets information and rating agency models to estimate subordination levels and dealer price quotes on proxy securities with collateral characteristics matched to our portfolio to value the expected credit losses and the risk premium for unexpected losses related to our guarantee portfolio. We segmented the portfolio into distinct loan cohorts to diÅerentiate between product types, coupon rate, seasoning, and interests retained by us versus those held by third parties. Because typical structured securitizations of single-family collateral only include performing loans, we utilize a separate method for estimating the fair value of the Guarantee obligation for non-performing loans. For loans that are extremely delinquent and have been purchased out of pools, we obtained dealer indications that reÖect their non-performing status. To value delinquent loans remaining in PCs, we started with the market driven performing loan and non-performing whole loan values and used empirically observed delinquency transition rates to interpolate the appropriate values in each phase of delinquency (i.e., 30 days, 60 days, 90 days). We evaluated market sources to determine the appropriate credit costs associated with the Guarantee obligation for the manufactured housing portfolio, approximately 1 percent of our total guarantee portfolio and 19 percent of the fair value of the Guarantee obligation, and determined that there is not suÇciently reliable market data. As a result, we used our judgment to develop an alternative approach for estimating the incremental credit costs associated with the manufactured housing portfolio. SpeciÑcally, we calculated the ratio of realized credit losses for performing loans and manufactured housing loans to determine a loss history ratio. We then applied the loss history ratio to market implied performing loan Guarantee obligation fair value estimates to calculate the implied credit costs for the manufactured housing portfolio. This approach grounded the Guarantee obligation related to manufactured housing in performing loan market prices, while adjusting for the loss history reÖected in empirical data. We undertook a similar process for estimating the fair value of seriously delinquent manufactured housing loans. The components of the Guarantee obligation associated with administering the collection and distribution of payments on the mortgage loans underlying a PC are estimated based upon amounts we believe other market participants would charge. Finally, we use our models to estimate the present value of net cash Öows related to security program cycles. This estimate is included in the Guarantee obligation valuation. For 2004, the Guarantee obligation fair value was calculated using internal models to estimate future cash Öows using a Monte Carlo simulation. The components of estimated cash Öows associated with the Guarantee obligation included estimates of expected future credit losses using statistically based models that were benchmarked periodically to the non- conforming loan, or jumbo, securitization market. For all periods our estimates included costs to administer the collection and distribution of payments on the mortgage loans underlying a PC and considered net cash Öows due to security program cycles. Recognized PC residuals The fair value of recognized PC residuals is determined in a manner that is consistent with the approach described above for the recognized Guarantee asset and Guarantee obligation. Key assumptions used in the valuation of the Guarantee asset Table 2.2 summarizes the key assumptions associated with the fair value measurements of the recognized Guarantee asset. The assumptions included in this table for 2004 relate to those used in our internal models. For 2006 and 2005, the fair values at the time of securitization and the subsequent fair value measurements were estimated using third party information. However, the assumptions included in this table for those years are those implied by our fair value estimates, with the Internal Rates of Return, or IRRs, adjusted where necessary to align our internal models with estimated fair values determined using third party information. Prepayment rates are presented as implied by our internal models which are benchmarked periodically to market prepayment estimates. 114 Freddie Mac At December 31, 2006, our Guarantee asset totaled $6,070 million on our consolidated balance sheets and of that amount, approximately $5,905 million (or approximately 97 percent), related to PCs and Structured Securities backed by single-family mortgage loans. The key assumptions utilized in fair value measurements of the Guarantee asset presented in Table 2.2 and the sensitivity analysis presented in Table 2.3 and Table 2.4 relate solely to the Guarantee asset associated with PCs and Structured Securities backed by single-family mortgage loans. Table 2.2 Ì Key Assumptions Utilized in Fair Value Measurements of the Guarantee Asset Valuation Assumptions for the Guarantee Asset Internal rates of return(1) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2.3% - 13.5% Prepayment rates(2)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 7.4% - 57.8% Range(3) Mean(4) 8.4% 15.7% Range(3) Mean(4) Range(3) Mean(4) 1.8% - 13.8% 7.6% - 59.8% 8.7% (1.4)% - 13.6% 6.9% - 58.6% 17.2% 6.7% 19.1% 2006 2005 2004 (1) The IRRs reported above represent an unpaid principal balance weighted average of the discount rates inherent in the fair value of the recognized Guarantee asset. (2) Average Prepayment rates are simulated on a monthly frequency, although rates reported above represent an unpaid principal balance weighted average of annualized values of such Prepayment rates. (3) The lowest value in each presented range represents the Ñrst percentile IRRs and prepayment rates throughout 2006, 2005 and 2004. Likewise, the highest value in each range represents the 99th percentile IRRs and prepayment rates throughout 2006, 2005 and 2004. (4) Reported values represent the weighted average value of all IRRs and prepayment rates throughout the 2006, 2005 and 2004 periods. Weighted average lives of the Guarantee asset during 2006, 2005 and 2004 ranged between 1.7 and 9.0 years, 1.6 and 8.9 years, and 1.2 and 8.7 years, respectively, while the derived weighted average lives of the Guarantee asset for the same periods were 5.5, 5.1 and 5.3 years, respectively. Such derived weighted average lives are reÖective of prepayment speed assumptions cited in Table 2.2 above. At December 31, 2006 and 2005, the fair value of the recognized Guarantee asset was based upon a valuation approach that incorporates market-based information. In order to report the hypothetical sensitivity of the carrying value of the Guarantee asset to changes in key assumptions, we used internal models to approximate their reported carrying values. We then measured the hypothetical impact of changes in key assumptions using our models to estimate the potential view of fair value the market might have in response to those changes. In our models, the assumed Internal Rates of Return were adjusted to calibrate our model results with the reported carrying value. However, the weighted average prepayment rate assumption used in this hypothetical sensitivity was based on our internal model which is benchmarked periodically to market prepayment estimates. The sensitivity analysis in Table 2.3 illustrates hypothetical adverse changes in the fair value of the Guarantee asset for changes in key assumptions. Table 2.3 Ì Sensitivity Analysis of the Guarantee Asset Fair value(1)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Weighted average IRR assumptions: ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Impact on fair value of 100 bps upward change ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Impact on fair value of 200 bps upward change ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Weighted average prepayment rate assumptions: ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Impact on fair value of 10% upward change ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Impact on fair value of 20% upward change ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ December 31, 2006 Guarantee Asset (dollars in millions) $5,905 7.0% $ (224) $ (431) 18.4% $ (298) $ (565) (1) At December 31, 2006, our Guarantee asset totaled $6,070 million on our consolidated balance sheet and of that amount, approximately $165 million (or approximately 3 percent), related to PCs backed by multifamily mortgage loans. The sensitivity analysis presented in Table 2.3 relates solely to the Guarantee asset associated with PCs backed by single-family mortgage loans. Valuation of Other Retained Interests Other retained interests include securities that were issued by us as part of a resecuritization transaction which was recorded as a sale. The majority of these securities are classiÑed as available-for-sale. The fair value of Other retained interests is generally based on independent price quotations obtained from third-party pricing services or dealer marks. To report the hypothetical sensitivity of the carrying value of Other retained interests, we used internal models calibrated to the fair values. The sensitivity analysis in Table 2.4 illustrates hypothetical adverse changes in the fair value of Other retained interests for changes in key assumptions based on these models. 115 Freddie Mac Table 2.4 Ì Sensitivity Analysis of Other Retained Interests Fair valueÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Weighted average IRR assumptions: ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Impact on fair value of 100 bps upward change ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Impact on fair value of 200 bps upward change ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Weighted average prepayment rate assumptions: ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Impact on fair value of 10% upward change ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Impact on fair value of 20% upward change ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ December 31, 2006 Other Retained Interests(1) (dollars in millions) $127,490 5.6% $ (4,551) $ (8,813) 11.0% (66) (132) $ $ (1) The fair value of Other retained interests includes accrued interest. The sensitivity analysis presented in Table 2.4 includes only Other retained interests whose fair value is impacted as a result of changes in IRR and prepayment rate assumptions. At December 31, 2006, the fair value of Other retained interests not impacted due to IRR and prepayment assumptions was $51 million. Cash Flows on Transfers of Securitized Interests and Corresponding Retained Interests Table 2.5 below summarizes cash Öows on retained interests. Table 2.5 Ì Details of Cash Flows 2006 Year Ended December 31, 2005 (in millions) 2004 Cash Öows from: Transfers of Freddie Mac securities that were accounted for as sales ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Cash Öows received on the Guarantee asset(1) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Other Retained Interests principal and interest(2)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Purchases of delinquent or foreclosed loans(3)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $63,613 1,475 24,784 (4,748) $74,005 1,270 25,611 (4,373) $138,541 1,086 28,439 (4,931) (1) Represents contractual guarantee-related cash Öows received by us in connection with the recognized Guarantee asset. (2) Excludes cash Öows related to retained interests held in the portfolio of our Securities Sales and Trading Group, or SS&TG, business unit which ceased operations in the fourth quarter of 2004. Such cash Öows were not material. (3) Represents delinquent mortgage loans purchased out of securitized pools that back issued PCs or Structured Securities. NOTE 3: VARIABLE INTEREST ENTITIES We are a party to numerous entities that are considered to be variable interest entities, or VIEs. A VIE is an entity (a) that has a total equity investment at risk that is not suÇcient to Ñnance its activities without additional subordinated Ñnancial support from other entities or (b) where the group of equity holders does not have the ability to make signiÑcant decisions about the entity's activities, or obligation to absorb the entity's expected losses or right to receive the entity's expected residual returns, or both. Our investments in VIEs include LIHTC partnerships, certain Structured Securities transactions and a mortgage reinsurance entity. In addition, we buy the highly-rated senior securities in certain securitization trusts that are VIEs. Highly-rated senior securities issued by these securitization trusts are not designed to absorb a signiÑcant portion of the variability created by the assets/collateral in the trusts. Therefore, our investments in these securities do not represent a signiÑcant variable interest in the securitization trusts and we do not consolidate them. Further, we invest in securitization entities that are qualifying special purpose entities, which are not subject to consolidation because of our inability to unilaterally liquidate or change the qualifying special purpose entity. See ""NOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Ì Consolidation and Equity Method of Accounting'' for further informa- tion regarding the consolidation practices of our VIEs. Low-Income Housing Tax Credit Partnerships We invest as a limited partner in LIHTC partnerships formed for the purpose of providing funding for aÅordable multifamily rental properties. These LIHTC partnerships invest directly in limited partnerships that develop or rehabilitate multifamily rental properties. Completed properties are rented to qualiÑed low-income tenants, allowing the properties to be eligible for federal tax credits. Most of these LIHTC partnerships are VIEs. A general partner operates the partnership, identifying investments and obtaining debt Ñnancing as needed to Ñnance partnership activities. Although these partnerships generate operating losses, we realize a return on our investment through reductions in income tax expense that result from tax credits and the deductibility of the operating losses of these partnerships. The partnership agreements are typically structured to meet a required 15-year period of occupancy by qualiÑed low-income tenants. These investments were made between 1989 and 2006. At December 31, 2006 and 2005, we did not guarantee any obligations of these partnerships and our exposure was limited to the amount of our investments. At December 31, 2006 and 2005, we were the primary beneÑciary of investments in six LIHTC partnerships and we consolidated these investments. The investors in the obligations of the consolidated LIHTC partnerships have recourse only to the assets of those VIEs and do not have recourse to us. 116 Freddie Mac Consolidated VIEs Table 3.1 represents the carrying amounts and classiÑcation of consolidated assets that are collateral for the consolidated VIEs. Table 3.1 Ì Assets of Consolidated VIEs Consolidated Balance Sheets Line Item December 31, 2006 2005 (in millions) Cash and cash equivalents ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Accounts and other receivables, net ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total assets of consolidated VIEs ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 44 173 $217 $ 45 167 $212 VIEs Not Consolidated Low-Income Housing Tax Credit Partnerships At December 31, 2006 and 2005, we had unconsolidated investments in 179 and 168 LIHTC partnerships, respectively, in which we had a signiÑcant variable interest. The size of these partnerships at December 31, 2006 and 2005, as measured in total assets, was $8.9 billion and $8.1 billion, respectively. These partnerships are accounted for using the equity method, as described in ""NOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES.'' As a limited partner, our maximum exposure to loss equals the undiscounted book value of our equity investment. At December 31, 2006 and 2005, our maximum exposure to loss on unconsolidated LIHTC partnerships, in which we had a signiÑcant variable interest, was $3.7 billion and $3.7 billion, respectively. Asset-Backed Investment Trusts We invest in a variety of non-mortgage-related, asset-backed investment trusts. These investments represent interests in trusts consisting of a pool of receivables or other Ñnancial assets, typically credit card receivables, auto loans or student loans. These trusts act as vehicles to allow originators to securitize assets. Securities are structured from the underlying pool of assets to provide for varying degrees of risk. Primary risks include potential loss from the credit risk and interest-rate risk of the underlying pool. The originators of the Ñnancial assets or the underwriters of the deal create the trusts and typically own the residual interest in the trust assets. At December 31, 2006 and 2005, we did not have a signiÑcant variable interest in and were not the primary beneÑciary of any asset-backed investment trusts. Structured Transactions We issue securities in Structured Transactions, which are backed by mortgage loans or mortgage-related securities using collateral pools transferred to a trust speciÑcally created for the purpose of issuing securities. These trusts issue various senior interests, subordinated interests or both. We purchase certain senior interests of the trusts and simultaneously issue and guarantee Structured securities backed by these interests. The subordinated interests are generally either held by the seller or other party or sold in the capital markets. Generally, the structure of the transactions and the trusts as qualifying special purpose entities exempts them from the scope of FASB Interpretation No. 46 (Revised December 2003), ""Consolidation of Variable Interest Entities,'' or FIN 46(R). However, at both December 31, 2006 and 2005, we had investments or guarantees related to two Structured Transactions that did not fall within this scope exception and in which we had a signiÑcant variable interest. At December 31, 2006 and 2005, we were not the primary beneÑciary of any such transactions. Our involvement in the two Structured Transactions, mentioned above, began in 1996 and 2002, respectively. The size of these two transactions at December 31, 2006 and 2005, as measured in total assets, was $67 million and $105 million, respectively. At December 31, 2006 and 2005, our maximum exposure to loss on these transactions, in which we had a signiÑcant variable interest, was $55 million and $88 million, respectively, consisting of the book value of our investments plus incremental guarantees of the senior interests that are held by third parties. 117 Freddie Mac Principal and Interest Guarantees of PCs and Structured Securities NOTE 4: FINANCIAL GUARANTEES We guarantee the payment of principal and interest on the PCs and Structured Securities we issue that are held by third parties. At December 31, 2006 and 2005, the maximum potential amount of future payments under these guarantees approximates the total unpaid principal balance of our PCs and Structured Securities held by third parties, which was $1,123 billion and $974 billion, respectively. However, the actual amount of future payments under these guarantees will be determined by the performance of the mortgage loans that underlie these PCs and Structured Securities. During 2006 and 2005, we guaranteed $360.0 billion and $397.9 billion, respectively, of PCs and Structured Securities to third parties. Upon completion of the transfer of PCs or Structured Securities to third parties, we recognize the initial fair value of our obligation to make guarantee payments. The accounting methods for our guarantees of PCs and Structured Securities are further discussed in ""NOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES.'' At December 31, 2006 and 2005, we had a recognized Guarantee obligation on our consolidated balance sheets of $7.1 billion and $5.5 billion, respectively, which included $2.2 billion and $1.8 billion, respectively, of deferred guarantee income. In addition, we have a Reserve for guarantee losses on Participation CertiÑcates that totaled $350 million and $295 million at December 31, 2006 and 2005, respectively, for incurred credit losses that were recognized in conjunction with PCs and Structured Securities held by third parties. The balance of PCs and Structured Securities held by third parties also included securities and loans issued by third parties that we guarantee totaling $6.7 billion and $6.6 billion at December 31, 2006 and 2005, respectively. Details of these guarantees are as follows: ‚ Multifamily: We guaranteed multifamily housing revenue bonds totaling $6.0 billion and $5.8 billion at Decem- ber 31, 2006 and 2005, respectively, via two principal forms. First, we provide a guarantee of the payment of principal and interest on tax-exempt (and related taxable) multifamily housing revenue bonds that support pass-through certiÑcates issued by third parties. These housing revenue bonds are collateralized by mortgage loans on low- and moderate-income multifamily housing projects. Second, we provide a guarantee of principal and interest on multifamily mortgage loans that are originated and held by state and municipal housing Ñnance agencies to support tax-exempt (and related taxable) multifamily housing revenue bonds. ‚ Single-family: We guaranteed single-family mortgage loans held by third parties totaling $0.7 billion and $0.8 billion at December 31, 2006 and 2005, respectively. As part of the guarantee arrangements pertaining to multifamily housing revenue bonds, we provided a commitment to advance funds, commonly referred to as ""liquidity guarantees,'' totaling $5.8 billion and $5.7 billion at December 31, 2006 and 2005, respectively. These guarantees enable the repurchase by others of tendered tax-exempt (and related taxable) pass-through certiÑcates and housing revenue bonds that are unable to be remarketed. Any repurchased securities would be pledged to us to secure such funding until such time as the securities could be remarketed. We have not made any payments to date under these liquidity guarantees. Generally, the contractual terms of our guarantees on PCs and Structured Securities are 15 to 30 years. However, the actual term of each guarantee may be signiÑcantly less than the contractual term due to the prepayment characteristics of the mortgage-related assets that back PCs and Structured Securities. We generally purchase a defaulted mortgage when it has been delinquent for 120 consecutive days, we do not expect the maximum potential interest payments we would be required to make associated with these guarantees to signiÑcantly exceed 120 days of interest at the certiÑcate rate. At December 31, 2006 and 2005, in connection with PCs or Structured Securities backed by single-family mortgage loans, we had maximum coverage totaling $30.7 billion and $27.5 billion, respectively, in primary mortgage insurance, $3.2 billion and $3.4 billion, respectively, in pool insurance and other credit enhancements and $8.9 billion and $5.6 billion, respectively, in recourse to lenders. The coverage does not include credit enhancements related to the outstanding Structured Transactions which had unpaid principal balances that totaled $7.8 billion and $8.6 billion, at December 31, 2006 and 2005, respectively. In addition, at December 31, 2006 and 2005, $1.5 billion and $1.9 billion, respectively, of outstanding Structured Securities related to Ginnie Mae CertiÑcates, which are backed by the full faith and credit of the U.S. government. With respect to PCs and Structured Securities backed by multifamily mortgage loans, we had maximum combined credit enhancements totaling $1.2 billion and $7.3 billion at December 31, 2006 and 2005, respectively. At December 31, 2006 and 2005, our recorded balance of credit enhancements on our consolidated balance sheets was $466 million and $420 million, respectively. Guarantees of Stated Final Maturity of Issued Structured Securities We commonly issue Structured Securities with stated Ñnal maturities that are shorter than the stated maturity of the underlying mortgage loans. If the assets that back such Structured Securities have not been purchased by a third party or fully matured as of the stated Ñnal maturity date of such securities, we may sponsor an auction of the underlying assets. To 118 Freddie Mac the extent that purchase or auction proceeds are insuÇcient to cover unpaid principal amounts due to investors in such Structured Securities, we are obligated to fund such principal. Such guarantees of stated Ñnal maturity are accounted for as derivative instruments. At December 31, 2006 and 2005, the maximum potential amount of payments we could be required to make under guarantees of stated Ñnal maturity of issued Structured Securities was $22.7 billion and $11.7 billion, respectively, which represents the outstanding unpaid principal balance of the underlying mortgage loans. At December 31, 2006 and 2005, the total fair value of recognized liabilities concerning such guarantees was $6 million and $2 million, respectively. IndemniÑcations In connection with various business transactions, we sometimes provide indemniÑcation to counterparties for breaches of certain obligations (e.g., those arising from representations and warrantees) in contracts entered into in the normal course of business. It is diÇcult to estimate our maximum exposure under these indemniÑcation arrangements because in many cases there are no stated or notional amounts included in the indemniÑcation clauses. At December 31, 2006, our assessment is that the risk of any material loss from such a claim for indemniÑcation is remote. Such indemniÑcation provisions pertain to matters such as hold harmless clauses, adverse changes in tax laws, breaches of conÑdentiality, misconduct and potential claims from third parties related to items such as actual or alleged infringement of intellectual property. We have not recorded any liabilities related to these indemniÑcations on our consolidated balance sheets at December 31, 2006 and 2005 because there are no reasonably probable and estimable losses associated with these contracts. Other Guarantees We have guaranteed the performance of interest-rate swap contracts in three circumstances. First, as part of a resecuritization transaction, we transferred certain swaps and related assets to a third party. We guaranteed that interest income generated from the assets would be suÇcient to cover the required payments under the interest-rate swap contracts. Second, we guaranteed that a borrower would perform under an interest-rate swap contract linked to a customer's variable- rate mortgage. And third, in connection with certain Structured Securities, we guaranteed that the sponsor of the securitized multifamily housing revenue bonds would perform under the interest-rate swap contract linked to the variable- rate certiÑcates we issued, which are backed by the bonds. The maximum remaining terms of any of these guarantees at December 31, 2006 and 2005 were 28 years and 29 years, respectively; however, the actual terms may be signiÑcantly less than the contractual terms because the mortgage loans underlying the swaps are prepayable. The maximum potential amount of future undiscounted payments under the guarantees was $779 million and $717 million at December 31, 2006 and 2005, respectively. At December 31, 2006 and 2005, the total fair value of recognized liabilities concerning such guarantees was $3 million and $2 million, respectively. We provide guarantees to reimburse servicers for premiums paid to acquire servicing in situations where the original seller is unable to perform under its separate servicing agreement. Our servicing-related premium guarantees are payable according to a vesting schedule for up to Ñve years from the date of purchase of servicing rights. The maximum potential amount of future payments under these servicing-related premium guarantees was $44 million and $54 million at December 31, 2006 and 2005, respectively. We have not established a liability on our consolidated balance sheets at December 31, 2006 and 2005 because we do not expect material amounts to be paid under these arrangements. 