Federal Home Loan Mortgage
Annual Report 2007

Plain-text annual report

A N N U A L R E P O R T FREDDIE MAC FACTS In 2007, Freddie Mac continued our commitment to making home possible for America’s families by providing a stable source of home mortgage funding throughout the housing downturn; helping financially stressed families avoid foreclosure; financing sustainable, affordable homeownership options for borrowers; enhancing our homeownership education tools; and raising funds to reduce family homelessness, among other efforts. The year’s highlights include: n Freddie Mac made –– and surpassed –– a n Don’t Borrow Trouble® community commitment to buy $20 billion in consumer- friendly mortgages for subprime borrowers seeking to refinance out of problematic loans. Freddie Mac has purchased roughly $43 billion of conventional conforming mortgages that financed borrowers who otherwise might have been limited to subprime mortgages. n Freddie Mac and our servicers helped nearly 47,000 borrowers avoid foreclosure and keep their homes in 2007. In the majority of cases, the borrowers were able to stay in their homes through a repayment plan, a loan modification or forbearance. campaigns debuted in California, New York, Pennsylvania, Texas and Virginia. Freddie Mac has brought the campaign to more than 50 communities across the country to combat predatory lending practices and help consumers learn about foreclosure alternatives. n To continue rebuilding New Orleans and helping put families back into their homes, Freddie Mac helped establish a $4.5 million home renovation reserve for hurricane- damaged homes, bringing total contributions made following Hurricanes Katrina and Rita to more than $17 million. n Freddie Mac’s Multifamily business n Freddie Mac enhanced its CreditSmart® processed record volumes of transactions in 2007, as the company expanded our efforts to finance affordable apartment properties. Over the years, Freddie Mac has financed properties that provide homes for more than 4 million renters. multilingual financial literacy curriculum by adding new material on homeownership preservation, including preventing foreclosure and avoiding financial traps. CreditSmart Asian was introduced to address the needs of the Asian-American homebuyer. F R E D D I E M A C 2 0 0 7 A N N U A L R E P O R T C O M P A N Y O V E R V I E W Freddie Mac’s mission is to provide liquidity, stability and affordability to the U.S. housing and mortgage markets. That mission –– defined in our congressional charter –– forms the framework of our business lines, shapes the products we bring to market and drives the services we provide to the nation’s housing and mortgage finance industry. Liquidity: Freddie Mac serves the secondary mortgage market by providing a stable supply of money for lenders, which lowers rates for millions of consumers. Stability: Freddie Mac plays a vital role by moderating cyclical swings in the housing sector, equalizing the flow of mortgage funds regionally throughout the United States and making mortgage funds available in a variety of economic conditions. Affordability: Freddie Mac provides financing options that increase opportunities for affordable homeownership and affordable rental housing for families across the nation. ( 1 ) F R E D D I E M A C 2 0 0 7 A N N U A L R E P O R T A M E S S A G E F R O M T H E C H A I R M A N To ouR SToCkholDERS: In 2007, our sector suffered the most severe housing correction since the Great Depression. In my 35 years as an economist, central banker, regulator and businessman, I have never witnessed a situation quite like this one –– in which a housing bubble has played such a central role in bringing the world’s largest economy to the brink of recession. Freddie Mac’s financial results last year were acutely affected by the extraordinary downturn in housing; later in this letter I will discuss them with you fully. But before detailing our performance, it’s worth taking a closer look at how and why the housing finance environment became so challenging. If you’ll bear with me, I’d like to describe what we’ve observed, what we’ve been doing about it, and what we think it means. WhAT hApp EnED? While many of the difficulties began in the subprime mortgage market, it’s important to understand that what the markets face today is a broader problem of transparency and confidence. In one area after another, markets have ceased functioning as creditors have lost confidence in the portfolios of their lending partners. Looking back over the problems of the past year, at least three factors contributed to the sharp declines we saw. First was a global glut of liquidity, resulting in part from the rapid rise of the world’s largest emerging economy, China, as a net exporter of both capital and, in effect, of labor. Second were advances in technology and financial engineering that separated lending decisions from investment decisions. Third was a decline in underwriting standards, as too many lenders and borrowers threw caution to the winds. In the process, the subprime mortgage was transformed from a niche product and used far more indiscriminately than in the past. Housing finance was stretched beyond the breaking point by ever- more exotic mortgages that enabled more home buying on the front end but carried unacceptable risks of home loss on the back end as soon as home prices stopped rising. ( 2 ) F R E D D I E M A C 2 0 0 7 A N N U A L R E P O R T Of course, markets correct –– and this time, they did so rapidly and viciously. Indeed, the markets may have already overcorrected in pricing and in underwriting certain products, such as jumbo mortgages, outside the conforming space. To a large extent, only the conforming market served by the housing government-sponsored enterprises (GSEs) has continued to function normally, in the process diminishing risk and saving families thousands of dollars in payments over the lifetimes of their loans. SoME lESS onS lEAR nED In recent months, many policymakers have discussed options to ease stresses on the housing and mortgage markets. Many of these efforts have merit, most specifically the fiscal stimulus program to avert the risk of recession. While the Federal Reserve has been creative and responsible in dealing with the problem, we also need to realize that there are very real limits to what monetary policy can do in a situation like this. It is, as often said, a very “blunt” instrument. So we should all applaud the Administration and the Congress for delivering a timely stimulus package. To my mind, when it was passed is more important than all the exact elements of what it contained. The problems in the subprime market remind us of a longstanding truth that was nearly obscured during the last years of the long housing boom: not every family that wants to own a home is financially ready for homeownership. To understand why this is so, consider the subprime market, which can be roughly divided into three parts. The top group of subprime loans might have been eligible for prime credit, but for one reason or another ended up in the subprime category. A middle group of loans are legitimately in subprime, but should benefit from enhanced underwriting standards and more reasonable reset terms. Finally, a sizable bottom group of subprime loans may not have been repayable in any reasonable scenario unless home prices continued to escalate. I am an ardent proponent of the long-term benefits of homeownership. That also makes me an ardent opponent of practices that unduly raise the risk of foreclosure. We need to face the fact that, as a matter of both policy and attitude, our nation did not sufficiently question whether homeownership is the right thing for every household in America at every point in time. For ( 3 ) F R E D D I E M A C 2 0 0 7 A N N U A L R E P O R T most homeowners in the bottom group of subprime today, it may be better to be renters than homeowners at this point in the cycle. That’s how it was when many of us grew up. Accordingly, some of the housing stock that is now or soon will be facing the threat of foreclosure will likely need to be converted, at least temporarily, into rental housing. So it makes sense to undertake efforts that would enable at least some of the families that briefly owned the properties to stay in them under certain circumstances, whether as ordinary renters, or on some kind of innovative shared-equity, rent-to-own or lease-to-buy basis. The specifics would have to be worked out as a matter of law and policy. But what’s already clear is that the right kinds of creative solutions would be better than foreclosure –– for lenders, families and neighborhoods alike. One lesson I hope we all absorb from last year’s experience is that housing finance alone cannot resolve all the housing affordability challenges facing our nation. To achieve lasting gains in affordability, advances in mortgage finance must be accompanied by changes affecting the supply side of the housing equation –– such as in zoning, permitting, transportation and other policies. In sum, we need a change of perspective, emphasizing sustainable homeownership –– homes that families can afford to buy and keep –– over mere homebuying. Any other approach elevates statistics over human lives: the short-term satisfaction of telling ourselves the homeownership rate is increasing, when what really matters is the long-term strength of our families, our neighborhoods and our economy, as shown by the events of 2007. That’s a perspective on the extraordinary developments of the last year. Now let’s take a closer look at how Freddie Mac has managed its way through them –– starting with our progress in financial reporting. ADvAnCES I n FInAnCIAl REpoRTIng We have reached a major milestone on Freddie Mac’s road back to normalcy. With the publication of this 2007 annual report, we are again timely in our financial reporting. This has taken a lot of time, effort and resources, but the benefits are substantial. While much remains to be done, the company and its employees have taken an important step forward. Our advances in financial reporting go beyond timeliness. We continued to strengthen our accounting and internal controls infrastructure. To enhance transparency, we have updated several key accounting policies so as to enhance our GAAP disclosures. We are debuting in this annual report a new segment measure that will more clearly convey the specific risk/reward characteristics of our three lines of business –– and also enable investors to better assess this firm’s performance relative to its peers. ( 4 ) F R E D D I E M A C 2 0 0 7 A N N U A L R E P O R T All this progress in financial reporting brings important benefits: We can be more transparent to our investors, more comparable to other financial services companies, and more focused on our business and our mission. FInAnCIAl RESulTS A nD kE y TREnDS As I’ve said, 2007 was an especially difficult year in many ways. The worsening environment made it very hard for any company in the housing sector to be profitable. This brought even greater challenges for a GSE like Freddie Mac, whose congressional charter limits us to serving only the U.S. residential mortgage market. Unlike other financial services companies, we did not have the option of shifting our focus or withdrawing from the mortgage markets. Rather, as required by our charter, Freddie Mac provided liquidity and stability to the conforming market –– even as others pulled back and provided neither. In so doing, we continued to support our customers and serve our public mission at a critical time. As a result, only the conventional, conforming market supported by the GSEs was able to function more or less normally. Indeed, many observers made the point that if not for the GSEs in the conforming market, there would have been very little of a healthy U.S. mortgage market during this period. However, clearly last year’s weakening house prices and punishing deterioration of credit hurt Freddie Mac’s results, along with those of other mortgage market participants. On a GAAP basis, based on the accounting policy changes I mentioned earlier, our 2007 net losses amounted to roughly $3.1 billion, or $5.37 per diluted share, compared with 2006 net income of $2.3 billion. These results reflected substantial losses on mark-to-market items and a higher provision for credit losses. Our mark-to-market losses of $8.1 billion mainly included $4.3 billion in interest-rate related items and $3.9 billion in credit-related items, offset by certain fees. Our provision for credit losses of $2.9 billion reflected the significant worsening of mortgage credit resulting from continued weakness in housing. These results are plainly disappointing and put pressure on our capital, which is determined by GAAP. Looking across the U.S. financial services landscape, it’s clear that a number of other financial institutions experienced larger losses relative to the size of their mortgage portfolios. But as a company that prides itself on our singular focus and expertise in managing mortgage risk, we can and must do better –– even in the most challenging environments. Later in this letter, I’ll describe some of the steps we are taking to do so. ( 5 ) F R E D D I E M A C 2 0 0 7 A N N U A L R E P O R T It is essential to note that a significant portion of our losses were not economic, but the result of accounting conventions. Freddie Mac is committed to serving our mission for the long term and building enduring shareholder value. Yet in our business, mark-to-market accounting has the effect of increasing volatility and often requires us to book losses in excess of those that we ultimately expect to incur. Thus, a significant fraction of the credit impact from our current guarantee portfolio has already been reflected in our results. We expect a good portion of the “front-loaded” mark-to- market losses in our GAAP results will ultimately reverse over time. There is a related dynamic at work here. Much of what Freddie Mac did in 2007 served our mission in ways that hurt our GAAP results in the short term. For example, the day we buy a loan and issue a credit guarantee, we have to mark the credit to market –– and in this environment, that’s generating large current-period losses (commonly called day one losses). Yet over the long run, with robust growth in our guarantee-fee business and wider spreads resulting from enhanced underwriting standards and increased guarantee fees, we expect the 2008 business we’re putting on today to generate attractive returns tomorrow. In order to communicate our business results in a manner consistent with how we manage our business –– and as discussed in our Management’s Discussion and Analysis (MD&A) –– we are providing supplementary new disclosures and segment reporting in this annual report. These new disclosures show clearly the results of our underlying lines of business. Investors have asked for such an additional measure for several years, and Chief Financial Officer Buddy Piszel deserves great credit for bringing it to fruition. On the basis of the new measure (which we call Adjusted operating income, or AOI), our earnings totaled $2.1 billion for 2007, down from $3.9 billion on this basis for 2006. That decline is consistent with the credit costs we experienced. (AOI is a non-GAAP financial measure. For a reconciliation of AOI to GAAP and for more on AOI and our new segment reporting, please see the MD&A and Note 15 of this annual report.) BuSInESS pERFoRMAnCE A nD pR oSpECTS Overall, I believe the market shift we saw in 2007 toward fixed-rate originations and improved pricing and credit standards positions Freddie Mac well, enabling us to build on our traditional strengths. Let me explain why. One key reason management believes strongly in Freddie Mac’s future is the quality of our book of business, which we view as among the very best in the industry. Compared to our competitors, our mortgage portfolio is low in loan-to-value, low in holdings of exotic loans, high in regional diversification and high in credit quality. For example, following a year of marked deterioration in ( 6 ) F R E D D I E M A C 2 0 0 7 A N N U A L R E P O R T credit, our total single-family delinquency rate on December 31, 2007 was 65 basis points, still less than half the industry average –– and well below that of our principal competitor. While we expect this to rise, it should remain substantially lower than others. As evident in our disclosures, even in a deteriorating credit environment, we believe our sound credit standards and policies will stand us in good stead. A second positive factor involves how the markets have come back in our direction, in terms of quality as well as volume. Growth in total U.S. residential mortgage debt outstanding slowed to roughly 7 percent in 2007. By contrast, our total portfolio grew by 15 percent last year as Americans remembered the virtues of the American Mortgage –– the long-term, fixed-rate, prepayable mortgage that remains a sweet spot for Freddie Mac. Moreover, across a range of products, much of the irresponsibility in pricing and credit began to be wrung out of the system. The shift away from exotic mortgages and back toward long-term, fixed-rate lending and more rational underwriting standards puts your company in a solid position going forward. Our guarantee- fee income increased throughout the year, based on credit guarantee portfolio growth of almost 18 percent. At the same time as we grew volume and gained overall market share, we have also moved to raise prices in our credit guarantee business to better reflect changing credit and market conditions. As a result, we expect revenues from our guarantee business to increase materially in 2008. The aggregate price increases were substantial but they were needed –– and were accompanied by tightened and more risk-based credit standards as well. Net interest margin stabilized throughout the year, in large part a function of increased spreads and reduced average volumes. With the current illiquidity and lack of demand elsewhere in the mortgage security market, the option-adjusted spreads we are able to earn on new business have improved significantly. Our multifamily business showed striking growth. This increasingly important part of our business –– which is a “goal rich” contributor to our affordable housing goals –– eclipsed its previous record set in 2006 by almost 55 percent. Consistent with the accelerating momentum of our business as a whole, the lion’s share of this growth occurred in the second half of the year. The company remains safe and sound, and we continue to enhance our capital management and financial controls. We began the year with an estimated $2.1 billion capital cushion above the 30 percent surplus directed by our regulator; at year-end, this cushion stood at an estimated $3.5 billion. Credit quality is high, as discussed, and interest rate risk management remains strong. Finally, we continued to strengthen our safety and soundness regime by taking advantage of opportunities to enhance our senior management team. ( 7 ) F R E D D I E M A C 2 0 0 7 A N N U A L R E P O R T In November, facing GAAP losses that we knew would count against our regulatory capital, we faced a fundamental decision about the company’s direction. We could radically shrink the firm –– and thus shirk our mission –– in order to conserve capital, or we could take the hard decision to raise additional capital and halve the dividend. We chose the latter course, and in the days that followed, we found that many of America’s shrewdest institutional investors share our strong confidence in the future of this franchise. We were thus able to successfully raise $6 billion in a preferred stock offering that was greatly oversubscribed –– and which, importantly, avoided any dilution of existing common stockholders. We believe this additional capital will enable Freddie Mac to continue fulfilling its urgent mission and better position us to effectively manage the company going forward. In doing so, we must treat capital as a precious resource and manage it wisely. By its nature, the guarantee-fee business is less capital intensive than the investment portfolio business. Accordingly, you can anticipate that we will work to derive a greater share of Freddie Mac’s value from the guarantee business going forward. Be assured that this does not represent a lack of interest in pursuing investment portfolio opportunities, but rather, is simply a matter of balance, emphasis and prudence. Controlling G&A costs is a key to Freddie Mac’s competitive prospects. We held administrative expenses flat in 2007 and actually reduced them slightly as a percentage of our total portfolio. This year, we expect to achieve further savings by shedding substantial consultant headcount associated with our accounting systems improvements, which are largely winding down. In 2009, we plan to extend these savings through voluntary attrition and other steps as necessary. I want to turn very briefly from our efforts to save money at Freddie Mac, to our plans to invest in enhancing the capabilities of the business. In recent years we have had to devote the bulk of our new spending to upgrade our accounting infrastructure and internal controls. As that effort nears completion, we will be able to reinvigorate our efforts and our spending to improve the company’s products, time to market and customer service. Beyond that, I would single out three specific areas of focus. One, we are working to enhance our capabilities to meet all our customer needs and act as a conduit between the primary market where loans are originated and the investment world, including Wall Street. Two, we are taking steps to improve our security performance –– the structure and liquidity of the currency we use to purchase mortgages. Finally, we are upgrading our systems to make Freddie Mac as easy as possible for our customers to work with. All these initiatives are intended to make us a stronger competitor when the secondary mortgage market again becomes intensely competitive. ( 8 ) F R E D D I E M A C 2 0 0 7 A N N U A L R E P O R T A MISSIon-CRITICAl yEAR If last year’s turmoil in the housing finance markets had any silver lining, it was this: though it was very hard for the GSEs to be profitable, it was also very hard to deny our necessity. Freddie Mac’s mission is always important, but in 2007, it plainly was essential. We provided stability and liquidity to the mortgage market, even as our private-label competitors withdrew from it. As a result, in discussions across the ideological spectrum, we are seen as a part of the solution to the subprime and broader economic challenges facing the country. Thus, in the fiscal stimulus package signed into law on February 13, 2008, the GSEs were entrusted with the important added responsibility of bringing relief to parts of the jumbo mortgage market. Our task is to provide liquidity, stability, and help enable lower costs in high-cost areas in such states as California –– where thousands of middle class families and homebuyers are struggling with mortgages above the prior conforming loan limit of $417,000. Doing so will pose a particular challenge for us in light of the capital demands of this task and the capital cushion to which we manage. But it is a task we embrace –– because it is the right thing to do for our mission and for the broader economy. Too often in recent years, as rising house prices, regional stability and easy access to products became the norm in housing finance, commentators have focused on just one aspect of our three- part mission, effectively contending that our sole responsibility was affordable housing. But in fact the importance of all three parts of our mission –– especially the need for us to provide liquidity and stability to housing markets –– was demonstrated very clearly last year. Freddie Mac was created in part to cushion the impact of crises such as the one that paralyzed the markets in 2007. We have played such a role before –– as we did after Hurricane Katrina, 9/11, and the implosion of Long-Term Capital Management –– but the extent of last year’s market turmoil was extraordinary. As a result, Freddie Mac stepped up its mortgage purchases, and by year-end had injected nearly $580 billion in liquidity into the markets. We took early, concrete steps to stabilize the markets and cushion the negative effects of the housing downturn on borrowers and communities. In February of last year, we became the first financial institution to announce tighter underwriting standards that limit payment shock for certain subprime borrowers. This is consistent with the leadership we have shown in other efforts to combat predatory lending. In April, we made a commitment to buy $20 billion in consumer-friendly mortgages that provide better choices for subprime borrowers. Since May, we have bought roughly $43 billion of prime rate mortgages that financed borrowers who previously may have found themselves in subprime. ( 9 ) F R E D D I E M A C 2 0 0 7 A N N U A L R E P O R T Freddie Mac has long led the industry in helping borrowers pursue innovative alternatives to foreclosure. The company and our servicers helped nearly 47,000 borrowers avoid foreclosure and keep their homes in 2007 –– bringing to more than 200,000 the number of such workouts since the beginning of 2004. We also introduced new tools to help homeowners facing foreclosure recognize and avoid mortgage fraud. All this work is in keeping with our conviction that while preventing home loss and harm to markets and neighborhoods may be less glamorous than opening the doors of homeownership, it is no less essential –– especially at this point in the cycle. I am proud, as you should be also, of this company’s extensive efforts last year to prevent foreclosures, combat predatory lending and strengthen sustainable homeownership. Freddie Mac achieved a very strong affordable performance in 2007 –– despite the fact that curtailed subprime credit and tightened underwriting standards put affordable mortgage financing out of reach of many borrowers. We made extraordinary efforts to meet the increasingly demanding annual affordable housing goals, and while the U.S. Department of Housing and Urban Development makes the final determination, we believe we met the three main goals. Almost 56 percent of the nearly 3.3 million homes we financed last year were affordable to low- or moderate-income families. Freddie Mac also helped more than 360,000 first-time homebuyers with their mortgage financing. And our burgeoning multifamily business provided the financing for nearly 600,000 affordable apartment units around the country. 2007 saw the expansion of Freddie Mac’s multilingual financial literacy program and our anti- predatory lending educational campaign. Since their inception, these programs together have reached well over 1.5 million people with important information about credit and the homebuying process. And continuing our efforts to rebuild the Gulf Coast, Freddie Mac helped to establish a $4.5 million home renovation reserve fund in New Orleans, which will be used to rebuild hurricane- damaged properties and get families back into their homes. A vIEW T o ThE FuTuRE A dark cloud hung over the housing sector in 2007, and it has cast a growing shadow over the U.S. economy –– and increasingly, the global economy as well. Freddie Mac has shared in the pain that afflicts our sector. And we have learned important lessons that we are applying going forward. The markets are coming back in our direction. Fixed-rate lending is in demand; GSE share of the total market is up; unsustainable pricing, credit and underwriting have mostly headed for the exits. ( 1 0 ) F R E D D I E M A C 2 0 0 7 A N N U A L R E P O R T With that said, no one pretends this painfully deep housing recession will be easy on this or any other company in our sector. For that matter, no one can responsibly say how long the downturn will be. But I can say this with confidence: the housing finance companies that prosper most in the long term will be those that have built the strongest foundation for the future. And Freddie Mac, albeit with some difficulty, has built such a foundation in the last several years –– one whose pillars include more transparent accounting; more robust internal controls; better products and systems; stronger customer relationships and service; a higher-performing corporate culture; a stronger, broader and deeper management team; and the financial wherewithal to compete and succeed over the long term. In all likelihood, this will be my last annual letter to you as CEO of Freddie Mac. I have entered into a transition plan with the company’s board of directors, under which we have agreed to separate the roles of CEO and chairman of the board. After splitting the roles, I expect to remain at the company as executive chairman until the end of 2009. We had expected this transition to occur this past summer, until my designated successor, Eugene McQuade, decided to return to his private sector banking roots. The search for the company’s next CEO is underway and we all look forward to its successful completion. As Freddie Mac shareholders, you have shown extraordinary patience in an extraordinary time. But let’s remember that for all that has changed, very important long-term aspects of demography and demand have not changed –– and are positive. America remains a growing developed nation: one with relatively high rates of birth, immigration and household formation. Long-term demand for housing finance will remain strong. And now, having built a firm foundation, Freddie Mac is positioned like very few other companies to benefit from the inevitable recovery of housing in this country. So thank you for your fortitude and confidence in Freddie Mac. During this difficult time for housing and the economy, rarely have they been as needed or as beneficial for our nation. Yet also, from my perspective, rarely as well justified. Sincerely, Richard F. Syron Chairman and Chief Executive Officer February 28, 2008 ( 1 1 ) 2 0 0 7 A N N U A L R E P O R T T O S T O C K H O L D E R S FEDERAL HOME LOAN MORTGAGE CORPORATION FREDDIE MAC INFORMATION STATEMENT AND ANNUAL REPORT TO STOCKHOLDERS For the Ñscal year ended December 31, 2007 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: 703-903-3883 or 1-800-FREDDIE (800-373-3343) E-mail: 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 FEBRUARY 28, 2008 TABLE OF CONTENTS BUSINESSÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ REGULATION AND SUPERVISION ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ RISK FACTORS ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ PROPERTIES ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ LEGAL PROCEEDINGS ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ MARKET FOR THE COMPANY'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ FORWARD-LOOKING STATEMENTS ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ SELECTED FINANCIAL DATA AND OTHER OPERATING MEASURESÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 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 PORTFOLIO BALANCES AND ACTIVITIESÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ OFF-BALANCE SHEET ARRANGEMENTSÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ CONTRACTUAL OBLIGATIONS ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ CRITICAL ACCOUNTING POLICIES AND ESTIMATES ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ CREDIT RISKS ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ OPERATIONAL RISKSÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ RISK MANAGEMENT AND DISCLOSURE COMMITMENTS ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ FINANCIAL STATEMENTS AND SUPPLEMENTARY DATAÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ QUARTERLY SELECTED FINANCIAL DATA ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 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 RELATED STOCKHOLDER MATTERSÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS AND DIRECTOR INDEPENDENCE ÏÏ PRINCIPAL ACCOUNTANT FEES AND SERVICES ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ RATIO OF EARNINGS TO FIXED CHARGES ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ RATIO OF EARNINGS TO COMBINED FIXED CHARGES AND PREFERRED STOCK DIVIDENDS ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ ADDITIONAL INFORMATION ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ CERTIFICATIONS ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Page 1 7 13 22 22 23 26 28 29 29 35 54 63 66 72 76 78 79 82 90 109 110 112 181 182 182 187 188 188 188 188 189 189 189 190 i Freddie Mac FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA CONSOLIDATED STATEMENTS OF INCOME ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ CONSOLIDATED BALANCE SHEETS ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ CONSOLIDATED STATEMENTS OF CASH FLOWS ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ NOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ NOTE 2: FINANCIAL GUARANTEES AND TRANSFERS OF SECURITIZED INTERESTS IN MORTGAGE-RELATED ASSETS ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ NOTE 3: VARIABLE INTEREST ENTITIESÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ NOTE 4: RETAINED PORTFOLIO AND CASH AND INVESTMENTS PORTFOLIO ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ NOTE 5: MORTGAGE LOANS AND LOAN LOSS RESERVES ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ NOTE 6: REAL ESTATE OWNED ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ NOTE 7: DEBT SECURITIES AND SUBORDINATED BORROWINGS ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ NOTE 8: STOCKHOLDERS' EQUITYÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ NOTE 9: REGULATORY CAPITALÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ NOTE 10: STOCK-BASED COMPENSATION ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ NOTE 11: DERIVATIVES ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ NOTE 12: LEGAL CONTINGENCIES ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ NOTE 13: INCOME TAXES ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ NOTE 14: EMPLOYEE BENEFITSÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ NOTE 15: SEGMENT REPORTINGÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ NOTE 16: FAIR VALUE DISCLOSURES ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ NOTE 17: CONCENTRATION OF CREDIT AND OTHER RISKS ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ NOTE 18: MINORITY INTERESTSÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ NOTE 19: EARNINGS PER SHARE ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ NOTE 20: CHANGES IN ACCOUNTING PRINCIPLES ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Page 114 115 116 117 118 129 133 135 140 143 144 146 147 149 153 154 156 157 161 167 172 175 175 176 ii Freddie Mac This Information Statement 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 ""MANAGEMENT'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 and securitizing them into mortgage-related securities that can be sold to investors. We are one of the largest purchasers of mortgage loans in the U.S. Our purchases of mortgage assets provide lenders with a steady Öow of low-cost mortgage fundings. We purchase single-family and multifamily mortgage-related securities for our investments portfolio. We also purchase multifamily residential mortgages in the secondary mortgage market and hold those loans for investment. We Ñnance our purchases for our investments portfolio and our multifamily mortgage loan portfolio, and manage interest-rate and other market risks, primarily by issuing a variety of debt instruments and entering into derivative contracts in the capital markets. See ""MD&A Ì PORTFOLIO BALANCES AND ACTIVITIES Ì Table 37 Ì Total Mortgage Portfolio and Segments Portfolio Composition'' for an overview of our various portfolios. Though we are chartered by Congress, our business is funded 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, the products we bring to market and 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 ""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 for low- and moderate-income families involving an economic return that may be less than the return earned on other activities); and ‚ to promote access to mortgage credit throughout the U.S. (including central cities, rural areas and other underserved areas). 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 set in accordance with our charter. These lower rates help make homeownership aÅordable for more families and individuals than would be possible without our participation in the secondary mortgage market. To facilitate our mission, our charter provides us with special attributes including: ‚ exemption from the registration and reporting requirements of the Securities Act and 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 SEC under the Exchange Act; ‚ favorable treatment of our securities under various investment laws and other regulations; 1 Freddie Mac ‚ 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. Types of Mortgages We Purchase Our charter establishes requirements for and limitations on the mortgages and mortgage-related securities we may purchase, as described below. Within our charter parameters, the residential mortgage loans we purchase or that underlie the 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 primary 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 are generally balloon mortgages with terms ranging from Ñve to thirty years. Our multifamily mortgage products, services and initiatives are designed 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 original principal balance of single- family mortgage loans we purchase. This limit is determined annually each October using a methodology based on changes in the national average price of a one-family residence, as surveyed by the Federal Housing Finance Board. For 2006 to 2008, the conforming loan limit for a one-family residence was set at $417,000. Higher limits apply to two- to four-family residences. The conforming loan limits are 50% 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. As part of the Economic Stimulus Act of 2008, these conforming loan limits were temporarily increased. See ""REGULATION AND SUPERVISION Ì Legislation Ì Temporary Increase in Conforming Loan Limits.'' Loan and Credit Quality 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% of the value of the property securing the mortgage. Our charter also limits our mortgage purchases, so far as practicable, to mortgages we deem to be of a quality, type and class that meet the purchase standards of private institutional mortgage investors. See ""CREDIT RISKS Ì Mortgage Credit Risk Ì Underwriting Requirements and Quality Control Standards'' for additional information. 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 in which lenders originate mortgage loans for home buyers and a secondary mortgage market in which the mortgage loans are resold. At December 31, 2007, our total mortgage portfolio, which includes our retained portfolio and credit guarantee portfolio, was $2.1 trillion, while the total U.S. residential mortgage debt outstanding, which includes single-family and multifamily loans, was approximately $11.8 trillion. See ""MD&A Ì PORTFOLIO BALANCES AND ACTIVITIES'' for further information on the composition of our mortgage portfolios. 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, homeownership 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 mortgage purchase and securitization activity of other Ñnancial institutions. See ""RISK FACTORS'' for additional information. 2 Freddie Mac Table 1 includes important indicators for the U.S. residential mortgage market. Table 1 Ì Mortgage Market Indicators Year-Ended December 31, 2006 2007 2005 Home sale units (in thousands)(1) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ House price appreciation(2) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Single-family originations (in billions)(3)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Adjustable-rate mortgage share(4)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ ReÑnance share(5)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ U.S. single-family mortgage debt outstanding (in billions)(6) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ U.S. multifamily mortgage debt outstanding (in billions)(7) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 5,713 (0.3)% 6,728 4.1% $ 2,430 $ 2,980 10% 45% 22% 41% $11,028 813 $ $10,421 751 $ 7,463 9.6% $3,120 30% 44% $9,345 $ 692 (1) Includes sales of new and existing homes in the U.S. and excludes condos/co-ops. Source: National Association of Realtors» news release dated February 25, 2008 (sales of existing homes) and U.S. Census Bureau news release dated January 28, 2008 (sales of new homes). (2) Source: OÇce of Federal Housing Enterprise Oversight's 4Q 2007 House Price Index Report dated February 26, 2008 (purchase-only U.S. index). (3) Source: Inside Mortgage Finance estimates of originations of single-family Ñrst- and second liens dated February 8, 2008. (4) Adjustable-rate mortgage share of the number of conventional one-family mortgages for home purchase. Data for 2007 and 2006 are annual averages of monthly Ñgures and 2005 is an annual composite. Source: Federal Housing Finance Board's Monthly Interest Rate Survey release dated January 24, 2008. (5) ReÑnance share of the number of conventional mortgage applications. Source: Mortgage Bankers Association's Mortgage Applications Survey. Data reÖect annual averages of weekly Ñgures. (6) U.S. single-family mortgage debt outstanding as of September 30 for 2007 and December 31 for 2006 and 2005. Source: Federal Reserve Flow of Funds Accounts of the United States dated December 6, 2007. (7) U.S. multifamily mortgage debt outstanding as of September 30 for 2007 and December 31 for 2006 and 2005. Source: Federal Reserve Flow of Funds Accounts of the United States dated December 6, 2007. 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 and continued to weaken in 2007. In 2007, the volume of new and existing home sales continued to decline and increased inventories of unsold homes undermined property values. 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 decline, the risk of borrower defaults generally increases and the severity of credit losses also increases. Estimates of nationwide home price appreciation varied for 2006, with some estimates indicating a slight overall decline in home prices and others indicating moderate growth. Home prices registered broad declines across the nation, with prices in some markets falling sharply, particularly in the fourth quarter. Forecasts of nationwide home prices indicate a continued overall decline through the near term. Despite the slowdown in the housing market, total residential mortgage debt outstanding in the U.S. grew by an estimated 7.1% in 2007 as compared with 11.3% in 2006. We expect that the amount of total residential mortgage debt outstanding will continue to rise in 2008, though at a slower rate than in the past few years. Credit concerns and resulting liquidity issues have recently aÅected the Ñnancial markets. In addition, the market for mortgage-related securities has been characterized by high levels of volatility and uncertainty, reduced demand and liquidity and signiÑcantly wider credit spreads. Mortgage-related securities, particularly those backed by non-traditional mortgage products, have been subject to various rating agency downgrades and price declines. Many lenders tightened credit standards in the second half of 2007 or elected to stop originating certain types of mortgages, resulting in higher mortgage rates for riskier mortgage products in the market, such as some types of ARMs. This has adversely aÅected many borrowers seeking to reÑnance out of ARMs scheduled to reset to higher rates, contributing to higher observed delinquencies. The credit performance of subprime and Alt-A loans, as well as other non-traditional mortgage products, deteriorated during 2007. See ""CREDIT RISKS Ì Mortgage Credit Risk'' for additional information regarding mortgage-related securities backed by subprime and Alt-A loans. The market for multifamily mortgage debt diÅers from the residential single-family market in several respects. The likelihood that a multifamily borrower will make scheduled payments on its mortgage is a function of the ability of the property to generate income suÇcient to make those payments, which is aÅected by rent levels and the percentage of available units that are occupied. Strength in the multifamily market therefore is aÅected by the balance between the supply of and demand for rental housing (both multifamily and single-family), which in turn is aÅected not only by employment growth but also by the number of new units added to the rental housing supply, rates of household formation and the relative cost of owner-occupied housing alternatives. Demographics for the multifamily market are favorable at present, due to high levels of immigration and high rates of household formation in parts of the population most likely to choose rental housing (ages 20-29 and 55-64). In the long term, the prospects for the balance of supply and demand are also favorable due to several barriers to entry including neighborhood opposition to new construction, rising construction costs and limited supply of appropriately zoned land 3 Freddie Mac suitable for multifamily development. Overbuilding (a problem at times in the past) has not occurred in most markets, though supply may be increased in the near future to the extent conditions in the single-family housing markets result in conversion of owner-occupied units to rentals. Primary Mortgage Market Ì Our Customers Our customers are predominantly lenders in the primary mortgage market that originate mortgages for homeowners and apartment owners. 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. We acquire a signiÑcant portion of our mortgages from several large lenders. These 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 increased business from a decreasing number of key lenders. In 2007, three mortgage lenders each accounted for 12% or more of our single-family mortgage purchase volume. These lenders collectively accounted for approximately 45% of this volume. In addition, in 2007, our top ten lenders represented approximately 79% of our single- family mortgage purchase volume. In 2007, our top three multifamily lenders collectively represented approximately 44% of our multifamily purchase volume. Our top ten multifamily lenders represented approximately 80% of our multifamily purchase volume in 2007. See ""RISK FACTORS Ì Competitive and Market Risks'' for additional information. Secondary Mortgage Market We participate in the secondary mortgage market by purchasing mortgage loans and mortgage-related securities for investment and by issuing guaranteed mortgage-related securities. We do not lend money directly to homeowners. 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 through investment activities and credit guarantee activities focusing on three long-term business drivers: the proÑtability of new business, growth and market share. Purchases of mortgage loans beneÑting low- and moderate-income families and neighborhoods are also an integral part of our mission and business. We are committed to fulÑlling the needs of these borrowers and markets. AÅordable housing goals and subgoals are set for us by the U.S. Department of Housing and Urban Development, or HUD. 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 our long-term business drivers. At December 31, 2007, we had total assets of $794.4 billion and total stockholders' equity of $26.7 billion, and for the year ended December 31, 2007, we reported a net loss of $3.1 billion. Securitization Activities We securitize certain of the mortgages we have purchased and issue mortgage-related securities that can be sold to investors or held by us. We guarantee the payment of principal and interest on these mortgage-related securities in exchange for a fee, which we refer to as a guarantee fee. Our guarantee increases the marketability of our mortgage-related securities, providing additional liquidity to the mortgage market. 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. Our PCs represent beneÑcial interests in trusts that own pools of mortgages we have purchased. 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 investors purchase our PCs, including pension funds, insurance companies, securities dealers, money managers, commercial banks, foreign central banks and other Ñxed-income investors. Our Structured Securities represent beneÑcial interests in pools of PCs and certain other types of mortgage-related assets. We guarantee the payment of principal and interest to the holders of our Structured Securities. By issuing Structured Securities, we seek to provide liquidity to alternative sectors of the mortgage market. We issue single-class Structured Securities and multi-class Structured Securities. Single-class Structured Securities pass through the cash Öows of the 4 Freddie Mac 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. 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 in exchange for cash. We primarily create Structured Securities using PCs or previously issued Structured Securities as collateral. However, we also issue Structured Securities backed by mortgage loans or non- Freddie Mac mortgage-related securities using collateral transferred to trusts that were speciÑcally created for the purpose of issuing the securities. These trusts may issue various senior and subordinated interests. We purchase interests, including senior interests, of the trusts and 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 underlying structure employed and additional credit enhancement features. We also enter into long-term standby commitments for mortgage assets held by third parties that require us to purchase loans from lenders when the loans subject to these commitments meet certain delinquency criteria. In addition, we have entered into mortgage credit agreements under which we assume default risk for mortgage loans held by third parties for up to a 90-day period in exchange for a monthly fee. We enter into guarantee contracts for the payment of principal and interest on tax-exempt and taxable multifamily housing revenue bonds that are collateralized by mortgage loans on low- and moderate-income multifamily housing projects. By engaging in these activities, we provide liquidity to this sector of the mortgage market. 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 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 Because our PCs are homogeneous, issued in high volume and highly liquid, they trade 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 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. The Securities Industry and Financial Markets Association publishes guidelines pertaining to the types of mortgages that are eligible for TBA trades. On February 15, 2008, the Securities Industry and Financial Markets Association announced that the higher loan balances, which are now eligible for purchase by the Federal Housing Administration, or FHA, or GSEs under the temporary increase to conforming loan limits in the Economic Stimulus Act of 2008, described in ""REGULATION AND SUPERVISION Ì Legislation Ì Temporary Increase in Conforming Loan Limits,'' will not be eligible for inclusion in TBA pools. By segregating these mortgages with higher loan balances from TBA eligible securities, we minimize any impact to the existing TBA market for our securities. 5 Freddie Mac Segments We manage our business through three reportable segments: ‚ Investments; ‚ Single-family Guarantee; and ‚ Multifamily. Certain activities that are not part of a segment are included in the All Other category. For a summary and description of our Ñnancial performance and Ñnancial condition on a consolidated as well as segment basis, see ""MD&A'' and ""FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA'' and the accompanying notes to our consolidated Ñnancial statements. Investments Segment Through our Investments segment, we invest principally in mortgage-related securities and single-family mortgages through our mortgage-related investment portfolio. Our Investments segment activities may include the purchase of mortgages and mortgage-related securities with less attractive investment returns and with incremental risk in order to achieve our aÅordable housing goals and subgoals. We also maintain a cash and non-mortgage-related securities investment portfolio in this segment to help manage our liquidity needs. We seek to generate attractive returns on our portfolio of mortgage-related investments while maintaining a disciplined approach to interest-rate risk and capital management. We seek to accomplish this objective through opportunistic purchases, sales and restructuring of mortgage assets or repurchase of liabilities. Although we are primarily a buy and hold investor in mortgage assets, we may sell assets to reduce risk, to respond to capital constraints, to provide liquidity or to structure certain transactions. We estimate our expected investment returns using an option-adjusted spread, or OAS, approach. We fund our investment activities by issuing short-term and long-term debt. Competition for funding can vary with economic and Ñnancial market conditions and regulatory environments. See ""MD&A Ì LIQUIDITY AND CAPITAL RESOURCES'' for a description of our funding activities. We use derivatives to: (a) regularly adjust or rebalance our funding mix in order to more closely match changes in the interest-rate characteristics of our mortgage-related assets; (b) economically hedge forecasted issuances of debt and synthetically create callable and non-callable funding; and (c) economically hedge foreign-currency exposure. For more information regarding our derivatives, see ""QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK'' and ""NOTE 11: DERIVATIVES'' to our consolidated Ñnancial statements. Single-family Guarantee Segment In our Single-family Guarantee segment, we guarantee the payment of principal and interest on single-family mortgage- related securities, including those held in our retained portfolio, in exchange for guarantee fees. Earnings for this segment consist of guarantee fee revenues less the related credit costs (i.e., provision for credit losses) and operating expenses. Also included is the interest earned on assets held in the Investments segment related to single-family guarantee activities, net of allocated funding costs and amounts related to net Öoat beneÑts. Through our Single-family Guarantee segment, we seek to issue guarantees with fee terms that we believe oÅer attractive long-term returns relative to anticipated credit costs. In addition, we seek to improve our share of the total residential mortgage securitization market by improving customer service, expanding our customer base, and expanding the types of mortgages we guarantee and the products we oÅer. We may make trade-oÅs in our pricing and our risk proÑle in order to maintain market share, support liquidity in various segments of the residential mortgage market, support the price performance of our PCs and acquire business in pursuit of our aÅordable housing goals and subgoals. We provide guarantees to many of our larger customers through contracts that require them to sell or securitize a speciÑed minimum share of their eligible loan originations to us, subject to certain conditions and exclusions. The purchase and securitization of mortgage loans from customers under these longer-term contracts have Ñxed pricing schedules for our guarantee fees that are negotiated at the outset of the contract. We call these transactions ""Öow'' activity and they represent the majority of our purchase volumes. The remainder of our purchases and securitizations of mortgage loans occurs in ""bulk'' transactions for which purchase prices and guarantee fees are negotiated on an individual transaction basis. Mortgage purchase volumes from individual customers can Öuctuate signiÑcantly. Multifamily Segment Our Multifamily segment activities include purchases of multifamily mortgages for our retained portfolio and guarantees of payments of principal and interest on multifamily mortgage-related securities and mortgages underlying multifamily housing revenue bonds. The assets of the Multifamily segment include mortgages that Ñnance low- and 6 Freddie Mac moderate-income multifamily rental apartments. Our Multifamily segment also includes certain equity investments in various limited partnerships that sponsor low- and moderate-income multifamily rental apartments, which beneÑt from low- income housing tax credits, or LIHTC. These activities support our mission to supply Ñnancing for aÅordable rental housing. We guarantee the payment of principal and interest on multifamily mortgage loans and securities that are originated and held by state and municipal housing Ñnance agencies to support tax-exempt and taxable multifamily housing revenue bonds. By engaging in these activities, we provide liquidity to this sector of the mortgage market. We seek to generate attractive investment returns on our multifamily mortgage loans while fulÑlling our mission to supply aÅordable rental housing. We also issue guarantees that we believe oÅer attractive long-term returns relative to anticipated credit costs. Employees At January 31, 2008, we had 5,281 full-time and 115 part-time employees. Our principal oÇces are located in McLean, Virginia. 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 (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. REGULATION AND SUPERVISION In addition to the limitations on our business activities described above in ""BUSINESS Ì Our Charter and Mission,'' we are subject to regulation and oversight by HUD and the OÇce of Federal Housing Enterprise Oversight, or OFHEO, under our charter and the Federal Housing Enterprises Financial Safety and Soundness Act of 1992, or the GSE Act. We are also subject to certain regulation by other government agencies. Department of Housing and Urban Development HUD has general regulatory authority over Freddie Mac, including authority 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. Housing Goals and Home Purchase Subgoals HUD establishes annual aÅordable housing goals, which are set forth below in Table 2. 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 7 Freddie Mac 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. Table 2 Ì Housing Goals and Home Purchase Subgoals for 2007 and 2008(1) Low- and moderate-income goal ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Underserved areas goal ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Special aÅordable goal ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Multifamily special aÅordable volume target (in billions) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Housing Goals 2007 2008 55% 56% 38 39 25 27 $3.92 $3.92 Home Purchase Subgoals 2008 2007 Low- and moderate-income subgoal ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Underserved areas subgoal ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Special aÅordable subgoal ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 47% 34 18 47% 33 18 (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. Our performance with respect to the goals and subgoals is summarized in Table 3. HUD ultimately determined that we met the goals and subgoals for 2006. We expect to report our performance with respect to the 2007 goals and subgoals in March 2008. At this time, we believe that we did not achieve two home purchase subgoals (the low- and moderate-income subgoal and the special aÅordable subgoal) for 2007. We believe, however, that achievement of these two home purchase subgoals was infeasible in 2007 under the terms of the GSE Act of 1992. Accordingly, we have submitted an infeasibility analysis to HUD, which is in the process of reviewing our submission. Table 3 Ì Housing Goals and Home Purchase Subgoals and Reported Results(1) Housing Goals and Reported Results Year Ended December 31, 2005 2006 Goal Result Goal Result Low- and moderate-income goal ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Underserved areas goal ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Special aÅordable goal ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Multifamily special aÅordable volume target (in billions) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 53% 38 23 $3.92 55.9% 42.7 26.4 $13.58 52% 37 22 $3.92 54.0% 42.3 24.3 $12.35 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 47.0% 33.6 17.0 45% 32 17 46.9% 35.5 17.7 (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. From time to time, we make signiÑcant adjustments to our mortgage loan sourcing and purchase strategies in an eÅort to meet the increased housing goals and subgoals. These strategies include entering into some purchase and securitization transactions with lower expected economic returns than our typical transactions. At times, we also relax some of our underwriting criteria to obtain goals-qualifying mortgage loans and may make additional investments in higher-risk mortgage loan products that are more likely to serve the borrowers targeted by HUD's goals and subgoals. EÅorts to meet the goals and subgoals could further increase our credit losses. We continue to evaluate the cost of these activities. Declining market conditions and regulatory changes during 2007 made meeting our aÅordable housing goals and subgoals more challenging than in previous years. The increased diÇculty we are experiencing has been driven by a combination of factors, including: ‚ the decreased aÅordability of single-family homes that began in 2005; ‚ deteriorating conditions in the mortgage credit markets, which have resulted in signiÑcant decreases in the number of originations of subprime mortgages; and ‚ increases in the levels of the goals and subgoals. We anticipate that these market conditions will continue to aÅect our aÅordable housing activities in 2008. See also ""RISK FACTORS Ì Legal and Regulatory Risks.'' However, we view the purchase of mortgage loans that are eligible to 8 Freddie Mac 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. If the Secretary of HUD Ñnds that we failed to meet a housing goal established under section 1332, 1333, or 1334 of 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 on this issue, 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. 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 purchasing, servicing, selling, lending on the security of, or otherwise dealing in, conventional mortgages that is signiÑcantly diÅerent from: ‚ programs that HUD has approved; ‚ programs that HUD had approved or we had engaged in before the date of enactment of the GSE Act; or ‚ programs that represent 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 such 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. 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. Anti-Predatory Lending Predatory lending practices are in direct opposition to our mission, our goals and our practices. 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. 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. The Director who heads OFHEO 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. In this regard, OFHEO is authorized 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 each enterprise's 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 has adopted guidance on a number of diÅerent topics, including accounting practices, corporate governance and compensation practices. OFHEO also has exclusive administrative enforcement authority that is 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; 9 Freddie Mac violate our charter, the GSE Act, OFHEO regulations, or a written agreement with or order issued by OFHEO; or engage in conduct that threatens to cause a signiÑcant depletion of 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 U.S. generally accepted accounting principles, or 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 the restatement of our previously issued consolidated Ñnancial statements for the years ended December 31, 2000 and 2001 and the revision of fourth quarter and full-year consolidated Ñnancial statements for 2002. 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. Voluntary, Temporary Growth Limit In response to a request by OFHEO on August 1, 2006, we announced that we would voluntarily and temporarily limit the growth of our retained portfolio to 2.0% annually. On September 19, 2007, OFHEO provided an interpretation regarding the methodology for calculating the voluntary, temporary growth limit. As of March 1, 2008, this voluntary temporary growth limit will no longer be in place. Capital Standards and Dividend Restrictions The GSE Act established regulatory capital requirements for us that 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. These standards determine the amounts of core capital and total capital that we must maintain to meet regulatory capital requirements. 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% of aggregate on-balance sheet assets and approximately 0.45% 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% 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% of aggregate on-balance sheet assets and approximately 0.25% 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% 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% (up-rate scenario) and one in which they fall by as much as 50% (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. 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. 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. 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. 10 Freddie Mac 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 include 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. 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 will: (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. In a letter dated January 28, 2004, OFHEO created a framework for monitoring our capital. The letter directed that we: ‚ maintain a mandatory target capital surplus of 30% over our minimum capital requirement, subject to certain conditions and variations; ‚ submit weekly reports concerning our capital levels; and ‚ obtain OFHEO's prior approval of certain capital transactions, including common stock repurchases, redemption of any preferred stock and payment of dividends on preferred stock above stated contractual rates. Our failure to manage to 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. We reported to OFHEO that our estimated capital surplus at November 30, 2007 was below the 30% mandatory target capital surplus. In order to manage to the 30% mandatory target capital surplus and to improve business Öexibility, we reduced our common stock dividend for the fourth quarter of 2007, issued $6.0 billion of non-cumulative, perpetual preferred stock and reduced the size of our retained and cash and investments portfolio. See ""RISK FACTORS Ì Competitive and Market Risks Ì Market uncertainty and volatility may adversely aÅect our business, proÑtability, results of operations and capital management.'' However, as of December 31, 2007, we reported to OFHEO that we exceeded each of our regulatory capital requirements in addition to the 30% mandatory target capital surplus. OFHEO has announced that it will discuss with management a gradual decrease of the 30% mandatory target capital surplus as we complete the requirements of the consent order. The approach and timing of this decrease will also include consideration of our Ñnancial condition, our overall risk proÑle and current market conditions. It will also include consideration of the importance of remaining soundly capitalized to fulÑll our public purpose and recent temporary expansion of our mission. For additional information about the OFHEO mandatory target capital surplus framework, see ""NOTE 9: 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. Guidance on Non-traditional Mortgage Product Risks and Subprime Lending In October 2006, Ñve federal Ñnancial institution regulatory agencies jointly issued Interagency Guidance that clariÑed how Ñnancial institutions should oÅer non-traditional mortgage products in a safe and sound manner and in a way that clearly discloses the risks that borrowers may assume. In June 2007, the same Ñnancial institution regulatory agencies published the Ñnal interagency Subprime Statement, which addressed risks relating to subprime short-term hybrid ARMs. The Interagency Guidance and the Subprime Statement set forth principles that regulate Ñnancial institutions originating certain non-traditional mortgages (interest-only mortgages and option ARMs) and subprime short-term hybrid ARMs with respect to their underwriting practices. These principles included providing borrowers with clear and balanced 11 Freddie Mac information about the relative beneÑts and risks of these products suÇciently early in the process to enable them to make informed decisions. OFHEO has directed us to adopt practices consistent with the risk management, underwriting and consumer protection principles of the Interagency Guidance and the Subprime Statement. These principles apply to our purchases of non- traditional mortgages and subprime short-term hybrid ARMs and our related investment activities. In response, in July 2007, we informed our customers of new underwriting and disclosure requirements for non-traditional mortgages. In September 2007, we informed our customers and other counterparties of similar new requirements for subprime short-term hybrid ARMs. These new requirements are consistent with our announcement in February 2007 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. See ""RISK FACTORS Ì Legal and Regulatory Risks.'' 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 has proposed certain changes to its process for approving our debt oÅerings. The impact of these changes, if adopted, on our debt issuance activities will depend on their ultimate content and the manner in which they are implemented. Securities and Exchange Commission While we are exempt from Securities Act and Exchange Act registration and reporting requirements, we have committed to register our common stock under the Exchange Act. We plan to begin the process of registering our common stock with the SEC this year. 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 under which we will 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. Legislation GSE Regulatory Oversight Legislation We face a highly uncertain regulatory environment in light of GSE regulatory oversight legislation currently under consideration in Congress. The House of Representatives passed GSE regulatory oversight legislation on May 22, 2007. This legislation would establish a new regulator with substantial authority to assess our safety and soundness and to regulate our portfolio investments, including requiring reductions in those investments, consistent with our mission and safe and sound operation. This legislation includes provisions that would increase the regulator's authority to require us to maintain higher minimum and risk-based capital levels, and would require us to make an annual contribution from 2007 to 2011 to an aÅordable housing fund in an amount equal to 1.2 basis points of the average aggregate unpaid balance of our total mortgage portfolio. This legislation also includes provisions that would give our regulator enhanced authority to regulate our business activities, which could constrain our ability to respond quickly to a changing marketplace. 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 of our business 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. Temporary Increase in Conforming Loan Limits On February 13, 2008, the President signed into law the Economic Stimulus Act of 2008 that includes a temporary increase in conventional conforming loan limits. The law raises the conforming loan limits for mortgages originated from July 1, 2007 through December 31, 2008 to the higher of the applicable 2008 conforming loan limits, set at $417,000 for a mortgage secured by a one-unit single-family residence, or 125% of the area median house price for a residence of applicable 12 Freddie Mac size, not to exceed 175% of the applicable 2008 conforming loan limit, or $729,750 for a one-unit single-family residence. We are currently evaluating the impact this law may have on our business. 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 ""QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK,'' ""CREDIT RISKS'' and ""OPERATIONAL RISKS.'' 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. Competitive and Market Risks We are subject to mortgage credit risks and increased credit costs related to these risks could adversely aÅect our Ñnancial condition and/or results of operations. We are exposed to mortgage credit risk within our total mortgage portfolio, which consists of mortgage loans, PCs, Structured Securities and other mortgage guarantees we have issued in our guarantee business. Mortgage credit risk is the risk that a borrower will fail to make timely payments on a mortgage or an issuer will fail to make timely payments on a security we own or guarantee. Factors that aÅect the level of our mortgage credit risk include the credit proÑle of the borrower, the features of the mortgage loan, the type of property securing the mortgage and local and regional economic conditions, including regional unemployment rates and home price appreciation. Recent changes in mortgage pricing and uncertainty may limit borrowers' future ability to reÑnance in response to lower interest rates. Borrowers of the mortgage loans and securities held in our retained portfolio and underlying our guarantees may fail to make required payments of principal and interest on those loans, exposing us to the risk of credit losses. The proportion of higher risk mortgage loans that were originated in the market during the last four years increased signiÑcantly. We have increased our securitization volume of non-traditional mortgage products, such as interest-only loans and loans originated with less documentation in the last two years in response to the prevalence of these products within the origination market. Total non-traditional mortgage products, including those designated as Alt-A and interest-only loans, made up approximately 30% and 24% of our single-family mortgage purchase volume in the years ended December 31, 2007 and 2006, respectively. Our increased purchases of these mortgages and issuances of guarantees of them expose us to greater credit risks. In addition, we have increased purchases of mortgages that were underwritten by our sellers/servicers using alternative automated underwriting systems or agreed-upon underwriting standards that diÅer from our system or guidelines. Those diÅerences may increase our credit risk and may result in increases in credit losses. Furthermore, signiÑcant purchases pursuant to the temporary increase in conforming loan limits may also expose us to greater credit risks. In addition, if a recession occurs that negatively impacts national or regional economic conditions, we could experience signiÑcantly higher delinquencies and credit losses which will likely reduce our earnings or cause losses in future periods and will adversely aÅect our results of operations or Ñnancial condition. Market uncertainty and volatility may adversely aÅect our business, proÑtability, results of operations and capital management. The mortgage credit markets experienced diÇcult conditions and volatility during 2007. These deteriorating conditions in the mortgage market decreased the availability of corporate credit and liquidity within the mortgage industry in the second half of 2007 and disrupted the normal operations of major mortgage originators, including some of our largest customers. These conditions resulted in less liquidity, greater volatility, widening of credit spreads and a lack of price transparency. We operate in these markets and are subject to potential adverse eÅects on our results of operations and Ñnancial condition due to our activities involving securities, mortgages, mortgage commitments and other derivatives with our customers. Mortgage market conditions and volatility have also adversely aÅected our capital levels, including our ability to manage to the 30% mandatory target capital surplus. Factors that could adversely aÅect the adequacy of our capital for future periods include GAAP net losses; continued declines in home prices; changes in our credit and interest-rate risk proÑles; adverse changes in interest rates or implied volatility; adverse OAS changes; legislative or regulatory actions that increase capital requirements; or changes in accounting practices or standards. As a result of the impact of GAAP net losses on our regulatory core capital, we reported to OFHEO that our capital surplus at November 30, 2007 was below the 30% mandatory target capital surplus. On November 27, 2007, we also 13 Freddie Mac announced a 50% reduction in our common stock dividend for fourth quarter 2007. Also as part of these eÅorts and to improve business Öexibility, we issued $6.0 billion of non-cumulative, perpetual preferred stock and reduced the size of our cash and investments portfolio. In the future, to help us manage to the mandatory target capital surplus, we may consider additional measures, such as limiting the growth or reducing the size of our retained portfolio, slowing issuances of our credit guarantees, issuing preferred or convertible preferred stock, issuing common stock or further reducing our common stock dividend. Our ability to execute any of these actions or their eÅectiveness may be limited and we might not be able to manage to the mandatory target capital surplus. If we are not able to manage to the mandatory target capital surplus, OFHEO may, among other things, seek to require us to submit a plan for remediation or take other remedial steps. 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. See ""REGULATION AND SUPERVISION Ì OÇce of Federal Housing Enterprise Oversight Ì Capital Standards and Dividend Restrictions'' and ""NOTE 9: REGULATORY CAPITAL Ì ClassiÑcation'' to our consolidated Ñnancial statements for information regarding additional potential actions OFHEO may seek to take against us. While it is diÇcult to predict how long these conditions will exist and how our markets or products will ultimately be aÅected, these factors could adversely impact our business, our results of operations, as well as our ability to provide liquidity to the mortgage markets. 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 and loss mitigation strategies will eÅectively 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 increases the fair value of our existing guarantee obligation. We are exposed to increased credit risk related to subprime and Alt-A mortgage loans that back our non-agency mortgage- related securities investments. We invest in non-agency mortgage-related securities that are backed by Alt-A and subprime mortgage loans. Approximately $17.3 billion of non-agency mortgage-related securities in our retained portfolio backed by Alt-A and subprime mortgage loans were downgraded to ratings below AAA by at least one nationally recognized statistical rating organization between January 1, 2008 and February 25, 2008. In recent months, mortgage loan delinquencies and credit losses generally have increased, particularly in the subprime and Alt-A sectors. In addition, home prices in many areas have declined, after extended periods during which home prices appreciated. If delinquency and loss rates on subprime and Alt-A mortgages continue to increase, or there is a further decline in home prices, we could experience reduced yields or losses on our investments in non-agency mortgage-related securities backed by subprime or Alt-A loans. In addition, the fair value of these investments has declined and may be further adversely aÅected by additional ratings downgrades or market events. These factors could negatively aÅect our core capital and results of operations, if we were to conclude that other than temporary impairments occurred. We depend on our institutional counterparties to provide services that are critical to our business and our results of operations or Ñnancial condition may be adversely aÅected if one or more of our institutional counterparties is unable to meet their obligations to us. We face the risk that one or more of the institutional counterparties that has entered into a business contract or arrangement with us may fail to meet its obligations. Our primary exposures to institutional counterparty risk are with: ‚ mortgage insurers; ‚ mortgage sellers/servicers; 14 Freddie Mac ‚ issuers, guarantors or third party providers of credit enhancements (including bond insurers); ‚ mortgage investors; ‚ multifamily mortgage guarantors; ‚ issuers, guarantors and insurers of investments held in both our retained portfolio and our cash and investments portfolio; and ‚ derivatives counterparties. In some cases, our business with institutional counterparties is concentrated. A signiÑcant failure by a major institutional counterparty could have a material adverse eÅect on our retained portfolio, cash and investments portfolio or credit guarantee activities. See ""NOTE 17: CONCENTRATION OF CREDIT AND OTHER RISKS'' to our consolidated Ñnancial statements for additional information. As of December 31, 2007, our ten largest mortgage seller/servicers represented approximately 79% of our single-family mortgage purchase volume. We are exposed to the risk that we could lose purchase volume to the extent these arrangements are terminated or modiÑed and not replaced from other lenders. Some of our counterparties also may become subject to serious liquidity problems aÅecting, either temporarily or permanently, their businesses, which may adversely aÅect their ability to meet their obligations to us. Challenging market conditions have adversely aÅected and are expected to continue to adversely aÅect the liquidity and Ñnancial condition of a number of our counterparties, including some seller/servicers, mortgage insurers and bond insurers. Some of our largest seller/servicers have experienced ratings downgrades and liquidity constraints. A default by a counterparty with signiÑcant obligations to us could adversely aÅect our ability to conduct our operations eÇciently and at cost-eÅective rates, which in turn could adversely aÅect our results of operations or our Ñnancial condition. We are also exposed to risk relating to the potential insolvency or non-performance of mortgage insurers and bond insurers. At December 31, 2007, our top four mortgage insurers, each accounted for more than 10% of our overall mortgage insurance coverage, collectively represented approximately 75% of our overall mortgage insurance coverage. As of December 31, 2007, the top three of our bond insurers, each accounted for more than 20% of our overall bond insurance coverage (including secondary policies), collectively represented approximately 80% of our bond insurance coverage. See ""CREDIT RISKS Ì Institutional Credit Risk'' for additional information regarding our credit risks to our counterparties and how we manage them. A continued decline in U.S. housing prices or other changes in the U.S. housing market could negatively impact our business and earnings. The national averages for new and existing home prices in the U.S. declined in 2007 for the Ñrst time in many years. This decline follows a decade of strong appreciation and dramatic price increases in the past few years. A continued declining trend in home price appreciation in any of the geographic markets we serve could result in a continued increase in delinquencies or defaults and a level of credit-related losses higher than our expectations when our guarantees were issued, which could signiÑcantly reduce our earnings. For more information, see ""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 2007, the Federal Housing Finance Board reported that the national average price of a one-family residence had declined slightly. OFHEO subsequently announced that the conforming loan limits would be maintained at the 2007 limits for 2008 and deferred any changes for one year. But, see ""REGULATION AND SUPERVISION Ì Legislation Ì Temporary Increase in Conforming Loan Limits'' regarding the temporary increase to the conforming loan limits in the Economic Stimulus Act of 2008 for additional information. 