119 Freddie Mac NOTE 5: RETAINED PORTFOLIO AND CASH AND INVESTMENTS PORTFOLIO Table 5.1 summarizes amortized cost, estimated fair values and corresponding gross unrealized gains and gross unrealized losses by major security type for available-for-sale securities. Table 5.1 Ì Available-For-Sale Securities Amortized Cost Gross Unrealized Gains Gross Unrealized Losses Fair Value (in millions) December 31, 2006 Retained portfolio: Mortgage-related securities issued by: Freddie MacÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $347,700 44,223 Fannie Mae ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Ginnie Mae ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 720 224,642 OtherÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Obligations of states and political subdivisions ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 13,622 630,907 Total mortgage-related securitiesÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Cash and investments portfolio: Non-mortgage-related securities: Asset-backed securities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Obligations of states and political subdivisions ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Commercial paper ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total non-mortgage-related securities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 32,179 2,273 11,191 45,643 Total available-for-sale securitiesÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $676,550 December 31, 2005 Retained portfolio: Mortgage-related securities issued by: Freddie MacÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $354,573 43,784 Fannie Mae ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Ginnie Mae ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 1,085 231,693 OtherÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Obligations of states and political subdivisions ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 11,022 642,157 Total mortgage-related securitiesÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Cash and investments portfolio: Non-mortgage-related securities: Asset-backed securities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Obligations of states and political subdivisions ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Commercial paper ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total non-mortgage-related securities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 30,712 5,835 5,764 42,311 Total available-for-sale securitiesÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $684,468 $1,753 323 17 553 334 2,980 23 Ì Ì 23 $3,003 $1,848 389 33 692 272 3,234 22 Ì Ì 22 $3,256 $(5,365) (660) (4) (1,096) (31) (7,156) $344,088 43,886 733 224,099 13,925 626,731 (80) Ì Ì (80) $(7,236) 32,122 2,273 11,191 45,586 $672,317 $(4,974) (867) (3) (1,029) (53) (6,926) $351,447 43,306 1,115 231,356 11,241 638,465 (156) (12) Ì (168) $(7,094) 30,578 5,823 5,764 42,165 $680,630 Table 5.2 shows the fair value of available-for-sale securities in a gross unrealized loss position and whether they have been in that position less than 12 months or 12 months or greater. Table 5.2 Ì Available-For-Sale Securities in a Gross Unrealized Loss Position December 31, 2006 Retained portfolio: Less than 12 months Gross Unrealized Losses Fair Value 12 months or Greater Gross Unrealized Losses Fair Value Total Gross Unrealized Losses Fair Value (in millions) Mortgage-related securities issued by: Freddie Mac ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $38,386 5,604 Fannie Mae ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 146 Ginnie Mae ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 35,228 Other ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 959 Obligations of states and political subdivisions ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 80,323 Total mortgage-related securitiesÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $(262) (69) Ì (110) (7) (448) $190,504 22,567 99 36,072 1,245 250,487 $(5,103) $228,890 28,171 245 71,300 2,204 330,810 (591) (4) (986) (24) (6,708) $(5,365) (660) (4) (1,096) (31) (7,156) Cash and investments portfolio: Non-mortgage-related securities: Asset-backed securitiesÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total non-mortgage-related securities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 6,402 6,402 Total available-for-sale securities in a gross unrealized loss position ÏÏÏÏÏÏ $86,725 (7) (7) $(455) 9,141 9,141 $259,628 (73) (73) 15,543 15,543 $(6,781) $346,353 (80) (80) $(7,236) 120 Freddie Mac At December 31, 2006, gross unrealized losses on available-for-sale securities were $7,236 million, or approximately 2 percent of the fair value of such securities in an unrealized loss position, as noted in Table 5.2. The gross unrealized losses relate to approximately 84 thousand individual lots representing approximately 16 thousand separate securities. We routinely purchase multiple lots of individual securities at diÅerent times and at diÅerent costs. We determine gross unrealized gains and gross unrealized losses by speciÑcally identifying investment positions at the lot level; therefore, some of the lots we hold for a single security may be in an unrealized gain position while other lots for that security are in an unrealized loss position, depending upon the amortized cost of the speciÑc lot. We have the ability and intent to hold the available-for-sale securities in an unrealized loss position for a period of time suÇcient to recover all unrealized losses. Based on our ability and intent to hold these available-for-sale securities and our consideration of other factors described below, we have concluded that the impairment of these securities is temporary. ‚ Freddie Mac securities. The unrealized losses on our securities are primarily a result of movements in interest rates. Because we guarantee the payment of principal and interest on these securities, we review the estimated credit exposure of the mortgages underlying these securities in evaluating potential impairment. The extent and duration of the decline in fair value relative to the amortized cost have met our criteria that are used to indicate that the impairment of these securities is temporary. ‚ Federal National Mortgage Association, or Fannie Mae, securities and Obligations of states and political subdivisions. The unrealized losses on Fannie Mae securities and Obligations of states and political subdivisions are primarily a result of movements in interest rates. The extent and duration of the decline in fair value relative to the amortized cost have met our criteria that are used to indicate that the impairment of these securities is temporary and no other facts or circumstances existed to suggest that the decline was not temporary. The issuer guarantees related to these securities have led us to conclude that any credit risk is minimal. ‚ Other securities in the Retained portfolio and Asset-backed securities in the Cash and investments portfolio. The unrealized losses on mortgage-related securities included in Other and Asset-backed securities are principally a result of movements in interest rates. The extent and duration of the decline in fair value relative to the amortized cost have met our criteria that are used to indicate that the impairment of these securities is temporary. Most of these securities are investment grade (i.e., rated BBB¿ or better on a Standard & Poor's, or S&P, or equivalent scale). Table 5.3 below illustrates the gross realized gains and gross realized losses received from the sale of available-for-sale securities. Table 5.3 Ì Gross Realized Gains and Gross Realized Losses on Available-For-Sale Securities Gross realized gainsÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Gross realized (losses) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Net realized gains ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2006 Year Ended December 31, 2005 (in millions) $ 891 2004 $ 787 $ 440 (418) 22 $ (345) $ 546 (203) $ 584 For the years ended December 31, 2006, 2005 and 2004, we recorded impairments related to investments in securities of $540 million, $371 million and $126 million, respectively. 121 Freddie Mac Table 5.4 summarizes, by major security type, the remaining contractual maturities and weighted average yield of available-for-sale securities. Table 5.4 Ì Maturities and Weighted Average Yield of Available-For-Sale Securities December 31, 2006 Retained portfolio: Total mortgage-related securities(2) Amortized Cost Fair Value Average Yield(1) Weighted (dollars in millions) Due 1 year or less ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Due after 1 through 5 years ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Due after 5 through 10 years ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Due after 10 years ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 128 2,848 14,508 613,423 $630,907 $ 127 2,847 14,550 609,207 $626,731 4.06% 5.41 5.62 5.32 5.33 Cash and investments portfolio: Non-mortgage-related securities: Asset-backed securities(2) Due 1 year or less ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Due after 1 through 5 years ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Due after 5 through 10 years ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Due after 10 years ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 8 20,919 9,201 2,051 32,179 $ 8 20,866 9,197 2,051 32,122 Obligations of states and political subdivisions(2) Due 1 year or less ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Due after 1 through 5 years ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Due after 5 through 10 years ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Due after 10 years ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Commercial paper Due 1 year or less ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Due after 1 through 5 years ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Due after 5 through 10 years ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Due after 10 years ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total non-mortgage-related securities Due 1 year or less ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Due after 1 through 5 years ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Due after 5 through 10 years ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Due after 10 years ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total available-for-sale securities for Retained portfolio and Cash and investments portfolio: Due 1 year or less ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Due after 1 through 5 years ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Due after 5 through 10 years ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Due after 10 years ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 12 183 32 2,046 2,273 11,191 Ì Ì Ì 11,191 11,211 21,102 9,233 4,097 $ 45,643 $ 11,339 23,950 23,741 617,520 $676,550 12 183 32 2,046 2,273 11,191 Ì Ì Ì 11,191 11,211 21,049 9,229 4,097 $ 45,586 $ 11,338 23,896 23,779 613,304 $672,317 2.09 4.94 5.27 5.39 5.07 3.01 4.74 5.27 5.31 5.25 5.25 Ì Ì Ì 5.25 5.24 4.94 5.27 5.35 5.12 5.23 5.00 5.48 5.32 5.32 (1) The weighted average yield is calculated based on a yield for each individual lot held at the balance sheet date. The numerator for the individual lot yield consists of the sum of (a) the year-end interest coupon rate multiplied by the year-end unpaid principal balance and (b) the annualized amortization income or expense calculated for December 2006 (excluding any adjustments recorded for changes in the eÅective rate). The denominator for the individual lot yield consists of the year-end amortized cost of the lot excluding eÅects of other-than-temporary impairments on the unpaid principal balances of impaired lots. (2) Maturity information provided is based on contractual maturities, which may not represent expected life, as obligations underlying these securities may be prepaid at any time without penalty. 122 Freddie Mac Table 5.5 presents the changes in AOCI, net of taxes, related to available-for-sale securities. The Net unrealized holding (losses), net of tax, represents the net fair value adjustments recorded on available-for-sale securities throughout the year, after the eÅects of our statutory tax rate of 35 percent. The Net reclassiÑcation adjustment for net realized losses (gains), net of tax, represents the amount of those fair value adjustments, after the eÅects of our statutory tax rate of 35 percent, that have been recognized in earnings due to a sale of an available-for-sale security or the recognition of an impairment loss. See ""NOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES'' for further information regarding the component of AOCI related to available-for-sale securities. Table 5.5 Ì AOCI, Net of Taxes, Related to Available-For-Sale Securities 2006 Year Ended December 31, 2005 (in millions) 2004 Net unrealized holding (losses), net of tax(1) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Net reclassiÑcation adjustment for net realized losses (gains), net of tax(2)(3) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Beginning balanceÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $(2,485) $ 4,339 (6,707) (117) Ending balance ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $(2,749) $(2,485) (525) 261 $ 6,349 (1,709) (301) $ 4,339 (1) Net of tax (beneÑt) of $(282) million, $(3,611) million and $(920) million for the years ended December 31, 2006, 2005 and 2004, respectively. (2) Net of tax beneÑt (expense) of $139 million, $(63) million and $(162) million for the years ended December 31, 2006, 2005 and 2004, respectively. (3) Includes the reversal of previously recorded unrealized losses that have been recognized as impairment losses on available-for-sale securities of $281 million, $234 million and $72 million, net of taxes, for the years ended December 31, 2006, 2005 and 2004, respectively. Table 5.6 summarizes the estimated fair values by major security type for trading securities held in our Retained portfolio. Table 5.6 Ì Trading Securities in the Retained Portfolio December 31, 2006 2005 (in millions) Mortgage-related securities issued by: Freddie MacÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Fannie Mae ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Ginnie Mae ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total trading securities in the Retained portfolioÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $6,573 802 222 $7,597 $ 8,156 534 204 $ 8,894 For the years ended December 31, 2006, 2005 and 2004 we recorded net unrealized losses on trading securities held at December 31, 2006, 2005 and 2004 of $11 million, $261 million and $240 million, respectively. Retained Portfolio Voluntary Growth Limit EÅective as of July 1, 2006, we voluntarily limited the growth of our Retained portfolio to no more than 2.0 percent annually (and 0.5 percent quarterly on a cumulative basis) based on its carrying value as reported in our minimum capital report to OFHEO Ñled on July 28, 2006, which was $710.3 billion. This voluntary, temporary growth limit was made in response to a request from OFHEO. At December 31, 2006, the carrying value of the Retained portfolio as reported on our consolidated balance sheets was $700.5 billion, below the voluntary limit of $717.4 billion at that time. Collateral Pledged Collateral Pledged to Freddie Mac Our counterparties are required to pledge collateral for reverse repurchase transactions and most interest-rate swap agreements, after giving consideration to collateral posting thresholds generally related to a counterparty's credit rating. Even though it is our practice not to repledge assets held as collateral, based on master agreements a portion of the collateral may be repledged. At December 31, 2006 and 2005, we did not have collateral in the form of securities pledged to and held by us under secured lending transactions and interest-rate swap agreements. Collateral Pledged by Freddie Mac We are also required to pledge collateral for margin requirements with third-party custodians in connection with secured Ñnancings, interest-rate swap agreements, futures and daily trade activities with some counterparties. In 2006, we opened three uncommitted intraday lines of credit with third-parties, two of which are secured, in connection with the Federal Reserve Board's revised payments system risk policy, which restricts or eliminates daylight overdrafts by GSEs, including us, in connection with our use of the Fedwire system. In certain limited circumstances, the line of credit agreements give the secured parties the right to repledge the securities underlying our Ñnancing to other third parties, including the Federal Reserve Bank. We pledge collateral to meet these requirements upon a demand by the respective counterparty. 123 Freddie Mac Table 5.7 summarizes all securities pledged as collateral by us, including assets that the secured party may repledge and those that may not be repledged. Table 5.7 Ì Collateral in the Form of Securities Pledged December 31, 2006 (in millions) 2005 Securities pledged with ability for secured party to repledge (parenthetically disclosed on our consolidated balance sheets) Available-for-sale ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $20,463 $168 Securities pledged without ability for secured party to repledge Available-for-sale ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 161 Total securities pledged ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $20,688 $329 225 We maintain separate loan loss reserves for mortgage loans in the Retained portfolio that we classify as held-for- investment and for credit-related losses associated with certain mortgage loans that underlie guaranteed PCs and Structured Securities held by third parties. NOTE 6: LOAN LOSS RESERVES Table 6.1 summarizes loan loss reserve activity: Table 6.1 Ì Detail of Loan Loss Reserves 2006 Year-Ended December 31, 2005 2004 Reserves related to: Reserves related to: Reserves related to: Retained Mortgages Outstanding PCs Total Loan Loss Retained Reserves Mortgages Outstanding PCs Total Loan Loss Retained Reserves Mortgages Outstanding PCs Beginning balance ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Provision for credit losses ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Charge-oÅs(1) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Recoveries(1) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Transfers-outÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Other transfers, net(2) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Ending balance ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 119 98 (313) 166 Ì Ì 70 $ $295 117 Ì Ì (71) 9 $350 $ 414 215 (313) 166 (71) 9 $ 420 $ 114 106 (294) 185 Ì 8 $ 119 (in millions) $150 145 Ì Ì (11) 11 $295 $ 264 251 (294) 185 (11) 19 $ 414 $ 174 111 (300) 160 Ì (31) $ 114 $125 32 Ì Ì (20) 13 $150 Total Loan Loss Reserves $ 299 143 (300) 160 (20) (18) $ 264 (1) It is our practice to purchase mortgage loans from the pools that underlie PCs principally at the point the mortgage loan is identiÑed as being 120 days past due. Because all credit losses related to oÅ-balance sheet PCs are preceded by the purchase of a delinquent mortgage loan from the PC pool, all charge-oÅs or recoveries are presented in the Retained Mortgages columns above. (2) Represents the portion of the Guarantee obligation recognized through Guarantor Swap transactions or upon the sale of PCs and Structured Securities that corresponds to incurred credit losses reclassiÑed to reserve for guarantee losses on Participation CertiÑcates upon initial recognition of a Guarantee obligation. In addition, the amount includes an increase (reduction) of loan loss reserves of $9 million and $(31) million in 2005 and 2004, respectively, related to prior period adjustments for which the related income was recorded in Other income. Impaired Loans Total loan loss reserves, as presented in ""Table 6.1 Ì Detail of Loan Loss Reserves,'' consists of a speciÑc valuation allowance related to impaired loans, which is presented in Table 6.2, and an additional reserve for other probable incurred losses, which totaled $414 million, $398 million and $261 million at December 31, 2006, 2005 and 2004, respectively. Our recorded investment in impaired loans and the related valuation allowance are summarized in Table 6.2. Table 6.2 Ì Impaired Loans(1) 2006 December 31, 2005 2004 Recorded SpeciÑc Investment(2) Reserve Net Investment Recorded SpeciÑc Investment(2) Reserve Net Investment Recorded SpeciÑc Investment(2) Reserve Net Investment (in millions) Impaired loans having: Related-valuation allowance ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ No related-valuation allowance(3)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 86 5,869 $5,955 $(6) Ì $(6) $ 80 5,869 $5,949 $ 54 2,536 $2,590 $(16) Ì $(16) $ 38 2,536 $2,574 $ 46 2,261 $2,307 $(3) Ì $(3) $ 43 2,261 $2,304 (1) Single-family impaired loans include performing and non-performing troubled debt restructurings. Also, in 2006, all loans purchased out of PC pools that were 120 days delinquent were impaired. Multifamily impaired loans are deÑned as performing and non-performing troubled debt restructurings, loans that are 60 days or more delinquent, except for certain credit-enhanced loans, and certain mortgage loans with real estate collateral values less than the outstanding unpaid principal balances. For more details on multifamily impaired loans, see ""NOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES.'' (2) Recorded Investment includes the unpaid principal balance of mortgage loans plus other amortized basis adjustments, which are modiÑcations to their carrying value. (3) Impaired loans with no related valuation allowance primarily represent performing single-family troubled debt restructuring loans and impaired loans purchased out of PC pools. 