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 7.1% in 2007 from 11.3% in 2006. 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, which could reduce our earnings and margins, as we could face more competition to purchase a smaller number of loans. Changes in general business and economic conditions may adversely aÅect our business and earnings. Our business and earnings may continue to 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 15 Freddie Mac 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. 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.). 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. 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. GAAP net losses and signiÑcant deterioration in our capital levels, as well as actions by governmental entities or others, sustained declines in our long-term proÑtability and other factors 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 or impair our liquidity by requiring us to Ñnd other sources of Ñnancing. 16 Freddie Mac 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 as 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 ""QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK'' for a description of the types of market risks to which we are exposed and how we manage those risks. Changes in OAS could materially impact our fair value of net assets and aÅect future earnings. OAS is an estimate of the yield spread between a given security and an agency debt yield curve. The OAS between the mortgage and agency debt sectors can signiÑcantly aÅect the fair value of our net assets. The fair value impact of changes in OAS for a given period represents an estimate of the net unrealized increase or decrease in the fair value of net assets arising from net Öuctuations in OAS during that period. We do not attempt to hedge or actively manage the impact of changes in mortgage-to-debt OAS. Changes in market conditions, including changes in interest rates, may cause Öuctuations in the OAS. A widening of the OAS on a given asset typically causes a decline in the current fair value of that asset and may adversely aÅect current earnings or Ñnancial condition, but may increase the number of attractive opportunities to purchase new assets for our retained portfolio. Conversely, a narrowing or tightening of the OAS typically causes an increase in the current fair value of that asset, but may reduce the number of attractive opportunities to purchase new assets for our retained portfolio. Consequently, a tightening of the OAS may adversely aÅect future earnings or Ñnancial condition. See ""MD&A Ì CONSOLIDATED FAIR VALUE BALANCE SHEETS ANALYSIS Ì Discussion of Fair Value Results'' for a more detailed description of the impacts of changes in mortgage-to-debt OAS. The loss of business volume from 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. We purchase a signiÑcant percentage of our single-family mortgages from several large mortgage originators. During the years ended December 31, 2007 and 2006, approximately 79% and 76%, respectively, of our guaranteed mortgage securities issuances originated from purchase volume associated with our ten largest customers. Three of our customers each accounted for greater than 12% of our mortgage securitization volume for the year ended December 31, 2007. We enter into mortgage purchase volume commitments with many of our customers that are renewed annually and provide for a minimum level of mortgage volume that these customers will deliver to us. One of our customers, which accounted for more than 10% of our mortgage purchase volume for the year ended December 31, 2007, reduced its minimum mortgage volume commitments to us upon renewal of its contract at July 1, 2007. In addition, ABN Amro Mortgage Group, Inc., which accounted for more than 8% of our guaranteed securitization volume for the six months ended June 30, 2007, was acquired by a third party and, as a result, its contract was not renewed when it expired in July 2007. In January 2008, Bank of America Corporation announced it would acquire Countrywide Financial Corp. Together these companies accounted for approximately 28% and 16% of our securitization volume in 2007 and 2006, respectively. Because the transaction is still pending, it is uncertain how the transaction will aÅect the volume of our securitization business in the future. The mortgage industry has been consolidating and a decreasing number of large lenders originate most single-family mortgages. The loss of business from any one of our 17 Freddie Mac major lenders could adversely aÅect our market share, our revenues and the performance of our guaranteed 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. Business and Operational Risks DeÑciencies in internal control over Ñnancial reporting and disclosure controls could result in errors, aÅect operating results and cause investors to lose conÑdence in our reported results. We face continuing challenges because of deÑciencies in our accounting infrastructure and controls and the operational complexities of our business. There are a number of factors that may impede our eÅorts to establish and maintain eÅective internal control and a sound accounting infrastructure, including: the complexity our business activities and related GAAP requirements; uncertainty regarding the operating eÅectiveness and sustainability of newly established controls; and the uncertain impacts of recent housing and credit market volatility on the reliability of our models used to develop our accounting estimates. We cannot be certain that our eÅorts to improve our internal control over Ñnancial reporting will ultimately be successful. Controls and procedures, no matter how well designed and operated, provide only reasonable assurance that material errors in our Ñnancial statements will be prevented or detected on a timely basis. A failure to establish and maintain eÅective internal control over Ñnancial reporting increases the risks of a material error in our reported Ñnancial results and delay 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. 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 in extrapolating 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 and/or historical experience. Our models could produce unreliable results for a number of reasons, including incorrect coding of the models, invalid or incorrect assumptions underlying the models, the need for manual adjustments to respond to rapid changes in economic conditions, incorrect data being used by the models or actual results that do not conform to historical trends and experience. In addition, the complexity of the models and the impact of the recent turmoil in the housing and credit markets create additional risk regarding the reliability of our 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, assumption, judgment or estimate is implemented. Any such changes may also cause diÇculties in comparisons of the Ñnancial condition or results of operations of prior or future periods. 18 Freddie Mac If our models are not reliable we could also make poor business decisions, impacting loan purchases, guarantee fee pricing, asset and liability management, or other decisions. 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 ""QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Ì Interest-Rate Risk and Other Market Risks'' for more information 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. 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 retrospectively, which may result in the revision of prior period Ñnancial statements by material amounts. In addition, as described in ""MD&A'' and ""NOTE 20: CHANGES IN ACCOUNTING PRINCIPLES'' to our consolidated Ñnancial statements, we have retrospectively applied certain changes in accounting principles that resulted in the revision of prior period Ñnancial statements by material amounts. We may be required to establish a valuation allowance against our deferred tax assets, which could materially aÅect our results of operations and capital position in the future. As of December 31, 2007, we had approximately $10.3 billion of net deferred tax assets as reported on our consolidated balance sheet. The realization of these deferred tax assets is dependent upon the generation of suÇcient future taxable income. We currently believe that it is more likely than not that we will generate suÇcient taxable income in the future to utilize these deferred tax assets. However, if future events diÅer from current forecasts, a valuation allowance may need to be established which could have a material adverse eÅect on our results of operations and capital position. 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. 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. 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. However, we can make no assurances that these measures will be suÇcient to respond to the full range of catastrophic events that may occur. 19 Freddie Mac 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 and eÅorts to remediate such weaknesses, see ""CONTROLS AND PROCEDURES 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 and loss mitigation 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. 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 ""QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK,'' ""CREDIT RISKS'' and ""OPERATIONAL RISKS'' 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. 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. 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 adversely aÅect our legislative or regulatory environment, including: ‚ any changes aÅecting our charter, aÅordable housing goals or capital (including our ability to manage to the mandatory target capital surplus); ‚ the interpretation of these developments or factors by our regulators; ‚ the adequacy of internal systems, controls and processes related to these developments or factors; ‚ the exercise or assertion of regulatory or administrative authority beyond current practice; ‚ the imposition of additional remedial measures; ‚ voluntary agreements with our regulators; or ‚ the enactment of new legislation. We are currently voluntarily limiting the growth of our retained portfolio, as described in ""REGULATION AND SUPERVISION Ì OÇce of Federal Housing Enterprise Oversight Ì Voluntary, Temporary Growth Limit.'' HUD may periodically review certain of our activities to ensure conformity with our mission and charter. In addition, the Treasury Department has proposed certain changes to its process for approving our debt oÅerings. We cannot predict the prospects for 20 Freddie Mac the timing, content or impact of any changes or whether our business activities will be restricted as a result of any such changes. 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, OFHEO or the Treasury Department 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 laws and regulations aÅecting us were signiÑcantly amended. Any of these changes could have a material 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) impose restrictions on the size of our retained portfolio, (c) make us less competitive by 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. We cannot predict when or whether any potential legislation will be enacted or regulation will be promulgated. In addition, capital levels or other operational limitations may limit our ability to purchase a signiÑcant number of additional mortgages available to us as a result of the temporary increase in conforming loan limits. See ""REGULATION AND SUPERVISION Ì Legislation Ì Temporary Increase in Conforming Loan Limits.'' 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 fair value of our assets; or our ability to recruit qualiÑed oÇcers and directors. We may make certain changes to our business in an attempt to meet HUD's housing goals and subgoals that may adversely aÅect our proÑtability. We may make 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 may purchase 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. Doing so could cause us to forgo 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 further reduce our proÑtability. 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 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 establish reserves and 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 ""LEGAL PROCEEDINGS'' for information about our pending legal proceedings. Legislation or regulation aÅecting the Ñnancial services industry 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 constitute a signiÑcant part of our customer base. Legislative or regulatory provisions that create or remove incentives for these entities either to sell 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 set of risk-based capital standards for banking organizations. The U.S. banking regulators 21 Freddie Mac have adopted new capital standards for certain banking organizations that incorporate the Basel Committee's risk-based capital standards. Decisions by U.S. banking organizations about whether to hold or sell mortgage assets could be aÅected by the new standards. However, the manner in which U.S. banking organizations may respond to them remains uncertain. The actions we are taking in connection with the Interagency Guidance and the Subprime Statement are described in ""CREDIT RISKS Ì Mortgage Credit Risk Ì Portfolio DiversiÑcation Ì Guidance on Non-traditional Mortgage Product Risks and Subprime Mortgage Lending.'' These changes to our underwriting and borrower disclosure requirements and investment standards could reduce the number of these mortgage products available for us to purchase. These initiatives may also adversely aÅect our proÑtability or our ability to achieve our aÅordable 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. We may be required to materially modify our disclosures or Ñnancial statements in connection with the process of registering our common stock with the SEC. We plan to register our common stock with the SEC during 2008. We expect that as part of the registration process, the SEC staÅ will comment on our disclosures and our Ñnancial statements as is customary during registration. The Company cannot predict the outcome of such review. However, given the complexity of our accounting, the fact that we previously have had accounting errors that resulted in the restatement of certain of our Ñnancial statements and have identiÑed numerous material weaknesses and signiÑcant deÑciencies in internal control over Ñnancial reporting and the nature of our business, the SEC may have signiÑcant comments and we may be required to modify our disclosures and Ñnancial statements in response to some of the SEC staÅ comments we receive and depending on the circumstances, such modiÑcations could be material. PROPERTIES We own a 75% 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. 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 indemniÑcation against liability arising from their wrongful actions. Litigation and claims resolution are subject to many uncertainties and are not susceptible to accurate prediction. Losses that might result from the adverse resolution of any of the remaining legal proceedings could be greater than reserves we may establish. See ""NOTE 12: LEGAL CONTINGENCIES'' to our consolidated Ñnancial statements for additional information regarding our legal proceedings. Recent Putative Securities Class Action Lawsuits. Reimer vs. Freddie Mac, Syron, Cook, Piszel and McQuade and Ohio Public Employees Retirement System vs. Freddie Mac, Syron, et al. Two virtually identical putative securities class action lawsuits were Ñled against Freddie Mac and certain of our current and former oÇcers alleging that the defendants violated federal securities laws by making ""false and misleading statements concerning our business, risk management and the procedures we put into place to protect the company from problems in the mortgage industry.'' One suit was Ñled on November 21, 2007 in the U.S. District Court for the Southern District of New York and the other was Ñled on January 18, 2008 in the U.S. District Court for the Northern District of Ohio. The plaintiÅs are seeking unspeciÑed damages and interest, reasonable costs, including attorneys' fees and equitable and other injunctive relief. At present, it is not possible to predict the probable outcomes of these lawsuits or any potential impact on our business, Ñnancial condition, or results of operation. Recent Purported Shareholder Demand Letters. In late 2007, the Board of Directors received two letters from purported shareholders of Freddie Mac alleging corporate mismanagement and breaches of Ñduciary duty in connection with the company's risk management. One letter demands that the Board commence an independent investigation into the alleged conduct, institute legal proceedings to recover damages from the responsible individuals, and implement corporate governance initiatives to ensure that the alleged problems do not recur. The other letter demands that Freddie Mac commence legal proceedings to recover damages from responsible Board members, senior oÇcers, Freddie Mac's outside 22 Freddie Mac auditors, and other parties who allegedly aided or abetted the improper conduct. The Board of Directors formed a special committee to investigate the purported shareholders' allegations. Antitrust Lawsuits. Consolidated lawsuits were Ñled against Fannie Mae and us in the U.S. District Court for the District of Columbia, originally on January 10, 2005, alleging that both companies conspired to establish and maintain 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. The New York Attorney General's Investigation. In connection with the New York Attorney General's suit Ñled against eAppraiseIT and its parent corporation, First American, alleging appraisal fraud in connection with loans originated by Washington Mutual, in November 2007, the New York Attorney General demanded that we either retain an independent examiner to investigate our mortgage purchases from Washington Mutual supported by appraisals conducted by eAppraiseIT, or immediately cease and desist from purchasing or securitizing Washington Mutual loans and any loans supported by eAppraiseIT appraisals. We also received a subpoena from the New York Attorney General's oÇce for information regarding appraisals and property valuations as they relate to our mortgage purchases and securitizations from January 1, 2004 to the present. Currently, we are discussing with the New York Attorney General and OFHEO resolution of the matter. 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 January 31, 2008, there were 646,273,620 shares outstanding of our common stock. 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 2007 Quarter Ended December 31 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ September 30ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ June 30 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ March 31 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2006 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 15, 2008, the closing price for our common stock was $28.40 per share. Sale Prices(1) High Low $65.88 67.20 68.12 68.55 $71.92 66.47 63.99 68.75 $22.90 54.97 58.62 58.88 $64.80 55.64 56.50 60.64 23 Freddie Mac Holders As of February 15, 2008, we had 2,081 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 December 31 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ September 30 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ June 30 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ March 31 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2006 Quarter Ended December 31 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ September 30 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ June 30 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ March 31 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $0.25 0.50 0.50 0.50 $0.50 0.47 0.47 0.47 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 9: REGULATORY CAPITAL'' to our consolidated Ñnancial statements for additional information regarding dividend payments and potential restrictions on such payments and ""NOTE 8: STOCKHOLDERS' EQUITY'' to our consolidated Ñnancial statements for additional information regarding our preferred stock dividend rates. 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. 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, 2002. Total return calculations assume annual dividend reinvestment. The graph does not forecast performance of our common stock. Comparative Cumulative Total Stockholder Return (in dollars) $200 $175 $150 $125 $100 $75 $50 12/31/2002 12/31/2003 12/31/2004 12/31/2005 12/31/2006 12/31/2007 Freddie Mac S&P 500 Financials S&P 500 Freddie Mac S&P 500 Financials S&P 500 2002 $100 100 100 2003 $101 131 129 24 At December 31, 2004 $130 145 143 2005 $118 155 150 2006 $126 185 173 2007 $ 65 150 183 Freddie Mac Issuer Purchases of Equity Securities On March 23, 2007, we announced that our board of directors had authorized us to repurchase up to $1 billion of outstanding shares of common stock. The repurchase program was completed in August 2007. We did not repurchase any of our common stock during the three months ended December 31, 2007 and we do not currently have any outstanding authorizations to repurchase common stock. 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 the three months ended December 31, 2007, we issued 240 million shares of Ñxed-to-Öoating rate non- cumulative, perpetual preferred stock in an oÅering underwritten by a syndicate of dealers represented by Lehman Brothers Inc. and Goldman, Sachs & Co. for aggregate oÅering proceeds of $6.0 billion and an aggregate underwriting discount of $90 million. See ""NOTE 8: STOCKHOLDERS' EQUITY'' to our consolidated Ñnancial statements for more information regarding our preferred stock oÅerings. 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 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 three months ended December 31, 2007, 13,655 stock options were exercised and no stock options were granted under our Employee Plans and Directors' Plan. Under our ESPP, 69,251 options to purchase stock were exercised and 82,566 options to purchase stock were granted. Further, during the three months ended December 31, 2007, under the Employee Plans and Directors' Plan, 89,147 restricted stock units were granted and restrictions lapsed on 178,758 restricted stock units. See ""NOTE 10: STOCK-BASED COMPENSATION'' 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 July 9, 2007, 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. 25 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 the ""BUSINESS'' and ""MD&A'' sections of 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 ""seek,'' ""forecasts,'' ""objective,'' ""believe,'' ""expect,'' ""outlook,'' ""plan,'' ""uncertain,'' ""future,'' ""potential,'' ""assumptions,'' ""judgments,'' ""estimates,'' ""continue,'' ""ability,'' ""may,'' ""anticipate,'' ""indicator,'' ""eÅorts,'' ""long-term,'' ""if,'' ""likely,'' ""might,'' ""could,'' ""would,'' 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 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; ‚ 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; ‚ further adverse rating actions by credit rating agencies in respect of structured credit products, other credit-related exposures, or mortgage or bond insurers; ‚ changes in general economic conditions, including the risk of U.S. or global economic recession, regional employment rates, liquidity of the markets and availability of credit in the markets; ‚ our ability to manage and forecast our capital levels; ‚ 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 manage and implement changes, developments or impacts of accounting or tax standards and interpretations; ‚ changes in the loans available for us to purchase, such as increases or decreases in the conforming loan limits; ‚ 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; ‚ the rate of growth in total outstanding U.S. residential mortgage debt, the size of the U.S. residential mortgage market and , homeownership rates, supply and demand of available multifamily housing; ‚ direct and indirect impacts of continuing deterioration of subprime and other real estate markets; ‚ the levels and volatility of interest rates, mortgage-to-debt option adjusted spreads, and home prices; ‚ preferences of originators in selling into the secondary market and borrower preferences for Ñxed-rate mortgages or ARMs; ‚ Investor preferences for mortgage loans and mortgage-related and debt securities versus other investments; 26 Freddie Mac ‚ the occurrence of a major natural or other disaster in geographic areas that would adversely aÅect our Total mortgage portfolio holdings; ‚ 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. 27 Freddie Mac SELECTED FINANCIAL DATA AND OTHER OPERATING MEASURES(1) Income Statement Data Net interest incomeÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ Non-interest income (loss) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Net income (loss) before cumulative eÅect of change in accounting principle ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Cumulative eÅect of change in accounting principle, net of taxesÏÏÏÏÏÏ Net income (loss) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Net income (loss) available to common stockholders ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ Earnings (loss) per common share before cumulative eÅect of change in accounting principle: Basic ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ Diluted ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Earnings (loss) per common share after cumulative eÅect of change in accounting principle: Basic ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ Diluted ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Dividends per common share ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ Weighted average common shares outstanding (in thousands): At or for the Year Ended December 31, Adjusted(1) 2007 2006 2005 2004 2003 (dollars in millions, except share-related amounts) 3,099 194 $ (3,094) Ì (3,094) (3,503) $ (5.37) (5.37) (5.37) (5.37) 1.75 $ $ $ 3,412 2,086 2,327 Ì 2,327 2,051 3.01 3.00 3.01 3.00 1.91 $ $ $ $ $ 4,627 1,003 2,172 (59) 2,113 1,890 2.82 2.81 2.73 2.73 1.52 $ $ $ $ $ 8,313 (2,723) $ 2,603 Ì 2,603 2,392 3.47 3.46 3.47 3.46 1.20 $ $ $ $ 8,598 532 4,809 Ì 4,809 4,593 6.68 6.67 6.68 6.67 1.04 Basic ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Diluted ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 651,881 651,881 Balance Sheet Data Total assetsÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 794,368 295,921 Senior debt, due within one year ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 438,147 Senior debt, due after one year ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 4,489 Subordinated debt, due after one year ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 28,911 All other liabilitiesÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 176 Minority interests in consolidated subsidiaries ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Stockholders' equity ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 26,724 Portfolio Balances(2) Retained portfolio(3) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 720,813 Total PCs and Structured Securities issued(4) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 1,738,833 2,102,676 Total mortgage portfolio ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Non-performing Assets(5) Troubled debt restructurings ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ Real estate owned, net ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Other delinquent loans ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total non-performing assets ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 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 Preferred stock to core capital ratio(11) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 3,621 1,736 13,089 18,446 (0.4)% (21.0) (11.5) N/A 3.4 37.3 680,856 682,664 691,582 693,511 689,282 691,521 687,094 688,675 $ 804,910 285,264 452,677 6,400 33,139 516 26,914 $ 703,959 1,477,023 1,826,720 $ 798,609 279,764 454,627 5,633 31,945 949 25,691 $ 710,346 1,335,524 1,684,546 $ 779,572 266,024 443,772 5,622 32,720 1,509 29,925 $ 653,261 1,208,968 1,505,531 $ $ 3,103 743 5,700 9,546 $ 2,605 629 6,439 9,673 2,297 741 6,345 9,383 $ 787,962 279,180 438,738 5,613 32,094 1,929 30,408 $ 645,767 1,162,068 1,414,700 $ 2,370 795 7,491 10,656 0.3% 9.8 8.8 63.9 3.3 17.3 0.3% 8.1 7.6 56.9 3.5 13.2 0.3% 9.4 8.6 34.9 3.8 13.5 0.6% 17.7 15.8 15.6 4.0 14.2 (1) See ""NOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES'' and ""NOTE 20: CHANGES IN ACCOUNTING PRINCIPLES'' to our consolidated Ñnancial statements for more information regarding our accounting policies and adjustments made to previously reported results due to changes in accounting principles. 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 certain mortgage-backed securities. EÅective January 1, 2005, we changed to the eÅective interest method of accounting for interest expense related to callable debt. (2) Represent the unpaid principal balance and exclude mortgage loans and mortgage-related securities traded, but not yet settled. EÅective December 2007, we established a trust for the administration of cash remittances received related to the underlying assets of our PCs and Structured Securities issued. As a result, we adjusted the reported balance of our mortgage portfolios to reÖect the publicly-available security balances of our PCs and Structured Securities. Previously, we reported these balances based on the unpaid principal balance of the underlying mortgage loans. (3) 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 22 Ì Characteristics of Mortgage Loans and Mortgage-Related Securities in our Retained Portfolio'' for more information. (4) Excludes Structured Securities for which we have resecuritized our PCs and Structured Securities. These resecuritized 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. Includes other guarantees issued that are not in the form of a PC, such as long-term stand-by commitments and credit enhancements for multifamily housing revenue bonds. (5) Represents mortgage loans held in our retained portfolio, as well as mortgage loans backing our guaranteed PCs and Structured Securities, including those held by third parties. (6) Ratio computed as net income (loss) divided by the simple average of the beginning and ending balances of total assets. (7) Ratio computed as net income (loss) available to common stockholders divided by the simple average of the beginning and ending balances of stockholders' equity, net of preferred stock (at redemption value). (8) Ratio computed as net income (loss) divided by the simple average of the beginning and ending balances of stockholders' equity. (9) Ratio computed as common stock dividends declared divided by net income available to common stockholders. For the year ended December 31, 2007, net income (loss) available to common stockholders was a loss, thus this calculation is not applicable. (10) Ratio computed as the simple average of the beginning and ending balances of stockholders' equity divided by the simple average of the beginning and ending balances of total assets. (11) Ratio computed as preferred stock, at redemption value divided by core capital. See ""NOTE 9: REGULATORY CAPITAL'' to our consolidated Ñnancial statements for more information regarding core capital. 28 Freddie Mac MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS EXECUTIVE SUMMARY Our Business We generate income through our portfolio investment activities and credit guarantee activities, operating as three reportable segments: Investments, Single-family Guarantee and Multifamily. To achieve our objectives for long-term growth, we focus on three long-term business drivers Ì the proÑtability of new business, growth 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. Market Overview The U.S. residential mortgage market weakened considerably during 2007, adversely aÅecting our Ñnancial condition and results of operations. We expect that weakened conditions in the residential mortgage market will continue in 2008. Home prices declined in 2007. The volume of new and existing home sales continued to decline and increased inventories of unsold homes have undermined property values. Forecasts of nationwide home prices indicate a continued overall decline through 2008. Changes in home prices are an important market indicator for us. When home prices decline, the risk of borrower defaults and the severity of credit losses generally increase. Credit concerns and resulting liquidity issues aÅected the Ñnancial markets. Recently, the market for mortgage-related securities has been characterized by high levels of volatility and uncertainty, reduced demand and liquidity, signiÑcantly wider credit spreads and a lack of price transparency. Mortgage-related securities, particularly those backed by non- traditional mortgage products, have been subject to various rating agency downgrades and price declines. Many lenders tightened credit standards in the second half of 2007 or stopped originating certain types of mortgages for riskier products in the market, such as some types of ARMs, resulting in higher mortgage rates. This response has adversely aÅected many borrowers seeking to reÑnance out of ARMs scheduled to reset to higher rates, contributing to higher observed delinquencies. The credit performance of all mortgage products deteriorated during 2007; however, the performance of subprime, Alt- A loans and other non-traditional mortgage products deteriorated more severely. See ""CREDIT RISKS Ì Mortgage Credit Risk'' for additional information regarding mortgage-related securities backed by subprime and Alt-A loans. Consolidated Results Ì GAAP EÅective December 31, 2007, we retrospectively changed our method of accounting for our guarantee obligation: a) to a policy of no longer extinguishing our guarantee obligation when we purchase all or a portion of a Freddie Mac-guaranteed security from a policy of eÅective extinguishment through the recognition of a Participation CertiÑcate residual and b) to a policy that amortizes our guarantee obligation into earnings in a manner that corresponds more closely to our economic release from risk under our guarantee than our former policy, which amortized our guarantee obligation according to the contractual expiration of our guarantee as observed by the decline in the unpaid principal balance of securitized mortgage loans. While our previous accounting is acceptable, we believe the newly adopted method of accounting for our guarantee obligation is preferable because it: ‚ signiÑcantly enhances the transparency and understandability of our Ñnancial results; ‚ promotes uniformity in the accounting model for the credit risk retained in our primary credit guarantee business; ‚ better aligns revenue recognition to the release from economic risk of loss under our guarantee; and ‚ increases comparability with other similar Ñnancial institutions. The results of operations for all periods presented in this discussion reÖect the retrospective application of our new method of accounting for our guarantee obligation. The net cumulative eÅect of these changes in accounting principles through December 31, 2007 was an increase to our retained earnings of $1.3 billion. See ""NOTE 20: CHANGES IN ACCOUNTING PRINCIPLES'' to our consolidated Ñnancial statements for additional information. In 2007, we reported net losses of $(3.1) billion, or $(5.37) per diluted share, compared to net income of $2.3 billion, or $3.00 per diluted share, in 2006. Net losses in 2007 were primarily due to higher credit-related expenses and mark-to- market losses on our portfolio of derivatives and guarantee assets. Without giving eÅect to the changes in accounting method, net losses would have been $(3.7) billion for the fourth quarter of 2007 and $(5.2) billion for the year ended December 31, 2007. Net interest income decreased to $3.1 billion in 2007 from $3.4 billion in 2006. The decline in net interest income reÖected higher replacement costs associated with the funding of our retained portfolio. Our long-term debt interest costs increased because our lower-rate debt matured and was replaced with higher-rate debt. 29 Freddie Mac In 2007, management and guarantee income increased to $2.6 billion from $2.4 billion in 2006, resulting from a 13% increase in the average balance of our PCs and Structured Securities issued. Despite increases in contractual guarantee fees, our total management and guarantee fee rate decreased to 16.6 basis points in 2007 from 17.1 basis points in 2006, primarily attributable to declines in amortization income resulting from slower prepayment projections in 2007. Other components of non-interest income (loss) totaled $(2.4) billion in 2007, compared to $(0.3) billion in 2006. These amounts include $(4.3) billion of valuation losses in 2007 compared to $(1.3) billion in 2006. The change in valuation losses was primarily attributable to the impact of decreasing long-term interest rates on our derivatives portfolio. Our valuation losses in 2007 were partially oÅset by $0.5 billion of recoveries on loans impaired upon purchase. Credit-related expenses, which consist of the total of provision for credit losses and real estate owned, or REO, operations expense, were $3.1 billion and $0.4 billion in 2007 and 2006, respectively. In 2007, our provision for credit losses increased due to signiÑcant credit deterioration in our single-family credit guarantee portfolio. Other non-interest expense included losses on certain credit guarantees and losses on loans purchased, which totaled $3.9 billion in 2007, compared to $0.6 billion in 2006. Increases in losses on certain credit guarantees reÖect expectations of higher defaults and severity in the credit market in 2007 which were not fully oÅset by increases in guarantee and delivery fees due to competitive pressures and contractual fee arrangements. Increases in losses on loans purchased reÖect reduced fair values and higher volume of delinquent loans purchased under our guarantees. See "CONSOLIDATED RESULTS OF OPERATIONS Ì Non-Interest Expenses Ì Losses on Certain Credit Guarantees'' for additional information. We reported income tax expense (beneÑt) of $(2.9) billion and $(45) million in 2007 and 2006 resulting in eÅective tax rates of 48% and (2)%, respectively. See ""NOTE 13: INCOME TAXES'' to our consolidated Ñnancial statements for additional information. Segment Results-Adjusted Operating Income Our operations consist of three reportable segments, which are based on the type of business activities each performs Ì Investments, Single-family Guarantee and Multifamily. The activities of our business segments are described in ""BUSINESS Ì Business Activities.'' Certain activities that are not part of a segment are included in the ""All Other'' category; this category consists of certain unallocated corporate items, such as remediation and restructuring costs, costs related to the resolution of certain legal matters and certain income tax items. We manage and evaluate performance of the segments and All Other using an Adjusted operating income approach. Adjusted operating income diÅers signiÑcantly from, and should not be used as a substitute for net income (loss) before cumulative eÅect of change in accounting principle or net income (loss) as determined in accordance with GAAP. There are important limitations to using Adjusted operating income as a measure of our Ñnancial performance. Among other things, our regulatory capital requirements are based on our GAAP results. Adjusted operating income adjusts for the eÅects of certain gains and losses and mark-to-market items which, depending on market circumstances, can signiÑcantly aÅect, positively or negatively, our GAAP results and which, in recent periods, have caused us to record GAAP net losses. GAAP net losses will adversely impact our regulatory capital, regardless of results reÖected in Adjusted operating income. See ""CONSOLIDATED RESULTS OF OPERATIONS Ì Segment Measures Ì Adjusted Operating Income'' for a description of ""Adjusted operating income'' and a discussion of its use as a measure of segment operating performance. The objective of Adjusted operating income is to present our results on an accrual basis as the cash Öows from our segments are earned over time. We are primarily a buy and hold investor in mortgage assets, and given our business objectives, we believe it is meaningful to measure performance of our investment business using long-term returns, not on a short-term fair value basis. The business model for our investment activity is one where we generally hold our investments for the long term, fund the investments with debt and derivatives to minimize interest rate risk, and generate net interest income in line with our return on equity objectives. The business model for our credit guarantee activity is one where we are a long-term guarantor of the conforming mortgage markets, manage credit risk, and generate guarantee and credit fees, net of incurred credit losses. As a result of these business models, we believe that an accrual-based metric is a meaningful way to present the emergence of our results as actual cash Öows are realized, net of credit losses and impairments. In summary, Adjusted operating income provides us with a view of our Ñnancial results that is more consistent with our business objectives, which helps us better evaluate the performance of our business, both from period to period and over the longer term. Table 6 presents Adjusted operating income by segment and the All Other category and includes a reconciliation of Adjusted operating income to net income (loss) prepared in accordance with GAAP. 30 Freddie Mac Table 6 Ì Reconciliation of Adjusted Operating Income to GAAP Net Income (Loss) 2007 Year Ended December 31, 2006 (in millions) 2005 Adjusted operating income (loss) after taxes: Investments ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Single-family Guarantee ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Multifamily ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ All Other ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total Adjusted operating income, net of taxes ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Reconciliation to GAAP net income (loss): Derivative- and foreign currency translation-related adjustments ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Credit guarantee-related adjustments ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Investment sales, debt retirements and fair value-related adjustmentsÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Fully taxable-equivalent adjustments ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total pre-tax adjustments ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Tax-related adjustmentsÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total reconciling items, net of taxesÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Net income (loss)(1) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 2,028 (256) 398 (103) 2,067 (5,667) (3,268) 987 (388) (8,336) 3,175 (5,161) $(3,094) $ 2,111 1,289 434 19 3,853 (2,371) (201) 231 (388) (2,729) 1,203 (1,526) $ 2,284 965 363 (437) 3,175 (1,644) (458) 570 (336) (1,868) 865 (1,003) $ 2,327 $ 2,172 (1) Total per consolidated statement of income reÖects the impact of the adjustments described in ""NOTE 20: CHANGES IN ACCOUNTING PRINCIPLES'' to our consolidated Ñnancial statements. Additionally, Net income (loss) is presented before the cumulative eÅect of a change in accounting principle related to 2005. Investments Through our Investments segment, we seek to generate attractive returns on our mortgage-related investment portfolio while maintaining a disciplined approach to interest-rate risk and capital management. We seek to accomplish this objective through opportunistic purchases, sales and restructuring of mortgage assets. Although we are primarily a buy and hold investor in mortgage assets, we may sell assets to reduce risk, respond to capital constraints, provide liquidity or structure certain transactions that improve our returns. We estimate our expected investment returns using an OAS approach. Adjusted operating income for our Investments segment declined in 2007 compared to 2006. We experienced higher funding costs in 2007 for our mortgage-related investment portfolio as our long-term debt interest expense increased, reÖecting the replacement of maturing debt. Performance Highlights of 2007 versus 2006: ‚ Unpaid principal balance of our mortgage-related investment portfolio increased 1% to $663 billion at December 31, 2007. ‚ Adjusted operating net interest yield was Öat in 2007, as compared to 2006, due to increased funding costs oÅset by a decline in amortization expense of our mortgage-related portfolio. ‚ Capital constraints limited our ability to signiÑcantly increase our mortgage-related investment portfolio in order to take advantage of wider mortgage-to-debt OAS. Single-family Guarantee Through our Single-family Guarantee segment, we seek to issue guarantees that we believe oÅer attractive long-term returns relative to anticipated credit costs while fulÑlling our mission to provide liquidity, stability and aÅordability in the residential mortgage market. In addition, we seek to improve our share of the total residential mortgage securitization market by enhancing customer service and expanding our customer base, the types of mortgages we guarantee and the products we oÅer. Adjusted operating income for our Single-family Guarantee segment declined in 2007 compared to 2006. In 2007, we experienced an increase in credit costs largely driven by higher volumes of both non-performing loans and foreclosures, higher severity of losses on a per-property basis, a national decline in home prices and declines in regional economic conditions. Performance Highlights of 2007 versus 2006: ‚ Credit guarantee portfolio increased by 17.7% for the year ended December 31, 2007, compared to 11.1% for the year ended December 31, 2006. ‚ Average rates of Adjusted operating management and guarantee fee income for the Single-family Guarantee segment remained unchanged at 18.0 basis points. ‚ Adjusted operating provision for credit losses for the Single-family Guarantee segment increased to $3.0 billion for the year ended December 31, 2007 from $0.3 billion for the year ended December 31, 2006. 31 Freddie Mac ‚ Realized single-family credit losses in 2007 were 3.0 basis points of the average total mortgage portfolio, excluding non-Freddie Mac securities, compared to 1.4 basis points in 2006. ‚ Announced signiÑcant delivery fee increases eÅective March 2008. Also, in February 2008, we announced an additional increase in delivery fees, eÅective June 2008, for certain Öow transactions. Multifamily Through our Multifamily segment, we seek to generate attractive returns on our investments in multifamily mortgage loans while fulÑlling our mission to supply aÅordable rental housing. We also seek to issue guarantees that we believe oÅer attractive long-term returns relative to anticipated credit costs. Adjusted operating income for our Multifamily segment decreased in 2007 compared to 2006 as a result of a decrease in net interest income. The decrease in net interest income is primarily attributable to increased debt expense related to higher debt funding costs as well as lower interest yields on the portfolio. Despite market volatility and credit concerns in the single-family market, the multifamily market fundamentals generally continued to display positive trends. Tightened credit standards and reduced liquidity caused many market participants to limit purchases of multifamily mortgages during the second half of 2007, creating investment opportunities for us with higher long-term expected returns and enhancing our ability to meet our aÅordable housing goals. Despite the investment limitations created by our current capital position, our purchases of multifamily retained mortgages were at record levels in 2007. Performance Highlights of 2007 versus 2006: ‚ Mortgage purchases into our multifamily loan portfolio increased approximately 50% in 2007, to $18.2 billion from $12.1 billion in 2006. ‚ Unpaid principal balance of our mortgage loan portfolio increased to $57.6 billion at December 31, 2007 from $45.2 billion at December 31, 2006. ‚ Our provision for credit losses for the Multifamily segment remained low at $38 million for the year ended December 31, 2007. 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. We make investment decisions based on our capital levels. OFHEO monitors our capital adequacy using several capital standards and since 2004 has directed a 30% mandatory target capital surplus above our regulatory minimum capital requirement. Weakness in the housing market and volatility in the Ñnancial markets continue to adversely aÅect our capital, including our ability to manage to the 30% mandatory target capital surplus. As a result of the impact of GAAP net losses on our regulatory core capital, our estimated capital surplus was below the 30% mandatory target capital surplus at the end of November 2007. In order to manage to the 30% mandatory target capital surplus and improve business Öexibility, on December 4, 2007, we issued $6 billion of non-cumulative, perpetual preferred stock. In addition, during the fourth quarter of 2007, we reduced our common stock dividend by 50% and reduced the size of our cash and investments portfolio. In the future, to help us manage to the 30% mandatory target capital surplus, we may consider additional measures, such as limiting the growth or reducing the size of our retained portfolio, slowing issuances of our credit guarantees, issuing preferred or convertible preferred stock, issuing common stock or further reducing our common stock dividend. Factors that could adversely aÅect the adequacy of our capital in future periods include GAAP net losses; continued declines in home prices; changes in our credit and interest-rate risk proÑles; adverse changes in interest rates or implied volatility; adverse OAS changes; legislative or regulatory actions that increase capital requirements; or changes in accounting practices or standards. Other items positively aÅecting our capital position include: (a) certain operational changes in December 2007 for purchasing delinquent loans from PCs, (b) changes in accounting principles we adopted, which increased core capital by $1.3 billion at December 31, 2007 and (c) our adoption of SFAS No. 159, ""The Fair Value Option of Financial Assets and Financial Liabilities, including an amendment of FASB Statement No. 115,'' or SFAS 159, on January 1, 2008, which increased core capital by an estimated $1.0 billion. We will submit amended quarterly minimum and critical capital reports to OFHEO that are adjusted to reÖect the impacts of the retrospective application of our changes in method of accounting for our guarantee obligation. OFHEO is the authoritative source for our regulatory capital calculations. However, we believe that we remain adequately capitalized for all historical quarters, on an adjusted basis. At December 31, 2007 our estimated regulatory core capital was $37.9 billion after the eÅects of the adjustments, which was an estimated $11.4 billion in excess of our minimum capital requirement and 32 Freddie Mac $3.5 billion in excess of the 30% mandatory target capital surplus. See ""NOTE 9: REGULATORY CAPITAL'' to our consolidated Ñnancial statements for additional information about our regulatory capital. Fair Value Results We use estimates of fair value on a routine basis to make decisions about our business activities. Our attribution of the changes in fair value relies on models, assumptions and other measurement techniques that will evolve over time. Our consolidated fair value measurements are a component of our risk management processes. For information about how we estimate the fair value of Ñnancial instruments, see ""NOTE 16: FAIR VALUE DISCLOSURES'' to our consolidated Ñnancial statements. In 2007, the fair value of net assets attributable to common stockholders, before capital transactions, decreased by $23.6 billion, compared to a $2.5 billion increase in 2006. The payment of common dividends and the repurchase of common shares, net of reissuance of treasury stock, reduced total fair value by an additional $2.1 billion. The fair value of net assets attributable to common stockholders as of December 31, 2007 was $0.3 billion, compared to $26.0 billion as of December 31, 2006. The following attribution of changes in fair value reÖects 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 decreased fair value by approximately $18.1 billion in 2007. This estimate includes declines in fair value of approximately $23.8 billion attributable to net mortgage-to-debt OAS widening. Of this amount, approximately $13.4 billion was related to the impact of the net mortgage-to-debt OAS widening on our portfolio of non-agency mortgage- related securities. Our investment activities increased fair value by an estimated $1.3 billion in 2006. This increase in fair value was primarily attributable to the core spread earned on our retained portfolio. The impact of mortgage-to-debt OAS widening during 2007 increases the likelihood that, in future periods, we will be able to recognize core spread income from our investment activities at a higher spread level. We estimate that we recognized core spread income at a net mortgage-to-debt OAS level of approximately 100 to 105 basis points at December 31, 2007, as compared to approximately 25 to 30 basis points estimated at December 31, 2006. See ""CONSOLIDATED FAIR VALUE BALANCE SHEETS ANALYSIS Ì Discussion of Fair Value Results Ì Estimated Impact of Changes in Mortgage-To- Debt OAS on Fair Value Results'' for additional information. Our credit guarantee activities, including multifamily and single-family whole loan credit exposure, decreased fair value by an estimated $18.5 billion in 2007. This estimate includes an increase in the single-family guarantee obligation of approximately $22.2 billion, primarily attributable to higher expected future credit costs and increased uncertainty in the market. This increase in the single-family guarantee obligation was partially oÅset by a fair value increase in the single- family guarantee asset of approximately $2.1 billion and cash receipts related to management and guarantee fees and other up-front fees. During 2006, our credit guarantee activities increased fair value by an estimated $1.9 billion. This estimate includes a fair value increase related to the single-family guarantee asset of approximately $0.9 billion and cash receipts related to management and guarantee fees and other up-front fees. These increases were partially oÅset by an increase in the single- family guarantee obligation of approximately $1.3 billion. Business Outlook We expect that our realized credit losses will continue to increase, which will adversely aÅect the proÑtability of our Single-family Guarantee segment. We expect the increase will be largely driven by the credit characteristics of loans originated in 2006 and 2007, which are generally of lower credit quality than loans underlying our issuances in prior years. In addition, the average management and guarantee fees on our 2007 issuances did not keep pace with the increase in expected default costs on the underlying loans. We expect to continue to pursue increases to our guarantee fees and delivery fees on bulk and Öow transactions to better reÖect our expectations of future default costs. We expect to continue to experience attractive purchase opportunities for our retained portfolio, due to wider mortgage spreads and continued attractive debt funding levels. As a result of the temporary increase in the conventional conforming loan limits, we expect to purchase mortgages with signiÑcantly higher unpaid principal balances. Our ability to purchase these mortgages is subject to certain operational constraints and any conditions that may be imposed by our regulators as well as our ability to manage the additional credit risks associated with such mortgages. In addition, our ability to take full advantage of these and other market opportunities may also be limited by our ability to manage to the 30% mandatory target capital surplus and our voluntary, temporary growth limit. The turmoil in the credit and mortgage markets is also presenting opportunities to proÑtably grow our single-family and multifamily portfolios. We expect our share of the mortgage securitization market to grow as mortgage originators have 33 Freddie Mac generally tightened their credit standards during 2007, causing conforming mortgages to be the predominant product in the market. We expect to begin the process of registering our common stock with the SEC in 2008. As a part of this initiative, we expect to complete the remediation of the material weaknesses in our Ñnancial reporting processes. Although we have made substantial progress in the remediation of our control deÑciencies, the process of registering with the SEC and meeting our ongoing reporting obligations once our common stock is registered poses signiÑcant operational challenges for us. Over the next two years, we believe we should be able to reduce administrative expenses. We expect to begin this process in 2008, as we complete our Ñnancial remediation eÅorts and beneÑt from our investments in new technology. We expect that it will be challenging for us to achieve HUD's aÅordable housing goals and subgoals for 2008, due to the signiÑcant changes in the residential mortgage market that occurred in 2007 and that are likely to continue well into 2008. These changes include a decrease in single-family home sales that began in 2005 and deteriorating conditions in the mortgage credit markets, which have resulted in more rigorous underwriting standards, and greatly reduced originations of subprime and Alt-A mortgages. 34 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. EÅective December 31, 2007, we retrospectively changed our method of accounting for our guarantee obligation: a) to a policy of no longer extinguishing our guarantee obligation when we purchase all or a portion of a Freddie Mac-guaranteed security from a policy of eÅective extinguishment through the recognition of a Participation CertiÑcate residual and b) to a policy that amortizes our guarantee obligation into earnings in a manner that corresponds more closely to our economic release from risk under our guarantee than our former policy, which amortized our guarantee obligation according to the contractual expiration of our guarantee as observed by the decline in the unpaid principal balance of securitized mortgage loans. While our previous accounting is acceptable, we believe the newly adopted method of accounting for our guarantee obligation is preferable because it: ‚ signiÑcantly enhances the transparency and understandability of our Ñnancial results; ‚ promotes uniformity in the accounting model for the credit risk retained in our primary credit guarantee business; ‚ better aligns revenue recognition to the release from economic risk of loss under our guarantee; and ‚ increases comparability with other similar Ñnancial institutions. All of the results of operations discussed below for years ended December 31, 2006 and 2005 are shown as ""Adjusted'' in the tables to reÖect the retrospective application of our new method of accounting for our guarantee obligation. Results for the quarters of 2007 and the twelve months ended 2007 reÖect these changes for the full periods presented. On October 1, 2007, we adopted FASB Interpretation No. 39-1, ""Amendment to FASB Interpretation No. 39,'' or FSP FIN 39-1. See ""NOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Ì Recently Adopted Accounting Standards Ì OÅsetting of Amounts Related to Certain Contracts'' to our consolidated Ñnancial statements for additional information about our adoption of FSP FIN 39-1. The adoption of FSP FIN 39-1 had no eÅect on our consolidated statements of income. The net cumulative eÅect of these changes in accounting principles through December 31, 2007 was an increase to our net income of $1.3 billion, which includes a net cumulative increase of $2.2 billion for 2005, 2006 and 2007 and a net cumulative decrease of $0.9 billion related to periods prior to 2005. See ""NOTE 20: CHANGES IN ACCOUNTING PRINCIPLES'' to our consolidated Ñnancial statements for additional information. Table 7 Ì Summary Consolidated Statements of Income Ì GAAP Results Net interest income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Non-interest income: Management and guarantee income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Gains (losses) on guarantee asset ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Income on guarantee obligation ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Derivative gains (losses)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Gains (losses) on investment activity ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Gains on debt retirement ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Recoveries on loans impaired upon purchase ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Foreign-currency gains (losses), net ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Other income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Non-interest income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Non-interest expense: Administrative expenses ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Other expenses ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Non-interest expense ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Income (loss) before income tax (expense) beneÑt and cumulative eÅect of change in accounting principle Income tax (expense) beneÑt ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Net income (loss) before cumulative eÅect of change in accounting principle ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Cumulative eÅect of change in accounting principle, net of tax ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Net income (loss) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Year Ended December 31, Adjusted 2007 $ 3,099 2006 (in millions) $ 3,412 2005 $ 4,627 2,635 (1,484) 1,905 (1,904) 294 345 505 (2,348) 246 194 2,393 (978) 1,519 (1,173) (473) 466 Ì 96 236 2,086 (1,674) (7,596) (9,270) (5,977) 2,883 (3,094) (1,641) (1,575) (3,216) 2,282 45 2,327 Ì $(3,094) $ 2,327 Ì 2,076 (1,409) 1,428 (1,321) (97) 206 Ì (6) 126 1,003 (1,535) (1,565) (3,100) 2,530 (358) 2,172 (59) $ 2,113 35 Freddie Mac 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. Table 8 Ì Average Balance, Net Interest Income and Rate/Volume Analysis Year Ended December 31, Adjusted 2007 2006 2005 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 portfolio ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Investments(5) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Securities purchased under agreements to resell and $ 70,890 645,844 716,734 43,910 federal funds sold ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total interest-earning assets ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 24,469 $785,113 Interest-bearing liabilities: Short-term debt ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Long-term debt(6)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total debt securities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Due to PC investors ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total interest-bearing liabilitiesÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Expense related to derivativesÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 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 $174,418 576,973 751,391 7,820 759,211 25,902 $785,113 $ 4,449 34,893 39,342 2,285 1,283 $ 42,910 $ (8,916) (29,148) (38,064) (418) (38,482) (1,329) Ì $(39,811) 3,099 $ 392 6.28% 5.40 5.49 5.20 5.25 5.46 (5.11) (5.05) (5.07) (5.35) (5.07) (0.17) 0.17 (5.07) 0.39 0.05 $ 63,870 650,992 714,862 57,705 28,577 $801,144 $179,882 587,978 767,860 7,475 775,335 25,809 $801,144 $ 4,152 33,850 38,002 2,789 1,473 $ 42,264 $ (8,665) (28,218) (36,883) (387) (37,270) (1,582) Ì $(38,852) 3,412 $ 392 6.50% 5.20 5.32 4.83 5.15 5.28 (4.82) (4.80) (4.80) (5.18) (4.81) (0.20) 0.16 (4.85) 0.43 0.04 $ 61,256 611,761 673,017 53,252 25,344 $751,613 $192,497 524,270 716,767 10,399 727,166 24,447 $751,613 $ 4,010 28,968 32,978 1,773 833 $ 35,584 $ (6,102) (23,246) (29,348) (551) (29,899) (1,058) Ì $(30,957) $ 4,627 339 6.55% 4.74 4.90 3.33 3.28 4.73 (3.17) (4.43) (4.09) (5.30) (4.11) (0.15) 0.14 (4.12) 0.61 0.05 $ 3,491 0.44% $ 3,804 0.47% $ 4,966 0.66% 2007 vs. 2006 Variance Due to 2006 vs. 2005 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 portfolio ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Investments ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Securities purchased under agreements to resell and federal funds sold ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total interest-earning assets ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Interest-bearing liabilities: Short-term debt ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Long-term debtÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total debt securities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Due to PC investors ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total interest-bearing liabilitiesÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Expense related to derivativesÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total funding of interest-earning assets ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Net interest income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Fully taxable-equivalent adjustments ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Net interest income (fully taxable-equivalent basis) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ (147) 1,312 1,165 201 25 $ 1,391 $ (520) (1,465) (1,985) (13) (1,998) 253 $(1,745) $ (354) 9 $ (345) $ 444 (269) 175 (705) (215) $(745) $ 269 535 804 (18) 786 Ì $ 786 41 $ (9) 32 $ (in millions) $ $ 297 1,043 1,340 (504) (190) 646 $ (251) (930) (1,181) (31) (1,212) 253 $ (959) $ (313) Ì $ (28) 2,952 2,924 857 523 $ 4,304 $(2,986) (2,008) (4,994) 12 (4,982) (524) $(5,506) $(1,202) 29 $ (313) $(1,173) $ 170 1,930 2,100 159 117 $ 2,376 $ 423 (2,964) (2,541) 152 (2,389) Ì $(2,389) (13) $ 24 11 $ Total Change $ 142 4,882 5,024 1,016 640 $ 6,680 $(2,563) (4,972) (7,535) 164 (7,371) (524) $(7,895) $(1,215) 53 $(1,162) (1) Excludes mortgage loans and mortgage-related securities traded, but not yet settled. (2) For securities in our retained and investment portfolios, 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. (3) Non-performing loans, where interest income is recognized when collected, are included in average balances. (4) Loan fees included in mortgage loan interest income were $290 million, $280 million and $371 million for the years ended December 31, 2007, 2006 and 2005, respectively. (5) Consist of cash and cash equivalents and non-mortgage-related securities. (6) Includes current portion of long-term debt. See ""NOTE 7: 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 federal statutory tax rate of 35%. (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. 36 Freddie Mac Table 9 summarizes components of our net interest income. Table 9 Ì Net Interest Income Contractual amounts of net interest income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 6,038 Amortization expense, net:(1) Asset-related amortization expense, net ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Long-term debt-related amortization expense, net ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total amortization expense, net ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (268) (1,342) (1,610) 2007 2006 (in millions) $ 7,472 (875) (1,603) (2,478) 2005 $ 8,289 (1,158) (1,446) (2,604) Year Ended December 31, Adjusted Expense related to derivatives: Amortization of deferred balances in AOCI(2) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Accrual of periodic settlements of derivatives:(3) Receive-Ñxed swaps(4) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Foreign-currency swaps ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total accrual of periodic settlements of derivatives ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (1,329) Total expense related to derivatives ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 3,099 Net interest income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Fully taxable-equivalent adjustments ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 392 Net interest income (fully taxable-equivalent basis) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 3,491 Ì Ì Ì 502 (464) 38 (1,582) 3,412 392 $ 3,804 1,185 (277) 908 (1,058) 4,627 339 $ 4,966 (1,329) (1,620) (1,966) (1) 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. (2) 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. (3) ReÖects the accrual of periodic cash settlements of all derivatives in qualifying hedge accounting relationships. (4) Include imputed interest on zero-coupon swaps. Net interest income and net interest yield on a fully taxable-equivalent basis decreased for the year ended December 31, 2007 compared to the year ended December 31, 2006. During 2007, we experienced higher funding costs for our retained portfolio as our long-term debt interest expense increased, reÖecting the replacement of maturing debt that had been issued at lower interest rates to fund our investments in Ñxed-rate mortgage-related investments. The decrease in net interest income and net interest yield on a fully taxable-equivalent basis was partially oÅset by a decrease in our mortgage-related securities premium amortization expense as purchases into our retained portfolio in 2007 largely consisted of securities purchased at a discount. In addition, wider mortgage-to-debt OAS due to continued lower demand for mortgage-related securities from depository institutions and foreign investors, along with heightened market uncertainty regarding mortgage- related securities, resulted in favorable investment opportunities. However, to manage to our 30% mandatory target capital surplus, we reduced our average balance of interest earning assets and as a result, we were not able to take full advantage of these opportunities. Net interest income and net interest yield on a fully taxable-equivalent basis decreased in 2006 as compared to 2005 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 in previous years to fund our investments in fixed-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. During 2006, net interest margins declined as a result of changes in interest rates on variable-rate assets acquired in 2004 and 2005. 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. In addition, the impact of rising short-term interest rates on our funding costs was largely oÅset by the impact of rising rates on our variable-rate assets in our retained portfolio and 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 London Interbank OÅer Rate, or LIBOR, and the Euro Interbank OÅered Rate, or Euribor, interest rates increased during the year, adversely aÅecting net settlements on our receive-fixed and foreign-currency swaps (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 and foreign-currency swaps, as discussed in ""NOTE 11: DERIVATIVES'' to our consolidated Ñnancial statements. The net interest expense related to these swaps is no longer a component of net interest 37 Freddie Mac 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. 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. Non-Interest Income (Loss) Management and Guarantee Income The primary drivers aÅecting management and guarantee income are changes in the average balance of our PCs and Structured Securities issued and changes in guarantee fee rates. Contractual management and guarantee fees include adjustments for buy-ups and buy-downs, whereby the guarantee fee is adjusted for up-front cash payments we make (buy- up) or receive (buy-down) upon issuance of our guarantee. Our average rates of management and guarantee income are aÅected by the mix of products we issue, competition in the market and customer preference for buy-up and buy-down fees. The majority of our guarantees are issued under customer Öow channel contracts. The remainder of our purchase and guarantee securitization of mortgage loans occurs through bulk purchases. Table 10 provides summary information about management and guarantee income. Management and guarantee income consists of contractual amounts due to us (reÖecting buy-ups and buy-downs to base guarantee fees) as well as amortization of certain pre-2003 deferred credit and buy-down fees received by us which are recorded as deferred income as a component of other liabilities. Post-2002 credit fees and buy-down fees are reÖected as either increased income on guarantee obligation as the guarantee obligation is amortized or a reduction in losses on certain credit guarantees recorded at the initiation of a guarantee. Table 10 Ì Management and Guarantee Income Year Ended December 31, Adjusted 2007 2006 2005 Contractual management and guarantee feesÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Amortization of credit and buy-down fees included in other liabilitiesÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total management and guarantee income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $2,591 44 $2,635 Amount Rate Rate Amount Amount (dollars in millions, rates in basis points) $1,982 94 $2,076 $2,201 192 $2,393 15.7 1.4 17.1 16.3 0.3 16.6 Rate 15.8 0.8 16.6 Unamortized balance of credit and buy-down fees included in other liabilities, at period end ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 410 $ 440 $ 619 Management and guarantee income increased in 2007 compared to 2006 resulting from a 13% increase in the average balance of our PCs and Structured Securities. The total management and guarantee fee rate decreased in 2007 compared to 2006 due to declines in amortization income resulting from slowing prepayments attributable to increasing interest rate projections. The decline was partially oÅset by an increase in contractual management and guarantee fee rates as a result of an increase in buy-up activity in 2007. Management and guarantee income increased in 2006 compared to 2005 reÖecting a 12% increase in the average balance of our PCs and Structured Securities. The total management and guarantee fee rate increased in 2006 compared to 2005, which reÖects higher amortization income due to a decrease in interest rates. The contractual management and guarantee fee rate increase was oÅset by an increase in buy-down activity in 2006. Gains (Losses) on Guarantee Asset Upon issuance of a guarantee of securitized assets, we 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 our PCs or Structured 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 management and guarantee fees received that are considered a return of our recorded investment in the guarantee asset; ‚ changes in future management and guarantee fees we expect to receive over the life of the related PCs or Structured Securities, and ‚ The fair value of future management and guarantee fees is driven by expected changes in interest rates that aÅect the estimated life of the mortgages underlying our PCs and Structured Securities issued and the related discount rates used to determine the net present value of the cash Öows. For example, an increase in interest rates extends the life of the guarantee asset and increases the fair value of future management and guarantee fees. Our valuation 38 Freddie Mac methodology for the guarantee asset uses market-based information, including market values of excess servicing, interest-only securities, to determine the fair value of future cash Öows associated with the guarantee asset. Table 11 Ì Attribution of Change Ì Gains (Losses) on Guarantee Asset Year Ended December 31, Adjusted 2006 (in millions) Management and guarantee fees due ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $(2,288) $(1,873) Portion of contractual guarantee fees due related to imputed interest income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Return of investment on guarantee asset ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Change in fair value of management and guarantee feesÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Change in estimate(1)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Gains (losses) on guarantee asset ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $(1,484) $ (978) 549 (1,739) 309 (54) 580 (1,293) 261 54 2007 2005 $(1,565) 450 (1,115) (267) (27) $(1,409) (1) Represents a change in estimate related to gains (losses) on guarantee asset resulting from enhancing our approach for determining the fair value of the guarantee asset. Management and guarantee fees due represents cash received in the current period related to our PCs and Structured Securities with an established guarantee asset. A portion of management and guarantee fees due is attributed to imputed interest income on the guarantee asset. Management and guarantee fees due increased in both 2007 and 2006, primarily due to increases in the average balance of our PCs and Structured Securities issued. Gains on fair value of management and guarantee fees in 2007 primarily resulted from an increase in interest rates during the second quarter. The increase in gains on fair value of management and guarantee fees in 2006 was due to an increase in interest rates throughout the year. 