124 Freddie Mac For the years ended December 31, 2006, 2005 and 2004, the average recorded investment in impaired loans was $4,215 million, $2,601 million and $2,311 million, respectively. The increase in impaired loans in 2006 relates to impaired loans purchased out of PC pools at 120 days of delinquency. In 2006, we purchased approximately $4,833 million of such impaired loans out of PC pools. At December 31, 2006, the carrying value of such loans was approximately $3,160 million, net of a related discount of $227 million, a portion of which will be accreted to income if the related loans re-perform. In addition, impaired loans includes additions related to an economic downturn aÅecting the North Central region in 2006 and Hurricane Katrina in 2005. Interest income on multifamily impaired loans is recognized on an accrual basis for loans performing under the original or restructured terms and on a cash basis for non-performing loans, which collectively totaled approximately $25 million, $24 million and $13 million for the years ended December 31, 2006, 2005 and 2004, respectively. For single-family performing and non-performing loans, we recognize interest income on an accrual basis and establish reserves for estimated accrued but uncollectible interest for these loans at the consolidated balance sheet dates. Gross interest income on impaired troubled debt restructuring single-family loans totaled $177 million, $149 million and $157 million for the years ended December 31, 2006, 2005 and 2004, respectively. Delinquency Rates Table 6.3 summarizes the delinquency rates for our Total mortgage portfolio, excluding non-Freddie Mac mortgage- related securities and that portion of Structured Securities that is backed by Ginnie Mae CertiÑcates. Table 6.3 Ì Delinquency Performance(1) December 31, 2005 2006 2004 Delinquencies, end of period: Single-family:(2) Non-credit-enhanced portfolio: Delinquency rateÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total number of delinquent loans ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 22,854 0.25% 0.30% 0.24% 26,037 19,691 Credit-enhanced portfolio: Delinquency rateÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total number of delinquent loans ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 36,008 1.86% 2.46% 2.75% 47,000 54,913 Total portfolio: Delinquency rateÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total number of delinquent loans ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 58,862 0.53% 0.69% 0.73% 73,037 74,604 Multifamily:(3) Total portfolio: Delinquency rateÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Net carrying value of delinquent loans (in millions) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 0.05% 30 $ Ì% 2 0.06% 35 $ (1) Based on mortgage loans in the Retained portfolio and Total Guaranteed PCs and Structured Securities Issued, excluding that portion of Structured Securities that is backed by Ginnie Mae CertiÑcates and certain Structured Transactions where delinquency data on the underlying mortgage-related securities is not available. The Structured Transactions we have excluded represented 0.06 percent, 0.04 percent and 0.07 percent of our Total mortgage portfolio at December 31, 2006, 2005 and 2004, respectively. (2) Based on the number of mortgage loans 90 days or more delinquent or in foreclosure. (3) Based on net carrying value of mortgage loans 60 days or more delinquent. NOTE 7: REAL ESTATE OWNED We obtain REO properties when we are the highest bidder at foreclosure sales of properties that collateralize non- performing single-family and multifamily mortgage loans owned by us. Upon acquiring single-family properties, we establish a marketing plan to sell the property as soon as practicable by either listing it with a sales broker or by other means, such as arranging a real estate auction. Upon acquiring multifamily properties, we may operate them with third-party property- management Ñrms for a period to stabilize value and then sell the properties through commercial real estate brokers. For each of the years ended December 31, 2006 and 2005, the weighted average holding period for our disposed REO properties was less than one year. Table 7.1 provides a summary of our REO activity. Table 7.1 Ì Real Estate Owned Balance, December 31, 2004 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ Additions ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Dispositions and write-downs ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Balance, December 31, 2005 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Additions ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Dispositions and write-downs ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Balance, December 31, 2006 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 867 1,390 (1,513) 744 1,484 (1,357) 871 REO, Gross 125 Valuation Allowance (in millions) $(126) (78) 89 (115) (85) 72 $(128) REO, Net $ $ 741 1,312 (1,424) 629 1,399 (1,285) 743 Freddie Mac We recognized net losses of $59 million, $67 million and $67 million on REO dispositions for the years ended December 31, 2006, 2005 and 2004, respectively, which are included in REO operations income (expense). NOTE 8: DEBT SECURITIES AND SUBORDINATED BORROWINGS Debt securities are classiÑed as either due within one year or due after one year based on their remaining contractual maturity. Table 8.1 summarizes the balances and eÅective interest rates for debt securities, as well as subordinated borrowings. Table 8.1 Ì Total Debt Securities, Net 2006 Balance, Net(1) December 31, 2005 Balance, EÅective Rate(2) Net(1) (dollars in millions) EÅective Rate(2) Senior debt, due within one year: Short-term debt securitiesÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $176,982 117,879 Current portion of long-term debt ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 294,861 Senior debt, due within one year ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 5.14% $192,713 4.10 95,819 288,532 4.73 452,677 Senior debt, due after one year ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 6,400 Subordinated debt, due after one yearÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Senior and subordinated debt, due after one year ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 459,077 Total debt securities, net ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $753,938 5.08 5.86 5.09 454,627 5,633 460,260 $748,792 4.01% 3.42 3.81 4.64 6.15 4.66 (1) Includes unamortized discounts and premiums, and foreign-currency-related and hedging-related basis adjustments. (2) Represents the weighted average eÅective rate at the end of the period, which includes the amortization of discounts or premiums and issuance costs, but excludes the amortization of hedging-related basis adjustments. Senior Debt, Due Within One Year As indicated in Table 8.2, a majority of Senior debt, due within one year (excluding current portion of long-term debt) consisted of Reference Bills» securities and discount notes, paying only principal at maturity. Reference Bills» securities, discount notes and Medium-term Notes are unsecured general corporate obligations. Certain Medium-term Notes that have original maturities of one year or less are classiÑed as Short-term debt securities. Securities sold under agreements to repurchase are eÅectively collateralized borrowing transactions where we sell securities with an agreement to repurchase such securities. These agreements require the underlying securities to be delivered to the dealers who arranged the transactions. Federal funds purchased are unsecuritized borrowings from commercial banks that are members of the Federal Reserve System. Table 8.2 provides additional information related to our debt securities due within one year. Table 8.2 Ì Senior Debt, Due Within One Year 2006 Balance, Net(1) Par Value EÅective Rate Par Value 2005 Balance, Net(1) EÅective Rate December 31, Reference Bills» securities and discount notes(2) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $159,503 $157,553 Medium-term Notes(2) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 9,832 Securities sold under agreements to repurchase and Federal funds purchased(3) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Ì Swap collateral obligations(3) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 9,597 Ì Hedging-related basis adjustments ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 176,982 Short-term debt securities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 117,879 Current portion of long-term debt ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Senior debt, due within one year ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $296,859 $294,861 Ì 9,552 N/A 178,887 117,972 9,832 (dollars in millions) 5.14% 5.16 $183,357 $181,468 2,032 2,035 Ì 5.17 N/A 5.14 4.10 4.73 450 8,736 N/A 194,578 95,596 450 8,768 (5) 192,713 95,819 $290,174 $288,532 4.00% 4.17 4.25 4.09 N/A 4.01 3.42 3.81 (1) Represents par value, net of associated discounts, premiums and foreign-currency-related and hedging-related basis adjustments. Swap collateral obligations include the related accrued interest payable. (2) Represents the approximate weighted average eÅective rate for each instrument outstanding at the end of the period, which includes the amortization of discounts or premiums and issuance costs, but excludes the amortization of hedging-related basis adjustments. (3) Represents the weighted average eÅective rate for each instrument outstanding at the end of the period. 126 Freddie Mac Senior and Subordinated Debt, Due After One Year Table 8.3 summarizes our senior and subordinated debt, due after one year. Table 8.3 Ì Senior and Subordinated Debt, Due After One Year Senior debt, due after one year:(3) Contractual Balance, Maturity(1) Par Value Net(2) Interest Rates 2006 2005 Balance, Par Value Net(2) Interest Rates (dollars in millions) December 31, Fixed-rate: Medium-term Notes Ì Callable(4)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2008-2037 $183,611 $183,532 Medium-term Notes Ì Non-callable ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2008-2028 U.S. dollar Reference Notes» securities Ì Non-callableÏÏÏÏÏ 2008-2032 4Reference Notes» securities Ì Non-callableÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2008-2014 5,764 195,289 16,912 194,772 16,878 5,798 1.00% - 10.27% 2.57% - 7.50% $182,251 $182,173 2.00% - 7.91% 19,936 1.00% - 7.69% 171,962 2.38% - 7.00% 25,478 3.50% - 5.75% 19,927 2.75% - 7.00% 172,551 25,528 3.50% - 5.75% Variable-rate: Medium-term Notes Ì Callable(5)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2008-2030 Medium-term Notes Ì Non-callable(6) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2008-2026 Zero-coupon: Medium-term Notes Ì Callable(7)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2014-2036 Medium-term Notes Ì Non-callable(8) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2008-2034 Foreign-currency-related and hedging-related basis adjustments ÏÏ Total senior debt, due after one year ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Subordinated debt, due after one year: Fixed-rate(9) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2011-2018 Zero-coupon(10) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total subordinated debt, due after one year ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total senior and subordinated debt, due after one year ÏÏÏÏÏÏÏÏÏÏ 2019 28,617 421 28,616 460 Various Various 28,709 5,809 28,709 5,858 Various Various 43,248 10,535 N/A 484,397 8,610 6,204 7,807 452,677 6,382 332 6,714 6,309 91 6,400 $491,111 $459,077 Ì% Ì% 39,939 9,598 N/A 484,312 7,675 5,287 7,549 454,627 Ì% Ì% 5.00% - 8.25% Ì% 5,550 5.25% - 8.25% Ì% 5,564 332 5,896 83 5,633 $490,208 $460,260 (1) Represents contractual maturities at December 31, 2006. (2) Represents par value of long-term debt securities and subordinated borrowings, net of associated discounts or premiums. (3) For debt denominated in a currency other than the U.S. dollar, the outstanding balance is based on the exchange rate at the date of the debt issuance. Subsequent changes in exchange rates are reÖected in Foreign-currency-related and hedging-related basis adjustments. (4) Includes callable Estate NotesSMsecurities and FreddieNotes» securities of $12,951 million and $11,805 million at December 31, 2006 and 2005, respectively. These debt instruments represent Medium-term Notes that permit persons acting on behalf of deceased beneÑcial owners to require us to repay principal prior to the contractual maturity date. (5) Includes callable Estate NotesSMsecurities and FreddieNotes» securities of $7,800 million and $6,987 million at December 31, 2006 and 2005, respectively. (6) Includes Medium-term Notes of $Ì million and $800 million at December 31, 2006 and 2005, which are repayable in whole or in part at the option of the beneÑcial owner, acting through the holder, on or after November 22, 2002 and prior to November 20, 2007 at 100 percent of the principal amount plus accrued interest. (7) The eÅective rates for Zero-coupon Medium-term Notes Ì Callable ranged from 5.57% - 7.17% and 3.53% - 7.12% at December 31, 2006 and 2005, respectively. (8) The eÅective rates for Zero-coupon Medium-term Notes Ì Non-callable ranged from 2.65% - 10.68% and 2.56% - 10.68% at December 31, 2006 and 2005, respectively. (9) Balance, Net includes callable subordinated debt of $1,928 million and $3,493 million at December 31, 2006 and 2005, respectively. (10) The eÅective rates for Subordinated Debt, due after one year Zero-coupon were 10.20% and 10.20% at December 31, 2006 and 2005, respectively. A portion of our long-term debt is callable. Callable debt gives us the option to redeem the debt security at par on one or more speciÑed call dates or at any time on or after a speciÑed call date. Table 8.4 summarizes the contractual maturities of long-term debt securities (including current portion of long-term debt) and subordinated borrowings outstanding at December 31, 2006, assuming callable debt is paid at contractual maturity. Table 8.4 Ì Senior and Subordinated Debt, Due After One Year (including current portion of long-term debt) Annual Maturities 2007 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2008 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2009 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2010 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2011 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Thereafter ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total(1)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Net discounts, premiums and foreign-currency-related and hedging-related basis adjustments(2) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Senior and subordinated debt, due after one year, including current portion of long-term debt ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Contractual Maturity(1)(2) (in millions) $117,972 98,313 63,231 46,681 55,208 227,678 609,083 (32,127) $576,956 (1) Represents par value of long-term debt securities and subordinated borrowings. (2) For debt denominated in a currency other than the U.S. dollar, the par value is based on the exchange rate at the date of the debt issuance. Subsequent changes in exchange rates are reÖected in Net discounts, premiums and foreign-currency-related and hedging-related basis adjustments. 127 Freddie Mac Lines of Credit We opened intraday lines of credit with third-parties to provide additional liquidity to fund our intraday activities through the Fedwire system in connection with the Federal Reserve Board's revised payments system risk policy, which restricts or eliminates daylight overdrafts by GSEs, including us. At December 31, 2006, we had three uncommitted lines of credit of which $20.0 billion is secured and $1.0 billion is unsecured. No amounts were drawn on these lines of credit at December 31, 2006. We expect to continue to use these facilities from time to time to satisfy our intraday Ñnancing needs; however, since the lines are uncommitted, we may not be able to draw on them if and when needed. Preferred Stock NOTE 9: STOCKHOLDERS' EQUITY During 2006, we completed two preferred stock oÅerings consisting of three classes. We had no preferred stock oÅerings during 2005. All 20 classes of preferred stock outstanding at December 31, 2006 have a par value of $1 per share. We have the option to redeem these shares, on speciÑed dates, at their redemption price plus dividends accrued through the redemption date. In addition, all 20 classes of preferred stock are perpetual and non-cumulative, and carry no signiÑcant voting rights or rights to purchase additional Freddie Mac stock or securities. Costs incurred in connection with the issuance of preferred stock are charged to Additional paid-in capital. Table 9.1 provides a summary of our preferred stock outstanding at December 31, 2006. Table 9.1 Ì Preferred Stock Issue Date Shares Authorized Shares Outstanding Total Par Value Redemption Price per Share Total Outstanding Balance(1) Redeemable On or After(2) NYSE Symbol(3) (in millions, except redemption price per share) 1996 Variable-rate(4) ÏÏÏ 6.14% ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 5.81% ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 5% ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 1998 Variable-rate(6) ÏÏÏ 5.1% ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 5.3% ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 5.1% ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 5.79% ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 1999 Variable-rate(7) ÏÏÏ 2001 Variable-rate(8) ÏÏÏ 2001 Variable-rate(9) ÏÏÏ 5.81% ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 6% ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2001 Variable-rate(10)ÏÏÏ 5.7% ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 5.81% ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2006 Variable-rate(11)ÏÏÏ 6.42% ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 5.9% ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ April 26, 1996 June 3, 1997 October 27, 1997 March 23, 1998 September 23 and 29, 1998 September 23, 1998 October 28, 1998 March 19, 1999 July 21, 1999 November 5, 1999 January 26, 2001 March 23, 2001 March 23, 2001 May 30, 2001 May 30, 2001 October 30, 2001 January 29, 2002 July 17, 2006 July 17, 2006 October 16, 2006 5.00 12.00 3.00 8.00 4.40 8.00 4.00 3.00 5.00 5.75 6.50 4.60 3.45 3.45 4.02 6.00 6.00 15.00 5.00 20.00 132.17 5.00 12.00 3.00 8.00 4.40 8.00 4.00 3.00 5.00 5.75 6.50 4.60 3.45 3.45 4.02 6.00 6.00 15.00 5.00 20.00 132.17 $ 5.00 12.00 3.00 8.00 4.40 8.00 4.00 3.00 5.00 5.75 6.50 4.60 3.45 3.45 4.02 6.00 6.00 15.00 5.00 20.00 $132.17 $50.00 50.00 50.00 50.00 50.00 50.00 50.00 50.00 50.00 50.00 50.00 50.00 50.00 50.00 50.00 50.00 50.00 50.00 50.00 25.00 $ 250 600 150 400 220 400 200 150 250 287 325 230 173 173 201 300 300 750 250 500 $6,109 June 30, 2001 June 30, 2002 October 27, 1998 March 31, 2003 September 30, 2003 September 30, 2003 October 30, 2000 March 31, 2004 June 30, 2009 December 31, 2004 March 31, 2003 March 31, 2003 March 31, 2011 June 30, 2006 June 30, 2003 December 31, 2006 March 31, 2007 June 30, 2011 June 30, 2011 September 30, 2011 FRE.prB FRE.prD (5) FRE.prF FRE.prG FRE.prH (5) (5) FRE.prK FRE.prL FRE.prM FRE.prN FRE.prO FRE.prP FRE.prQ FRE.prR (5) FRE.prS FRE.prT FRE.prU (1) Amounts stated at redemption value. (2) As long as the capital monitoring framework established by the OÇce of Federal Housing Enterprise Oversight, or OFHEO, in January 2004 remains in eÅect, any preferred stock redemption will require prior approval by OFHEO. See ""NOTE 10: REGULATORY CAPITAL'' for more information. (3) Preferred stock is listed on the New York Stock Exchange, or NYSE, unless otherwise noted. (4) Dividend rate resets quarterly and is equal to the sum of three-month London Interbank OÅered Rate, or LIBOR, plus 1 percent divided by 1.377, and is capped at 9.00 percent. (5) Not listed on any exchange. (6) Dividend rate resets quarterly and is equal to the sum of three-month LIBOR plus 1 percent divided by 1.377, and is capped at 7.50 percent. (7) Dividend rate resets on January 1 every Ñve years after January 1, 2005 based on a Ñve-year Constant Maturity Treasury, or CMT, rate, and is capped at 11.00 percent. Optional redemption on December 31, 2004 and on December 31 every Ñve years thereafter. (8) Dividend rate resets on April 1 every two years after April 1, 2003 based on the two-year CMT rate plus 0.10 percent, and is capped at 11.00 percent. Optional redemption on March 31, 2003 and on March 31 every two years thereafter. (9) Dividend rate resets on April 1 every year based on 12-month LIBOR minus 0.20 percent, and is capped at 11.00 percent. Optional redemption on March 31, 2003 and on March 31 every year thereafter. (10) Dividend rate resets on July 1 every two years after July 1, 2003 based on the two-year CMT rate plus 0.20 percent, and is capped at 11.00 percent. Optional redemption on June 30, 2003 and on June 30 every two years thereafter. (11) Dividend rate resets quarterly and is equal to the sum of three-month LIBOR plus 0.50 percent but not less than 4.00 percent. Stock Repurchase and Issuance Programs 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. In accordance with OFHEO's capital monitoring framework, we obtained 128 Freddie Mac OFHEO's approval for the common stock repurchases and the preferred stock redemption. We did not repurchase any outstanding shares of common stock in 2005. Common Stock Dividends Declared Common stock dividends declared per share were $1.91, $1.52 and $1.20 for 2006, 2005 and 2004, respectively. Dividends Declared During the First Quarter of 2007 On March 2, 2007, our board of directors declared a quarterly dividend on our common stock of $0.50 per share and dividends on our preferred stock consistent with the contractual rates and terms shown in ""Table 9.1 Ì Preferred Stock.'' Regulatory Capital Standards NOTE 10: REGULATORY CAPITAL The Federal Housing Enterprises Financial Safety and Soundness Act of 1992, or GSE Act, established minimum, critical and risk-based capital standards for us. Those standards determine the amounts of Core capital and Total capital that we must maintain to meet regulatory capital requirements. Core capital consists 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, as determined in accordance with GAAP. Total capital includes Core capital and general reserves for mortgage and foreclosure losses and any other amounts available to absorb losses that OFHEO includes by regulation. Minimum Capital The minimum capital standard requires us to hold an amount of Core capital that is generally equal to the sum of 2.50 percent of aggregate on-balance sheet assets and approximately 0.45 percent of the sum of outstanding mortgage-related securities we guaranteed and other aggregate oÅ-balance sheet obligations. As discussed below, in 2004 OFHEO implemented a framework for monitoring our capital adequacy, which includes a mandatory target capital surplus of 30 percent over the minimum capital requirement. Critical Capital The critical capital standard requires us to hold an amount of Core capital that is generally equal to the sum of 1.25 percent of aggregate on-balance sheet assets and approximately 0.25 percent of the sum of outstanding mortgage-related securities we guaranteed and other aggregate oÅ-balance sheet obligations. Risk-Based Capital The risk-based capital standard requires the application of a stress test to determine the amount of Total capital that we must hold to absorb projected losses resulting from adverse interest-rate and credit-risk conditions speciÑed by the GSE Act and adds 30 percent additional capital to provide for management and operations risk. The adverse interest-rate conditions prescribed by the GSE Act include one scenario in which 10-year Treasury yields rise by as much as 75 percent (up-rate scenario) and one in which they fall by as much as 50 percent (down-rate scenario). The credit risk component of the stress tests simulates the performance of our mortgage portfolio based on loss rates for a benchmark region. The criteria for the benchmark region are established by the GSE Act and are 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. ClassiÑcation OFHEO monitors our performance with respect to the three regulatory capital standards by classifying our capital adequacy not less than quarterly. To be classiÑed 