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. Our guarantee obligation is amortized into income using a static eÅective yield calculated and Ñxed at inception of the guarantee based on forecasted unpaid principal balances. The static eÅective yield will be evaluated and adjusted when signiÑcant changes in economic events cause a shift in the pattern of our economic release from risk. For example, certain market environments may lead to sharp and sustained changes in home prices or prepayments of mortgages, leading to the need for an adjustment in the static eÅective yield for speciÑc mortgage pools underlying the guarantee. When a change is required, a cumulative catch-up adjustment, which could be signiÑcant in a given period, will be recognized and a new static eÅective yield will be used to determine our guarantee obligation amortization. Our guarantee obligation consists of: ‚ performance and other related costs, which consist of: estimated credit costs, including unrecoverable principal and interest over the expected life of the underlying mortgages; estimated foreclosure-related costs; and administrative and other costs related to our guarantee; and ‚ deferred guarantee income on newly-issued guarantor swap transactions, which represents the excess of compensation, if any, received on issued guarantees and the fair value of our related guarantee asset, compared to the fair value of our corresponding guarantee obligation. Compensation received includes credit and buy-down fees received at the time of securitization. Credit fees vary with the credit quality of the underlying mortgages and buy- down fees vary based on customer compensation payment preferences. Compensation also includes various types of seller-provided credit enhancements related to the underlying mortgage loans. See ""NOTE 20: CHANGES IN ACCOUNTING PRINCIPLES'' to our consolidated Ñnancial statements for further information regarding our guarantee obligation. Table 12 Ì Income on Guarantee Obligation Year Ended December 31, Adjusted 2007 2006 (in millions) 2005 Amortization income related to: Performance and other related costs ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 1,146 759 Deferred guarantee income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total income on guarantee obligation ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 1,905 Components of the guarantee obligation, at period end: Unamortized balance of performance and other related costsÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 9,930 3,782 Unamortized balance of deferred guarantee incomeÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total guarantee obligation ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $13,712 39 $ 804 715 $1,519 $5,841 3,641 $9,482 $ 747 681 $1,428 $4,556 3,351 $7,907 Freddie Mac Amortization income increased in 2007 and 2006. These increases reÖect the growth of the guarantee obligation associated with newly-issued guarantees, which have higher associated performance costs due to higher expected credit costs than issuances in previous years, as well as higher average balances of our PCs and Structured Securities. Our amortization method is intended to correlate to our economic release from risk under our guarantee, under changing economic scenarios. In the event of signiÑcant and sustained economic changes, we would revise our static eÅective yield amortization, by recognizing a cumulative, catch-up adjustment. We expect that the decline in national home prices in 2008 will require catch-up adjustments to our static eÅective yield method. This will result in higher amortization in the Ñrst quarter of 2008 than would be recognized under the static eÅective yield method absent these economic changes. Derivative Overview Table 13 presents the eÅect of derivatives on our consolidated Ñnancial statements, including notional or contractual amounts of our derivatives and our hedge accounting classiÑcations. Table 13 Ì Summary of the EÅect of Derivatives on Selected Consolidated Financial Statement Captions Consolidated Balance Sheets December 31, 2007 Adjusted December 31, 2006 Description Cash Öow hedges-openÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ No hedge designationÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Subtotal ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Balance related to closed cash Öow hedges ÏÏÏÏ TotalÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Notional or Contractual Amount(1) $ Ì 1,322,881 1,322,881 Ì $1,322,881 Fair Value (Pre-Tax)(2) AOCI (Net of Taxes)(3) Notional or Contractual Amount(1) Fair Value (Pre-Tax)(2) AOCI (Net of Taxes)(3) $ Ì 4,790 4,790 Ì $4,790 (in millions) $ Ì Ì Ì (4,059) $(4,059) $ 70 758,039 758,109 Ì $758,109 $ Ì 7,720 7,720 Ì $7,720 $ Ì Ì Ì (5,032) $(5,032) Description Cash Öow hedges-open ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ No hedge designation ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Consolidated Statements of Income Year Ended December 31, Adjusted 2007 Derivative Gains (Losses) $ Ì (1,904) $(1,904) 2006 Derivative Gains (Losses) (in millions) $ Ì (1,173) $(1,173) 2005 Derivative Gains (Losses) $ (25) (1,296) $(1,321) (1) Notional or contractual amounts are used to calculate the periodic settlement amounts to be received or paid and generally do not represent actual amounts to be exchanged. Notional or contractual amounts are not recorded as assets or liabilities. (2) The value of derivatives on our consolidated balance sheets is reported as derivative asset, net and derivative liability, net, and includes net derivative interest receivable or payable and cash collateral held or posted. Fair value excludes net derivative interest receivable of $1.7 billion and net derivative collateral held of $6.2 billion at December 31, 2007. Fair value excludes net derivative interest receivable of $2.3 billion and net derivative collateral held of $9.5 billion at December 31, 2006. (3) Derivatives that meet speciÑc criteria may be accounted for as cash Öow hedges. Changes in the fair value of the eÅective portion of open cash Öow hedges 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. Prior to 2007, we discontinued nearly all of our cash Öow hedge and fair value hedge accounting relationships. At December 31, 2007, we did not have any derivatives in hedge accounting relationships. From time to time, we designate as cash Öow hedges certain commitments to forward sell mortgage-related securities. See ""NOTE 11: 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 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, 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, 2007 and 2006, 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 an after-tax loss of approximately $4.1 billion and $5.0 billion, respectively. These amounts relate 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 40 Freddie Mac 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 recognized immediately in earnings. At December 31, 2007, over 70% and 90% of the $4.1 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 $18.6 billion to $104.7 billion in any one quarter, with an average of $58.3 billion per quarter. Table 14 presents the scheduled amortization of the net deferred losses in AOCI at December 31, 2007 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 into Income of Net Deferred Losses in AOCI Related to Closed Cash Flow Hedge Relationships Period of Scheduled Amortization into Income December 31, 2007 Amount (Pre-tax) Amount (After-tax) (in millions) 2008ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2009ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2010ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2011ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2012ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2013 to 2017ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Thereafter ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total net deferred losses in AOCI related to closed cash Öow hedge relationships ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $(1,331) (1,105) (910) (720) (563) (1,107) (509) $(6,245) $ (865) (718) (592) (468) (366) (719) (331) $(4,059) 41 Freddie Mac Derivative Gains (Losses) Table 15 provides a summary of the period-end notional amounts and the gains and losses recognized during the year related to derivatives not accounted for in hedge accounting relationships. Table 15 Ì Derivatives Not in Hedge Accounting Relationships Year Ended December 31, Adjusted 2007 2006 2005 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 Purchased ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 259,272 1,900 Written ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 2,472 (121) $194,200 Ì $(1,128) Ì $146,615 Ì $ (402) Ì Put swaptions Purchased ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Written ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Receive-Ñxed swaps ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Pay-Ñxed swaps ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Futures ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Foreign-currency swaps ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Forward purchase and sale commitments ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Other(1) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Subtotal ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Accrual of periodic settlements: Receive-Ñxed swaps(2) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Pay-Ñxed swaps ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Foreign-currency swaps ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Other ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total accrual of periodic settlements ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 18,725 2,650 301,649 409,682 196,270 20,118 72,662 39,953 1,322,881 29,725 Ì 222,631 217,565 22,400 29,234 9,942 32,342 758,039 (4) (72) 3,905 (11,362) 142 2,341 445 18 (2,236) (327) 703 (48) 4 332 Total ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $1,322,881 $ (1,904) $758,039 (100) Ì (290) 649 (248) (92) (95) 39 (1,265) (418) 541 (34) 3 92 $(1,173) 34,675 Ì 81,185 181,562 86,252 197 21,827 15,643 567,956 $567,956 202 Ì (1,535) 612 63 (9) 110 (25) (984) 426 (763) Ì Ì (337) $(1,321) (1) Consists of basis swaps, certain option-based contracts (including written options), interest-rate caps, credit derivatives and swap guarantee derivatives not accounted for in hedge accounting relationships. 2005 also included a prepayment management agreement which was terminated eÅective December 31, 2005. (2) 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 2005 through 2007, 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. 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. 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. 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). 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 our retained portfolio. Purchased call and put swaptions, where we make premium payments, are options for us to enter into receive- and pay-Ñxed swaps, respectively. Conversely, written call and put swaptions, where we receive premium payments, are options for our counterparty to enter into receive- and pay-Ñxed swaps, respectively. The fair values of both purchased and written 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. Potential losses on written options are unlimited. In 2007, overall decreases in interest rates across the swap yield curve resulted in fair value losses on our interest-rate swap derivative portfolio that were partially oÅset by fair value gains on our option-based derivative portfolio. Gains on our option-based derivative portfolio resulted from an overall increase in implied volatility and decreasing interest rates. The overall decline in interest rates resulted in a loss of $11.4 billion on our pay-Ñxed swaps that was only partially oÅset by a $3.9 billion gain on our receive-Ñxed swap position. Gains on option-based derivatives, particularly purchased call swaptions, increased in 2007 to $2.3 billion. We recognized a gain of $2.3 billion on our foreign-currency swaps as the Euro 42 Freddie Mac continued to strengthen against the dollar. The gains on foreign-currency swaps oÅset a $2.3 billion loss on the translation of our foreign-currency denominated debt, which is recorded in foreign-currency gains (losses), net. The accrual of periodic settlements for derivatives not in qualifying hedge accounting relationships increased in 2007 compared to 2006 due to the increase in our net pay-Ñxed swap position as we responded to the changing interest rate environment. 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 driven by increases in long-term swap interest rates. Our discontinuation of hedge accounting treatment resulted in an increase in the notional balance of our receive-Ñxed swaps not in qualifying hedge accounting relationships, which, combined with Öuctuations in swap interest rates throughout the year, reduced fair value losses recognized on our receive-Ñxed swaps during 2006. See ""NOTE 11: DERIVATIVES'' to our consolidated Ñnancial statements for additional information on our discontinuation of hedge accounting treatment. 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 resulting in an increase in income on our pay-Ñxed swaps. Gains (Losses) on Investment Activity Table 16 summarizes the components of gains (losses) on investment activity. Table 16 Ì Gains (Losses) on Investment Activity Year Ended December 31, Adjusted 2007 2006 (in millions) 2005 Gains (losses) on trading securities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 540 Gains (losses) on sale of mortgage loans(1) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 14 Gains (losses) on sale of available-for-sale securities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 232 Security impairments: Interest-only security impairmentsÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (36) Other security impairments ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (363) Total security impairments ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (399) (93) Lower-of-cost-or-market valuation adjustments ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total gains (losses) on investment activity ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 294 $ 1 90 (140) $(289) 124 370 (147) (257) (404) (20) $(473) (71) (221) (292) (10) $ (97) (1) Represent mortgage loans sold in connection with securitization transactions. Gains (Losses) on Trading Securities In 2007, the overall decrease in long-term interest rates resulted in gains related to our REMIC securities classiÑed as trading. In 2006, the increase in long-term interest rates resulted in gains related to our interest-only mortgage related securities classiÑed as trading. These gains were oÅset by losses on other mortgage-related securities classiÑed as trading as a result of the rise in interest rates. In 2005, increases in long-term interest rates resulted in losses on mortgage-related securities classiÑed as trading. Gains (Losses) on Sale of Available-For-Sale Securities We realized net gains on the sale of available-for-sale securities of $232 million for the year ended December 31, 2007, compared to net losses of $140 million for the year ended December 31, 2006. During the fourth quarter of 2007, we sold approximately $27.2 billion of PCs and Structured Securities, classiÑed as available-for-sale, for capital management purposes. These sales generated net gains of approximately $186 million included in gains (losses) on sale of available-for- sale securities. These gains were partially oÅset by losses generated by the sale of securities during the second quarter of 2007. In 2006, losses on sales of available-for-sale securities were primarily driven by resecuritization activity, partially oÅset by net gains of $188 million related to the sale of certain commercial mortgage-backed securities, or CMBS, as discussed in ""Security Impairments.'' Security Impairments Security impairments on mortgage-related securities remained Öat for the year ended December 31, 2007, compared to the year ended December 31, 2006. Security impairments in 2007 were primarily related to impairments recognized during the second quarter of 2007 on agency securities that we sold in the third quarter of 2007 and thus did not have the intent to hold until the loss would be recovered. In addition, we recognized $36 million of impairments on our mortgage-related interest-only securities due to the decline in interest rates during the second half of 2007. 43 Freddie Mac For the year ended December 31, 2006 and 2005 security impairments included $147 million and $71 million, respectively, related to mortgage-related interest-only securities, primarily due to periodic declines in mortgage interest rates experienced during those years. During the years ended December 31, 2006 and 2005, security impairments also included $196 million and $36 million, respectively, of interest-rate related impairments related to mortgage-related securities where we did not have the intent to hold the security until the loss would be recovered. Security impairments during the years ended December 31, 2006 and 2005 also included $61 million and $185 million, respectively, related to certain CMBSs backed by 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. Recoveries on Loans Impaired upon Purchase Recoveries on loans impaired upon purchase represent the recapture into income of previously recognized losses on loans purchased and provision for credit losses associated with purchases of delinquent loans from our PCs and Structured Securities in conjunction with our guarantee activities. Recoveries occur when a non-performing loan is repaid in full or when at the time of foreclosure the estimated fair value of the acquired property, less costs to sell, exceeds the carrying value of the loan. During 2007, we recognized recoveries on loans impaired upon purchase of $505 million. During 2006, we recaptured $58 million on impaired loans, which reduced losses on loans purchased. For impaired loans where the borrower has made required payments that return to current status, the basis adjustments are accreted into interest income over time, as periodic payments are received. Foreign-Currency Gains (Losses), Net We actively manage the foreign-currency exposure associated with our foreign-currency denominated debt through the use of derivatives. For the year ended December 31, 2007, we recognized net foreign-currency translation losses of $2.3 billion primarily due to the weakening of the U.S. dollar relative to the Euro. These losses oÅset an increase in fair value of $2.3 billion related to foreign-currency-related derivatives during the period, which is recorded in derivative gains (losses). For the year ended December 31, 2006, we recognized net foreign-currency translation gains related to our foreign- currency denominated debt of $96 million. These gains oÅset a decrease in fair value of $92 million related to foreign- currency-related derivatives during the period, which is recorded in derivative gains (losses). In December 2006, we voluntarily discontinued hedge accounting for our foreign-currency swaps. See ""Derivative Gains (Losses)'' and ""NOTE 11: DERIVATIVES'' to our consolidated Ñnancial statements for additional information about our derivatives. Other Income Other income increased in 2007 compared to 2006 due to $18 million of trust management income that was related to the establishment of securitization trusts in December 2007 for the underlying assets of our PCs and Structured Securities. Trust management income represents the fees we earn as master servicer, issuer and trustee. These fees are derived from interest earned on principal and interest cash Öows between the time they are remitted to the trust by servicers and the date of distribution to our PC and Structured Securities holders. Other income increased in 2006 compared to 2005, primarily due to $80 million of expense recorded in 2005 that was related to certain errors not material to our consolidated Ñnancial statements with respect to income in previously reported periods. 44 Freddie Mac Non-Interest Expense Table 17 summarizes the components of non-interest expense. Table 17 Ì Non-Interest Expense Year Ended December 31, Adjusted 2007 2006 (in millions) 2005 Administrative Expenses: Salaries and employee beneÑts ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 896 443 Professional services ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 64 Occupancy expense ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 271 Other administrative expensesÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 1,674 Total administrative expenses ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2,854 Provision for credit losses ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 206 REO operations expense ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 1,988 Losses on certain credit guarantees ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 1,865 Losses on loans purchasedÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 469 LIHTC partnershipsÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (8) Minority interests in earnings of consolidated subsidiariesÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Other expenses ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 222 Total non-interest expense ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $9,270 $ 830 460 61 290 1,641 296 60 406 148 407 58 200 $3,216 $ 805 386 58 286 1,535 307 40 272 Ì 320 96 530 $3,100 Administrative Expenses Salaries and employee beneÑts increased during the past three years as we hired additional employees to support our Ñnancial reporting and infrastructure activities. Certain long-term employee incentive compensation costs also increased as we worked to attract and retain key talent to reduce reliance on external resources. Professional services decreased in 2007 compared to 2006 as we modestly decreased our reliance on consultants and relied more heavily on our employee base to complete certain Ñnancial initiatives and our control remediation activities. Professional services increased in 2006 compared to 2005 as we increased the number of consultants utilized to assist in our initiatives to build new Ñnancial accounting systems and improve our Ñnancial controls. Despite continued increases in administrative expenses, administrative expenses as a percentage of our average total mortgage portfolio declined to 8.6 basis points for the year ended December 31, 2007 from 9.3 basis points and 9.7 basis points for the years ended 2006 and 2005, respectively. Provision for Credit Losses Our credit loss reserves reÖect our best estimates of incurred losses. Our reserve estimate includes projections related to strategic loss mitigation initiatives, including a higher rate of loan modiÑcations for troubled borrowers, and projections of recoveries through repurchases by seller/servicers of defaulted loans due to failure to follow contractual underwriting requirements at the time of the loan origination. Our reserve estimate also reÖects our best projection of defaults. However, the unprecedented deterioration in the national housing market and the uncertainty in other macro economic factors makes forecasting of default rates increasingly imprecise. The inability to realize the beneÑts of our loss mitigation plans, a lower realized rate of seller/servicer repurchases or default rates that exceed our current projections will cause our losses to be signiÑcantly higher than those currently estimated. The provision for credit losses increased signiÑcantly in 2007 compared to 2006, as continued weakening in the housing market aÅected our single-family portfolio. In 2007, and to a lesser extent in 2006, we recorded additional reserves for credit losses on our single-family portfolio as a result of: ‚ increased estimates of incurred losses on mortgage loans that are expected to experience higher default rates, particularly for mortgage loans originated during 2006 and 2007, which do not have the beneÑt of signiÑcant home price appreciation; ‚ an observed increase in delinquency rates and the rates at which loans transition through delinquency to foreclosure; and ‚ increases in the severity of losses on a per-property basis, driven in part by the declines in home sales and home prices, particularly in the North Central, East and West regions of the U.S. We expect our loan loss reserves to increase in future periods commensurate with our outlook for future charge-oÅs. The rate of change will depend on a number of factors including property values, geographic distribution, loan balances and third-party insurance coverage. In 2005, we recorded an additional loss provision of $128 million for our estimate of 45 Freddie Mac incurred losses for loans aÅected by Hurricane Katrina. During 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 $378 million and $179 million in 2006 and 2005, respectively. REO Operations Expense The increase in REO operations expense in 2007, as compared to 2006, was due to a 64% increase in our REO property inventory in 2007 and declining REO property values. The decline in home prices during 2007, combined with our higher REO inventory balance, resulted in an increase in the market-based writedowns of REO, which totaled $129 million and $5 million in 2007 and 2006, respectively. The increase in REO expense in 2006, as compared to 2005, was due to higher real estate taxes, maintenance and net losses on sales experienced in 2006. Losses on Certain Credit Guarantees We recognize losses on certain credit guarantees when, upon the issuance of PCs in guarantor swap transactions, we determine that the fair value of our guarantee obligation net of other initial compensation exceeds the fair value of our guarantee asset plus buy-up fees and credit enhancement-related assets. Our recognition of losses on guarantee contracts can occur due to any one or a combination of several factors, including long-term contract pricing for our Öow business, the diÅerence in overall transaction pricing versus pool-level accounting measurements and, to a lesser extent, eÅorts to support our aÅordable housing mission. We negotiate contracts with our customers based on 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 assets and guarantee obligations is not determined at the level at which we negotiate contracts; rather, it is determined separately for each PC-related pool of loans. We determine the initial fair value of the pool-level guarantee assets and guarantee obligations using methodologies that employ direct market-based information. These methodologies diÅer from the methodologies we use to determine pricing on new contracts. 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 2007, 2006 and 2005 we recognized losses of $2.0 billion, $0.4 billion and $0.3 billion, respectively, on certain guarantor swap transactions entered into during those periods. We also deferred income related to newly-issued guarantees of $0.9 billion, $1.0 billion and $1.2 billion in 2007, 2006 and 2005, respectively. Increases in losses on certain credit guarantees reÖect expectations of higher defaults and severity in the credit market in 2007 which were not fully oÅset by increases in guarantee and delivery fees due to competitive pressures and contractual fee arrangements. Increases in losses on loans purchased reÖect reduced fair values and higher volume of delinquent loans purchased under our guarantees. Losses on certain credit guarantees are expected to continue to increase until the fair values of our newly-issued obligations return to historical levels or our price increases are suÇcient to mitigate the rise in higher expected default costs. Our guarantee fees with customers are negotiated periodically and remain in eÅect for an initial contract period of up to one year. We expect most of our guarantor swap transactions under these contracts to generate positive economic returns over the lives of the related PCs. During periods in which conditions in the mortgage credit market deteriorate, such as experienced in 2007,we may incur losses on certain transactions until such time as contract terms are changed or business conditions improve. While we continue to believe the fair value of the guarantee obligation recorded exceeds the losses that we ultimately expect to incur, our expectation of losses on new guarantees have increased signiÑcantly. During the fourth quarter of 2007, we announced increases in delivery fees which are paid at the time of securitization. These increases represent additional fees assessed on all loans issued through Öow activity channels, including extra fees for non-traditional and higher risk mortgage loans, that are eÅective in March 2008. Also, in February 2008, we announced an additional increase in delivery fees, eÅective in June 2008, for certain Öow transactions. We expect that price increases, including the delivery fee increase eÅective in March and June 2008, will mitigate a portion of the losses on certain credit guarantees. Losses on Loans Purchased Losses on non-performing loans purchased from the mortgage pools underlying our PCs and Structured Securities occur when the acquisition basis of the purchased loan exceeds the estimated fair value of the loan on the date of purchase. 46 Freddie Mac In 2007, the market-based valuation of non-performing loans was adversely aÅected by the market's expectation of higher default costs. The decrease in fair values of these loans, combined with an increase in the volume of purchases of non- performing loans and an increase in the average unpaid principal balance of those loans, resulted in losses of $1.9 billion and $0.1 billion for 2007 and 2006, respectively. We expect to recover a portion of the losses on loans purchased over time as these market-based valuations imply future credit losses that are signiÑcantly higher than we expect to ultimately incur. See ""Non-Interest Income (Loss) Ì Recoveries on Loans Impaired upon Purchase'' for discussion related to recoveries on those previously purchased loans. See ""CREDIT RISKS Ì Table 52 Ì Changes in Loans Purchased Under Financial Guarantees'' for additional information about our purchases of non-performing loans. EÅective December 2007 we made certain operational changes for purchasing delinquent loans from PC pools, which reduced the amount of our losses on loans purchased during the fourth quarter of 2007. We believe that our historical practice of purchasing loans from PC pools once they become 120 days delinquent does not reÖect our historical cure rate for most of these delinquent loans. Allowing the loans to remain in PC pools until they become modiÑed, foreclosure occurs or they reach 24 months past due unless we determine it is economically beneÑcial to purchase the loans sooner, better reÖects our expectations for credit losses, because a signiÑcant number of these loans reperform. Taking this action is expected to reduce our losses on loans purchased, and result in higher provision for credit losses associated with our PCs and Structured Securities. However, due to the increases in delinquency rates of loans underlying our PCs and Structured Securities in 2007, we expect that the number of loan modiÑcations will increase signiÑcantly in 2008, contributing to losses on loans purchased. Other Expenses Other expenses increased slightly from 2007 to 2006 and decreased from 2006 to 2005 due to $339 million of expenses we recorded in 2005 to increase our reserves for legal settlements, net of expected insurance proceeds. See ""NOTE 12: LEGAL CONTINGENCIES'' to our consolidated Ñnancial statements for more information. Income Tax Expense (BeneÑt) For 2007, 2006 and 2005, we reported income tax expense (beneÑt) of $(2.9) billion, $(45) million, and $358 million, respectively, resulting in eÅective tax rates of 48%, (2)% and 14%, respectively. The volatility in our eÅective tax rate over the past three years is primarily the result of Öuctuations in pre-tax income. Our eÅective tax rate continues to be favorably impacted by our investments in LIHTC partnerships and interest earned on tax-exempt housing related securities. Our 2006 eÅective tax rate also beneÑted from releases of tax reserves of $174 million. For the year ended December 31, 2007, our pre-tax loss exceeded our pre-tax income for years 2005 and 2006. We have not recorded a valuation allowance against our deferred tax assets as we believe that realization is more likely than not. See ""NOTE 13: INCOME TAXES'' to our consolidated Ñnancial statements for additional information. Segment Measures Ì Adjusted Operating Income Adjusted Operating Income In managing our business, we measure the operating performance of our segments using Adjusted operating income. Adjusted operating income diÅers signiÑcantly from, and should not be used as a substitute for net income (loss) before cumulative eÅect of change in accounting principle or net income (loss) as determined in accordance with GAAP. There are important limitations to using Adjusted operating income as a measure of our Ñnancial performance. Among other things, our regulatory capital requirements are based on our GAAP results. Adjusted operating income adjusts for the eÅects of certain gains and losses and mark-to-market items which, depending on market circumstances, can signiÑcantly aÅect, positively or negatively, our GAAP results and which, in recent periods, have contributed to GAAP net losses. GAAP net losses will adversely impact our regulatory capital, regardless of results reÖected in Adjusted operating income. Also, our deÑnition of Adjusted operating income may diÅer from similar measures used by other companies. However, we believe that the presentation of Adjusted operating income highlights the results from ongoing operations and the underlying results of the segments in a manner that is useful to the way we manage and evaluate the performance of our business. See ""NOTE 15: SEGMENT REPORTING'' to our consolidated Ñnancial statements for more information regarding segments and Adjusted operating income. As described below, Adjusted operating income is calculated for the segments by adjusting net income (loss) before cumulative eÅect of change in accounting principle for certain investment-related activities and credit guarantee-related activities. Adjusted operating income includes certain reclassiÑcations among income and expense categories that have no impact on net income (loss) but provide us with a meaningful metric to assess the performance of each segment and the company as a whole. 47 Freddie Mac Investment Activity-Related Adjustments We are primarily a buy and hold investor in mortgage assets, although we may sell assets to reduce risk, respond to capital constraints, provide liquidity, or structure transactions that improve our returns. Our measure of Adjusted operating income for our investment-related activities is useful to us because it reÖects the way we manage and evaluate the performance of our business. The most signiÑcant inherent risk in our investing activities is interest-rate risk, including duration, convexity and volatility. We actively manage these risks through asset selection and structuring, Ñnancing asset purchases with a broad range of both callable and non-callable debt and the use of interest-rate derivatives designed to economically hedge a signiÑcant portion of our interest-rate exposure. Our interest rate derivatives include interest-rate swaps, exchange-traded futures, and both purchased and written options (including swaptions). GAAP-basis earnings related to investment activities of our Investments segment, and to a lesser extent, our Multifamily segment, are subject to signiÑcant period-to-period variability, which we believe is not necessarily indicative of the risk management techniques that we employ and the performance of these segments. Our derivative instruments are adjusted to fair value under GAAP with resulting gains or losses recorded in GAAP- basis income. Certain other assets are also adjusted to fair value under GAAP with resulting gains or losses recorded in GAAP-basis income. These assets consist primarily of mortgage-related securities classiÑed as trading and mortgage-related securities classiÑed as available-for-sale when a decline in the fair value of available-for-sale securities is deemed to be other than temporary. To help us assess the performance of our investment-related activities, we make the following adjustments to earnings as determined under GAAP. We believe this measure of performance, which we call Adjusted operating income, enhances the understanding of operating performance for speciÑc periods, as well as trends in results over multiple periods, as this measure is consistent with assessing our performance against our investment objectives and the related risk-management activities. ‚ Derivative- and foreign currency translation-related adjustments: ‚ Fair value adjustments on derivative positions, recorded pursuant to GAAP, are not recognized in Adjusted operating income as these positions economically hedge our investment activities. ‚ Payments or receipts to terminate derivative positions are amortized prospectively into Adjusted operating income on a straight-line basis over the associated term of the derivative instrument. ‚ Payments of up-front premiums (e.g., payments made to third parties related to purchased swaptions) are amortized prospectively on a straight-line basis into Adjusted operating income over the contractual life of the instrument. The up-front payments, primarily for option premiums, are amortized to reÖect the periodic cost associated with the protection provided by the option contract. ‚ Foreign-currency translation gains and losses associated with foreign-currency denominated debt along with the foreign currency derivatives gains and losses are excluded from Adjusted operating income because the fair value adjustments on the foreign-currency swaps that we use to manage foreign-currency exposure are also excluded through the fair value adjustment on derivative positions as described above as the foreign currency exposure is economically hedged. ‚ Investment sales, debt retirements and fair value-related adjustments: ‚ Gains and losses on investment sales and debt retirements that are recognized at the time of the transaction pursuant to GAAP are not immediately recognized in Adjusted operating income. Gains and losses on securities sold out of the retained portfolio and cash and investments portfolio are amortized prospectively into Adjusted operating income on a straight-line basis over Ñve years and three years, respectively. Gains and losses on debt retirements are amortized prospectively into Adjusted operating income on a straight-line basis over the original terms of the repurchased debt. ‚ Trading losses or impairments that reÖect expected or realized credit losses are realized immediately pursuant to GAAP and in Adjusted operating income since they are not economically hedged. Fair value adjustments to trading securities related to investments that are economically hedged are not included in Adjusted operating income. Similarly, non-credit related impairment losses on securities are not included in Adjusted operating income. These amounts are deferred and amortized prospectively into Adjusted operating income on a straight- line basis over Ñve years for securities in the retained portfolio and over three years for securities in the cash and investments portfolio. GAAP-basis accretion income that may result from impairment adjustments is also not included in Adjusted operating income. 48 Freddie Mac ‚ Fully taxable-equivalent adjustment: ‚ Interest income on tax-exempt investments is adjusted to reÖect its equivalent yield on a fully taxable basis. We fund our investment assets with debt and derivatives to minimize interest-rate risk as evidenced by our PMVS and duration gap metrics. As a result, in situations where we record gains and losses on derivatives, securities or debt buybacks, these gains and losses are oÅset by economic hedges that we do not mark-to-market for GAAP purposes. For example, when we realize a gain on the sale of a security, the debt which is funding the security has an embedded loss that is not recognized under GAAP, but instead over time as we realize the interest expense on the debt. As a result, in Adjusted operating income, we defer and amortize the security gain to interest income to match the interest expense on the debt that funded the asset. Because of our risk management strategies, we believe that amortizing gains or losses on economically hedged positions in the same periods as the oÅsetting gains or losses is a meaningful way to assess performance of our investment activities. We believe it is useful to measure our performance using long-term returns, not on a short-term fair value basis. Fair value Öuctuations in the short-term are not an accurate indication of long-term returns. In calculating Adjusted operating income, we make adjustments to our GAAP-basis results that are designed to provide a more consistent view of our Ñnancial results, which helps us better assess the performance of our business segments, both from period to period and over the longer term. The adjustments we make to present our Adjusted operating income results are consistent with the Ñnancial objectives of our investment activities and related hedging transactions and provide us with a view of expected investment returns and eÅectiveness of our risk management strategies that we believe is useful in managing and evaluating our investment-related activities. Although we seek to mitigate the interest-rate risk inherent in our investment-related activities, our hedging and portfolio management activities do not eliminate risk. We believe that a relevant measure of performance should closely reÖect the economic impact of our risk management activities. Thus, we amortize the impact of terminated derivatives as well as gains and losses on asset sales and debt retirements into Adjusted operating income. Although our interest-rate risk and asset/liability management processes ordinarily involve active management of derivatives as well as asset sales and debt retirements, we believe that Adjusted operating income, although it diÅers signiÑcantly from, and should not be used as a substitute for GAAP-basis results, is indicative of the longer-term time horizon inherent in our investment-related activities. Credit Guarantee Activity-Related Adjustments The credit guarantee activities of our Single-family Guarantee and Multifamily segments consist largely of our guarantee of the payment of principal and interest on mortgages and mortgage-related securities in exchange for guarantee and other fees. Over the longer-term, earnings consist almost entirely of the guarantee fee revenues we receive less related credit costs (i.e., provision for credit losses) and operating expenses. Our measure of Adjusted operating income for these activities consists primarily of these elements of revenue and expense. We believe this measure is a relevant indicator of operating performance for speciÑc periods, as well as trends in results over multiple periods, because it more closely aligns with how we manage and evaluate the performance of the credit guarantee business. We purchase mortgages from sellers/servicers in order to securitize and issue PCs and Structured Securities. In addition to the components of earnings noted above, GAAP-basis earnings for these activities include gains or losses realized upon the execution of such transactions, subsequent fair value adjustments to the guarantee asset and amortization of the guarantee obligation. Our credit-guarantee activities also include the purchase of signiÑcantly past due mortgage loans from loan pools that underlie our guarantees. Pursuant to GAAP, at the time of our purchase, the loans are recorded at fair value. To the extent the adjustment of a purchased loan to market value exceeds our own estimate of the losses we will ultimately realize on the loan, as reÖected in our loan loss reserve, an additional loss is recorded in our GAAP-basis results. When we determine Adjusted operating income for our credit guarantee-related activities, the adjustments we apply to earnings computed on a GAAP-basis include the following: ‚ Amortization and valuation adjustments pertaining to the guarantee asset and guarantee obligation are excluded from Adjusted operating income. Cash compensation exchanged at the time of securitization, excluding buy-up and buy- down fees, is amortized into earnings. ‚ The initial recognition of gains and losses in connection with the execution of either securitization transactions that qualify as sales or guarantor swap transactions, such as losses on certain credit guarantees, is excluded from Adjusted operating income. ‚ Fair value adjustments recorded upon the purchase of delinquent loans from pools that underlie our guarantees are excluded from Adjusted operating income. However, for Adjusted operating income reporting, our GAAP-basis loan loss provision is adjusted to reÖect our own estimate of the losses we will ultimately realize on such items. 