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 classiÑed higher than ""undercapitalized.'' If we fail to meet the minimum capital requirement but exceed the critical capital requirement, we cannot be classiÑed higher than ""signiÑcantly undercapitalized.'' If we fail to meet the critical capital standard, we must be classiÑed as ""critically undercapitalized.'' In addition, OFHEO has discretion to reduce our capital classiÑcation by one level if OFHEO determines that we are engaging in conduct OFHEO did not approve that could result in a rapid depletion of Core capital or determines that the value of property subject to mortgage loans we hold or guarantee has decreased signiÑcantly. When we are classiÑed as adequately capitalized, we generally can 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 OFHEO 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 129 Freddie Mac OFHEO'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 classiÑed 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 OFHEO approval, which could adversely aÅect our ability to make capital distributions. If we were classiÑed as signiÑcantly 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 OFHEO 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 Ñnancial safety and soundness; or (c) otherwise be in the public interest. Also under this classiÑcation, OFHEO 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 OFHEO approval, which could adversely aÅect our ability to make capital distributions. If we were classiÑed as critically undercapitalized, OFHEO would be required to appoint a conservator for us, unless OFHEO made a written Ñnding that it should not do so and the Secretary of the Treasury concurred in that determination. We would be able to make a capital distribution only if OFHEO 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 Ñnancial safety and soundness; or (c) otherwise be in the public interest. Performance Against Regulatory Capital Standards OFHEO has never classiÑed us as other than ""adequately capitalized,'' the highest possible classiÑcation, reÖecting our consistent compliance with the minimum, critical and risk-based capital requirements. Table 10.1 summarizes our regulatory capital requirements and surpluses. Table 10.1 Ì Regulatory Capital Requirements(1) Minimum capital requirement(2)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Core capital(2) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Minimum capital surplus(2) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Critical capital requirement(2) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Core capital(2) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Critical capital surplus(2) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Risk-based capital requirement(3) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total capital(3) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Risk-based capital surplus(3) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ December 31, 2006 2005 (in millions) $25,844 36,170 10,326 $13,237 36,170 22,933 $25,010 35,964 10,954 $12,782 35,964 23,182 N/A $11,282 36,781 N/A 25,499 N/A (1) OFHEO is the authoritative source of the capital calculations that underlie our capital classiÑcations. (2) Amounts for 2006 are based on amended reports we submitted to OFHEO in March 2007. (3) OFHEO determines the amounts reported with respect to our risk-based capital requirement. Amounts for 2006 are not yet available. Factors that could adversely aÅect the adequacy of our regulatory capital for future periods include declines in GAAP income; increases in our risk proÑle; changes in the economic environment, such as large interest-rate or implied volatility moves or home-price declines; changes in option-adjusted spreads; legislative or regulatory action that could increase capital requirements or changes in or adoption of new accounting standards. See ""NOTE 1: SUMMARY OF SIGNIFI- CANT ACCOUNTING POLICIES Ì Recently Issued Accounting Standards, Not Yet Adopted'' for more information. In particular, interest-rate levels or implied volatility can aÅect the amount of our Core capital, even if we were economically well hedged against interest-rate changes, because certain gains or losses are recognized through GAAP earnings while other oÅsetting gains or losses may not be. Changes in option-adjusted spreads can also aÅect the amount of our Core capital, because option-adjusted spreads are a factor in the valuation of our guaranteed mortgage portfolio. Subordinated Debt Commitment In October 2000, we announced our voluntary adoption of a series of commitments designed to enhance market discipline, liquidity and capital. In September 2005, we entered into a written agreement with OFHEO that updated those commitments and set forth a process for implementing them. Under the terms of this agreement, we committed to issue qualifying subordinated debt for public secondary market trading and rated by no less than two nationally recognized statistical rating organizations in a quantity such that the sum of Total capital plus the outstanding balance of qualifying subordinated debt will equal or exceed the sum of 0.45 percent of outstanding guaranteed PCs and Structured Securities and 4 percent of on-balance sheet assets at the end of each quarter. Qualifying subordinated debt is deÑned as subordinated debt that contains a deferral of interest payments for up to Ñve years if our Core capital falls below 125 percent of our 130 Freddie Mac critical capital requirement or our Core capital falls below our minimum capital requirement and pursuant to our request, the Secretary of the Treasury exercises discretionary authority to purchase our obligations under Section 306(c) of our charter. Qualifying subordinated debt will be discounted for the purposes of this commitment as it approaches maturity with one-Ñfth of the outstanding amount excluded each year during the instrument's last Ñve years before maturity. When the remaining maturity is less than one year, the instrument is entirely excluded. Table 10.2 summarizes our compliance with our subordinated debt commitment. Table 10.2 Ì Subordinated Debt Commitment December 31, 2006 2005 (in millions) Total on-balance sheet assets and guaranteed PCs and Structured Securities outstanding target(1)(2)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total capital plus qualifying subordinated debt(2)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Surplus(2)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $37,576 42,602 5,026 $36,633 41,831 5,198 (1) Equals the sum of 0.45 percent of outstanding guaranteed PCs and Structured Securities and 4 percent of on-balance sheet assets. (2) Amounts for 2006 are based on amended reports we submitted to OFHEO in March 2007. Regulatory Capital Monitoring Framework In a letter dated January 28, 2004, OFHEO created a framework for monitoring our capital due to our higher operational risk, including our inability to produce timely Ñnancial statements in accordance with GAAP. The letter directed that we maintain a mandatory target capital surplus of 30 percent over our minimum capital requirement, subject to certain conditions and variations; that we submit weekly reports concerning our capital levels; and that we obtain prior approval of certain capital transactions. Our failure to meet the mandatory target capital surplus would result in an OFHEO inquiry regarding the reason for such failure. If OFHEO were to determine that we had acted unreasonably regarding our compliance with the framework, as set forth in OFHEO's letter, OFHEO could seek to require us to submit a remedial plan or take other remedial steps. In addition, under this framework, we are required to obtain prior written approval from the Director of OFHEO before engaging in certain capital transactions, as described above. We must also submit a written report to the Director of OFHEO after the declaration, but before the payment, of any dividend on our common stock. The report must contain certain information on the amount of the dividend, the rationale for the payment and the impact on our capital surplus. This framework will remain in eÅect until the Director of OFHEO determines that it should be modiÑed or expire. OFHEO's letter indicated that this determination would consider our resumption of timely Ñnancial and regulatory reporting that complies with GAAP, among other factors. Table 10.3 summarizes our compliance with the mandatory target capital surplus portion of OFHEO's capital monitoring framework. Table 10.3 Ì Mandatory Target Capital Surplus December 31, 2006 2005 (in millions) Minimum capital requirement plus 30% add-on(1) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Core capital(1) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Surplus(1)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $33,597 36,170 2,573 $32,513 35,964 3,451 (1) Amounts for 2006 are based on amended reports we submitted to OFHEO in March 2007. NOTE 11: STOCK-BASED COMPENSATION We have three stock-based compensation plans under which grants are being made: (a) the ESPP; (b) the 2004 Stock Compensation Plan, or 2004 Employee Plan; and (c) the 1995 Directors' Stock Compensation Plan, as amended and restated, or Directors' Plan. Prior to the stockholder approval of the 2004 Employee Plan, employee stock-based compensation was awarded in accordance with the terms of the 1995 Stock Compensation Plan, or 1995 Employee Plan. Although grants are no longer made under the 1995 Employee Plan, we currently have awards outstanding under this plan. We collectively refer to the 2004 Employee Plan and 1995 Employee Plan as the Employee Plans. Common stock delivered under these plans may consist of authorized but previously unissued shares, treasury stock or shares acquired in market transactions on behalf of the participants. During 2006, stock-based awards we granted consisted of stock options and restricted stock units. Such awards, discussed below, are generally forfeitable for at least one year after the grant date, with vesting provisions contingent upon service requirements. 131 Freddie Mac Stock options Stock options granted allow for the purchase of our common stock at an exercise price equal to the fair market value of our common stock on the grant date. During 2006, the 2004 Employee Plan was amended to change the deÑnition of fair market value to the closing sales price of a share of common stock from the average of the high and low sales prices, eÅective for all grants after December 6, 2006. Options generally may be exercised for a period of 10 years from the grant date, subject to a vesting schedule commencing on the grant date. Stock options that we previously granted included dividend equivalent rights. Depending on the terms of the grant, the dividend equivalents may be paid when and as dividends on our common stock are declared. Alternatively, dividend equivalents may be paid upon exercise or expiration of the stock option. Subsequent to November 30, 2005, dividend equivalent rights were no longer granted in connection with awards of stock options to grantees to address Internal Revenue Code Section 409A. Restricted stock units A restricted stock unit entitles the grantee to receive one share of common stock at a speciÑed future date. Restricted stock units do not have voting rights, but do have dividend equivalent rights, which are (a) paid to restricted stock unit holders who are employees as and when dividends on common stock are declared or (b) accrued as additional restricted stock units for non-employee members of our board of directors. Restricted stock Restricted stock entitles participants to all the rights of a stockholder, including dividends, except that the shares awarded are subject to a risk of forfeiture and may not be disposed of by the participant until the end of the restriction period established at the time of grant. The following is a description of each of our stock-based compensation plans under which grants are currently being made. ESPP: We have an ESPP that is qualiÑed under Internal Revenue Code Section 423. Under the ESPP, substantially all full-time and part-time employees that choose to participate in the ESPP have the option to purchase shares of common stock at speciÑed dates, with an annual maximum market value of $20,000 per employee as determined on the grant date. The purchase price is equal to 85 percent of the lower of the average price (average of the daily high and low prices) of the stock on the grant date or the average price of the stock on the purchase (exercise) date. At December 31, 2006, the maximum number of shares of common stock authorized for grant to employees totaled 6.8 million shares, of which approximately 0.4 million shares had been issued and approximately 6.4 million shares remained available for grant. At December 31, 2006, no options to purchase stock were exercisable under the ESPP, as the options to purchase stock outstanding at year-end become exercisable subsequent to year-end, and are exercised or forfeited during the subsequent year. 2004 Employee Plan: Under the 2004 Employee Plan, we may grant employees stock-based awards, including stock options, restricted stock units and restricted stock. In addition, we have the right to impose performance conditions with respect to these awards. Employees may also be granted stock appreciation rights; however, at December 31, 2006, no stock appreciation rights had been granted under the 2004 Employee Plan. At December 31, 2006, the maximum number of shares of common stock authorized for grant to employees in accordance with the 2004 Employee Plan totaled 14.3 million shares, of which approximately 3.4 million shares had been issued and approximately 10.9 million shares remained available for grant. Directors' Plan: Under the Directors' Plan, we are permitted to grant stock options, restricted stock units and restricted stock to non-employee members of our board of directors. At December 31, 2006, the maximum number of shares of common stock authorized for grant to members of our board of directors in accordance with the Directors' Plan totaled 2.4 million shares, of which approximately 0.9 million shares had been issued and approximately 1.5 million shares remained available for grant. See ""NOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES,'' for a description of the accounting treatment for stock-based compensation, including grants under the ESPP, Employee Plans and Directors' Plan. Estimates used to determine the assumptions noted in the table below are determined as follows: (a) the expected volatility is based on the historical volatility of the stock over a time period equal to the expected life; (b) the weighted average volatility is the weighted average of the expected volatility; (c) the weighted average expected dividend yield is based on the most recent dividend announcement relative to the grant date and the stock price at the grant date; 132 Freddie Mac (d) the weighted average expected life is based on historical option exercise experience; and (e) the weighted average risk-free interest rate is based on the U.S. Treasury yield curve in eÅect at the time of the grant. Changes in the assumptions used to calculate the fair value of stock options could result in materially diÅerent fair value estimates. The actual value of stock options will depend on the market value of our common stock when the stock options are exercised. Table 11.1 summarizes the assumptions used in determining the fair values of options granted under our stock-based compensation plans using a Black-Scholes option-pricing model as well as the weighted average grant-date fair value of options granted and the total intrinsic value of options exercised. Table 11.1 Ì Assumptions and Valuations Employee Stock Purchase Plan 2005 2004 2006 Employee Plans and Directors' Plan 2005(1) 2006 2004 (dollars in millions, except share-related amounts) Assumptions: Expected volatilityÏÏÏÏÏÏÏÏÏÏÏÏÏ 11.2% to 18.7% 16.8% to 21.1% 15.4% to 20.4% 27.8% to 28.9% 18.4% to 30.3% 30.5% to 32.0% Weighted average: VolatilityÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Expected dividend yield ÏÏÏÏÏÏ Expected life ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Risk-free interest rate ÏÏÏÏÏÏÏÏ Valuations: Weighted average grant-date fair value of options granted ÏÏÏÏÏÏ Total intrinsic value of options exercised ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 15.7% 2.98% 3 months 4.82% $11.20 $3 19.7% 2.15% 3 months 3.20% $11.56 $2 17.8% 1.85% 3 months 1.33% $11.23 $3 28.7% 3.09% 7.1 years 4.91% $16.78 $20 30.0% Ì 7.4 years 4.23% $26.84 $32 31.5% Ì 7.0 years 3.55% $25.04 $66 (1) The value of the dividend equivalent feature of options for the Employee Plans and Directors' Plan was incorporated into the Black-Scholes model by using an expected dividend yield of zero percent. To account for a modiÑcation of stock options on November 30, 2005, the dividend equivalent feature of aÅected stock options for the Employee Plans and Directors' Plan was valued separately. Other assumptions used to value the aÅected stock options were as follows: (a) expected volatility of 25.4 percent, (b) expected dividend yield of 2.96 percent, (c) expected life of 5.1 years, and (d) risk- free interest rate of 4.34 percent. Subsequent to November 30, 2005, dividend equivalent rights are no longer granted in connection with new awards of stock options to grantees. Table 11.2 provides a summary of activity under the ESPP for the year ended December 31, 2006, and those options to purchase stock that are exercisable at December 31, 2006. Table 11.2 Ì ESPP Activity Outstanding at January 1, 2006(1) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Granted(1) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Exercised ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Forfeited or expired ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Outstanding at December 31, 2006(1) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Exercisable at December 31, 2006 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Options to Purchase Stock 61,584 226,266 (222,703) (12,249) 52,898 Ì Weighted Average Exercise Price Weighted Average Remaining Contractual Term Aggregate Intrinsic Value (dollars in millions, except share-related amounts) $52.16 53.73 50.51 51.67 58.09 Ì 1 month Ì $1 Ì (1) Weighted average exercise price noted for options to purchase stock granted under the ESPP is calculated based on the average price on the grant date. Table 11.3 provides a summary of option activity under the Employee Plans and Directors' Plan for the year ended December 31, 2006, and options exercisable at December 31, 2006. Table 11.3 Ì Employee Plans and Directors' Plan Option Activity Stock Options Weighted Average Exercise Price Weighted Average Remaining Contractual Term Aggregate Intrinsic Value (dollars in millions, except share-related amounts) Outstanding at January 1, 2006 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ GrantedÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Exercised ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Forfeited or expiredÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Outstanding at December 31, 2006 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 6,693,684 423,294 (914,368) (350,685) 5,851,925 Exercisable at December 31, 2006 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 3,706,396 $56.20 60.66 42.02 61.38 58.43 57.17 5.76 years 4.61 years $55 $40 We received cash of $35 million from the exercise of stock options under the Employee Plans and the Directors' Plan during 2006. We realized a tax beneÑt of $7 million as a result of tax deductions available to us upon the exercise of stock options under the Employee Plans and the Directors' Plan during 2006. During 2006, we did not pay cash to settle share- 133 Freddie Mac based liability awards granted under share-based payment arrangements associated with Employee Plans and the Directors' Plan. During 2005 and 2004, we paid $1 million and $1 million, respectively, to settle share-based awards. Table 11.4 provides a summary of activity related to restricted stock units and restricted stock under the Employee Plans and the Directors' Plan. Table 11.4 Ì Employee Plans and Directors' Plan Restricted Stock Units and Restricted Stock Activity Restricted Stock Units Weighted Average Grant-Date Fair Value Restricted Stock Weighted Average Grant-Date Fair Value Year Ended December 31, 2006 Outstanding at January 1, 2006 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Granted(1)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Lapse of restrictions ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Forfeited ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Outstanding at December 31, 2006ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 1,474,183 1,486,080 (384,649) (171,039) 2,404,575 $61.28 64.96 61.79 62.95 63.35 69,702 Ì (28,542) Ì 41,160 $63.57 Ì 67.64 Ì 60.75 (1) During 2006, restricted stock units granted under the Employee Plans and the Directors' Plan were 1,469,047 and 17,033, respectively. The total fair value of restricted stock units vested during 2006, 2005 and 2004 was $24 million, $42 million and $10 million, respectively. The total fair value of restricted stock vested during 2006, 2005 and 2004 was $2 million, $5 million and $15 million, respectively. We realized a tax beneÑt of $9 million as a result of tax deductions available to us upon the lapse of restrictions on restricted stock units and restricted stock under the Employee Plans and the Directors' Plan during 2006. Table 11.5 provides information on compensation expense related to stock-based compensation plans. Table 11.5 Ì Compensation Expense Related to Stock-based Compensation Stock-based compensation expense recorded on our consolidated statements of stockholders' equity ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Other stock-based compensation expense(1) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total stock-based compensation expense(2)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Tax beneÑt related to compensation expense recognized on our consolidated statements of incomeÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Compensation expense capitalized within Other assets on our consolidated balance sheets ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Year Ended December 31, 2005 (in millions) $67 2 $69 $23 5 2004 $56 3 $59 $19 6 2006 $60 3 $63 $21 5 (1) For 2006, primarily comprised of dividend equivalents paid on stock options and restricted stock units that have been or are expected to be forfeited. Also included expense related to share-based liability awards granted under share-based payment arrangements. (2) Component of Salaries and employee beneÑts expense as recorded on our consolidated statements of income. As of December 31, 2006, $127 million of compensation expense related to non-vested awards had not yet been recognized in earnings. This amount is expected to be recognized in earnings over the next four years. During 2006, the modiÑcation of individual awards, which provided for continued or accelerated vesting, was made to fewer than 20 employees and resulted in incremental compensation expense of $0.1 million. We use derivatives to conduct our risk management activities. We principally use the following types of derivatives: ‚ LIBOR- and the Euro Interbank OÅered Rate, or Euribor-, based interest-rate swaps; NOTE 12: DERIVATIVES ‚ LIBOR- and Treasury-based options (including swaptions); ‚ LIBOR- and Treasury-based exchange-traded futures; and ‚ Foreign-currency swaps. Our derivative portfolio also includes certain forward purchase and sale commitments and other contractual agreements, including credit derivatives and swap guarantee derivatives in which we guarantee the sponsor's or the borrower's performance as a counterparty on certain interest-rate swaps. Hedging Activity Derivative instruments are reported at their fair value and generally netted by counterparty (provided that a legally enforceable master netting agreement exists), as either Derivative assets, at fair value, or Derivative liabilities, at fair value, on our consolidated balance sheets. See ""NOTE 17: CONCENTRATION OF CREDIT AND OTHER RISKS'' for further information related to our derivative counterparties. 134 Freddie Mac No Hedge Designation At December 31, 2006, 2005 and 2004, most of our derivative portfolio was not designated in hedge accounting relationships. We record changes in the fair value of derivatives not in hedge accounting relationships as Derivative gains (losses) on our consolidated statements of income. Any associated interest received or paid is recognized on an accrual basis and also recorded in Derivative gains (losses) on our consolidated statements of income. At the beginning of the second quarter of 2004, we determined that substantially all pay-Ñxed swaps and other derivatives that previously had been in cash Öow hedge accounting relationships no longer met the hedged item shared risk exposure requirement and hedge eÅectiveness assessment as required by SFAS 133. Consequently, we discontinued hedge accounting treatment for these relationships, resulting in the movement of pay-Ñxed swaps with a notional balance of approximately $108 billion from the cash Öow hedge designation to no hedge designation. We also voluntarily discontinued hedge accounting treatment for a signiÑcant amount of our receive-Ñxed swaps eÅective November 1, 2004, resulting in the movement of receive-Ñxed swaps with a notional balance of approximately $50 billion from the fair value hedge designation to no hedge designation. At the beginning of the second quarter of 2005, we voluntarily discontinued hedge accounting treatment for all new forward purchase commitments and the majority of our new commitments to forward sell mortgage- related securities. In addition, eÅective March 31, 2006, we discontinued hedge accounting treatment for all derivatives, with the exception of certain derivatives related to foreign-currency debt issuances and certain commitments to forward sell mortgage-related securities. The discontinuation resulted in the movement of receive-Ñxed swaps with a notional amount of approximately $58.8 billion from the fair value hedge designation to no hedge designation and the movement of foreign- currency swaps with a notional amount of approximately $550 million from the cash Öow hedge designation to no hedge designation. Hedge accounting treatment for the remaining derivatives related to foreign-currency debt issuances was voluntarily discontinued on December 1, 2006, resulting in a movement of receive-Ñxed swaps and foreign-currency swaps with a notional amount of approximately $56 billion from the fair value hedge designation to no hedge designation. We believe that our voluntary discontinuation of hedge accounting treatment for these derivatives assists us in addressing the operational complexity and related control remediation eÅorts that would otherwise be needed to ensure ongoing compliance with the requirements for obtaining and maintaining hedge accounting treatment. We may consider implementing new hedge accounting strategies in the future. Fair Value Hedges Fair value hedges represented hedges of exposure to foreign-currency Öuctuations and changes in the fair value of a recognized liability. We primarily used interest-rate swaps and foreign-currency swaps to hedge against the changes in fair value of Ñxed-rate debt due to changes in benchmark interest rates (either LIBOR or Euribor), or foreign-currency Öuctuations, or a combination of both. For a derivative accounted for in a fair value hedge relationship, we reported changes in the fair value of the derivative as Hedge accounting gains (losses) on our consolidated statements of income along with the oÅsetting changes in the fair value of the hedged item attributable to the risk being hedged. Any diÅerences arising from fair value changes that were not exactly oÅset resulted in hedge ineÅectiveness. Hedge accounting gains (losses) varied from period to period based on the notional amount of derivatives accounted for in hedge accounting relationships and the extent of hedge ineÅectiveness. Table 12.1 summarizes certain gains (losses) recognized related to our hedge accounting categories. Table 12.1 Ì Hedge Accounting Categories Information Year Ended December 31, 2005 2004 2006 (in millions) Fair value hedges Hedge ineÅectiveness recognized in Hedge accounting gains (losses) Ì pre-tax(1) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Cash Öow hedges Hedge ineÅectiveness recognized in Hedge accounting gains (losses) Ì pre-tax(1) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Ì Net pre-tax gains (losses) resulting from the determination that it was probable that forecasted transactions would $ 2 not occur ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Ì $ 22 $742 Ì (25) 1 2 (1) No amounts have been excluded from the assessment of eÅectiveness. Cash Flow Hedges Cash Öow hedges represent hedges of exposure to the variability in the cash Öows of a variable-rate or foreign-currency denominated instrument or related to a forecasted transaction. We used interest-rate swaps, foreign-currency swaps and forward purchase and sale commitments to hedge the changes in cash Öows associated with the forecasted issuances of debt, forecasted purchase or sale of mortgage-related assets, and foreign-currency Öuctuations. At December 31, 2006, the only derivatives accounted for as cash Öow hedges were certain commitments to forward sell mortgage-related securities with a total notional amount of $70 million. 135 Freddie Mac For a derivative accounted for as a cash Öow hedge, changes in fair value are reported in AOCI, net of taxes, on our consolidated balance sheets to the extent the hedge is eÅective. The remaining ineÅective portion of changes in fair value is reported as Hedge accounting gains (losses) on our consolidated statements of income. As shown in Table 12.2 below, the total AOCI, net of taxes, related to cash Öow hedge relationships was a loss of $5,033 million at December 31, 2006, primarily composed of deferred net losses on closed cash Öow hedges. Closed cash Öow hedges involve derivatives that have been terminated or are no longer designated as cash Öow hedges. Fluctuations in prevailing market interest rates have no impact on the deferred portion of AOCI relating to losses on closed cash Öow hedges. Over the 12 months beginning January 1, 2007, we estimate that approximately $953 million of deferred losses in AOCI, net of taxes, will be reclassiÑed into earnings. The maximum remaining length of time over which we have hedged the exposure related to the variability in future cash Öows on forecasted transactions, primarily interest payments on forecasted debt issuances, is 27 years. However, over 70 percent and 90 percent of the AOCI, net of taxes, balance relating to cash Öow hedges at December 31, 2006 is linked to forecasted transactions occurring in the next 5 and 10 years, respectively. The occurrence of forecasted transactions may be satisÑed by either periodic issuances of short-term debt over the required time period or longer-term debt, such as Reference Notes» securities. Table 12.2 presents the changes in AOCI, net of taxes, related to derivatives designated as cash Öow hedges. Net change in fair value related to cash Öow hedging activities, net of tax, represents the net change in the fair value of the derivatives that were designated as cash Öow hedges, after the eÅects of our statutory tax rate of 35 percent, to the extent the hedges were eÅective. Net reclassiÑcations of losses to earnings, net of tax, represents the AOCI amount, after the eÅects of our statutory tax rate of 35 percent, that was recognized in earnings as the originally hedged forecasted transactions aÅected earnings, unless it was deemed probable that the forecasted transaction would not occur. If it is probable that the forecasted transaction will not occur, then the entire deferred gain or loss associated with the hedge related to the forecasted transaction would be reclassiÑed into earnings immediately. Table 12.2 Ì AOCI, Net of Taxes, Related to Cash Flow Hedge Relationships Beginning balance(1) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Net change in fair value related to cash Öow hedging activities, net of tax (beneÑt) expense of $(5), $27 and $(1,089), respectively ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Net reclassiÑcations of losses to earnings, net of tax beneÑt of $680, $855 and $1,042, respectively ÏÏÏÏÏÏ Ending balance(1)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2006 Year Ended December 31, 2005 (in millions) $(6,287) $(7,924) $(7,837) 2004 (9) 1,263 50 1,587 $(5,033) $(6,287) $(7,924) (2,021) 1,934 (1) Represents the eÅective portion of the fair value of open derivative contracts (i.e., net unrealized gains and losses) and net deferred gains and losses on closed (i.e., terminated or redesignated) cash Öow hedges. NOTE 13: LEGAL CONTINGENCIES We are involved as a party to a variety of legal proceedings arising from time to time in the ordinary course of business including, among other things, contractual disputes, personal injury claims, employment-related litigation and other legal proceedings incidental to our business. We are frequently involved, directly or indirectly, in litigation involving mortgage foreclosures. From time to time, we are also involved in proceedings arising from our termination of a seller/servicer's eligibility to sell mortgages to, and service mortgages for, us. In these cases, the former seller/servicer sometimes seeks damages against us for wrongful termination under a variety of legal theories. In addition, we are sometimes sued in connection with the origination or servicing of mortgages. These suits typically involve claims alleging wrongful actions of seller/servicers. Our contracts with our seller/servicers generally provide for indemnification against liability arising from their wrongful actions. We are subject to various other legal proceedings, including regulatory investigations and administrative and civil litigation, arising from the restatement of our previously issued consolidated Ñnancial statements for the years 2000 and 2001 and the Ñrst three quarters of 2002 and the revision of fourth quarter and full-year consolidated Ñnancial statements for 2002 (collectively referred to as the ""restatement''). In the Ñrst quarter of 2005, we recorded a $339 million expense related to our litigation reserves for legal settlements, including our settlement of the securities class action lawsuits, the shareholder derivative lawsuits and the Federal Election Commission, or FEC, investigation, discussed below. We maintain reserves for the amount of the estimated probable loss in connection with the remaining legal proceedings related to the restatement. As of the Ñrst quarter of 2006, we recorded a $25 million reduction in our reserves for this loss contingency. Litigation and claims resolution are subject to many uncertainties and are not susceptible to accurate prediction. Any additional losses that might result from the adverse resolution of any of the remaining legal proceedings could be greater than our current reserves. 136 Freddie Mac SEC Investigation. In June 2003, the SEC initiated a formal investigation of Freddie Mac in connection with the restatement. On August 18, 2004, we announced that we had received a ""Wells Notice'' from the staÅ of the SEC. The Wells Notice advised us that the SEC staÅ is considering recommending that the SEC initiate a civil injunctive action against us for possible violations of federal securities laws, including Section 10(b) of the Securities Exchange Act of 1934 and the SEC's Rule 10b-5, as well as Sections 17(a)(1), (2) and (3) of the Securities Act of 1933. The Wells Notice also indicated that the SEC staÅ may seek a permanent injunction and a civil money penalty in connection with the contemplated action. We continue to cooperate fully with the SEC's investigation. Securities Class Action Lawsuits. In June 2003 and thereafter, securities class action lawsuits were brought in against us and certain former executive oÇcers in connection with the restatement and eventually in the U.S. District Court for the Southern District of New York. The plaintiÅs claimed that the defendants improperly managed earnings to create a misleading impression of steady earnings by Freddie Mac, that they engaged in a number of improper transactions that violated GAAP and that they made false and misleading statements regarding the same. On October 26, 2006, the court approved a settlement of the securities class action lawsuits, as well as the shareholder derivative actions described below. The settlement of these actions included a cash payment of $410 million. The settlement does not include any admission of wrongdoing by the company. Shareholder Derivative Lawsuits. Two shareholder derivative lawsuits were Ñled during 2003 against certain former and current executives and, in one of the suits, certain former and current members of the board of directors and Ñve counterparties. The plaintiÅs alleged claims for breach of Ñduciary duties, indemniÑcation, waste of corporate assets, unjust enrichment and aiding and abetting breach of Ñduciary duties in connection with the restatement. Both cases were ultimately assigned to the same judge in New York who handled the securities class action lawsuits described above. As described above, on October 26, 2006, the court approved a settlement of both shareholder derivative actions, as well as the securities class action lawsuits. The settlement of these cases was based in part on corporate governance reforms we instituted under our current management. ERISA Lawsuits. Two class action lawsuits were Ñled in 2003 in the U.S. District Court for the Southern District of Ohio against us, certain former executives, a former member of our board of directors, and our Retirement Committee alleging violations of the Employee Retirement Income Security Act, or ERISA. On March 1, 2007, the court approved a settlement of the ERISA lawsuits, which resulted in the closure of the Department of Labor investigation described below. The settlement of these actions includes a payment of $4.65 million, which will be fully covered by insurance, and certain non-monetary relief, including an agreement to appoint an independent Ñduciary to oversee the Freddie Mac Stock Fund, one of the investment options under our Thrift/401(k) Savings Plan. The settlement does not include any admission of wrongdoing by the company. Department of Labor Investigation. In July 2003, the Department of Labor began an investigation of our Thrift/401(k) Savings Plan in relation to the restatement. We announced on August 21, 2006, that in anticipation of the proposed settlement of the ERISA litigation, the Labor Department informed the company that it closed its investigation of the Thrift/401(k) Savings Plan. OFHEO Proceedings. In December 2003, OFHEO Ñled administrative notices of charges against us and Messrs. Brendsel and Clarke, two of our former executive oÇcers. In its charge against us, OFHEO sought to have us take certain actions in connection with these individuals' salaries and compensation as well as their termination status with the company. On September 9, 2005, we entered into a stipulated consent order with OFHEO to settle the administrative notice of charges against us. Under the terms of the consent order, we agreed to produce certain documents and make available any current employees that OFHEO requests to interview in connection with its ongoing administrative actions against Messrs. Brendsel and Clarke, and to take certain additional steps following the administrative actions against the former oÇcers in accordance with any Ñnal order resulting in those actions. The text of this consent order and a related production agreement are available on OFHEO's website at www.ofheo.gov. In agreeing to the consent order, we made no admission regarding any wrongdoing by the company. Based on the consent order, OFHEO has dismissed the administrative notice of charges against us and we have produced certain documents for OFHEO's review and made numerous current employees available for interviews at OFHEO's request. U.S. Attorney's Investigation. In June 2003, the U.S. Attorney's OÇce in Alexandria, Virginia commenced an investigation of us related to the restatement. At present, we do not believe that the U.S. Attorney's OÇce will take any adverse action against the company related to the restatement given the passage of time and the fact that no action has been taken to date. It is the policy of the U.S. Attorney's OÇce not to comment on investigations or announce when an investigation is closed without action. Accordingly, we cannot make any assurances that this matter has been resolved. Antitrust Lawsuits. Consolidated lawsuits were Ñled against Fannie Mae and us in the U.S. District Court for the District of Columbia, originally Ñled on January 10, 2005, alleging that both companies conspired to establish and maintain 137 Freddie Mac artiÑcially high guarantee fees. The complaint covers the period January 1, 2001 to the present and asserts a variety of claims under federal and state antitrust laws, as well as claims under consumer-protection and similar state laws. The plaintiÅs seek injunctive relief, unspeciÑed damages (including treble damages with respect to the antitrust claims and punitive damages with respect to some of the state claims) and other forms of relief. We Ñled a motion to dismiss the action and are awaiting a ruling from the court. At present, it is not possible for us to predict the probable outcome of the consolidated lawsuit or any potential impact on our business, Ñnancial condition or results of operations. Other Inquiries. We receive inquiries from the Internal Revenue Service, or IRS, in connection with its regular audits of our tax returns for prior years, some of which relate to matters connected with the restatement. We continue to respond to these inquiries. See ""NOTE 14: INCOME TAXES'' for more information. FEC Investigation. In March 2004, we provided certain information to the FEC concerning compliance with federal election laws. The FEC conducted an investigation into this matter and, on April 18, 2006, we announced we had entered into a conciliation agreement with the FEC. Under the terms of the conciliation agreement, we agreed to pay a civil penalty of $3.8 million and to cease and desist from engaging in activities that violate speciÑed provisions of the Federal Election Campaign Act relating to prohibitions on the use of corporate resources for political fundraising. We are exempt from state and local income taxes. Table 14.1 presents the components of our provision for income NOTE 14: INCOME TAXES taxes. Table 14.1 Ì Provision for Income Taxes Current tax provision (beneÑt) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ Deferred tax provision (beneÑt) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 966 (1,074) Total provision (beneÑt) for income taxes(1) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ (108) (1,452) 367 $ (346) $ 790 2006 Year Ended December 31, 2005 (in millions) $ 1,819 2004 $1,136 (1) Does not reÖect (a) the deferred tax eÅects of unrealized (gains) losses on available-for-sale securities, net (gains) losses related to the eÅective portion of derivatives designated in cash Öow hedge relationships, and certain changes in our deÑned beneÑt plans which are reported as part of AOCI, (b) certain stock-based compensation tax eÅects reported as part of additional paid-in capital, and (c) the tax eÅect of cumulative eÅect of change in accounting principles. Table 14.2 summarizes our deferred tax assets and liabilities. Table 14.2 Ì Deferred Tax Assets and (Liabilities) December 31, 2006 2005 (in millions) Deferred tax assets: Deferred fees related to securitizations ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 1,870 108 Credit related items and reserve for loan lossesÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Employee compensation and beneÑt plans ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 148 4,237 Cash Öow hedge deferrals and unrealized (gains) losses related to available-for-sale securities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Other items, netÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Ì 6,363 Total deferred tax assets ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Deferred tax liabilities: (1,320) Premium and discount amortization ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (357) Basis diÅerences related to assets held-for-investment ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (1,034) Basis diÅerences related to derivative instrumentsÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (52) Other items, netÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total deferred tax liabilities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (2,763) Net deferred tax assets and (liabilities)(1) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 3,600 $ 1,779 61 171 4,724 36 6,771 (1,426) (560) (1,779) Ì (3,765) $ 3,006 (1) Included in Other assets on our consolidated balance sheets. 138 Freddie Mac Table 14.3 reconciles the statutory federal tax rate to the eÅective tax rate. Table 14.3 Ì Reconciliation of Statutory to EÅective Tax Rate Year Ended December 31, 2005 2004 2006 Statutory corporate rate ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Tax-exempt interest ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Tax credits ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Provision related to tax contingencies ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Penalties ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ OtherÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ EÅective rate ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 35.0% 35.0% 35.0% (4.7) (8.7) (12.2) (7.3) (14.3) (21.9) (2.0) 1.9 (6.4) Ì 0.1 Ì 0.2 0.4 0.4 (5.1)% 14.4% 21.2% Our negative eÅective tax rate in 2006 and the decrease in our eÅective tax rate over the past three years is primarily due to the decline in pre-tax income, the 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. In 2006, our negative eÅective tax rate also reÖects reductions in our tax reserves as discussed below. Impact of tax issues. The IRS has a policy to examine the income tax returns of large corporate taxpayers, including us, generally every year. We believe that an adequate provision has been made for contingencies related to all income taxes and related interest and potential penalties in accordance with SFAS 5. However, making a provision for such contingencies requires signiÑcant judgment. The ultimate outcome of these tax contingencies is subject to uncertainties, diÇcult to predict and could result in a tax beneÑt or tax provision that could be material to our quarterly or annual results of operations. We do not believe that liabilities arising from these matters, if any, will have a material adverse eÅect on our consolidated Ñnancial condition. Tax Years 1985 through 1997. We are in litigation in the U.S. Tax Court, or Court, to contest income tax deÑciencies asserted by the IRS for years 1985 through 1997. The principal matters in controversy in the case involve questions of tax law as applied to our transition from non-taxable to taxable status in 1985 and primarily involve the amortization of two types of intangible assets: ‚ Favorable Financing. A number of Ñnancing arrangements where the contract rates of interest were less than the market rates of interest as of January 1, 1985 due to an increase in interest rates since the date on which we had entered into the respective arrangements; and, ‚ Customer Relationships. Our business relationships with a substantial number of mortgage originating institutions that sold mortgages to us on a regular basis. In July 2006, the Court ruled favorably for Freddie Mac on the questions of value and useful life of Favorable Financing. In response to this decision, we recorded a $108 million reduction in our tax contingency reserves as of Ñrst quarter 2006. The Court's rulings to date in the case are subject to appeal by the parties upon Ñnal resolution by the Court. If the IRS were to appeal the July 2006 or any prior Court decisions and any adverse rulings resulted, we may reconsider our reserves. We are in discussions with the IRS regarding settlement of the Customer Relationships controversy. The favorable resolution of this controversy would represent a gain contingency which we have not recorded. In November 2006, Freddie Mac entered into a settlement with the IRS that included resolution of several other controversies in the case, including a controversy regarding the timing for recognition of certain Management and guarantee fees. In view of the settlement, we recorded a $50 million reduction in our tax contingency reserves as of Ñrst quarter 2006. Tax Years 1998 through 2005. The IRS has completed its regular examination of our 1998 through 2002 tax returns, but could raise additional issues. As a result of the regular examination, the principal matter in controversy involves questions of timing and potential penalties regarding our tax accounting method for certain hedging transactions. We believe the risk of loss due to the assertion of penalties by the IRS related to our tax accounting methods is remote. As to the questions of timing, we believe that an adequate provision in accordance with SFAS 5 has been made for contingencies related to income taxes and related interest as described under ""Impact of tax