49 Freddie Mac Over the long term, Adjusted operating income and GAAP-basis income both capture the aggregate cash Öows associated with our guarantee-related activities. Although Adjusted operating income diÅers signiÑcantly from, and should not be used as a substitute for GAAP-basis income, we believe that excluding the impact of changes in the fair value of expected future cash Öows from our Adjusted operating income provides a meaningful measure of performance for a given period as well as trends in performance over multiple periods, because it more closely aligns with how we manage and evaluate the performance of the credit guarantee business. Segment Allocations Results of each reportable segment include directly attributable revenues and expenses. Administrative expenses that are not directly attributable to a segment are allocated ratably using alternative quantiÑable measures such as headcount distribution or system usage if considered semi-direct or on a pre-determined basis if considered indirect. Expenses not allocated to segments consist primarily of costs associated with remediating our internal controls and near-term restructuring costs and are included in the All Other category. Net interest income for each segment includes an allocation related to investments and debt based on each segment's assets and oÅ-balance sheet obligations. The LIHTC tax beneÑt is allocated to the Multifamily segment. All remaining taxes are calculated based on a 35% federal statutory rate as applied to Adjusted operating income. We continue to assess the methodologies used for segment reporting and reÑnements may be made in future periods. See ""NOTE 15: SEGMENT REPORTING'' to our consolidated Ñnancial statements for further discussion of Adjusted operating income as well as the management reporting and allocation process used to generate our segment results. Segment Results Ì Adjusted Operating Income Investments In this segment, we invest principally in mortgage-related securities and single-family mortgage loans through our mortgage-related investment portfolio. Adjusted operating income consists primarily of the returns on these investments, less the related Ñnancing costs and administrative expenses. Within this segment, our activities may include the purchase of mortgage loans and mortgage-related securities with less attractive investment returns and with incremental risk in order to achieve our aÅordable housing goals and subgoals. We maintain a cash and a non-mortgage-related securities investment portfolio in this segment to help manage our liquidity. We Ñnance these activities primarily through issuances of short- and long-term debt in the public markets. Results also include derivative transactions we enter into to help manage interest-rate and other market risks associated with our debt Ñnancing activities and mortgage-related investment portfolio. Table 18 presents the Adjusted operating income results of our Investments segment. Table 18 Ì Adjusted Operating Income Segment Results Ì Investments 2007 Year Ended December 31, 2006 (in millions) 2005 Adjusted operating income results: Net interest income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 3,626 Non-interest income (loss) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 40 Non-interest expense: Administrative expensesÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Other non-interest expense ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total non-interest expense ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Adjusted operating income before income tax expense ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Income tax expense ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Adjusted operating income, net of taxes ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (515) (31) (546) 3,120 (1,092) 2,028 Reconciliation to GAAP net income (loss): Derivative and foreign currency translation-related adjustments ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2 Credit guarantee-related adjustments ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 987 Investment sales, debt retirements and fair value-related adjustmentsÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (388) Fully taxable-equivalent adjustment ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2,026 Tax-related adjustmentsÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (3,031) Total reconciling items, net of taxesÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Net income (loss)(1) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ (1,003) 0.51% Net interest yield Ì Adjusted operating income basis ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (5,658) $ 3,736 38 $ 4,117 (74) (495) (31) (526) 3,248 (1,137) 2,111 (2,374) 1 231 (388) 1,139 (1,391) 720 0.51% $ (466) (63) (529) 3,514 (1,230) 2,284 (1,652) Ì 570 (336) 717 (701) 1,583 0.60% $ (1) Net income (loss) is presented before the cumulative eÅect of a change in accounting principle related to 2005. Adjusted operating income for our Investments segment declined slightly in 2007 compared to 2006. In 2007 and 2006, the growth rates of our mortgage-related investment portfolio were 0.7% and (1.6)%, respectively. In 2007, wider mortgage- to-debt OAS resulted in favorable investment opportunities, particularly in the second half of the year. In response to these market conditions, we took advantage of these opportunities by increasing our purchase activities in CMBS and agency 50 Freddie Mac mortgage-related securities. In November 2007, additional widening in OAS levels negatively impacted our GAAP results and lowered our overall capital position. Capital constraints forced us to reduce our balance of interest earning assets, issue $6 billion of non-cumulative, perpetual preferred stock and reduce our common stock dividend by 50% in the fourth quarter of 2007. As a result, the unpaid principal balance of our mortgage-related investment portfolio increased only slightly from $658.8 billion at December 31, 2006 to $663.2 billion at December 31, 2007. The unpaid principal balance of our mortgage-related investment portfolio declined to $658.8 billion at December 31, 2006 from $669.3 billion at December 31, 2005, as relatively tight mortgage-to-debt OASs limited attractive investment opportunities. In addition, we began managing our mortgage-related investment portfolio under a voluntary, temporary growth limit during the second half of 2006. Our net interest yield remained unchanged for the year ended December 31, 2007 compared to the year ended December 31, 2006; however, our Adjusted operating net interest income declined. This decline is due, in part, to a decrease in the average balance of our mortgage-related investment portfolio. We also experienced higher funding costs as our long- term debt interest expense increased, reÖecting the replacement of maturing debt that we issued at lower interest rates during the past few years. Increases in our funding costs were oÅset by a decline in our mortgage-related securities amortization expense as purchases in 2007 largely consisted of securities purchased at a discount. During the year ended December 31, 2007, demand for our debt securities remained strong, allowing us to issue our debt securities at rates below those of comparable maturities on the LIBOR yield curve. Single-Family Guarantee In this segment, we guarantee the payment of principal and interest on single-family mortgage-related securities, including those held in our retained portfolio, in exchange for guarantee fees received over time and other up-front compensation. Earnings for this segment consist of guarantee fee revenues less the related credit costs (i.e., provision for credit losses) and operating expenses. Also included is the interest earned on assets held in the Investments segment related to single-family guarantee activities, net of allocated funding costs and amounts related to net Öoat beneÑts. Float arises from timing diÅerences between when the borrower makes principal payments on the loan and the reduction of the PC balance. Table 19 presents the Adjusted operating income results of our Single-family Guarantee segment. Table 19 Ì Adjusted Operating Income Segment Results Ì Single-Family Guarantee 2007 Year Ended December 31, 2006 (in millions) 2005 703 $ 556 $ 349 Adjusted operating income results: Net interest income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ Non-interest income: Management and guarantee income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Other non-interest income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total non-interest income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Non-interest expense: Administrative expensesÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Provision for credit losses ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ REO operations expense ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Other non-interest expense ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total non-interest expense ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Adjusted operating income (loss) before income tax expense ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Income tax (expense) beneÑt ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Adjusted operating income (loss), net of taxes ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2,889 117 3,006 (806) (3,014) (205) (78) (4,103) (394) 138 (256) Reconciliation to GAAP net income (loss): (3,270) Credit guarantee-related adjustments ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 1,144 Tax-related adjustmentsÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total reconciling items, net of taxesÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (2,126) Net income (loss) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $(2,382) 2,541 159 2,700 (815) (313) (61) (84) (1,273) 1,983 (694) 1,289 2,341 78 2,419 (767) (447) (40) (30) (1,284) 1,484 (519) 965 (205) 72 (133) $ 1,156 (462) 161 (301) 664 $ Adjusted operating income for our Single-family Guarantee segment declined in 2007 compared to 2006. This decline reÖects an increase in credit costs largely driven by a decline in home prices and other declines in regional economic conditions, partially oÅset by an increase in management and guarantee income. The increases in management and guarantee income in 2006 and 2007 are primarily due to higher average balances of the single-family credit guarantee portfolio. 51 Freddie Mac Table 20 below provides summary Adjusted operating income information about management and guarantee income for the Single-family Guarantee segment. Management and guarantee income consists of contractual amounts due to us related to our management and guarantee fees as well as amortization of credit fees. Table 20 Ì Adjusted Operating Management and Guarantee Income Ì Single-Family Guarantee 2007 Year Ended December 31, 2006 2005 Contractual management and guarantee feesÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Amortization of credit fees included in other liabilities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total Adjusted operating management and guarantee incomeÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Adjustments to reconcile to consolidated GAAP: ReclassiÑcation between net interest income and guarantee fee(1)(2) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Credit guarantee-related activity adjustments(3) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Multifamily management and guarantee income(4) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Management and guarantee income, GAAP ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Amount $2,514 375 2,889 Rate Rate Amount Amount (dollars in millions, rates in basis points) $1,934 407 2,341 $2,186 355 2,541 15.7 2.3 18.0 15.5 2.5 18.0 Rate 15.4 3.2 18.6 29 (342) 59 $2,635 (37) (172) 61 $2,393 (9) (315) 59 $2,076 (1) Guarantee fees earned on mortgage loans held in our retained portfolio are reclassiÑed from net interest income within the Investments segment to management and guarantee fee within the Single-family Guarantee segment. (2) Buy-up and buy-down fees are transferred from the Single-family Guarantee segment to the Investments segment. (3) Primarily represents credit fee amortization adjustments. (4) Represents management and guarantee income recognized related to our Multifamily segment that is not included in our Single-family Guarantee segment. In 2007 and 2006, the growth rates of our credit guarantee portfolio were 17.7% and 11.1%, respectively. We estimate the annual growth in total U.S. residential mortgage debt outstanding to be approximately 7.1% in 2007 compared to 11.3% in 2006. Our single-family mortgage purchase and guarantee volumes are impacted by several factors, including origination volumes, mortgage product and underwriting trends, competition, customer-speciÑc behavior and contract terms. Mortgage purchase volumes from individual customers can Öuctuate signiÑcantly. In 2007, Öow and bulk transactions represented approximately 78% and 22%, respectively, of our single-family mortgage purchase and securitization volumes. The credit markets have been increasingly volatile and the securitization market was extremely competitive. Competitive pressure on Öow business guarantee contracts in early 2007 during the renewal periods of some of our longer- term contracts limited our ability to increase Öow-business guarantee fees in 2007. As a result, some of our guarantee business in 2007 was acquired below our normal expected return thresholds. At the same time, the expected future credit costs associated with our new credit guarantee business increased. We negotiated increases in our contractual fee rates for securitization issuances through bulk activity channels throughout 2007 in response to increases in market pricing of mortgage credit risk. We continue to pursue guarantee fee price increases in our Öow-business as contracts are renewed. During the fourth quarter of 2007, we announced increases in delivery fees, which are paid at the time of securitization. These increases, which will be eÅective in March 2008, represent an additional 25 basis points of fees assessed on all loans issued through Öow-business channels, as well as extra fees for non- traditional and higher risk mortgage loans. Also, in February 2008, we announced an additional increase in delivery fees for certain Öow-business transactions that will be eÅective in June 2008. Net interest income increased due to interest earned on cash and investment balances held in the Investments segment related to single-family guarantee activities, net of allocated funding costs. We expect net interest income from cash and investments to decline in 2008, as we begin to recognize trust management income in other non-interest income. The trust management income will be oÅset by interest expense we incur when a borrower prepays. Our Adjusted operating provision for credit losses for the Single-family Guarantee segment increased to $3.0 billion in 2007, compared to $0.3 billion in 2006, due to continued credit deterioration in our single-family credit guarantee portfolio, primarily related to 2006 and 2007 loan originations. Mortgages in our portfolio originated in 2006 and 2007 have higher transition rates from delinquency to foreclosure, higher delinquency rates as well as higher loss severities on a per-property basis. Our provision is based on our estimate of incurred credit losses inherent in both our retained mortgage loan and our credit guarantee portfolio using recent historical performance, such as the trends in delinquency rates, recent charge-oÅ experience, recoveries from credit enhancements and other loss mitigation activities. The proportion of higher risk mortgage loans that were originated in the market during the last several years increased signiÑcantly. We have increased our securitization volume of non-traditional mortgage products, such as interest-only loans and loans originated with less documentation in the last two years in response to the prevalence of these products within the origination market. Total non-traditional mortgage products, including those designated as Alt-A and interest-only loans, made up approximately 30% and 24% of our single-family mortgage purchase volume in the years ended December 31 2007 and 2006, respectively. Our increased purchases of these mortgages and issuances of guarantees of them expose us to greater 52 Freddie Mac credit risks. In addition, we have increased purchases of mortgages that were underwritten by our seller/servicers using alternative automated underwriting systems or agreed-upon underwriting standards that diÅer from our system or guidelines. The delinquency rate on our single-family credit guarantee portfolio, representing those loans which are 90 days or more past due and excluding loans underlying Structured Transactions, increased to 65 basis points as of December 31, 2007 from 42 basis points as of December 31, 2006. Increases in delinquency rates occurred in all product types in 2007, but were most signiÑcant for interest-only and option ARM mortgages. Although we believe that our delinquency rates remain low relative to conforming loan delinquency rates of other industry participants, we expect our delinquency rates will rise in 2008. See ""CREDIT RISKS Ì Table 51 Ì Single-Family Ì Delinquency Rates Ì By Product'' for further discussion. Single-family charge-oÅs, gross, increased 71% in 2007 compared to 2006, primarily due to a considerable increase in the volume of REO properties acquired at foreclosure. In addition, there has been a substantial increase in the average size of the associated unpaid principal balances in 2007, especially for those loans in major metropolitan areas. Higher volumes of foreclosures and higher average loan balances resulted in higher charge-oÅs, on a per property basis, during 2007. We experienced increases in delinquency rates and REO activity in the Northeast, North Central, Southeast and West regions during 2007 compared to 2006. The increases in delinquencies and foreclosures have been most evident in the North Central region, where unemployment rates continue to be high. During 2007, we experienced increases in the rate at which loans in our single-family credit guarantee portfolio transitioned from delinquency to foreclosure. The increase in the delinquency transition rates which is the percentage of delinquent loans that proceed to foreclosure or are modiÑed as troubled debt restructurings, compared to our historical experience, has been progressively worse for mortgage loans originated in 2006 and 2007. We believe this trend is, in part, due to the increase of non-traditional mortgage loans, such as interest-only mortgages, as well as an increase in total loan-to-value ratios for mortgage loans originated during these years. In addition, the average size of the unpaid principal balance related to REO properties in our portfolio rose signiÑcantly in 2007, especially those REO properties in the Northeast, Southeast and West regions. Declines in home prices have contributed to the increase in the weighted average estimated current loan-to-value, or LTV, ratio for loans underlying our single-family credit guarantee portfolio to 63% at December 31, 2007 from 57% at December 31, 2006. Approximately 10% of loans in our single-family mortgage portfolio had estimated current LTV ratios above 90% at December 31, 2007, compared to 2% at December 31, 2006. However, as home prices increased during 2006 and prior years, many borrowers used second liens at the time of purchase to potentially reduce the LTV ratio to below 80%, thus avoiding requirements to have private mortgage insurance. Including this secondary Ñnancing that our borrowers secured with other Ñnancial institutions, we estimate that the percentage of loans underlying our single-family portfolio with total LTV ratios above 90% has risen to approximately 14% at December 31, 2007. In general, higher total LTV ratios indicate that the borrower has less equity in the home and would thus be more susceptible to foreclosure in the event of a Ñnancial downturn. Multifamily In this segment, we purchase multifamily mortgages for our retained portfolio and guarantee the payment of principal and interest on multifamily mortgage-related securities and mortgages underlying multifamily housing revenue bonds. These activities support our mission to supply Ñnancing for aÅordable rental housing. This segment also includes certain equity investments in various limited partnerships that sponsor low- and moderate-income multifamily rental apartments, which beneÑt from low-income housing tax credits. Also included is the interest earned on assets held in the Investments segment related to multifamily guarantee activities, net of allocated funding costs. 53 Freddie Mac Table 21 presents the Adjusted operating income results of our Multifamily segment. Table 21 Ì Adjusted Operating Income Segment Results Ì Multifamily 2007 Year Ended December 31, 2006 (in millions) 2005 Adjusted operating income results: Net interest incomeÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Non-interest income: Management and guarantee income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Other non-interest income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total non-interest incomeÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Non-interest expense: Administrative expenses ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Provision for credit losses ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ REO operations expenseÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ LIHTC partnerships ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Other non-interest expense ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total non-interest expense ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Adjusted operating (loss) before income tax beneÑtÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ LIHTC partnerships tax beneÑtÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Income tax beneÑtÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Adjusted operating income, net of taxes ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Reconciliation to GAAP net income: Derivative and foreign currency translation-related adjustments ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Credit guarantee-related adjustments ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Tax-related adjustments ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total reconciling items, net of taxes ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Net incomeÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 426 $ 479 $ 417 59 24 83 (189) (38) (1) (469) (21) (718) (209) 534 73 398 (9) Ì 2 (7) $ 391 61 28 89 (182) (4) 1 (407) (17) (609) (41) 461 14 434 3 3 (1) 5 $ 439 59 19 78 (151) (7) Ì (320) (20) (498) (3) 365 1 363 8 4 (4) 8 $ 371 Adjusted operating income for our Multifamily segment decreased $36 million, or 8%, in 2007 compared to 2006 primarily due to lower net interest income, higher provision for credit losses and higher LIHTC losses. Net interest income includes interest earned on cash and investment balances held in the Investments segment related to multifamily guarantee activities, net of allocated funding costs. The net interest income of this segment declined slightly in 2007, compared to 2006, as higher funding costs more than oÅset the increase in our loan portfolio balances. We experienced higher funding costs in 2007 versus 2006, reÖecting the replacement of maturing long-term debt that was issued at lower rates in prior years. Despite market volatility and credit concerns in the single-family market, the multifamily market fundamentals generally continued to display positive trends throughout 2007. Tightened credit standards and reduced liquidity caused many market participants to limit purchases of multifamily mortgages during the second half of 2007, creating investment opportunities for us with higher long-term expected returns and enhancing our ability to meet our aÅordable housing goals. Mortgage purchases into our multifamily loan portfolio increased approximately 50% in 2007, to $18.2 billion from $12.1 billion in 2006. The balance of our multifamily loan portfolio increased to $57.6 billion at December 31, 2007 from $45.2 billion at December 31, 2006. The credit quality of the Multifamily segment remains strong, reÖecting a geographically diversiÑed portfolio. While current market developments indicate higher credit losses for most multifamily mortgage investors, we expect a modest impact to our results, as we continued our conservative approach to underwriting multifamily assets throughout the past two years while credit standards for many lenders deteriorated sharply. Our relatively low provision for credit losses and other non-interest expenses in 2007 and 2006 for this segment reÖects our disciplined approach. We increased our LIHTC investment in 2007 compared to 2006. These investments generated losses and tax credits during development and construction phases and income when the properties were placed into service. At December 31, 2007, the unconsolidated LIHTC equity investment portfolio consisted of 268 funds invested in 5,064 properties and had a net investment balance of $4.6 billion. Our continued investment in LIHTC partnership funds resulted in tax beneÑts of $534 million and $461 million for the years ended December 31, 2007 and 2006, respectively. 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. On October 1, 2007, we adopted FSP FIN 39-1. See ""NOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Ì Recently Adopted Accounting Standards Ì OÅsetting of Amounts Related to Certain Contracts'' to our 54 Freddie Mac consolidated Ñnancial statements for additional information about adoption of FSP FIN 39-1. The adoption of FSP FIN 39-1 reduced derivative assets, net, derivative liabilities, net and senior debt, due within one year on our consolidated balance sheets. EÅective December 31, 2007, we retrospectively applied changes in our method of accounting for our guarantee obligation. See ""NOTE 20: CHANGES IN ACCOUNTING PRINCIPLES'' to our consolidated Ñnancial statements for additional information regarding these changes and the eÅect on our consolidated balance sheets. Previously reported consolidated balance sheet amounts as of December 31, 2006 discussed below have been adjusted to reÖect the retrospective application of these changes in method. Retained Portfolio We refer to our investments in mortgage loans and mortgage-related securities recorded on our consolidated balance sheets as our retained portfolio. See ""PORTFOLIO BALANCES AND ACTIVITIES'' for further information on the composition of our mortgage portfolios. In response to a request by OFHEO, on August 1, 2006, we voluntarily and temporarily limited the growth of our retained portfolio. For a further discussion of our retained portfolio growth limitation see ""REGULATION AND SUPERVISION Ì OÇce of Federal Housing Enterprise Oversight Ì Voluntary, Temporary Growth Limit.'' The average unpaid principal balance of our retained portfolio for the six months ended December 31, 2007, calculated using cumulative average month-end portfolio balances, was $26.9 billion below our voluntary growth limit of $742.4 billion. 55 Freddie Mac Table 22 provides detail regarding the mortgage loans and mortgage-related securities in our retained portfolio. Table 22 Ì Characteristics of Mortgage Loans and Mortgage-Related Securities in our Retained Portfolio December 31, Fixed Rate 2007 Variable Rate Total 2006 (Adjusted) Variable Rate Fixed Rate Total (in millions) Mortgage loans: Single-family(1) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 21,889 Multifamily(2)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 53,114 75,003 Total mortgage loansÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ PCs and Structured Securities:(1)(3) $ 2,700 4,455 7,155 $ 24,589 57,569 82,158 $ 19,407 41,866 61,273 $ 1,233 3,341 4,574 $ 20,640 45,207 65,847 Single-family ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ MultifamilyÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total PCs and Structured Securities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 269,896 2,522 272,418 84,415 137 84,552 354,311 2,659 356,970 282,052 241 282,293 71,828 141 71,969 353,880 382 354,262 Non-Freddie Mac mortgage-related securities:(1) Agency mortgage-related securities:(4) Fannie Mae: Single-family ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ MultifamilyÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Government National Mortgage Association, or Ginnie Mae: Single-family ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ MultifamilyÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total agency mortgage-related securities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 23,140 759 537 13 24,449 Non-agency mortgage-related securities: Single-family: Subprime(5) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Alt-A and other(6) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ CMBSÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Mortgage revenue bonds(7) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Manufactured housing(8)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 498 3,762 25,709 14,870 1,250 46,089 Total unpaid principal balance of retained portfolio ÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $417,959 Total non-agency mortgage-related securities(9) Premiums, discounts, deferred fees, impairments of unpaid principal balances and other basis adjustments ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Net unrealized gains (losses) on mortgage-related securities, pre- tax ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Allowance for loan losses on mortgage loans held-for-investment ÏÏÏ Total retained portfolio per consolidated balance sheets ÏÏÏÏÏÏÏÏÏÏÏ 25,779 1,013 707 13 27,512 17,441 201 231 Ì 17,873 408 3,683 23,517 13,775 1,381 42,764 $413,842 121,691 52,579 21,243 59 129 195,701 $290,117 23,043 163 181 Ì 23,387 100,827 47,551 39,095 65 222 187,760 $302,854 46,183 922 718 13 47,836 101,325 51,313 64,804 14,935 1,472 233,849 720,813 (655) (10,116) (256) $709,786 43,220 1,214 938 13 45,385 122,099 56,262 44,760 13,834 1,510 238,465 703,959 993 (4,950) (69) $699,933 (1) Variable-rate single-family mortgage loans and mortgage-related securities include those with a contractual coupon rate that, prior to contractual maturity, is either scheduled to change or is subject to change based on changes in the composition of the underlying collateral. Single-family mortgage loans also include mortgages with balloon/reset provisions. (2) Variable-rate multifamily mortgage loans include only those loans that, as of the reporting date, have a contractual coupon rate that is subject to change. (3) For our PCs and Structured Securities, 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 AAA-rated or equivalent. (5) Single-family non-agency mortgage-related securities backed by subprime residential loans include signiÑcant credit enhancements, particularly through subordination, and approximately 81% of these securities held at December 31, 2007 were AAA-rated at February 25, 2008. (6) Single-family non-agency mortgage-related securities backed by Alt-A and other mortgage loans include signiÑcant credit enhancements, particularly through subordination, and approximately 98% of these securities held at December 31, 2007 were AAA-rated at February 25, 2008. (7) Consist of obligations of states and political subdivisions. Approximately 67% and 66% of these securities were AAA-rated at December 31, 2007 and 2006, respectively. (8) At December 31, 2007 and 2006, 34% and 30%, respectively, of mortgage-related securities backed by manufactured housing were rated BBB¿ or above. For the same dates, 97% 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 28% and 23% of these securities were AAA-rated at December 31, 2007 and 2006, respectively. (9) Credit ratings for most non-agency mortgage-related securities are designated by no fewer than two nationally recognized statistical rating organizations. At both December 31, 2007 and 2006, approximately 96% of total non-agency mortgage-related securities were AAA-rated. We invest in agency-issued mortgage-related securities, principally our own, when market conditions oÅer positive risk- adjusted returns relative to other permitted investments. We have also purchased non-agency mortgage-related securities in support of our aÅordable housing mission. Our purchases of non-agency single-family mortgage-related securities, which principally consist of securities backed by subprime and Alt-A mortgage products, have been in highly-rated, senior tranches of securitized mortgage pools. Due to credit concerns in the second half of 2007, new issuances of these securities in the market have declined dramatically. Consequently, our holdings of non-agency single-family mortgage-related securities have decreased in 2007, compared to 56 Freddie Mac 2006. We have replaced these investments with purchases of non-agency CMBS securities that meet our investment criteria. Table 23 provides additional detail regarding the fair value of mortgage-related securities in our retained portfolio. Table 23 Ì Fair Value of Available-For-Sale and Trading Mortgage-Related Securities in our Retained Portfolio 2007 December 31, 2006 (in millions) 2005 Available-for-sale securities: Mortgage-related securities issued by: Freddie Mac ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $346,967 45,857 Fannie Mae ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 562 Ginnie Mae ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 207,701 Other ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 14,578 Obligations of states and political subdivisions ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 615,665 Total available-for-sale mortgage-related securities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Trading securities: Mortgage-related securities issued by: Freddie Mac ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Fannie Mae ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Ginnie Mae ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Other ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total trading mortgage-related securitiesÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 12,216 1,697 175 1 14,089 Total fair value of available-for-sale and trading mortgage-related securities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $629,754 $344,088 43,886 733 224,099 13,925 626,731 6,573 802 222 Ì 7,597 $634,328 $351,447 43,306 1,115 231,356 11,241 638,465 8,156 534 204 Ì 8,894 $647,359 Upon the adoption of SFAS 159 we increased the number of securities categorized as trading in our retained portfolio on January 1, 2008. See ""NOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Ì Recently Issued Accounting Standards, Not Yet Adopted Ì The Fair Value Option for Financial Assets and Financial Liabilities'' to our consolidated Ñnancial statements for more information. Issuers Greater than 10% of Stockholders' Equity We held Fannie Mae securities in our retained portfolio with a fair value of $47.6 billion, which represented 178% of total stockholders' equity of $26.7 billion at December 31, 2007. In addition, we held securities issued by Citi Mortgage Loan Trust 2007-1 in our retained portfolio with a fair value of $4.0 billion, which represented 15% of total stockholders' equity at December 31, 2007. No other individual issuer at the individual trust level exceeded 10% of total stockholders' equity at December 31, 2007. Cash and Investments Table 24 provides additional detail regarding the non-mortgage-related securities in our cash and investments portfolio. Table 24 Ì Cash and Investments 2007 Fair Value Average Maturity (Months) Cash and cash equivalents ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 8,574 Investments: Available-for-sale securities: Non-mortgage-related securities: 18,513 Commercial paper ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Asset-backed securities(1) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 16,588 Obligations of states and political subdivisions(1) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Ì Total available-for-sale non-mortgage-related securities(2) ÏÏÏÏÏ 35,101 6,400 Securities purchased under agreements to resell ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 162 Federal funds sold and Eurodollars ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 6,562 Subtotal ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 41,663 Total investments ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total cash and investments per consolidated balance sheetsÏÏÏÏÏÏÏÏÏÏÏÏ $50,237 G3 G3 N/A N/A G3 G3 December 31, 2006 Average Maturity (Months) Fair Value (dollars in millions) G3 $11,359 G3 N/A 363 G3 G3 11,191 32,122 2,273 45,586 3,250 19,778 23,028 68,614 $79,973 2005 Fair Value Average Maturity (Months) $10,468 G3 G3 N/A 282 G3 G3 5,764 30,578 5,823 42,165 5,250 9,909 15,159 57,324 $67,792 (1) Consist primarily of securities that can be prepaid prior to their contractual maturity without penalty. (2) Credit ratings for most securities are designated by no fewer than two nationally recognized statistical rating organizations. At December 31, 2007, 2006 and 2005, all of our available-for-sale non-mortgage-related securities were rated A or better. During 2007, we reduced the balance of our cash and investments portfolio in order to take advantage of investment opportunities in mortgage-related securities as OAS widened. In addition, eÅective in December 2007 we established 57 Freddie Mac securitization trusts for the underlying assets of our PCs and Structured Securities. Consequently, we hold remittances in a segregated account and do not commingle those funds with our general operating funds. The cash owned by the trusts is not reÖected in our cash and investment balances on our consolidated balance sheets. During 2006, we made a 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. Derivative Assets and Liabilities, Net See ""CONSOLIDATED RESULTS OF OPERATIONS Ì Non-Interest Income (Loss) Ì Derivative Gains (Losses)'' for a description of gains (losses) on our derivative positions. Table 25 summarizes the notional or contractual amounts and related fair value of our total derivative portfolio by product type. Table 25 Ì Total Derivative Portfolio 2007 Notional or Contractual Amount(1) December 31, Adjusted 2006 Fair Value(2) Notional or Contractual Amount(1) Fair Value(2) (in millions) Interest-rate swaps: Receive-Ñxed ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Pay-Ñxed ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Basis (Öoating to Öoating) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total interest-rate swaps ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 301,649 409,682 498 711,829 $ 3,648 (11,492) Ì (7,844) Option-based: Call swaptions PurchasedÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ WrittenÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 259,272 1,900 Put swaptions PurchasedÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ WrittenÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Other option-based derivatives(3) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total option-based ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Futures ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Foreign-currency swaps ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Subtotal ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Forward purchase and sale commitments ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Credit derivatives ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Swap guarantee derivatives ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total derivative portfolio ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 18,725 2,650 30,486 313,033 196,270 20,118 1,241,250 72,662 7,667 1,302 $1,322,881 7,134 (27) 631 (74) (23) 7,641 92 4,568 4,457 327 10 (4) 4,790 $ $222,631 217,565 683 440,879 194,200 Ì 29,725 Ì 28,097 252,022 22,400 29,234 744,535 10,012 2,605 957 $758,109 $ (334) (1,352) Ì (1,686) 4,034 Ì 958 Ì (15) 4,977 28 4,399 7,718 6 (1) (3) $ 7,720 (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 value of derivatives on our consolidated balance sheets is reported as derivative asset, net and derivative liability, net, and includes net derivative interest receivable or payable and cash collateral held or posted. Fair value excludes net derivative interest receivable of $1.7 billion and net derivative collateral held of $6.2 billion at December 31, 2007. Fair value excludes net derivative interest receivable of $2.3 billion, and net derivative collateral held of $9.5 billion at December 31, 2006. 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. On October 1, 2007, we adopted FSP FIN 39-1. The position amends FASB Interpretation No. 39, ""OÅsetting of Amounts Related to Certain Contracts, an interpretation of APB Opinion No. 10 and FASB Statement No. 105,'' and permits a reporting entity to oÅset fair value amounts recognized for the right to reclaim cash collateral or the obligation to return cash collateral against fair value amounts recognized for derivative instruments executed with the same counterparty under a master netting agreement. Our adoption resulted in a decrease to total assets and total liabilities of $8.7 billion. We elected to reclassify net derivative interest receivable or payable and cash collateral held or posted on our consolidated balance sheets to derivative asset, net and derivative liability, net. Prior to adoption, these amounts were recorded in accounts and other receivables, net, accrued interest payable, other assets and senior debt: due within one year, as applicable. FSP FIN 39-1 requires retrospective application and certain amounts in prior periods' consolidated balance sheets have been reclassiÑed to conform to the current presentation. See ""NOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Ì Derivatives'' to our consolidated Ñnancial statements for additional information about our derivatives. 