issues'' above. The tax years 2003 to 2005 are being examined by the IRS. NOTE 15: EMPLOYEE BENEFITS DeÑned BeneÑt Plans We maintain a tax-qualiÑed, funded deÑned beneÑt pension plan, or Pension Plan, covering substantially all of our employees. Pension Plan beneÑts are based on an employee's years of service and highest average compensation, up to legal plan limits, over any consecutive 36 months of employment. Pension Plan assets are held in trust and the investments consist 139 Freddie Mac primarily of funds comprised of listed stocks and corporate bonds. In addition to our Pension Plan, we maintain a nonqualiÑed, unfunded deÑned beneÑt pension plan for our oÇcers, referred to as our Supplemental Executive Retirement Plan, or SERP. The related retirement beneÑts for our SERP are paid from our general assets. Our qualiÑed and nonqualiÑed deÑned beneÑt pension plans are collectively referred to as deÑned beneÑt pension plans. We maintain a deÑned beneÑt postretirement health care plan, or Retiree Health Plan, that generally provides postretirement health care beneÑts on a contributory basis to retired employees age 55 or older who rendered at least 10 years of service (Ñve years of service if the employee is eligible to retire prior to March 1, 2007) and who, upon separation or termination, immediately elected to commence beneÑts under the Pension Plan in the form of an annuity. Our Retiree Health Plan is currently unfunded and the beneÑts are paid from our general assets. This plan and our deÑned beneÑt pension plans are collectively referred to as deÑned beneÑt plans. For Ñnancial reporting purposes, we use a September 30 valuation measurement date for all of our deÑned beneÑt plans. See ""NOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES'' for further information regarding the pending change to our measurement date. We are required to accrue the estimated cost of retiree beneÑts as employees render the services necessary to earn their pension and postretirement health beneÑts. Our pension and postretirement health care costs related to these deÑned beneÑt plans for 2006, 2005 and 2004 presented in the following tables were calculated using assumptions as of September 30, 2005, 2004 and 2003, respectively. The funded status of our deÑned beneÑt plans for 2006, 2005 and 2004 presented in the following tables was calculated using assumptions as of September 30, 2006, 2005 and 2004, respectively. Table 15.1 below shows the changes in our beneÑt obligations and fair value of plan assets using a September 30 valuation measurement date for amounts recognized on our consolidated balance sheets at December 31, 2006 and 2005, respectively. Table 15.1 Ì Obligation and Funded Status of our DeÑned BeneÑt Plans Change in beneÑt obligation: BeneÑt obligation at October 1 (prior year) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Service cost ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Interest costÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Net actuarial loss (gain) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ BeneÑts paid ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ BeneÑt obligation at September 30 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Change in plan assets: Fair value of plan assets at October 1 (prior year) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Actual return on plan assets ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Employer contributions ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ BeneÑts paid ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Fair value of plan assets at September 30 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Funded status at September 30 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Amounts recognized on our consolidated balance sheets at December 31: Other assetsÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Other liabilities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ AOCI, net of taxes related to deÑned beneÑt plans: Net actuarial loss ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Prior service cost (credit) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total AOCI, net of taxes(1)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Pension BeneÑts 2005 2006 Postretirement Health BeneÑts 2006 2005 (in millions) $457 31 26 (1) (9) 504 $333 31 146 (9) 501 $ (3) $ 42 (45) $ 72 1 $ 73 $ 385 27 22 28 (5) 457 $ 260 29 49 (5) 333 $(124) $ $ $ 29 (28) 1 Ì 1 $ 110 9 6 (3) (1) 121 $ 102 9 6 (6) (1) 110 $(121) $(110) $ Ì (121) $ 17 (3) 14 $ $ Ì (84) $ Ì Ì $ Ì (1) These amounts represent a reduction to AOCI. The amount included in AOCI, net of taxes, arising from a change in the minimum pension liability was a loss of $2 million for the year ended December 31, 2006, and a gain of $7 million for the year ended December 31, 2005. The accumulated beneÑt obligation for all deÑned beneÑt pension plans was $362 million and $316 million at September 30, 2006 and 2005, respectively. The accumulated beneÑt obligation represents the actuarial present value of future expected beneÑts attributed to employee service rendered before the measurement date and based on employee service and compensation prior to that date. 140 Freddie Mac Table 15.2 provides additional information for our deÑned beneÑt pension plans. The aggregate accumulated beneÑt obligation and fair value of plan assets are disclosed as of September 30, 2006, with the projected beneÑt obligation included for illustrative purposes. Table 15.2 Ì Additional Information for DeÑned BeneÑt Pension Plans Projected beneÑt obligation ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Fair value of plan assets ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Accumulated beneÑt obligationÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Fair value of plan assets over (under) accumulated beneÑt obligation ÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Pension Plan $458 $501 329 $172 2006 SERP $ 46 Pension Plan Total (in millions) $504 $416 33 $ Ì $501 362 $(33) $139 $333 288 $ 45 2005 SERP Total $ 41 $457 28 $ Ì $333 316 $(28) $ 17 The measurement of our beneÑt obligations includes assumptions about the rate of future compensation increases included in Table 15.3 below. For the 2006 and 2005 plan years for our deÑned beneÑt pension plans, we reÑned our assumptions related to the rate of future compensation increase used to determine our beneÑt obligations to include assumptions that designate diÅerent compensation rate increases for participants based on their age. Table 15.3 Ì Weighted Average Assumptions Used to Determine Projected and Accumulated BeneÑt Obligations Pension BeneÑts September 30, 2006 2005 Postretirement Health BeneÑts September 30, 2005 2006 Discount rateÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Rate of future compensation increase ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 6.00% 5.10% to 6.50% 5.75% 5.10% to 6.50% 6.00% 5.75% Ì Ì Table 15.4 presents the components of the net periodic beneÑt cost with respect to pension and postretirement health care beneÑts for the years ended December 31, 2006, 2005 and 2004. Net periodic beneÑt cost is included in Salaries and employee beneÑts on our consolidated statements of income. Table 15.4 Ì Net Periodic BeneÑt Cost Detail Pension BeneÑts Year Ended December 31, 2005 2006 2004 (in millions) Postretirement Health BeneÑts Year Ended December 31, 2004 2005 2006 Net periodic beneÑt cost detail: Service costÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Interest cost on beneÑt obligation ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Expected return on plan assets ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Recognized net (gain) loss ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Recognized prior service cost (credit)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Net periodic beneÑt cost ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 31 26 (24) 6 Ì $ 39 $ 27 22 (18) 5 1 $ 37 $ 24 20 (16) 7 Ì $ 35 $ 9 6 Ì 2 (1) $16 $ 9 6 Ì 3 (1) $17 $10 6 Ì 5 (1) $20 Table 15.5 presents the changes in AOCI, net of taxes, related to our deÑned beneÑt plans recorded to AOCI throughout the year, after the eÅects of our statutory tax rate of 35 percent. Table 15.5 Ì AOCI, Net of Taxes, Related to DeÑned BeneÑt Plans DeÑned beneÑt plans: Minimum pension liability: Balance, at December 31, 2005ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2006 activity(1) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Adjustment to initially apply SFAS 158(2) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ DeÑned beneÑt plans, at December 31, 2006 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Year Ended December 31, 2006 (in millions) $ (1) (2) (84) $(87) (1) Net of tax (beneÑt) of $(1) million for the year ended December 31, 2006. (2) Net of tax (beneÑt) of $(45) million for the year ended December 31, 2006. 141 Freddie Mac Table 15.6 below includes the assumptions used in the measurement of our net periodic beneÑt cost. Table 15.6 Ì Weighted Average Assumptions Used to Determine Net Periodic BeneÑt Cost Pension BeneÑts Year Ended December 31, 2006 2005 2004 Postretirement Health BeneÑts Year Ended December 31, 2004 2005 2006 Discount rateÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Rate of future compensation increase ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 5.10% to 6.50% Expected long-term rate of return on plan assets ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 7.25% 5.75% 5.75% 6.00% 5.75% 5.75% 6.00% 4.50% 4.50% Ì 7.00% 7.00% Ì Ì Ì Ì Ì For the 2006 and 2005 beneÑt obligations, we determined the discount rate using a yield curve consisting of spot interest rates at half-year increments for each of the next 30 years, developed with pricing and yield information from high-quality bonds. The future beneÑt plan cash Öows were then matched to the appropriate spot rates and discounted back to the measurement date. Finally, a single equivalent discount rate was calculated that, when applied to the same cash Öows, results in the same present value of the cash Öows as of the measurement date. For 2004, we used the Moody's Aa Corporate Bond Rate Index as a basis for selecting the discount rate shown above. The expected long-term rate of return on plan assets was estimated using a portfolio return calculator model. The model considered the historical returns and the future expectations of returns for each asset class in our deÑned beneÑt plans in conjunction with our target investment allocation to arrive at the expected rate of return. The assumed health care cost trend rates used in measuring the accumulated postretirement beneÑt obligation as of September 30, 2006 are 10 percent in 2007, gradually declining to an ultimate rate of 5 percent in 2011 and remaining at that level thereafter. Table 15.7 sets forth the eÅect on the accumulated postretirement beneÑt obligation for health care beneÑts as of September 30, 2006, and the eÅect of the service cost and interest cost components of the net periodic postretirement health beneÑt cost that would result from a 1 percent increase or decrease in the assumed health care cost trend rate. Table 15.7 Ì Selected Data Regarding our Retiree Medical Plan One Percent Increase One Percent Decrease (in millions) EÅect on the accumulated postretirement beneÑt obligation for health care beneÑtsÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ EÅect on the service and interest cost components of the net periodic postretirement health beneÑt cost ÏÏÏÏÏÏÏÏÏ $28 4 $(22) (3) Plan Assets Table 15.8 sets forth our Pension Plan asset allocations, based on fair value, at September 30, 2006 and 2005, and target allocation by asset category. Table 15.8 Ì Pension Plan Assets by Category Asset Category Equity securities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Debt securitiesÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Other(1) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Target Allocation 65.0% 35.0 Ì 100.0% Plan Assets at September 30, 2006 2005 49.6% 25.9 24.5 100.0% 55.9% 29.4 14.7 100.0% (1) Consists of cash contributions made on September 29, 2006 and September 30, 2005, respectively, which were not fully invested by September 30th of that year. The Pension Plan's retirement investment committee has Ñduciary responsibility for establishing and overseeing the investment policies and objectives of our Pension Plan. The Pension Plan's retirement investment committee reviews the appropriateness of our Pension Plan's investment strategy on an ongoing basis. Our Pension Plan employs a total return investment approach whereby a diversiÑed blend of equities and Ñxed income investments is used to maximize the long-term return of plan assets for a prudent level of risk. Risk tolerance is established through careful consideration of plan characteristics, such as business and Ñnancial characteristics, demographics, and actuarial and company funding policies. Furthermore, equity investments are diversiÑed across U.S. and non-U.S. listed companies with small and large capitalizations. Derivatives may be used to gain market exposure in an eÇcient and timely manner; however, derivatives may not be used to leverage the portfolio beyond the market value of the underlying investments. Investment risk is measured 142 Freddie Mac and monitored on an ongoing basis through quarterly investment portfolio reviews, annual liability measurements and periodic asset and liability studies. Our Pension Plan assets did not include any direct ownership of our securities at September 30, 2006 and 2005. Cash Flows Related to DeÑned BeneÑt Plans Our general practice is to contribute to our Pension Plan an amount equal to at least the minimum required contribution, if any, but no more than the maximum amount deductible for federal income tax purposes each year. During 2006, we made two contributions totaling $143 million to our Pension Plan compared to one contribution totaling $48 million during 2005. The increase in contributions made to our Pension Plan was in response to the increase in tax- deductible contributions allowed under the Pension Protection Act passed in August 2006. We have not yet determined whether a contribution to our Pension Plan is required for 2007. In addition to the Pension Plan contributions noted above, we paid $3 million during 2006 and $1 million during 2005 in beneÑts under our SERP. Allocations under our SERP, as well as our Retiree Health Plan, are in the form of beneÑt payments, as these plans are required to be unfunded. Table 15.9 sets forth estimated future beneÑt payments expected to be paid for our deÑned beneÑt plans. The expected beneÑts are based on the same assumptions used to measure our beneÑt obligation at September 30, 2006. Table 15.9 Ì Estimated Future BeneÑt Payments Pension BeneÑts Postretirement Health BeneÑts (in millions) 2007 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2008 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2009 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2010 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2011 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Years 2012-2016ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 7 8 9 11 12 108 $ 2 2 2 3 3 25 DeÑned Contribution Plans Our Thrift/401(k) Savings Plan, or Savings Plan, is a tax-qualiÑed deÑned contribution pension plan oÅered to all eligible employees. Employees are permitted to contribute from 1 percent to 25 percent of their eligible compensation to the Savings Plan, subject to limits set by the Internal Revenue Code. We match employees' contributions up to 6 percent of their eligible compensation per pay period; the percentage matched depends upon the employee's length of service. Employee contributions and our matching contributions are immediately vested. We also have discretionary authority to make additional contributions to our Savings Plan that are allocated to each eligible employee, based on the employee's eligible compensation. Employees become vested in our discretionary contributions after 5 years of service. In addition to our Savings Plan, we maintain a non-qualiÑed deÑned contribution plan for our oÇcers, designed to make up for beneÑts lost due to limitations on eligible compensation imposed by the Internal Revenue Code and to make up for deferrals of eligible compensation under our Executive Deferred Compensation Plan. We incurred costs of $34 million, $31 million and $29 million for the years ended December 31, 2006, 2005 and 2004, respectively, related to these plans. These expenses were included in Salaries and employee beneÑts on our consolidated statements of income. Executive Deferred Compensation Plan Our Executive Deferred Compensation Plan is an unfunded, non-qualiÑed plan that allows certain key employees to elect to defer substantially all or a portion of their annual salary and cash bonus, and certain key management employees to defer the settlement of restricted stock units received from us, as well as substantially all or a portion of their annual salary and cash bonus, for any number of years speciÑed by the employee, but under no circumstances may the period elected exceed his or her life expectancy. During 2005, we amended the plan to modify certain provisions to address Internal Revenue Code Section 409A as a result of the issuance of proposed regulations and other guidance. Distributions are paid from our general assets. We record a liability equal to the accumulated deferred salary, cash bonus and accrued interest as set forth in the plan, net of any related distributions made to plan participants. We recognize expense equal to the interest accrued on deferred salary and bonus throughout the year. Expense associated with unvested deferred restricted stock units is recognized as part of stock-based compensation. NOTE 16: FAIR VALUE DISCLOSURES The supplemental consolidated fair value balance sheets in Table 16.1 present our estimates of the fair value of our recorded Ñnancial assets and liabilities and oÅ-balance sheet Ñnancial instruments at December 31, 2006 and 2005. Our consolidated fair value balance sheets include the estimated fair values of Ñnancial instruments recorded on our consolidated balance sheets prepared in accordance with GAAP, as well as oÅ-balance sheet Ñnancial instruments that 143 Freddie Mac represent our assets or liabilities that are not recorded on our GAAP consolidated balance sheets. These oÅ-balance sheet items predominantly consist of: (a) the unrecognized Guarantee asset and Guarantee obligation associated with our PCs issued through our Guarantor Swap program prior to the implementation of FIN 45, (b) certain commitments to purchase mortgage loans and (c) certain credit enhancements on manufactured housing asset-backed securities. The fair value balance sheets also include certain assets and liabilities that are not Ñnancial instruments (such as property and equipment and real estate owned, which are included in Other assets) at their carrying value in accordance with GAAP. The valuations of Ñnancial instruments on our consolidated fair value balance sheets are in accordance with GAAP fair value guidelines prescribed by SFAS No. 107, ""Disclosures about Fair Value of Financial Instruments,'' and other relevant pronouncements. Table 16.1 Ì Consolidated Fair Value Balance Sheets(1) December 31, 2006 2005 Carrying Amount(2) Fair Value Carrying Amount(2) Fair Value (in billions) Assets Mortgage loans ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Mortgage-related securities excluding PC residuals ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ PC residuals ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Retained portfolio ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Cash and cash equivalentsÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Investments ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Securities purchased under agreements to resell and Federal funds soldÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Derivative assets ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Guarantee asset(3)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Other assets(4) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total assets ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Liabilities and minority interests Total debt securities, net ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Guarantee obligation ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Derivative liabilities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Reserve for guarantee losses on PCs ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Other liabilities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Minority interests in consolidated subsidiaries ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total liabilities and minority interests ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Net assets attributable to stockholders Preferred stockholders ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Common stockholders ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total net assets ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total liabilities and net assets ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 65.6 634.3 0.6 700.5 11.4 45.6 23.0 7.9 6.1 18.6 $813.1 $753.9 7.1 0.2 0.4 22.7 0.5 784.8 6.1 22.2 28.3 $813.1 $ 65.4 634.3 0.6 700.3 11.4 45.6 23.0 7.9 6.4 16.7 $811.3 $752.3 4.7 0.2 Ì 21.8 0.5 779.5 5.8 26.0 31.8 $811.3 $ 61.4 647.4 0.6 709.4 10.5 42.2 15.2 7.1 5.1 16.7 $806.2 $748.8 5.5 0.6 0.3 22.9 0.9 779.0 4.6 22.6 27.2 $806.2 $ 62.3 647.4 0.6 710.3 10.5 42.2 15.2 7.1 5.6 14.3 $805.2 $747.0 3.7 0.6 Ì 22.0 1.0 774.3 4.1 26.8 30.9 $805.2 (1) The consolidated fair value balance sheets do not purport to present our net realizable, liquidation or market value as a whole. Furthermore, amounts we ultimately realize from the disposition of assets or settlement of liabilities may vary signiÑcantly from the fair values presented. (2) Carrying amounts equal the amounts reported on our GAAP consolidated balance sheets. (3) The fair value of the Guarantee asset reported exceeds the carrying value primarily because the fair value includes the Guarantee asset related to some PCs held by third parties that are not recognized on our GAAP consolidated balance sheets because such PCs were issued prior to the implementation of FIN 45 in 2003. (4) Fair values include estimated income taxes calculated using the 35 percent statutory rate on the diÅerence between the consolidated fair value balance sheets net assets, including deferred taxes from our GAAP consolidated balance sheets, and the GAAP consolidated balance sheets equity attributable to common stockholders. Limitations Our consolidated fair value balance sheets do not capture all elements of value that are implicit in our operations as a going concern because our consolidated fair value balance sheets only capture the values of the current investment and securitization portfolios. For example, our consolidated fair value balance sheets do not capture the value of new investment and securitization business that would likely replace prepayments as they occur. In addition, our consolidated fair value balance sheets do not capture the value associated with future growth opportunities in our investment and securitization portfolios. Thus, the fair value of net assets attributable to stockholders presented on our consolidated fair value balance sheets does not represent an estimate of our net realizable, liquidation or market value as a whole. We report certain assets and liabilities that are not Ñnancial instruments (such as property and equipment and real estate owned), as well as certain Ñnancial instruments that are not covered by the SFAS 107 disclosure requirements (such as pension liabilities) at their carrying amounts in accordance with GAAP on our consolidated fair value balance sheets. We believe these items do not have a signiÑcant impact on our overall fair value results. Other non-Ñnancial assets and liabilities on our GAAP consolidated balance sheets represent deferrals of costs and revenues that are amortized in accordance with GAAP, such as deferred debt issuance costs and deferred credit fees. Cash receipts and payments related to 144 Freddie Mac these items are generally recognized in the fair value of net assets when received or paid, with no basis reÖected on our fair value balance sheets. Valuation Methods and Assumptions Fair value is generally based on independent price quotations obtained from third-party pricing services, dealer marks or direct market observations, where available. However, certain Ñnancial instruments are less actively traded and, therefore, are not always able to be valued based on prices obtained from third parties. If quoted prices or market data are not available, fair value is based on internal valuation models