58 Freddie Mac 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 interest rates Öuctuate, we use derivatives to adjust the contractual funding of our debt in response to changes in the expected lives of mortgage-related assets in our retained portfolio. Notional or contractual amount increased year-over-year as we responded to the changing interest rate environment. It is often operationally more eÇcient to enter new derivative positions even though the same economic result can be achieved by terminating existing positions. The fair value of the total derivative portfolio decreased in 2007 due to net interest rate decreases across the yield curve that negatively impacted the fair value of our interest-rate swap portfolio. These fair values losses were partially oÅset by fair value increases on our purchased call swaption derivative portfolio that resulted from a net increase in implied volatility and net interest rate decreases. As interest rates decreased, the fair value of our pay-Ñxed swap portfolio decreased by $10.1 billion in 2007. This was partially oÅset by increases in the fair value of our receive-Ñxed swap portfolio of approximately $4.0 billion and our purchased call swaption portfolio of $3.1 billion. In 2007, we added to our portfolio of purchased call swaptions to manage convexity risk associated with the prepayment option in a decreasing interest rate environment. The notional amount of our pay-Ñxed swap portfolio increased because we enter into forward-starting pay-Ñxed swaps to mitigate the duration risk created when we enter into purchased call swaptions and to manage steepening yield curve eÅects on mortgage duration. Table 26 summarizes the changes in derivative fair values. Table 26 Ì Changes in Derivative Fair Values 2007(1) Adjusted 2006(1) (in millions) Beginning balance, at January 1 Ì Net asset (liability) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 7,720 $ 6,517 Net change in: Forward purchase and sale commitments ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Credit derivatives ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Swap guarantee derivatives ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Other derivatives:(2) Changes in fair value ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Fair value of new contracts entered into during the period(3) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Contracts realized or otherwise settled during the period ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Ending balance, at December 31 Ì Net asset (liability) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 321 11 (1) 40 Ì (1) (2,688) 1,146 (1,719) 2,008 2,577 (3,421) $ 4,790 $ 7,720 (1) The value of derivatives on our consolidated balance sheets is reported as derivative asset, net and derivative liability, net, and includes net derivative interest receivable or payable and cash collateral held or posted. Fair value excludes net derivative interest receivable of $1.7 billion and net derivative collateral held of $6.2 billion at December 31, 2007. Fair value excludes net derivative interest receivable of $2.3 billion and net derivative collateral held of $9.5 billion at December 31, 2006. Fair value excludes net derivative interest receivable of $1.8 billion and net derivative collateral held of $8.5 billion at January 1, 2006. (2) Includes fair value changes for interest-rate swaps, option-based derivatives, futures, foreign-currency swaps and interest-rate caps. (3) Consists primarily of cash premiums paid or received on options. Table 27 provides information on our outstanding written and purchased swaption and option premiums at December 31, 2007 and 2006, based on the original premium receipts or payments. We use written options primarily to mitigate convexity risk and reduce our overall hedging costs. See ""QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Ì Interest-Rate Risk and Other Market Risks Ì Sources of Interest-Rate Risk and Other Market Risks Ì Duration Risk and Convexity Risk'' for further discussion related to convexity risk. Table 27 Ì Outstanding Written and Purchased Swaption and Option Premiums Purchased:(1) At December 31, 2007 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ At December 31, 2006 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Written:(2) At December 31, 2007 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ At December 31, 2006 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (1) Purchased options exclude callable swaps. (2) Excludes written options on guarantees of stated Ñnal maturity of Structured Securities. Original Premium Amount (Paid) Received Original Weighted Average Life to Expiration Remaining Weighted Average Life (dollars in millions) $(5,478) $(5,316) $ $ 87 21 7.8 years 7.5 years 3.0 years 0.2 years 6.0 years 6.1 years 2.6 years 0.1 years Table 28 shows the fair value for each derivative type and the maturity proÑle of our derivative positions. A positive fair value in Table 28 for each derivative type is the estimated amount, prior to netting by counterparty, that we would be 59 Freddie Mac 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 44 Ì Derivative Counterparty Credit Exposure'' under ""QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Ì Interest-Rate Risk and Other Market Risks'' for additional information regarding derivative counterparty credit exposure. Table 28 also provides the weighted average Ñxed rate of our pay-Ñxed and receive-Ñxed swaps. Table 28 Ì Derivative Fair Values and Maturities December 31, 2007 Fair Value(1) Notional or Contractual Amount Total Fair Value(2) 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: SwapsÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Weighted-average Ñxed rate(3) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Forward-starting swaps(4) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Weighted-average Ñxed rate(3) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total receive-Ñxed ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Basis (Öoating to Öoating) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Pay-Ñxed: SwapsÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Weighted-average Ñxed rate(3) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Forward-starting swaps(4) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Weighted-average Ñxed rate(3) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total pay-Ñxed ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total interest-rate swaps ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Option-based: Call swaptions Purchased ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Written ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Put swaptions Purchased ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Written ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Other option-based derivatives(5) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total option-based ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Futures ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Foreign-currency swaps ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Forward purchase and sale commitments ÏÏÏÏÏÏÏÏÏÏÏ Swap guarantee derivatives ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Subtotal ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 282,504 $ 3,266 $ $ 1,557 $ 19,145 301,649 498 322,316 87,366 409,682 711,829 259,272 1,900 18,725 2,650 30,486 313,033 196,270 20,118 72,662 1,302 1,315,214 382 3,648 Ì (8,517) (2,975) (11,492) (7,844) 7,134 (27) 631 (74) (23) 7,641 92 4,568 327 (4) 4,780 27 4.61% Ì Ì 27 Ì (92) 5.10% Ì Ì (92) (65) 4.46% 5 4.78% 1,562 Ì (2,216) 4.77% Ì Ì (2,216) (654) 406 Ì 1,533 Ì 31 (4) Ì 433 93 1,173 327 Ì $1,961 68 (49) Ì 1,552 (1) 2,047 Ì Ì $ 2,944 785 4.54% 19 5.02% 804 Ì (1,849) 4.92% (4) 5.25% (1,853) (1,049) 1,940 (27) 61 (21) (1) 1,952 Ì 544 Ì Ì $ 1,447 $ 897 5.47% 358 5.34% 1,255 Ì (4,360) 5.15% (2,971) 5.66% (7,331) (6,076) 3,255 Ì 471 Ì (22) 3,704 Ì 804 Ì (4) $(1,572) Credit derivatives ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 7,667 $1,322,881 10 $ 4,790 (1) Fair value is categorized based on the period from December 31, 2007 until the contractual maturity of the derivative. (2) The value of derivatives on our consolidated balance sheets is reported as derivative asset, net and derivative liability, net, and includes net derivative interest receivable or payable and cash collateral held or posted. Fair value excludes net derivative interest receivable of $1.7 billion and net derivative collateral held of $6.2 billion at December 31, 2007. (3) Represents the notional weighted average rate for the Ñxed leg of the swaps. (4) Represents interest-rate swap agreements that are scheduled to begin on future dates ranging from less than one year to ten years. (5) Primarily represents written options, including guarantees of stated Ñnal maturity of issued Structured Securities and written call options on PCs we issued. 60 Freddie Mac Guarantee Asset Table 29 summarizes changes in the guarantee asset balance. Table 29 Ì Changes in Guarantee Asset December 31, 2007 Adjusted 2006 (in millions) Beginning balance ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 7,389 3,686 Additions, netÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (1,739) Return of investment on guarantee asset ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 309 Change in fair value of future management and guarantee fees ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (54) Change in estimate ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Gains (losses) on guarantee asset ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (1,484) Ending balance ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 9,591 $ 6,264 2,103 (1,293) 261 54 (978) $ 7,389 The increase in additions, net, in 2007, as compared to 2006, is due to an increase in our guarantee fee rates for both adjustable rate and Ñxed rate products, and to a lesser extent, the increase in our issuance volume in 2007. The losses on guarantee assets in 2007 increased as compared to 2006. This increase is due to the return of investment associated with a higher guarantee asset balance. Gains on fair value of management and guarantee fees in 2007 resulted from an increase in interest rates during the second quarter. The increase in gains on fair value of management and guarantee fees in 2006 was due to an increase in interest rates throughout the year. See ""CONSOLIDATED RESULTS OF OPERATIONS Ì Non-Interest Income (Loss) Ì Gains (Losses) on Guarantee Asset'' for further discussion of gains (losses) on our guarantee asset. Total Debt Securities, Net Table 30 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 30 Ì Reconciliation of the Par Value of Total Debt Securities to Our Consolidated Balance Sheets December 31, 2007 2006 (in millions) Total debt securities: Par value(1)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $775,847 Unamortized balance of discounts and premiums(2) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (43,540) Foreign-currency-related and hedging-related basis adjustments(3) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 6,250 Total debt securities, netÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $738,557 $778,418 (41,814) 7,737 $744,341 (1) Includes securities sold under agreements to repurchase and federal funds purchased. (2) Primarily represents unamortized discounts on zero-coupon debt securities. (3) Primarily represent deferrals related to the translation gain (loss) on foreign-currency denominated debt that was in hedge accounting relationships. 61 Freddie Mac Table 31 summarizes our senior debt, due within one year. Table 31 Ì Senior Debt, Due Within One Year December 31, 2007 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 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Securities sold under agreements to repurchase and federal funds purchased ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Short-term debt securities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Current portion of long-term debt ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Senior debt, due within one year ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $196,426 1,175 Ì 197,601 98,320 $295,921 (dollars in millions) 4.52% 4.36 $158,467 4,496 112 Ì 4.52 4.44 4.49 5.02% 5.27 5.42 $196,426 8,907 804 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 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Securities sold under agreements to repurchase and federal funds purchased ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Short-term debt securities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Current portion of long-term debt ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Senior debt, due within one year ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $157,553 9,832 Ì 167,385 117,879 $285,264 (dollars in millions) 5.14% 5.16 $165,270 4,850 81 Ì 5.14 4.10 4.71 4.76% 4.82 5.48 $182,946 9,832 2,200 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 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Securities sold under agreements to repurchase and federal funds purchased ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 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 (5) 183,945 95,819 $279,764 4.00% 4.17 4.25 N/A 4.00 3.42 3.80 (dollars in millions) $181,878 850 267 3.11% 3.35 3.08 Maximum Balance, Net Outstanding at Any Month End $194,578 2,032 1,000 (1) Represents par value, net of associated discounts, premiums and foreign-currency-related basis adjustments. (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 par value, net of associated discounts, 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 foreign-currency-related basis adjustments. Guarantee Obligation Our guarantee obligation is comprised of the unamortized balance of our contractual obligation on the performance of our PCs and Structured Securities and the unamortized balance of deferred guarantee income. Table 32 summarizes the 62 Freddie Mac changes in our guarantee obligation balances for 2007 and 2006, as well as the balances of the components of our guarantee obligation at December 31, 2007 and 2006. Table 32 Ì Changes in Guarantee Obligation December 31, 2007 Adjusted 2006 (in millions) Beginning balance ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 9,482 Transfer-out to the loan loss reserve(1) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (7) Additions, net: Fair value of performance and other related costs of newly-issued guarantees ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Deferred guarantee income of newly-issued guarantees ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 5,241 901 Amortization income: Performance and other related costs ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Deferred guarantee incomeÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Income on guarantee obligation ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Ending balance ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $13,712 (1,146) (759) (1,905) $ 7,907 (7) 2,097 1,004 (804) (715) (1,519) $ 9,482 Components of the guarantee obligation, at period end: Unamortized balance of performance and other related costs ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 9,930 3,782 Unamortized balance of deferred guarantee income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Ending balance ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $13,712 $ 5,841 3,641 $ 9,482 (1) Represents portions of the guarantee obligation that correspond to incurred credit losses reclassiÑed to reserve for guarantee losses on PCs. The primary drivers aÅecting our guarantee obligation balances are our credit guarantee business volumes, fair values of performance obligations on new guarantees and expected proÑtability of new guarantee business at origination. Additions related to the performance obligations of our newly-issued PCs and Structured Securities increased in 2007, as compared to 2006, due to widening credit spreads of both Ñxed-rate and adjustable-rate products and higher volume of credit guarantee business. We issued $471 billion and $360 billion of our PCs and Structured Securities in 2007 and 2006, respectively. Deferred guarantee income related to newly-issued guarantees declined in 2007, as compared to 2006, due to a decrease in proÑtability expected on guarantees issued in 2007. The increase in amortization income attributable to the performance and other related costs is primarily due to an increase in the guarantee obligation caused by higher expected default costs on newly-issued guarantees as well as a higher volume of credit guarantee business. See ""CONSOLIDATED RESULTS OF OPERATIONS Ì Non-Interest Income (Loss) Ì Income on Guarantee Obligation'' for additional discussion related to our guarantee obligation. Total Stockholders' Equity Total stockholders' equity decreased $0.2 billion during 2007. This decrease was primarily a result of a net loss of $3.1 billion, a $2.7 billion net increase in the AOCI loss, the repurchase of $1.0 billion of common stock and $1.6 billion of common and preferred stock dividends declared. These reductions were partially oÅset by a net increase of $8.0 billion in non-cumulative, perpetual preferred stock. We issued $8.6 billion of non-cumulative, perpetual preferred stock, consisting of $1.5 billion in connection with the planned replacement of common stock with an equal amount of preferred stock and $600 million to replace higher-cost preferred stock that we redeemed and additional issuances of $6.5 billion in the aggregate to bolster our capital base and for general corporate purposes. See ""LIQUIDITY AND CAPITAL RESOURCES Ì Capital Resources Ì Core Capital'' for additional information. The balance of AOCI at December 31, 2007 was a net loss of approximately $11.1 billion, net of taxes, compared to a net loss of $8.5 billion, net of taxes, at December 31, 2006. The increase in the net loss in AOCI was primarily attributable to unrealized losses on our single-family non-agency mortgage-related securities backed by subprime loans and Alt-A loans with net unrealized losses, net of taxes, recorded in AOCI of $5.6 billion and $1.7 billion, respectively, at December 31, 2007. The increase in the net loss in AOCI was partially oÅset by an increase in the value of available-for-sale securities as medium- and long-term rates declined since December 31, 2006 and the reclassiÑcation to earnings of deferred losses related to closed cash Öow hedge relationships. See ""CREDIT RISKS Ì Mortgage Credit Risk'' for more information regarding mortgage-related securities backed by subprime loans and Alt-A loans. 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 63 Freddie Mac issued through our Guarantor Swap program prior to the implementation of FIN 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,'' (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 2007 and 2006, 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. In conjunction with the preparation of our consolidated fair value balance sheets, we use a number of Ñnancial models. See ""OPERATIONAL RISKS'' and ""QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Ì Interest-Rate Risk and Other Market Risks'' for information concerning the risks associated with these models. Key Components of Changes in Fair Value of Net Assets Our attribution of changes in the fair value of net assets relies on models, assumptions, and other measurement techniques that will evolve over time. 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 our 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 our 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/ return proÑle of our investment activity and generate fair value growth. We expect that the net exposures related to market risks we actively manage will generate fair value returns that contribute to meeting our long-term growth objectives, although those positions may result in a net increase or decrease in fair value for a given period. See ""QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK 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 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. 64 Freddie Mac 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). 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 2007, the fair value of net assets attributable to common stockholders, before capital transactions, decreased by $23.6 billion compared to a $2.5 billion increase in 2006. The payment of common dividends and the repurchase of common shares, net of reissuance of treasury stock, reduced total fair value by $2.1 billion in 2007. The fair value of net assets attributable to common stockholders as of December 31, 2007 was $0.3 billion, compared to $26.0 billion as of December 31, 2006. Table 33 summarizes the change in the fair value of net assets attributable to common stockholders for 2007 and 2006. Table 33 Ì Summary of Change in the Fair Value of Net Assets Attributable to Common Stockholders 2007 2006 (in billions) Beginning balance ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 26.0 Changes in fair value of net assets attributable to common stockholders, before capital transactions ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Capital transactions: Common dividends, common share repurchases and issuances, net ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (23.6) $26.8 2.5 (2.1) (3.3) Ending balance ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 0.3 $26.0 Estimated Impact of Changes in Mortgage-To-Debt OAS on Fair Value Results For the years ended December 31, 2007 and 2006, we estimate that on a pre-tax basis the changes in the fair value of net assets attributable to common stockholders, before capital transactions, included decreases of approximately $23.8 billion and $0.9 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 objective. Due to the signiÑcant challenges that exist in the current market, we will not, in the near-term, achieve our objective of long- term returns, before capital transactions, on the average fair value of net assets attributable to common stockholders in the low-to mid-teens. Given the current level of uncertainty in the residential mortgage credit market, volatility in interest rates and our current capital constraints, we will not achieve our long-term objective until market conditions improve. 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, 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. 65 Freddie Mac An integral part of 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. 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. 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. Estimated Impact of Credit Guarantee on Fair Value Results Our credit guarantee activities, including multifamily and single-family whole loan credit exposure, decreased pre-tax fair value by an estimated $18.5 billion in 2007. This estimate includes an increase in the single-family guarantee obligation of approximately $22.2 billion, primarily attributable to the market's pricing of mortgage credit. Wider credit spreads on CMBS and whole loans also negatively impacted our multifamily guarantee obligation. These increases were partially oÅset by a fair value increase in the single-family guarantee asset of approximately $2.1 billion and cash receipts related to management and guarantee fees and other up-front fees. Liquidity LIQUIDITY AND CAPITAL RESOURCES Our business activities require that we maintain adequate liquidity to make payments upon the maturity, redemption 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 PCs and Structured Securities; make net payments on derivative instruments; fund our general operations; and pay dividends on and repurchase 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 or mortgage loans we hold; ‚ sales of securities we hold; ‚ 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 66 Freddie Mac 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 COMMITMENTS'' for further information. EÅective December 2007, we established securitization trusts for the underlying assets of our PCs and Structured Securities. Consequently, we hold remittances in a segregated account and do not commingle those funds with our general operating funds. We now receive trust management income, which represents the fees we earn as master servicer, issuer and trustee for our PCs and Structured Securities. These fees are derived from interest earned on principal and interest cash Öows between the time remitted to the trust by servicers and the date of distribution to our PC and Structured Securities holders. EÅective in July 2006, the Federal Reserve Board revised its payments system risk policy 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, 2007, we pledged approximately $16.8 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 4: RETAINED PORTFOLIO AND CASH AND INVESTMENTS PORTFOLIO'' to our consolidated Ñnancial statements for further information. 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 4: RETAINED PORTFOLIO AND CASH AND INVESTMENTS PORTFOLIO'' to our consolidated Ñnancial statements for information about assets we pledge as collateral. We are involved in various legal proceedings, including those discussed in ""LEGAL PROCEEDINGS,'' which may result in a use of cash. Debt Securities 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 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. 67 Freddie Mac We fund our business activities primarily through the issuance of short- and long-term debt. Table 34 summarizes the par value of the debt securities we issued, based on settlement dates, during 2007 and 2006. 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. Table 34 Ì Debt Security Issuances by Product, at Par Value(1) Year Ended December 31, 2007 2006 (in millions) Short-term debt: Reference Bills» securities and discount notesÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $597,587 4,100 Medium-term notes Ì callable ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Medium-term notes Ì non-callable ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 202 601,889 Total short-term debt ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Long-term debt: Medium-term notes Ì callable(2) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Medium-term notes Ì non-callable(3)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ U.S. dollar Reference Notes» securities Ì non-callable ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Freddie SUBS» securities(4)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total long-term debt ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 112,452 25,096 51,000 Ì 188,548 Total debt securities issuedÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $790,437 $593,444 8,532 1,550 603,526 106,777 17,721 55,000 3,299 182,797 $786,323 (1) Exclude securities sold under agreements to repurchase and federal funds purchased, lines of credit and securities sold but not yet purchased. (2) Include $145 million and $100 million of medium-term notes Ì callable issued for the years ended December 31, 2007 and 2006, respectively, which were accounted for as debt exchanges. (3) Include $Ì and $1.0 billion of medium-term notes Ì non-callable issued for the years ended December 31, 2007 and 2006, respectively, which were accounted for as debt exchanges. (4) Include $Ì and $1.5 billion of Freddie SUBS» securities issued for the years ended December 31, 2007 and 2006, respectively, which were accounted for as debt exchanges. Short-Term Debt We fund our operating cash needs, in part, 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 debt with maturities greater than one year 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 ten 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, U.S. dollar denominated, non-callable Ñxed-rate securities, which we currently issue with original maturities ranging from two through ten years. We have also issued 4Reference Notes» securities denominated in Euros, but did not issue any such securities in 2007 or 2006. We hedge our exposure to changes in foreign-currency exchange rates by entering into swap transactions that convert foreign-currency denominated obligations to U.S. dollar-denominated obligations. See ""QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK 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. 68 Freddie Mac Subordinated Debt During the year ended December 31, 2007, we called $1.9 billion of higher-cost Freddie SUBS» securities, while not issuing any new securities. During the year ended December 31, 2006, we issued approximately $3.3 billion of Freddie SUBS» securities. In addition, we called approximately $1.0 billion of previously issued Freddie SUBS» securities in August 2006. At December 31, 2007 and 2006, the balance of our subordinated debt outstanding was $4.5 billion and $6.4 billion, respectively. Our subordinated debt in the form of Freddie SUBS» securities is a component of 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 one-time 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 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. Table 35 provides the par value, based on settlement dates, of debt securities we repurchased, called and exchanged during 2007 and 2006. Table 35 Ì Debt Security Repurchases, Calls and Exchanges Repurchases of outstanding 4Reference Notes» securities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Repurchases of outstanding medium-term notes ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Calls of callable medium-term notes ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Calls of callable Freddie SUBS» securitiesÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Exchanges of medium-term notes ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Exchanges of Freddie SUBS» securities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Credit Ratings Year Ended December 31, 2007 2006 (in millions) $ 3,965 10,986 95,317 1,930 145 Ì $ 5,210 28,560 26,559 1,000 1,074 1,480 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 36 indicates our credit ratings at February 1, 2008. Table 36 Ì Freddie Mac Credit Ratings Nationally Recognized Statistical Rating Organization S&P Moody's Fitch Senior long-term debt(1) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Aaa Short-term debt(2) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ P-1 Subordinated debt(3) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ AA¿/Negative Aa2 Preferred stock ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ AA¿/Negative Aa3 AAA A-1° AAA F-1° AA¿ A° (1) Includes medium-term notes, U.S. dollar Reference Notes» securities and 4Reference Notes» securities. (2) Includes Reference Bills» securities and discount notes. (3) Includes Freddie SUBS» securities only. In addition to the ratings described in Table 36, 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¿ with a negative outlook at February 1, 2008. See ""RISK MANAGEMENT AND DISCLOSURE COMMITMENTS.'' A S&P rating outlook assesses the potential direction of a long-term credit rating over the intermediate term (typically six months to two years). A modiÑer of ""negative'' means that a rating may be lowered. 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 69 Freddie Mac from A, the highest, to E, the lowest rating. On January 9, 2008, Moody's placed our ""Bank Financial Strength'' rating on review for possible downgrade. Our ""Bank Financial Strength'' rating remained at A¿ as of February 1, 2008. Equity Securities See ""Capital Resources Ì Core Capital'' and ""MARKET FOR THE COMPANY'S COMMON EQUITY, RELATED 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, 2007, this portfolio consisted primarily of cash equivalents and non-mortgage-related securities, such as commercial paper and asset-backed 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. For additional information on our cash and investments portfolio, see ""CONSOLIDATED BALANCE SHEETS ANALYSIS Ì Cash and Investments.'' The non-mortgage-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 ""CREDIT RISKS Ì Institutional Credit Risk'' for more information. Cash Flows Our cash and cash equivalents decreased $2.8 billion to $8.6 billion for the year ended December 31, 2007. Cash Öows used for operating activities in 2007 were $7.4 billion, which reÖected a reduction in cash due to a net loss of $3.1 billion and a decrease in liabilities to PC investors as a result of a change in our PC issuance process. See ""NOTE 20: CHANGES IN ACCOUNTING PRINCIPLES'' to our consolidated Ñnancial statements for additional information. Net cash used was primarily provided by net interest income, management and guarantee fees and changes in other operating assets and liabilities. Cash Öows provided by investing activities in 2007 were $9.6 billion, primarily due to a net increase in cash Öows as we reduced our balance of federal funds sold and eurodollars. See ""CONSOLIDATED BALANCE SHEETS ANALYSIS Ì Cash and Investments'' for additional information. This was partially oÅset by an increase in cash used to purchase mortgage loans under Ñnancial guarantees as a result of increasing delinquencies. See ""CREDIT RISKS Ì Mortgage Credit Risk Ì Performing and Non-Performing Assets'' and ""Ì Delinquencies'' for additional information. Cash Öows used for Ñnancing activities in 2007 were $5.0 billion and resulted from a decrease in debt securities, net, preferred and common stock repurchases and dividends paid. Cash used was partially oÅset by proceeds from the issuance of preferred stock. See ""NOTE 8: STOCKHOLDERS' EQUITY'' to our consolidated Ñnancial statements for more information. Our cash and cash equivalents increased $0.9 billion to $11.4 billion for the year ended December 31, 2006. Cash Öows provided by operating activities in 2006 were $8.7 billion, which primarily reÖected cash Öows provided by net interest income, management and guarantee fees and changes in other operating assets and liabilities, partially oÅset by non-interest expenses. Cash Öows used for investing activities in 2006 were $4.9 billion, primarily resulting from purchases of held-for- investment mortgages and available-for-sale securities, as well as a net decrease in cash Öows from securities purchased under agreements to resell and federal funds sold, partially oÅset by proceeds from sales and maturities of available-for-sale securities and repayments of held-for-investment mortgages. Cash Öows used for Ñnancing activities in 2006 were $2.9 billion and were primarily due to repayments of debt securities, repurchases of common stock, payment of cash dividends on preferred stock and common stock, and payments of housing tax credit partnerships notes payable, partially oÅset by proceeds from issuance of debt securities. Our cash and cash equivalents decreased $24.8 billion to $10.5 billion for the year ended December 31, 2005. Cash Öows provided by operating activities in 2005 were approximately $6.2 billion, which primarily reÖected cash Öows provided by net interest income, management and guarantee fees and changes to other operating assets and liabilities, partially oÅset by non-interest expenses as well as net cash Öows used in purchases of held-for-sale mortgages. Cash Öows used for investing activities were $58.4 billion, primarily resulting from purchases of held-for-investment mortgages and available-for-sale securities as we increased our retained portfolio in 2005 and the repayment of swap collateral obligations. These outÖows were partially oÅset by proceeds from sales and maturities of available-for-sale securities and repayments of held-for- investment mortgages, as well as cash Öows from securities purchased under agreements to resell and federal funds sold. 70 Freddie Mac Cash Öows provided by Ñnancing activities in 2005 were $27.4 billion and were primarily due to proceeds from issuance of debt securities, partially oÅset by net cash Öows used in repayments of debt securities, payment of cash dividends on preferred stock and common stock, and payments of housing tax credit partnerships notes payable. 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 9: REGULATORY CAPITAL'' to our consolidated Ñnancial statements for more information regarding our regulatory capital requirements and OFHEO's capital monitoring framework. When 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, as well as the 30% mandatory target capital surplus 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, risk and economic environment. 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 at December 31, 2007 that we exceeded each of our regulatory capital requirements, in addition to the 30% mandatory target capital surplus. However, weakness in the housing market and volatility in the Ñnancial markets continue to adversely aÅect our capital, including our ability to manage to the 30% mandatory target capital surplus. Factors that could adversely aÅect the adequacy of our capital in future periods include GAAP net losses; continued declines in home prices; changes in our credit and interest-rate risk proÑles; adverse changes in interest-rate or implied volatility; adverse OAS changes; legislative or regulatory actions that increase capital requirements; or changes in accounting practices or standards. As a result of the impact of GAAP net losses on our core capital, we did not meet the 30% mandatory target capital surplus at the end of November 2007. In order to manage to the 30% mandatory target capital surplus and improve business Öexibility, on December 4, 2007, we issued $6 billion of non-cumulative, perpetual preferred stock. In addition, during the fourth quarter of 2007, we reduced our common stock dividend by 50% and reduced the size of our cash and investments portfolio. If these measures are not suÇcient to help us manage to the 30% mandatory target capital surplus, then we will consider additional measures in the future, such as limiting growth or reducing the size of our retained portfolio, slowing issuances of our credit guarantees, issuing preferred or convertible preferred stock, issuing common stock or further reducing our common stock dividend. Other items positively aÅecting our capital position include: (a) certain operational changes in December 2007 for purchasing delinquent loans from our PCs, (b) changes in accounting principles we adopted, which increased core capital by $1.3 billion at December 31, 2007 and (c) our adoption of SFAS 159 on January 1, 2008, which increased core capital by an estimated $1.0 billion. Our ability to execute additional actions or their eÅectiveness may be limited and we might not be able to manage to the 30% mandatory target capital surplus. If we are not able to manage to the 30% mandatory target capital surplus, OFHEO may, among other things, seek to require us to (a) submit a plan for remediation or (b) take other remedial steps. 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. See ""REGULATION AND SUPERVISION Ì OÇce of Federal Housing Enterprise Oversight Ì Capital Standards and Dividend Restrictions'' and ""NOTE 9: REGULATORY CAPITAL Ì ClassiÑcation'' to our consolidated Ñnancial statements for information regarding additional potential actions OFHEO may seek to take against us. Core Capital During 2007 and 2006, our core capital increased approximately $2.5 billion and $0.3 billion, respectively. The increase in 2007 was primarily due to a net increase in the balance of our non-cumulative, perpetual preferred stock of $8.0 billion and the cumulative eÅect of a change in accounting principle of $181 million, partially oÅset by a net loss of $3.1 billion, common stock repurchases of $1.0 billion, and common and preferred stock dividends declared of $1.6 billion. The increase in our core capital in 2006 was primarily from net income of $2.3 billion and a net increase in the balance of our non- cumulative, perpetual preferred stock of $1.5 billion, partially oÅset by common stock repurchases of $2.0 billion and the 71 Freddie Mac payment of common stock and preferred stock dividends totaling $1.6 billion. See ""NOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Ì Recently Adopted Accounting Standards Ì Accounting for Uncertainty in Income Taxes'' to our consolidated Ñnancial statements for further information regarding the cumulative eÅect of a change in accounting principle. We completed Ñve non-cumulative, perpetual preferred stock oÅerings during 2007. In these oÅerings, we issued an aggregate of $8.6 billion of non-cumulative, perpetual preferred stock, consisting of $1.5 billion in connection with the planned replacement of common stock with an equal amount of preferred stock and $600 million to replace higher-cost preferred stock that we redeemed and additional issuances of $6.5 billion in the aggregate to bolster our capital base and for general corporate purposes. We purchased a total of approximately 16.1 million shares of our outstanding common stock under the stock repurchase plan authorized in March 2007 at an average cost of $62.04 per share. Our board of directors approved a dividend per common share of $0.25 for the fourth quarter of 2007, a decrease from the $0.50 per share common dividend that was paid for each of the Ñrst three quarters of 2007 and the fourth quarter of 2006. Our common dividend per share was $0.47 for each of the Ñrst three quarters of 2006 and the fourth quarter of 2005. 