using market data inputs or internally developed assumptions, where appropriate. During 2006 and 2005, our fair value results were impacted by several improvements in our approach for estimating the fair value of certain Ñnancial instruments. In the Ñrst quarter of 2006, we enhanced our approach for estimating the fair value of certain Ñnancial instruments resulting in (a) an increase in the fair value of Total net assets of approximately $0.2 billion (after-tax) related to our guarantee-related assets and liabilities and (b) a net decrease in the fair value of Total net assets of approximately $0.1 billion (after-tax) related to other Ñnancial instruments. In the Ñrst quarter of 2005, we improved our approach for estimating the fair values of certain Ñnancial instruments resulting in (a) a decrease in the fair value of Total net assets of approximately $0.8 billion (after-tax) related to our guarantee-related assets and liabilities and (b) an increase in the fair value of Total net assets of approximately $0.3 billion (after-tax) related to our multifamily whole loans, the minority interests in our consolidated REIT subsidiaries and other Ñnancial instruments. Also, in the second quarter of 2005, we improved our approach for estimating the fair values of certain securities we hold, which increased the fair value of Total net assets by approximately $0.1 billion. The changes in our approach for estimating the fair values of these Ñnancial instruments are described below. The following methods and assumptions were used to estimate the fair value of assets and liabilities at December 31, 2006 and 2005. Mortgage loans Mortgage loans represent single-family and multifamily whole loans held in our Retained portfolio. For GAAP purposes, we must determine the fair value of these mortgage loans to calculate lower-of-cost-or-market adjustments for mortgages classiÑed as held-for-sale. For fair value balance sheet purposes, we used this same approach when determining the fair value of whole loans, including those held-for-investment. We determine the fair value of mortgage loans, excluding delinquent single-family loans purchased out of pools, based on comparisons to actively traded mortgage-related securities with similar characteristics, with adjustments for yield, credit and liquidity diÅerences. SpeciÑcally, we aggregate mortgage loans into pools by product type, coupon and maturity and then convert the pools into notional mortgage-related securities based on their speciÑc characteristics. We then calculate fair values for these notional mortgage-related securities as described below in ""Mortgage-related securities, excluding PC residuals.'' Part of the adjustments for yield, credit and liquidity diÅerences represent an implied guarantee fee. To accomplish this, the fair value of the single-family whole loans, excluding delinquent single-family loans purchased out of pools, includes an adjustment representing the estimated present value of the additional cash Öows on the mortgage coupon in excess of the coupon expected on the notional mortgage-related securities. For multifamily whole loans, the fair value adjustment is estimated by calculating the net present value of guarantee fees we expect to retain. This retained guarantee fee is estimated by subtracting the expected cost of funding and securitizing a multifamily whole loan of a comparable maturity and credit rating from the coupon on the whole loan at the time of purchase. The implied guarantee fee for both single-family and multifamily whole loans is also net of the related credit and other components inherent in our Guarantee obligation. For single-family whole loans, the process for estimating the related credit and other Guarantee obligation components is described in the ""Guarantee obligation'' section. For multifamily whole loans, the related credit and other Guarantee obligation components were estimated by extracting the credit risk premium that multifamily whole loan investors require from market prices on similar securities. This credit risk premium is net of expected funding, liquidity and other risk premiums that are embedded in the market price of the reference securities. Beginning in 2005, we reÑned the fair value estimates of multifamily whole loans by incorporating additional information and guidance from active market participants into the pricing of notional mortgage-related securities. In addition, beginning in 2005, for single-family whole loans that are extremely delinquent and have been purchased out of pools, we obtained dealer indications on aggregated groups of similar loans that reÖect their current performance status. These market price indications reÖect the estimated present value of all cash Öows related to the whole loans, including expected credit losses and recoveries. 145 Freddie Mac Mortgage-related securities, excluding PC residuals Mortgage-related securities represent pass-throughs and other mortgage-related securities classiÑed as available-for-sale and trading, which are already reÖected at fair value on our GAAP consolidated balance sheets. Mortgage-related securities consist of securities issued by us, Fannie Mae and Ginnie Mae, as well as non-agency mortgage-related securities. The fair value of securities with readily available third-party market prices is generally based on market prices obtained from broker/dealers or reliable third-party pricing service providers. Fair value may be estimated by using third-party quotes for similar instruments, adjusted for diÅerences in contractual terms. For other securities, a market option-adjusted spread approach based on observable market parameters is used to estimate fair value. Option-adjusted spreads for certain securities are estimated by deriving the option-adjusted spread for the most closely comparable security with an available market price, using proprietary interest-rate and prepayment models. If necessary, our judgment is applied to estimate the impact of diÅerences in prepayment uncertainty or other unique cash Öow characteristics related to that particular security. Fair values for these securities are then estimated by using the estimated option-adjusted spread as an input to the interest-rate and prepayment models, and estimating the net present value of the projected cash Öows. The remaining instruments are priced using other modeling techniques or by using other securities as proxies. PC residuals PC residuals are reported at fair value on our GAAP consolidated balance sheets. Fair value for PC residuals is estimated in the same manner as described for the Guarantee asset and the Guarantee obligation for PCs below. Cash and cash equivalents Cash and cash equivalents largely consist of highly liquid investment securities with an original maturity of three months or less used for cash management purposes, as well as cash collateral posted by our derivative counterparties. Given that these assets are short-term in nature with limited market value volatility, the carrying amount on our GAAP consolidated balance sheets is deemed to be a reasonable approximation of fair value. Investments At December 31, 2006 and 2005, Investments consists solely of non-mortgage-related securities, which are reported at fair value on our GAAP consolidated balance sheets. The fair values of Investments were estimated using the methods described above in ""Mortgage-related securities, excluding PC residuals.'' Securities purchased under agreements to resell and Federal funds sold Securities purchased under agreements to resell and Federal funds sold principally consists of short-term contractual agreements such as reverse repurchase agreements involving Treasury and agency securities, Federal funds sold and Eurodollar time deposits. Given that these assets are short-term in nature, the carrying amount on our GAAP consolidated balance sheets is deemed to be a reasonable approximation of fair value. Derivative assets Derivative assets, at fair value largely consists of interest-rate swaps, option-based derivatives, futures, and forward purchase and sale commitments that we account for as derivatives, which are reÖected at fair value on our GAAP consolidated balance sheets. The fair values of interest-rate swaps are determined by using the appropriate yield curves to calculate and discount the expected cash Öows for both the Ñxed-rate and variable-rate components of the swap contracts. Option-based derivatives, which principally include call and put swaptions, are valued using an option-pricing model. This model uses market interest rates and market-implied option volatilities, where available, to calculate the option's fair value. Market-implied option volatilities are based on information obtained from broker/dealers. The fair value of exchange- traded futures is based on end-of-day closing prices obtained from third-party pricing services. Derivative forward purchase and sale commitments are valued using the methods described for mortgage-related securities valuation above. The fair value of derivative assets considers the impact of institutional credit risk in the event that the counterparty does not honor its payment obligation. Our fair value of derivatives is not adjusted for expected credit losses because we obtain collateral from most counterparties typically within one business day of the daily market value calculation and substantially all of our credit risk arises from counterparties with investment-grade credit ratings of A¿ or above. Guarantee asset At December 31, 2006 and 2005, we had a Guarantee asset on our GAAP consolidated balance sheets for approximately 95 percent and 93 percent, respectively, of PCs and Structured Securities held by third parties. For more information regarding the accounting for the Guarantee asset related to PCs and Structured Securities, see ""NOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES.'' 146 Freddie Mac For fair value balance sheet purposes, the Guarantee asset is reÖected for all PCs and Structured Securities held by third parties and is valued using the same method as used for GAAP fair value purposes. For a description of how we determine the fair value of our Guarantee asset, see ""NOTE 2: TRANSFERS OF SECURITIZED INTERESTS IN MORTGAGE-RELATED ASSETS.'' Other assets Other assets consists of accrued interest and other receivables, investments in qualiÑed LIHTC partnerships that are eligible for federal tax credits, credit enhancement contracts related to PCs and Structured Securities (pool insurance and recourse and/or indemniÑcation agreements), Ñnancial guarantee contracts for additional credit enhancements on certain manufactured housing asset-backed securities, REO, property and equipment, and other miscellaneous assets. The receivables are Ñnancial instruments and are required to be measured at fair value for disclosure purposes pursuant to SFAS 107. Because these receivables are short-term in nature, we believe the carrying amount on our GAAP consolidated balance sheets is a reasonable approximation of their fair values. Our investments in LIHTC partnerships, reported as consolidated entities or equity method investments in the GAAP Ñnancial statements, are not within the scope of SFAS 107 disclosure requirements. However, we present the fair value of these investments in Other assets. For the LIHTC partnerships, the fair value of expected tax beneÑts is estimated using expected cash Öows discounted at a market- based yield. For the credit enhancement contracts related to PCs and Structured Securities (pool insurance and recourse and/or indemniÑcation agreements), fair value is estimated using an expected cash Öow approach, and is intended to reÖect the estimated amount that a third party would be willing to pay for the contracts. On our consolidated fair value balance sheets, these contracts are reported at fair value at each balance sheet date based on current market conditions. On our GAAP consolidated balance sheets, these contracts are initially recorded at fair value at inception, then amortized to expense. For the credit enhancements on manufactured housing asset-backed securities, the fair value is based on the diÅerence between the market price of non-credit-impaired manufactured housing securities and credit-impaired manufactured housing securities that are likely to produce future credit losses, as adjusted for our estimate of a risk premium attributable to the Ñnancial guarantee contracts. The value of the contracts, over time, will be determined by the actual credit-related losses incurred and, therefore, may have a value that is higher or lower than our market-based estimate. On our GAAP consolidated Ñnancial statements, these contracts are recognized as realized. The other categories of assets that comprise Other assets are not Ñnancial instruments required to be valued at fair value under SFAS 107, such as REO and property and equipment. For the majority of these non-Ñnancial assets in Other assets, we use the carrying amounts from our GAAP consolidated balance sheets as the reported values on our consolidated fair value balance sheets, without any adjustment. These assets represent an insigniÑcant portion of our GAAP consolidated balance sheets, and any change in their fair value would not be a meaningful part of our fair value of net assets business results. Certain non-Ñnancial assets in Other assets on our GAAP consolidated balance sheets are assigned a zero value on our consolidated fair value balance sheets. This treatment is applied to deferred items such as deferred debt issuance costs. We adjust the GAAP-basis deferred taxes reÖected on our consolidated fair value balance sheets to include estimated income taxes on the diÅerence between our consolidated fair value balance sheets net assets, including deferred taxes from our GAAP consolidated balance sheets, and our GAAP consolidated balance sheets equity attributable to common stockholders. To the extent the adjusted deferred taxes are a net asset, this amount is included in Other assets. If the adjusted deferred taxes are a net liability, this amount is included in Other liabilities. Total debt securities, net Total debt securities, net represents short-term and long-term debt used to Ñnance our assets and, on our consolidated GAAP balance sheets, debt securities are reported at amortized cost, which is net of deferred items, including premiums, discounts and hedging-related basis adjustments. This item includes both non-callable and callable debt as well as short- term zero-coupon discount notes. The fair value of the short-term zero-coupon discount notes is based on a discounted cash Öow model with market inputs. The valuation of other debt securities is generally based on market prices obtained from broker/dealers, reliable third-party pricing service providers or direct market observations. Guarantee obligation We did not establish a Guarantee obligation for GAAP purposes for PCs and Structured Securities held by third parties that were issued through our Guarantor Swap program prior to adoption of FIN 45. In addition, after it is initially recorded at fair value the Guarantee obligation is not subsequently carried at fair value for GAAP purposes. On our consolidated fair value balance sheets, the Guarantee obligation reÖects the fair value of our Guarantee obligation on all PCs held by third parties. Additionally, for fair value balance sheet purposes, the Guarantee obligation is valued using the same method as used for GAAP to determine its initial fair value. Because Guarantee asset, Guarantee obligation and credit enhancement-related 147 Freddie Mac assets that are recognized at the inception of an executed Guarantor Swap are valued independently of each other, net diÅerences between these recognized assets and liabilities may exist at inception. If the amount of the Guarantee asset plus the credit enhancement-related assets is greater than the amount of the Guarantee obligation, the diÅerence between such amounts is deferred on our GAAP consolidated balance sheets as a component of the Guarantee obligation. This component of the Guarantee obligation is not recorded on the consolidated fair value balance sheets. The diÅerence between the fair value and carrying value of the Guarantee obligation shown in Table 16.1 reÖects the diÅerent basis of accounting for this liability. For example, the fair value of the Guarantee obligation does not include the unamortized balance of deferred guarantee income that is a component of its carrying value on the GAAP consolidated balance sheets. For information concerning our valuation approach and accounting policies related to guarantee-related credit losses, see ""NOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES,'' and ""NOTE 2: TRANSFERS OF SECURITIZED INTERESTS IN MORTGAGE-RELATED ASSETS.'' Derivative liabilities See discussion under ""Derivative assets'' above. Reserve for guarantee losses on PCs The carrying amount of the Reserve for guarantee losses on PCs on our GAAP consolidated balance sheets represents loan loss reserves for oÅ-balance sheet PCs in accordance with GAAP that are not already accounted for under SFAS 140. This line item has no basis on our consolidated fair value balance sheets, because the estimated fair value of all expected default losses is included in the Guarantee obligation reported on our consolidated fair value balance sheets. Other liabilities Other liabilities principally consists of amounts due to PC investors (i.e., principal and interest), funding liabilities associated with investments in LIHTC partnerships, accrued interest payable on debt securities and other miscellaneous obligations of less than one year. We believe the carrying amount of these liabilities is a reasonable approximation of their fair value, except for funding liabilities associated with investments in LIHTC partnerships, for which fair value is estimated using expected cash Öows discounted at a market-based yield. Furthermore, certain deferred items reported as Other liabilities on our GAAP consolidated balance sheets are assigned zero value on our consolidated fair value balance sheets, such as deferred credit fees. Also, as discussed in ""Other assets,'' Other liabilities may include a deferred tax liability adjusted for fair value balance sheet purposes. Minority interests in consolidated subsidiaries Minority interests in consolidated subsidiaries primarily represent preferred stock interests that third parties hold in our two majority-owned REIT subsidiaries. In accordance with GAAP, we consolidated the REITs. The preferred stock interests are not within the scope of SFAS 107 disclosure requirements. However, we present the fair value of these interests on our consolidated fair value balance sheets. The fair value of the third-party minority interests in these REITs was based on the estimated value of the underlying REIT preferred stock we determined based on a valuation model. In 2005, we improved our fair value estimates to reÖect observed market activity. Net assets attributable to preferred stockholders To determine the preferred stock fair value, we use a market-based approach incorporating quoted dealer prices. Net assets attributable to common stockholders Net assets attributable to common stockholders is equal to the diÅerence between the fair value of total assets and the sum of total liabilities and minority interests reported on our consolidated fair value balance sheets, less the fair value of net assets attributable to preferred stockholders. 148 Freddie Mac NOTE 17: CONCENTRATION OF CREDIT AND OTHER RISKS Mortgages and Mortgage-Related Securities Table 17.1 summarizes the geographical concentration of mortgages and mortgage-related securities that are held by us or that are collateral for PCs and Structured Securities, excluding: ‚ $1,510 million and $2,021 million of mortgage-related securities issued by Ginnie Mae that back Structured Securities at December 31, 2006 and 2005, respectively, because these securities do not expose us to meaningful amounts of credit risk; ‚ $45,385 million and $44,626 million of agency mortgage-related securities at December 31, 2006 and 2005, respectively, because these securities do not expose us to meaningful amounts of credit risk; and ‚ $238,465 million and $242,915 million of non-agency mortgage-related securities held in the Retained portfolio at December 31, 2006 and 2005, respectively, because geographic information regarding these securities is not available. With respect to these securities, we look to third party credit enhancements (e.g., bond insurance) or other credit enhancements resulting from the securitization structure supporting such securities (e.g., subordination levels) as a primary means of managing credit risk. See ""NOTE 5: RETAINED PORTFOLIO AND CASH AND INVESTMENTS PORTFOLIO'' for more information about the securities we hold. Table 17.1 Ì Concentration of Credit Risk December 31, 2006 2005 Amount(1) Percentage Amount(2) Percentage (dollars in millions) By Region(3) Northeast ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 375,844 366,492 West ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 324,255 North Central ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 279,984 Southeast ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 194,785 Southwest ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $1,541,360 By State California ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 195,964 101,901 Florida ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 80,130 IllinoisÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 77,614 New York ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 1,085,751 All Others ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $1,541,360 24% 24 21 18 13 100% 13% 7 5 5 70 100% $ 340,821 327,029 304,288 247,484 175,362 $1,394,984 $ 182,267 86,916 72,952 71,961 980,888 $1,394,984 24% 23 22 18 13 100% 13% 6 5 5 71 100% (1) Calculated as Total mortgage portfolio less Structured Securities backed by Ginnie Mae CertiÑcates and agency and non-agency mortgage-related securities held in the Retained portfolio. (2) 2005 data has been revised to conform to the current year presentation. (3) Region Designation: West (AK, AZ, CA, GU, HI, ID, MT, NV, OR, UT, WA); Northeast (CT, DE, DC, MA, ME, MD, NH, NJ, NY, PA, RI, VT, VA, WV); North Central (IL, IN, IA, MI, MN, ND, OH, SD, WI); Southeast (AL, FL, GA, KY, MS, NC, PR, SC, TN, VI); Southwest (AR, CO, KS, LA, MO, NE, NM, OK, TX, WY). Mortgage Lenders and Insurers A signiÑcant portion of our single-family mortgage purchase volume is generated from several key mortgage lenders that have entered into business arrangements with us. These arrangements generally involve a lender's commitment to sell a high proportion of its conforming mortgage origination volume to us. During 2006, three mortgage lenders each accounted for 10 percent or more of our mortgage purchase volume. These lenders collectively accounted for approximately 51 percent of this volume. In addition, in 2006, our top ten lenders represented approximately 76 percent of our mortgage purchase volume. These top lenders are among the largest mortgage loan originators in the U.S. We are exposed to the risk that we could lose purchase volume to the extent these arrangements are terminated or modiÑed without replacement from other lenders. We have institutional credit risk relating to the potential insolvency or non-performance of mortgage insurers that insure mortgages we purchase or guarantee. Approximately 99 percent of all mortgage insurers providing primary mortgage insurance and pool insurance coverage on single-family mortgages we purchased during 2006 were rated ""AA'' or better by S&P. Excluding insurers of our non-agency mortgage-related securities portfolio at December 31, 2006, there were seven mortgage insurers that each provided more than 7 percent of our total mortgage insurance coverage (including primary mortgage insurance and pool insurance) and together accounted for approximately 99 percent of our overall coverage. In February 2007, two of these mortgage insurance companies announced an agreement to merge, with one acquiring the other. 149 Freddie Mac At December 31, 2006, these two companies together represented approximately 52 percent of our total mortgage insurance coverage. Derivative Portfolio On an ongoing basis, we review the credit fundamentals of all of our derivative counterparties to conÑrm that they continue to meet our internal standards. We assign internal ratings, credit capital and exposure limits to each counterparty based on quantitative and qualitative analysis, which we update and monitor on a regular basis. We conduct additional reviews when market conditions dictate or events aÅecting an individual counterparty occur. Derivative Counterparties. Our use of derivatives exposes us to counterparty credit risk, which arises from the possibility that the derivative counterparty will not be able to meet its contractual obligations. Exchange-traded derivatives, such as futures contracts, do not measurably increase our counterparty credit risk because changes in the value of open exchange-traded contracts are settled daily through a Ñnancial clearinghouse established by each exchange. Over-the- counter, or OTC, derivatives, however, expose us to counterparty credit risk because transactions are executed and settled between us and the counterparty. Our use of OTC interest-rate swaps, option-based derivatives and foreign-currency swaps is subject to rigorous internal credit and legal reviews. Our derivative counterparties carry external credit ratings among the highest available from major rating agencies. All of these counterparties are major Ñnancial institutions and are experienced participants in the OTC derivatives market. Master Netting and Collateral Agreements. We use master netting and collateral agreements to reduce our credit risk exposure to our active OTC derivative counterparties for interest-rate swaps, option-based derivatives and foreign-currency swaps. Master netting agreements provide for the netting of amounts receivable and payable from an individual counterparty, which reduces our exposure to a single counterparty in the event of default. On a daily basis, the market value of each counterparty's derivatives outstanding is calculated to determine the amount of our net credit exposure, which is equal to derivatives in a net gain position by counterparty after giving consideration to collateral posted. Our collateral agreements require most counterparties to post collateral for the amount of our net exposure to them above the applicable threshold. Bilateral collateral agreements are in place for the majority of our counterparties. Collateral posting thresholds are tied to a counterparty's credit rating. Derivative exposures and collateral amounts are monitored on a daily basis using both internal pricing models and dealer price quotes. Collateral is typically transferred within one business day based on the values of the related derivatives. This time lag in posting collateral can aÅect our net uncollateralized exposure to derivative counterparties. Collateral posted by a derivative counterparty is typically in the form of cash, U.S. Treasury securities, our PCs and Structured Securities or our debt securities. In the event a counterparty defaults on its obligations under the derivatives agreement and the default is not remedied in the manner prescribed in the agreement, we have the right under the agreement to direct the custodian bank to transfer the collateral to us or, in the case of non-cash collateral, to sale the collateral and transfer the proceeds to us. Our uncollateralized exposure to counterparties for OTC interest-rate swaps, option-based derivatives and foreign- currency swaps, after applying netting agreements and collateral, was $672 million and $190 million at December 31, 2006 and 2005, respectively. In the event that all of our counterparties for these derivatives were to have defaulted simultaneously on December 31, 2006, our maximum loss for accounting purposes would have been approximately $672 million. Our exposure to counterparties for OTC forward purchase and sale commitments treated as derivatives was $24 million and $35 million at December 31, 2006 and 2005, respectively. Because the typical maturity for our OTC commitments is less than one year, we do not require master netting and collateral agreements for the counterparties of these commitments. Therefore, the exposure to our OTC commitments counterparties is uncollateralized. Similar to counterparties for our OTC interest-rate swaps, option-based derivatives and foreign-currency swaps, we monitor the credit fundamentals of our OTC commitments counterparties on an ongoing basis to ensure that they continue to meet our internal risk-management standards. NOTE 18: MINORITY INTERESTS The equity and net earnings attributable to the minority stockholder interests in consolidated subsidiaries are reported on our consolidated balance sheets as Minority interests in consolidated subsidiaries and on our consolidated statements of income as Minority interests in earnings of consolidated subsidiaries. The majority of the balances in these accounts relate to our two majority-owned REITs. In February 1997, we formed two majority-owned REIT subsidiaries funded through the issuance of common stock (99.9 percent of which is held by us) and a total of $4.0 billion of perpetual, step-down preferred stock issued to outside investors. The dividend rate on the step-down preferred stock was 13.3 percent from initial issuance through December 2006 (the initial term). Beginning in 2007, the dividend rate will step-down to 1.0 percent. Dividends on this preferred stock 150 Freddie Mac accrue in arrears. The balance of the two step-down preferred stock issuances as recorded within Minority interests in consolidated subsidiaries on our consolidated balance sheets totaled $503 million and $934 million at December 31, 2006 and 2005, respectively. On November 10, 2005, we oÅered to purchase for cash any and all of the outstanding shares of the outstanding step- down preferred stock, of which $142 million was purchased between the oÅer date and December 31, 2005. During 2006, we purchased an additional $27 million of the preferred stock. The preferred stock continues to be redeemable by the REITs under certain circumstances described in the preferred stock oÅering documents as a ""tax event redemption.'' NOTE 19: EARNINGS PER COMMON SHARE Because we have participating securities, we use the ""two-class'' method of computing earnings per share. Basic earnings per common share are computed by dividing Net income available to common stockholders by Weighted average common shares outstanding-basic for the period. Diluted earnings per common share are computed as Net income available to common stockholders divided by Weighted average common shares outstanding-diluted for the period, which consider the eÅect of dilutive common equivalent shares outstanding. The eÅect of dilutive common equivalent shares outstanding includes: (a) the weighted average shares related to stock options (including the ESPP) that have an exercise price lower than the average market price during the period; (b) the weighted average of non-vested restricted shares; and (c) all restricted stock units. Such items are excluded from Weighted average common shares outstanding Ì basic. See ""NOTE 11: STOCK-BASED COMPENSATION'' for additional information. For the years ended December 31, 2006, 2005 and 2004, there were approximately 1,808,000, 1,929,000 and 2,239,000 of dilutive common equivalent shares outstanding that could potentially dilute earnings per common share. Options to purchase 1.9 million, 2.3 million and 2.4 million shares of common stock were excluded from the computation of Diluted earnings per common share at December 31, 2006, 2005 and 2004, respectively, because the options' exercise price exceeded the average market price of the common stock for the years ended December 31, 2006, 2005 and 2004, respectively. END OF CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA 151 Freddie Mac PROPERTIES We own a 75 percent interest in a limited partnership that owns our principal oÇces, consisting of four oÇce buildings in McLean, Virginia, that comprise approximately 1.3 million square feet. We occupy this headquarters complex under a long-term lease from the partnership. LEGAL PROCEEDINGS We are involved as a party to a variety of legal proceedings arising from time to time in the ordinary course of business including, among other things, contractual disputes, personal injury claims, employment-related litigation and other legal proceedings incidental to our business. Furthermore, we are frequently involved, directly or indirectly, in litigation involving mortgage foreclosures. We also are involved in proceedings arising from our termination of a seller/servicer's eligibility to sell mortgages to, and service mortgages for, us. In these cases, the former seller/servicer sometimes seeks damages against us for wrongful termination under a variety of legal theories. In addition, we are sometimes sued in connection with the origination or servicing of mortgages. These suits generally involve claims alleging wrongful actions of seller/servicers. Our contracts with our seller/ servicers generally provide for them to indemnify us against liability arising from their wrongful actions. We are also subject to various legal proceedings, including regulatory investigations and administrative and civil litigation, arising from the restatement of our 2002 and prior consolidated Ñnancial statements. In addition, we have been named in multiple lawsuits alleging violations of federal and state antitrust laws and state consumer protection laws in connection with the setting of our guarantee fees. Litigation and claims resolution are subject to many uncertainties and are not susceptible to accurate prediction. For additional information on our legal proceedings, see ""NOTE 13: LEGAL CONTINGENCIES'' and ""NOTE 14: INCOME TAXES'' to our consolidated Ñnancial statements. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS The following matters were presented for stockholder vote at our annual meeting of stockholders held on September 8, 2006: (a) election of 13 members to our board of directors, each for a term ending on the date of our next annual meeting of stockholders; (b) ratiÑcation of the appointment of PricewaterhouseCoopers LLP as our independent auditors for 2006; and (c) a stockholder proposal concerning charitable contributions. As shown in Table 53 below, the following persons were elected to our board of directors at the meeting by the respective votes indicated: Table 53 Ì Election of Directors Votes For Votes Withheld Barbara T. Alexander ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 596,345,274 GeoÅrey T. Boisi ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 598,396,467 Michelle Engler ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 598,900,945 Robert R. GlauberÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 599,045,153 Richard Karl Goeltz ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 599,036,707 Thomas S. Johnson ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 565,811,704 William M. Lewis, Jr.ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 598,961,629 Eugene M. McQuade ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 599,202,215 Shaun F. O'Malley ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 575,195,153 JeÅrey M. Peek ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 598,987,195 Ronald F. Poe ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 594,482,272 Stephen A. Ross ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 575,283,117 Richard F. Syron ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 594,431,345 7,932,999 5,881,806 5,377,328 5,233,120 5,241,566 38,466,569 5,316,644 5,076,058 29,083,120 5,291,078 9,796,001 28,995,156 9,846,928 The appointment of PricewaterhouseCoopers LLP was ratiÑed at the meeting by the following votes: Votes for 596,289,143 Votes Against 4,496,273 Abstentions 3,492,857 The stockholder proposal concerning charitable contributions was not adopted and received the following votes: Votes for 24,166,819 Votes Against 439,759,549 Abstentions 49,290,127 Broker Non-Votes 91,061,778 CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None. See ""MD&A Ì RISK MANAGEMENT Ì Operational Risks Ì Internal Control Over Financial Reporting'' for a description of our material weaknesses and other control deÑciencies. CONTROLS AND PROCEDURES 152 Freddie Mac DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE Our Board of Directors (as of March 15, 2007)(1) William M. Lewis, Jr.C, E Managing Director and Co-Chairman of Investment Banking Lazard Ltd. An investment banking company New York, New York Eugene M. McQuade President and Chief Operating OÇcer Freddie Mac McLean, Virginia Shaun F. O'Malley (Lead Director)A, B, D Chairman Emeritus Price Waterhouse LLP An accounting and consulting Ñrm Philadelphia, Pennsylvania JeÅrey M. PeekC, E Chairman and Chief Executive OÇcer CIT Group, Inc. A global commercial and consumer Ñnance company New York, New York Ronald F. PoeB, D, E President Ronald F. Poe & Associates A private real estate investment Ñrm White Plains, New York Stephen A. RossA, C, D Franco Modigliani Professor of Financial Economics Massachusetts Institute of Technology Cambridge, Massachusetts Richard F. Syron Chairman and Chief Executive OÇcer Freddie Mac McLean, Virginia Barbara T. AlexanderC, E Independent Consultant Monarch Beach, California GeoÅrey T. BoisiB, D, E Chairman and Senior Partner Roundtable Investment Partners LLC A private investment management Ñrm New York, New York Michelle EnglerB, E Trustee JNL Investor Series Trust and JNL Series Trust and Member of Board of Managers JNL/NY Variable Funds Each an investment company Lansing, Michigan Robert R. GlauberA, C Retired Chairman and Chief Executive OÇcer National Association of Securities Dealers, Inc. A private-sector regulator of the securities industry Washington, District of Columbia Richard Karl GoeltzA, C, D Retired Vice Chairman and Chief Financial OÇcer American Express Company A Ñnancial services company New York, New York Thomas S. JohnsonA, B Retired Chairman and Chief Executive OÇcer GreenPoint Financial Corporation A Ñnancial services company New York, New York Committees A Audit B Compensation and Human Resources C Finance and Capital Deployment D Governance, Nominating and Risk Oversight E Mission, Sourcing and Technology (1) Our enabling legislation establishes the membership of the board of directors at 18 directors: 13 directors elected by the stockholders and 5 directors appointed by the President of the United States. Prior to our March 31, 2004 Annual Meeting, the OÇce of Counsel to the President informed us that the President did not intend to reappoint any of his then-current presidential appointees. Consequently, each of their terms as presidential appointees ended on the date of that annual meeting. No new appointees have been named by the President as of March 15, 2007. Additional information regarding our directors and executive oÇcers is set forth in our proxy statement for our annual meeting of stockholders to be held on June 8, 2007, and is incorporated herein by reference. Additional information concerning our Audit Committee may be found in our proxy statement. We also provide information regarding beneÑcial ownership reporting compliance in our proxy statement, incorporated herein by reference. We have adopted a Code of Conduct for employees which is available on our website at www.freddiemac.com. Printed copies of the Code of Conduct may be obtained free of charge upon request from our Investor Relations department. We intend to disclose any amendments to, or waivers from, the employee Code of Conduct on behalf of the chief executive oÇcer, chief Ñnancial oÇcer, controller and persons performing similar functions on our website. 153 Freddie Mac EXECUTIVE COMPENSATION Information regarding executive compensation is set forth in our proxy statement and is incorporated by reference into this Information Statement. Information regarding compensation of our board of directors and information concerning members of the Compensation and Human Resources Committee is set forth in our proxy statement and is incorporated here by reference. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS Securities Authorized for Issuance under Equity Compensation Plans Information about our common stock that may be issued upon the exercise of options, warrants and rights under our existing equity compensation plans at December 31, 2006 is set forth in our proxy statement and is incorporated here by reference. Security Ownership of Management Information regarding the beneÑcial ownership of our common stock by each of our directors, each director nominee, certain executive oÇcers and by all directors and executive oÇcers as a group is set forth in our proxy statement and is incorporated here by reference. Security Ownership of Certain BeneÑcial Owners Information regarding the beneÑcial ownership of our common stock by certain beneÑcial owners is set forth in our proxy statement and is incorporated here by reference. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS AND DIRECTOR INDEPENDENCE Information regarding director independence, certain relationships and related transactions is set forth in our proxy statement and is incorporated here by reference. PRINCIPAL ACCOUNTANT FEES AND SERVICES Information regarding principal accountant fees and services is set forth in our proxy statement and is incorporated here by reference. 154 Freddie Mac I, Richard F. Syron, certify that: 1. I have reviewed this Information Statement of Freddie Mac; CERTIFICATION* 2. Based on my knowledge, this Information Statement does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this Information Statement; and 3. Based on my knowledge, the consolidated Ñnancial statements, and other Ñnancial information included in this Information Statement, fairly present in all material respects the Ñnancial condition, results of operations and cash Öows of Freddie Mac as of, and for, the periods presented in this Information Statement. Date: March 23, 2007 Richard F. Syron Chairman and Chief Executive OÇcer I, Anthony S. Piszel, certify that: 1. I have reviewed this Information Statement of Freddie Mac; CERTIFICATION* 2. Based on my knowledge, this Information Statement does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this Information Statement; and 3. Based on my knowledge, the consolidated Ñnancial statements, and other Ñnancial information included in this Information Statement, fairly present in all material respects the Ñnancial condition, results of operations and cash Öows of Freddie Mac as of, and for, the periods presented in this Information Statement. Date: March 23, 2007 Anthony S. Piszel Executive Vice President and Chief Financial OÇcer * For a discussion of our progress with respect to our internal control over Ñnancial reporting and disclosure controls and procedures, see ""MD&A Ì RISK MANAGEMENT Ì Operational Risks Ì Internal Control Over Financial Reporting.'' 155 Freddie Mac RATIO OF EARNINGS TO FIXED CHARGES Year Ended December 31, 2006 2005 2004 2003 2002 (dollars in millions) Net income before cumulative eÅect of changes in accounting principlesÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 2,211 $ 2,189 $ 2,937 Add: $ 4,816 $10,090 Income tax expense (beneÑt) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Minority interests in earnings of consolidated subsidiariesÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total interest expenseÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Interest factor in rental expenses ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Capitalized interestÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 790 129 26,566 6 1 Earnings, as adjusted ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $39,437 $32,557 $30,429 (108) 58 37,270 6 Ì 367 96 29,899 6 Ì Fixed charges: Total interest expenseÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $37,270 $29,899 $26,566 6 Interest factor in rental expenses ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 1 Capitalized interestÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total Ñxed charges ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $37,276 $29,905 $26,573 Ratio of earnings to Ñxed charges(1)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 6 Ì 6 Ì 1.09 1.06 1.15 2,202 157 26,509 5 Ì $33,689 $26,509 5 Ì $26,514 4,713 184 26,876 5 1 $41,869 $26,876 5 1 $26,882 1.27 1.56 (1) Ratio of earnings to Ñxed charges is computed by dividing Earnings, as adjusted by Total Ñxed charges. RATIO OF EARNINGS TO COMBINED FIXED CHARGES AND PREFERRED STOCK DIVIDENDS Net income before cumulative eÅect of changes in accounting principlesÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 2,211 $ 2,189 $ 2,937 Add: $ 4,816 $10,090 Year Ended December 31, 2006 2005 2004 2003 2002 (dollars in millions) Income tax expense (beneÑt) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Minority interests in earnings of consolidated subsidiariesÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total interest expenseÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Interest factor in rental expenses ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Capitalized interestÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 790 129 26,566 6 1 Earnings, as adjusted ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $39,437 $32,557 $30,429 (108) 58 37,270 6 Ì 367 96 29,899 6 Ì Fixed charges: Total interest expenseÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $37,270 $29,899 $26,566 6 Interest factor in rental expenses ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 1 Capitalized interestÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Preferred stock dividends(1) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 266 Total Ñxed charges including preferred stock dividends ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $37,546 $30,166 $26,839 Ratio of earnings to combined Ñxed charges and preferred stock dividends(2) ÏÏÏÏÏÏÏÏÏÏ 6 Ì 270 6 Ì 261 1.08 1.05 1.13 2,202 157 26,509 5 Ì $33,689 $26,509 5 Ì 315 $26,829 4,713 184 26,876 5 1 $41,869 $26,876 5 1 351 $27,233 1.26 1.54 (1) Preferred stock dividends represent pre-tax earnings required to cover any preferred stock dividend requirements using our eÅective tax rate for the relevant periods. (2) Ratio of earnings to combined Ñxed charges and preferred stock dividends is computed by dividing Earnings, as adjusted by Total Ñxed charges including preferred stock dividends. ANNUAL MEETING DIVIDEND PAYMENTS ADDITIONAL FINANCIAL INFORMATION The annual meeting of Freddie Mac's stockholders will be held: June 8, 2007 8000 Jones Branch Drive McLean, Virginia 22102 Proxy materials will be mailed to stockholders of record in accor- dance with Freddie Mac's bylaws and New York Stock Exchange requirements. Approved by Freddie Mac's board of directors, dividends on the company's common stock and non-cumulative, preferred stock in 2006 and the Ñrst three months of 2007 were or are expected to be paid on: March 31, 2006 June 30, 2006 September 29, 2006 December 29, 2006 March 30, 2007 Subject to approval by Freddie Mac's board of directors, dividends on the company's common stock and non-cumulative, preferred stock in the remaining nine months of 2007 are expected to be paid on or about: June 29, 2007 September 28, 2007 December 28, 2007 156 Freddie Mac We are providing this index of acronyms used in this Information Statement for the convenience of the reader. All of the acronyms listed below are deÑned at their Ñrst use in this document. INDEX OF ACRONYMS AOCI ARM CMT EITF ERISA ESPP Euribor Fannie Mae FASB FEC FHA FHFB FICO FIN FSP GAAP Ginnie Mae GSE GSE Act HUD IRS LIBOR LIHTC LTV MD&A NYSE OAS OFHEO OTC PC PMVS PMVS-L PMVS-YC REIT REMIC REO S&P SEC SFAS SS&TG TBA VIE Accumulated other comprehensive income (loss), net of taxes Adjustable-rate mortgage Constant Maturity Treasury Emerging Issues Task Force Employee Retirement Income Security Act Employee Stock Purchase Plan Euro Interbank OÅered Rate Federal National Mortgage Association Financial Accounting Standards Board Federal Election Commission Federal Housing Administration Federal Housing Finance Board Credit scores initially developed by Fair, Isaac and Co., Inc. Financial Accounting Standards Board Interpretation Financial Accounting Standards Board StaÅ Position U.S. generally accepted accounting principles Government National Mortgage Association Government-sponsored enterprise The Federal Housing Enterprises Financial Safety and Soundness Act of 1992 Department of Housing and Urban Development Internal Revenue Service London Interbank OÅered Rate Low-Income Housing Tax Credit Loan-to-Value Management's Discussion and Analysis of Financial Condition and Results of Operations New York Stock Exchange Option-Adjusted Spread OÇce of Federal Housing Enterprise Oversight Over-the-Counter Mortgage Participation CertiÑcate Portfolio Market Value Sensitivity Portfolio Market Value Sensitivity-Level Portfolio Market Value Sensitivity-Yield Curve Real Estate Investment Trust Real Estate Mortgage Investment Conduit Real Estate Owned Standard & Poor's Securities and Exchange Commission Statement of Financial Accounting Standards Securities Sales and Trading Group To Be Announced Variable interest entity 157 Freddie Mac 8200 Jones Branch Drive, McLean, Virginia 22102 n FreddieMac.com

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