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. Our board of directors also approved an increase in the number of authorized shares of common stock from 726 million to 806 million in November 2007. For the fourth quarter of 2005 through the fourth 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 8: STOCKHOLDERS' EQUITY'' to our consolidated Ñnancial statements for information regarding our outstanding issuances of preferred stock. PORTFOLIO BALANCES AND ACTIVITIES Total Mortgage Portfolio Our total mortgage portfolio includes mortgage loans and mortgage-related securities held in our retained portfolio as well as the balances of PCs and Structured Securities held by third parties. Guaranteed PCs and Structured Securities held by third parties are not included on our consolidated balance sheets. 72 Freddie Mac Table 37 provides information about our total mortgage portfolio at December 31, 2007, 2006 and 2005. Table 37 Ì Total Mortgage Portfolio and Segment Portfolio Composition(1)(2) Total mortgage portfolio: Retained portfolio: Single-family mortgage loans ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Multifamily mortgage loans ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total mortgage loansÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Guaranteed PCs and Structured Securities in the retained portfolioÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Non-Freddie Mac mortgage-related securities, agency ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Non-Freddie Mac mortgage-related securities, non-agency ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total non-Freddie Mac mortgage-related securities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total retained portfolio(3) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Guaranteed PCs and Structured Securities held by third parties: 2007 $ 24,589 57,569 82,158 356,970 47,836 233,849 281,685 720,813 Single-family Structured Transactions ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Multifamily Structured TransactionsÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Single-family PCs and other Structured Securities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Multifamily PCs and other Structured Securities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total guaranteed PCs and Structured Securities held by third parties ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total mortgage portfolio ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 9,351 900 1,363,613 7,999 1,381,863 $2,102,676 Segment portfolios: Investments Ì Mortgage-related investment portfolio: Single-family mortgage loans ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Guaranteed PCs and Structured Securities in the retained portfolioÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Non-Freddie Mac mortgage-related securities in the retained portfolio ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total Investments Ì Mortgage-related investment portfolio(4) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Single-family Guarantee Ì Credit guarantee portfolio: Guaranteed PCs and Structured Securities in the retained portfolioÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Guaranteed PCs and Structured Securities held by third parties ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Single-family Structured Transactions in the retained portfolioÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Single-family Structured Transactions held by third partiesÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total Single-family Guarantee Ì Credit guarantee portfolio ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Multifamily Ì Guarantee and loan portfolios: Multifamily loan portfolioÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2007 $ 24,589 356,970 281,685 $ 663,244 $ 343,071 1,363,613 11,240 9,351 $1,727,275 December 31, 2006 (in millions) $ 20,640 45,207 65,847 354,262 45,385 238,465 283,850 703,959 8,424 867 1,105,437 8,033 1,122,761 $1,826,720 December 31, 2006 (in millions) $ 20,640 354,262 283,850 $ 658,752 $ 336,869 1,105,437 17,011 8,424 $1,467,741 2005 $ 20,396 41,085 61,481 361,324 44,626 242,915 287,541 710,346 10,489 Ì 949,599 14,112 974,200 $1,684,546 2005 $ 20,396 361,324 287,541 $ 669,261 $ 344,922 949,599 16,011 10,489 $1,321,021 $ 57,569 $ 45,207 $ 41,085 Multifamily Structured TransactionsÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Multifamily PCs and other Structured Securities(5) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total multifamily guarantee portfolio ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total Multifamily Ì Guarantee and loan portfolios ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Less: Guaranteed PCs and Structured Securities in the retained portfolio(6)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total mortgage portfolio ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 900 10,658 11,558 69,127 (356,970) $2,102,676 $ 867 8,415 9,282 54,489 (354,262) $1,826,720 $ Ì 14,503 14,503 55,588 (361,324) $1,684,546 $ (1) Based on unpaid principal balance and excludes mortgage loans and mortgage-related securities traded, but not yet settled. (2) EÅective December 2007, we established securitization trusts for the underlying assets of our PCs and Structured Securities issued. As a result, we adjusted the reported balance of our mortgage portfolios to reÖect the publicly-available security balances of our PCs and Structured Securities. Previously these balances were based on the unpaid principal balance of the underlying mortgage loans. (3) See ""CONSOLIDATED BALANCE SHEETS ANALYSIS Ì Table 22 Ì Characteristics of Mortgage Loans and Mortgage-Related Securities in our Retained Portfolio'' for a reconciliation of the retained portfolio amounts shown in this table to the amounts shown under such caption in conformity with GAAP on our consolidated balance sheets. (4) Includes certain assets related to Single-family Guarantee activities and Multifamily activities. (5) Includes multifamily PCs and other Structured Securities both in the retained portfolio and held by third parties. (6) The amount of our PCs and Structured Securities in the retained portfolio is included in both our segments' mortgage-related and guarantee portfolios and thus deducted in order to reconcile to our total mortgage portfolio. These securities are managed by the Investments segment, which receives related interest income; however, the Single-family and Multifamily segments manage and receive associated guarantee fees. In 2007 and 2006, our total mortgage portfolio grew at a rate of 15% and 8%, respectively. Our new business purchases consist of mortgage loans and non-Freddie Mac mortgage-related securities that are purchased for our retained portfolio or 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. See ""BUSINESS Ì Our Charter and Mission Ì Types of Mortgages We Purchase'' for information about these relationships and consequent risks. Table 38 summarizes purchases into our total mortgage portfolio. 73 Freddie Mac Table 38 Ì Total Mortgage Portfolio Activity Detail(1) 2007 Year Ended December 31, 2006 2005 New business purchases: Single-family mortgage purchases: % of Purchase % of Purchase Amount Amounts Amount Amounts Amount Amounts (dollars in millions) % of Purchase Conventional: 30-year amortizing Ñxed-rate(2)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $326,455 28,910 15-year amortizing Ñxed-rate ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ ARMs/adjustable-rate(3) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 12,465 Interest-only(4) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 97,778 Option ARMs ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Ì Balloon/resets(5) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 125 FHA/VA(6)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 157 176 Rural Housing Service and other federally guaranteed loans ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 466,066 Total single-family ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Multifamily: Conventional and other ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total multifamily ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total mortgage purchases ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 21,645 21,645 487,711 Non-Freddie Mac mortgage-related securities purchased for Structured Securities: Ginnie Mae CertiÑcatesÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Structured Transactions(7) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total Non-Freddie Mac mortgage-related securities purchased for Structured Securities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 48 3,431 3,479 66% 6 3 20 Ì Ì Ì Ì 95 4 4 99 Ì 1 1 $251,143 21,556 18,854 58,176 Ì 419 946 176 351,270 13,031 13,031 364,301 48 8,592 8,640 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 Total single-family and multifamily mortgage purchases and total non-Freddie Mac mortgage-related securities purchased for Structured Securities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $491,190 100% $372,941 100% $407,213 100% Non-Freddie Mac mortgage-related securities purchased into the retained portfolio: Agency securities: Fannie Mae: Single-family: Fixed-rate ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ Variable-rate ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total Fannie MaeÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2,170 9,863 12,033 $ 4,259 8,014 12,273 Ginnie Mae: Single-family: Fixed-rate ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total Ginnie Mae ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total agency mortgage-related securities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Ì Ì 12,033 Non-agency securities: Single-family Single-family: Fixed-rate ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Variable-rate ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total single-family ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Commercial mortgage-backed securities: Fixed-rate ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Variable-rate ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total commercial mortgage-backed securities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Mortgage revenue bonds: Single-family: Fixed-rate ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Variable-rate ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Multifamily: Fixed-rate ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Variable-rate ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total mortgage revenue bonds ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 881 49,563 50,444 3,558 18,526 22,084 1,813 Ì Ì Ì 1,813 Manufactured Housing: Single-family: 127 Variable-rate ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 127 Total Manufactured Housing ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 74,468 Total non-agency mortgage-related securities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total non-Freddie Mac mortgage-related securities purchased into the retained portfolio ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 86,501 Total new business purchasesÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $577,691 Mortgage purchases with credit enhancementsÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Mortgage liquidations(8)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $298,089 Mortgage liquidations rate(8) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Freddie Mac securities repurchased into the retained portfolio: 16% 21% Single-family: Fixed-rate ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $111,976 26,800 Variable-rate ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Multifamily: Fixed-rate ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2,283 Total Freddie Mac securities repurchased into the retained portfolioÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $141,059 Ì Ì 12,273 718 96,906 97,624 2,534 13,432 15,966 3,062 Ì 116 Ì 3,178 Ì Ì 116,768 129,041 $501,982 17% $339,814 20% $ 76,378 27,146 Ì $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 Ì Ì 168,434 174,720 $581,933 17% $384,674 26% $106,682 29,805 Ì $136,487 (1) Based on unpaid principal balances. Excludes mortgage loans and mortgage-related securities traded but not yet settled. Also excludes net additions to the retained portfolio for delinquent mortgage loans and balloon reset mortgages purchased out of PC pools. (2) Includes 40-year and 20-year Ñxed-rate mortgages. (3) Includes ARMs with 1-, 3-, 5-, 7- and 10-year initial Ñxed-rate periods. (4) Represents loans where the borrower pays interest only for a period of time before the borrower begins making principal payments. (5) Represents 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. (6) Excludes FHA/Department of Veterans AÅairs, or VA, loans that back Structured Transactions. (7) Includes $312 million, $6,908 million and $14,331 million of option ARM loans purchased for Structured Transactions in 2007, 2006 and 2005, respectively. (8) Based on total mortgage portfolio. 74 Freddie Mac Guaranteed PCs and Structured Securities Guaranteed PCs and Structured Securities represent the unpaid principal balances of the mortgage-related securities we issue or otherwise guarantee. Table 39 presents the distribution of underlying mortgage assets for our PCs and Structured Securities. Table 39 Ì Guaranteed PCs and Structured Securities(1)(2) 2007 December 31, 2006 (in millions) 2005 Single-family: Conventional: 30-year Ñxed rate(3) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 20-year Ñxed-rate ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 15-year Ñxed rate ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ ARMs/adjustable-rate ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Option ARMs ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Interest-only(4) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Balloon/resets ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ FHA/VAÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Rural Housing Service and other federally guaranteed loans ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total single-family ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $1,091,212 72,225 272,490 91,219 1,853 159,028 17,242 1,283 132 1,706,684 $ 882,398 66,777 290,314 100,808 2,808 76,114 21,551 1,398 138 1,442,306 $ 741,913 67,937 321,176 106,644 3,830 25,697 26,321 849 154 1,294,521 Multifamily: Conventional and other ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total multifamily ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Structured Securities backed by non-Freddie Mac mortgage-related securities: Ginnie Mae CertiÑcates(5)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Structured Transactions(6) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total Structured Securities backed by non-Freddie Mac mortgage-related securities ÏÏÏÏÏÏÏÏÏ Total guaranteed PCs and Structured Securities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 10,658 10,658 8,415 8,415 14,503 14,503 1,268 20,223 21,491 $1,738,833 1,510 24,792 26,302 $1,477,023 2,021 24,479 26,500 $1,335,524 (1) Based on unpaid principal balances and excludes mortgage-related securities traded, but not yet settled. (2) EÅective December 2007, we established securitization trusts for the underlying assets of our PCs and Structured Securities. As a result, we adjusted the reported balance of our mortgage portfolios to reÖect the publicly-available security balances of our PCs and Structured Securities. Previously we reported these balances based on the unpaid principal balance of the underlying mortgage loans. (3) Portfolio balances include $1,762 million, $42 million and $Ì of 40-year Ñxed-rate mortgages at December 31, 2007, 2006 and 2005, respectively. (4) Includes both Ñxed and variable-rate interest only loans. (5) Ginnie Mae CertiÑcates that underlie the Structured Securities are backed by FHA/VA loans. (6) Represents Structured Securities backed by non-agency securities that include prime, FHA/VA and subprime mortgage loan issuances. Our guarantees of non-traditional mortgage products, including lower documentation loans, have increased in the last two years in response to newer products in the mortgage origination market. Interest-only loans represented approximately 20% and 16% of our securitization volume in 2007 and 2006, respectively. Other non-traditional mortgage products, including those designated as Alt-A loans, made up approximately 10% and 8% of our mortgage purchase volume in 2007 and 2006, respectively. We impose risk management thresholds on purchases of certain new products for which we have limited historical experience. See ""QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK'' and ""CREDIT RISKS'' for additional information regarding our non-traditional mortgage loans, including delinquency rate information. 75 Freddie Mac Table 40 provides additional detail regarding our PCs and Structured Securities. Table 40 Ì Single-Class and Multi-Class PCs and Structured Securities(1) December 31, 2007 Retained Portfolio PCs and Structured Securities: Single-class(2) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Multi-class(3)(4) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Other(5) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total PCs and Structured Securities(7)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $219,702 137,268 Ì $356,970 Held by Third Parties (in millions) $ 817,353 526,604 37,906 $1,381,863 Total Guaranteed PCs and Structured Securities(6) $1,037,055 663,872 37,906 $1,738,833 December 31, 2006 PCs and Structured Securities: Single-class(2) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Multi-class(3)(4) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Other(5) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total PCs and Structured Securities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $194,057 160,205 Ì $354,262 $ 624,383 491,696 6,682 $1,122,761 $ 818,440 651,901 6,682 $1,477,023 (1) Based on unpaid principal balances, and excludes Freddie Mac mortgage-related securities traded, but not yet settled. (2) Includes single-class Structured Securities backed by PCs and Ginnie Mae CertiÑcates. (3) Includes multi-class Structured Securities that are backed by PCs, Ginnie Mae CertiÑcates and non-agency mortgage-related securities. (4) Principal-only strips backed by our PCs and held in the retained portfolio are classiÑed as multi-class for the purpose of this table. (5) See ""NOTE 2: FINANCIAL GUARANTEES AND TRANSFERS OF SECURITIZED INTERESTS IN MORTGAGE-RELATED ASSETS'' to our consolidated Ñnancial statements for a discussion of our other mortgage guarantees. (6) Total PCs and Structured Securities exclude $1,519 billion and $1,240 billion at December 31, 2007 and 2006, 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. (7) EÅective December 2007, we established securitization trusts for the underlying assets of our PCs and Structured Securities issued. As a result, we adjusted the reported balance of our mortgage portfolios to reÖect the publicly-available security balances of our PCs and Structured Securities. Previously, we reported these balances based on the unpaid principal balance of the underlying mortgage loans. 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 assets and obligations, but the related securitized assets are owned by third parties. 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 Types of Mortgages We Purchase,'' we guarantee the payment of principal and interest on PCs and Structured Securities we issue. Mortgage-related assets that back PCs and Structured Securities held by third parties are not reÖected as assets on our consolidated balance sheets. We manage the risks of our credit guarantee activity carefully, sharing the risk in some cases with third parties through the use of primary mortgage insurance, pool insurance and other credit enhancements. ""NOTE 2: FINANCIAL GUARANTEES AND TRANSFERS OF SECURITIZED INTERESTS IN MORTGAGE-RELATED ASSETS'' to 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 ""CREDIT RISKS'' for more information. Our credit guarantee activities principally occur through our 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 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. 76 Freddie Mac 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 earn resecuritization fees in connection with the creation of certain Structured Securities. We resecuritized a total of $456.9 billion and $388.9 billion of single and multiclass Structured Securities during the year ended December 31, 2007 and 2006, respectively. The increase of 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 and securitization activities, see ""PORTFOLIO BALANCES AND ACTIVITIES.'' In addition, we also enter into long-term standby commitments for mortgage assets held by third parties that require that we purchase loans from lenders when the loans subject to these commitments meet certain delinquency criteria. We have included these transactions in the reported activity and balances of our PCs and Structured Securities. Long-term standby commitments represented approximately 2% and less than 1% of the balance of our PCs and Structured Securities as of December 31, 2007 and 2006, respectively. Our maximum potential oÅ-balance sheet exposure to credit losses relating to our PCs and Structured Securities is primarily represented by the unpaid principal balance of those securities held by third parties, which was $1,382 billion and $1,123 billion at December 31, 2007 and 2006, respectively. Based on our historical credit losses, which in 2007 averaged approximately 3.0 basis points of the aggregate unpaid principal balance of our PCs and Structured Securities, 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 include 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 the gains or losses from such transfers that are accounted for as sales are discussed in ""NOTE 2: FINANCIAL GUARANTEES AND 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 2: FINANCIAL GUARANTEES AND TRANSFERS OF SECURITIZED INTERESTS IN MORTGAGE-RELATED ASSETS'' 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 December 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. Their fair values are reported as either Derivative assets, net at fair value or Derivative liabilities, net at fair value on our consolidated balance sheets. See ""QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Ì Interest-Rate Risk and Other Market Risks'' for further information. Our non-derivative commitments are primarily related to commitments arising from mortgage swap transactions and, to a lesser extent, commitments to purchase certain multifamily mortgage loans that will be classiÑed as held-for-investment. These non-derivative commitments totaled $173.4 billion and $264.4 billion at December 31, 2007 and 2006, respectively. Such commitments are not accounted for as derivatives and are not recorded on our consolidated balance sheets. EÅective December 2007 we established securitization trusts for the administration of cash remittances received on the underlying assets of our PCs and Structured Securities. We receive trust management income, which represents the fees we earn as master servicer, issuer, trustee and administrator for our PCs and Structured Securities. These fees, which are included in our non-interest income, are derived from interest earned on principal and interest cash Öows between the time funds are remitted to the trust by servicers and the date of distribution to our PC and Structured Securities holders. The trust management income will be oÅset by interest expense we incur when a borrower prepays. 77 Freddie Mac CONTRACTUAL OBLIGATIONS Table 41 provides aggregated information about the listed categories of our contractual obligations as of December 31, 2007. 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, 2007. 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 Table 41, the amounts of future interest payments on debt securities outstanding at December 31, 2007 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, 2007 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, 2007, such as (a) changes in interest rates, (b) the call or retirement of any debt securities and (c) the issuance of new debt securities. Accordingly, the amounts presented in the table do not represent a forecast of our future cash interest payments or interest expense. Table 41 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 2008. See ""NOTE 14: 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 that 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 directors of the REITs. 78 Freddie Mac Table 41 Ì Contractual Obligations by Year at December 31, 2007 Total 2008 2009 2010 2011 2012 Thereafter (in millions) Long-term debt securities(1) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $576,349 $ 97,262 $ 79,316 $63,911 $45,966 $52,317 $237,577 Short-term debt securities(1) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 199,498 Ì Interest payable(2)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 144,405 54,460 Other liabilities reÖected on our consolidated balance sheet: 199,498 25,181 Ì 12,073 Ì 14,279 Ì 17,606 Ì 20,806 Other contractual liabilities(3)(4)(5) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2,912 2,293 300 104 66 12 137 Purchase obligations: Purchase commitments(6) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Other purchase obligations ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Operating lease obligations ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Capital lease obligationsÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Ì 19 40 Ì Total speciÑed contractual obligations ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $961,686 $362,529 $100,495 $81,662 $60,340 $64,427 $292,233 38,013 262 19 1 38,013 401 107 1 Ì 54 19 Ì Ì 27 14 Ì Ì 18 7 Ì Ì 21 8 Ì (1) Represent par value. Callable debt is included in this table at its contractual maturity. For additional information about our debt securities, see ""NOTE 7: 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 represent future cash payments due under our contractual obligations to make delayed equity contributions to LIHTC partnerships and payables to the trust established for the administration of cash remittances received related to the underlying assets of our PCs and Structured Securities issued. (4) Accrued obligations related to our deÑned beneÑt plans, deÑned contribution plans and executive deferred compensation plan are included in the Total and 2008 columns. However, the timing of payments due under these obligations is uncertain. See ""NOTE 14: EMPLOYEE BENEFITS'' to our consolidated Ñnancial statements for additional information. (5) As of December 31, 2007, we have recorded tax liabilities for unrecognized tax beneÑts totaling $563 million and allocated interest of $137 million. These amounts have been excluded from this table because we cannot estimate the years in which these liabilities may be settled. See ""NOTE 13: INCOME TAXES'' to our consolidated financial statements for additional information. (6) Purchase commitments represent 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. 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 our consolidated Ñnancial statements. Our critical accounting policies and estimates relate to: (a) valuation of Ñnancial instruments; (b) derivative instruments and hedging activities; (c) allowances for loan losses and reserve for guarantee losses; (d) application of the static eÅective yield method guarantee obligation; (e) application of 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 consists of Ñnancial instruments that are measured at fair value on our consolidated Ñnancial statements. For instruments that are complex in nature, the measurement of fair value 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 price that would be received to sell an asset or paid to transfer a liability in a transaction between market participants at the measurement date. The selection of a technique to measure fair value for each type of Ñnancial instrument depends on both the reliability and the availability of relevant market data. The amount of judgment involved in measuring the fair value of a Ñnancial instrument is aÅected by a number of factors, such as the type of 79 Freddie Mac instrument, the liquidity of the markets for the instrument and the contractual characteristics of the instrument. We measure fair value according to the following fair value hierarchy of inputs to valuation techniques: ‚ 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. 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 quotes or direct market observations. During the second half of 2007, the market for non-agency securities has become signiÑcantly less liquid, which has resulted in lower transaction volumes, wider credit spreads and less transparency with pricing for these assets. In addition, we have observed more variability in the quotations received from dealers and third-party pricing services. However we believe that these quotations provide reasonable estimates of fair value. Independent price quotations obtained from pricing services are valuations estimated by a service provider using available market information. Dealer quotes 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 prices are not readily available, we utilize models, including industry standard models and internally-developed models. These models use observable market inputs such as interest rate curves, market volatilities and pricing spreads. We maximize the use of observable 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 measurements 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 classiÑed as trading, which are recorded in gains (losses) on investment activity; 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 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 initial estimate results in losses on certain guarantees when the fair value of the guarantee obligation exceeds the fair value of the related guarantee asset and credit enhancement-related assets at issuance. This obligation also aÅects earnings over time through amortization to income on guarantee obligation. ‚ Mortgage loans purchased under our Ñnancial guarantees result in recognition of losses on loans purchased when fair values are less than our acquisition basis at the date of purchase. ‚ 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 techniques 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, 2007 and 2006, the fair values for approximately 99% of our mortgage-related securities were based on prices obtained from third parties or were determined using models with signiÑcant observable inputs. The fair values for the remainder of our mortgage-related securities were obtained from internal models with few or no observable inputs. All of the fair values for our non-mortgage-related securities at December 31, 2007, and the majority of them at December 31, 2006, were based on prices obtained from third parties. The majority of our derivative positions were valued using internally developed models that used market inputs because few of the derivative contracts we used were listed on exchanges. At December 31, 2007 and 2006, approximately 71% and 65%, respectively, of the gross fair value of our derivative portfolio 80 Freddie Mac 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 29% and 35%, respectively, of our derivatives portfolio was valued based on prices obtained from third parties or using models with signiÑcant observable inputs. See ""QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Ì Interest-Rate Risk and Other Market Risks'' for discussion of market risks and our interest-rate sensitivity measures, Portfolio Market Value Sensitivity or PMVS, and duration gap. Derivative Instruments and Hedging Activities We discontinued substantially all of our hedge accounting relationships by December 31, 2006. During 2006 and 2005, our hedge accounting relationships primarily consisted of hedging benchmark interest-rate risk related to the forecasted issuances of debt that were designated as cash Öow hedges, and fair value hedges of benchmark interest-rate risk and/or foreign currency risk on existing Ñxed-rate debt. The changes in fair value of the derivatives in these cash Öow hedge relationships were recorded as a separate component of AOCI to the extent the hedge relationships were eÅective, and amounts are reclassiÑed to earnings when the forecasted transaction aÅects earnings. When a cash Öow hedge is discontinued, the net derivative gain or loss remains in AOCI unless it is probable that the hedged transaction will not occur. This requires estimates based on our expectation of future funding needs and the composition of future debt issuances. Our expectations about future funding needs are based upon projected growth and historical activity. We believe that the forecasted issuances of debt previously hedged in cash Öow hedging relationships have not become probable of not occurring; therefore, we may continue to include previously deferred amounts in AOCI. In the event that these forecasted issuances of debt do not occur or become probable of not occurring, potentially material amounts that are currently deferred and reported in AOCI would then be immediately recognized in our consolidated statements of income under derivative gains (losses). The change in fair value of the derivatives in fair value hedge relationships were recorded in earnings along with the change in fair value of the hedged debt. Any diÅerence was reÖected as hedge ineÅectiveness in other income. For additional discussion of our use of derivatives and summaries of derivative positions, see ""CONSOLIDATED RESULTS OF OPERATIONS Ì Non-Interest Income (Loss) Ì Derivative Overview'' and ""NOTE 11: DERIVATIVES'' to our consolidated Ñnancial statements. Allowance for Loan Losses and Reserve for Guarantee Losses We maintain an allowance for loan losses on mortgage loans held-for-investment and a reserve for guarantee losses on PCs, collectively referred to as our loan loss reserves, to provide for credit losses when it is probable that a loss has been incurred. We use the same methodology to determine our allowance for loan losses and reserve for guarantee losses, as the relevant factors aÅecting credit risk are the same. 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 also 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 historical experience and current view of economic factors. Determining the adequacy of the loan loss reserves is a complex process that is subject to numerous estimates and assumptions requiring signiÑcant 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. 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. 81 Freddie Mac We believe the level of our loan loss reserves is reasonable based on internal reviews of the factors and methodologies used. A management committee reviews the overall 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. Application of the Static EÅective Yield Method We amortize our guarantee obligation under the static eÅective yield method. The static eÅective yield will be calculated and Ñxed at inception of the guarantee based on forecasted unpaid principal balances. The static eÅective yield will be evaluated and adjusted when signiÑcant changes in economic events cause a shift in the pattern of our economic release from risk. For example, certain market environments may lead to sharp and sustained changes in home prices or prepayments of mortgages, leading to the need for an adjustment in the static eÅective yield for speciÑc mortgage pools underlying the guarantee. When a change is required, a cumulative catch-up adjustment, which could be signiÑcant in a given period, will be recognized and a new static eÅective yield will be used to determine our guarantee obligation amortization. See ""NOTE 20: CHANGES IN ACCOUNTING PRINCIPLES'' to our consolidated Ñnancial statements for further information. Application of the EÅective Interest Method As described in ""NOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES'' to our consolidated Ñnancial statements, we use the eÅective interest method to: (a) recognize interest income on our investments in debt securities; and (b) amortize related deferred items into interest income. The application of the eÅective interest method requires us to estimate the eÅective yield at each period end using our current estimate of future prepayments. Determination of these estimates requires signiÑcant judgment, as expected prepayment behavior 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 updating those expectations over time in response to changes in market conditions, such as interest rates and other macroeconomic factors. See the discussion of market risks and our interest-rate sensitivity measures under ""QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Ì Interest-Rate Risk and Other Market Risks.'' We believe that our current estimates of future prepayments are reasonable and comparable to those used by other market participants. 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 Emerging Issues Task Force 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, 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 to determine whether we have the intent and ability to hold the investments until a forecasted recovery. 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. While market prices and rating agency actions are factors that are considered in the impairment analysis, cash Öow analysis based on default and prepayment assumptions serves as an important factor in determining if an other than temporary impairment has occurred. We recognize impairment losses when quantitative and qualitative factors indicate that it is probable that the security will suÅer a contractual principal loss or interest shortfall. 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 financial 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 and that will likely aÅect our consolidated Ñnancial statements. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK We are exposed to risks that include interest-rate and other market risks, including those described in ""RISK FACTORS.'' While we consider both our day-to-day and long-term management of interest-rate and other market risks to be satisfactory, we identiÑed weaknesses in prior years in our overall risk governance framework. We created an executive 82 Freddie Mac management enterprise risk committee 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. Interest-Rate Risk and Other Market Risks Our interest-rate risk management objective is to serve our 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 our retained portfolio, known as prepayment risk, and the resulting potential mismatch in the timing of our receipt of cash Öows related to our assets versus the timing of payment of cash Öows related to 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 make principal payments in accordance with their contractual obligation. 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 makes principal payments on the loan and the reduction of the PC balance, can lead to signiÑcant interest expense if the interest rate paid to a PC investor is higher than the reinvestment rate earned by the securitization trusts on payments received from mortgage borrowers and paid to us as trust management income. 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 and written options. 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 prepayment risk is generally inherent in mortgage assets, 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 OAS risk. See ""MD&A Ì CONSOLIDATED FAIR VALUE BALANCE SHEETS 83 Freddie Mac 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. 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, 2007, approximately 44% 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, a greater portion of our prepayment risk has been hedged. We also manage interest-rate risk by rebalancing the portfolio, primarily using 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. These limits are reÑned and updated from time to time. See ""MD&A Ì 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 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 (Portfolio Market Value Sensitivity-Level or (PMVS-L)) and the other to nonparallel movements (PMVS-YC). In December 2007, we changed our PMVS reporting to represent estimated dollars-at-risk, rather than expressed as a percentage of fair value to common equity. We believe this change provides more relevant information and better represents our overall level and low exposure to adverse interest-rate movements given the substantial reduction in the fair value of common equity that occurred during 2007. Our PMVS and duration gap estimates are determined using models that involve our best judgment of interest-rate and prepayment assumptions. 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 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 84 Freddie Mac Interest-Rate Risk and Other Market Risks'' discussed above for further information. DeÑnitions of our primary interest rate risk measures follow: ‚ PMVS-L shows the estimated loss in pre-tax portfolio market value 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). ‚ PMVS-YC shows the estimated loss in pre-tax portfolio market value 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% 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 is an estimate of the sensitivity to changes in interest rates of the fair value of all interest-earning assets, 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 over time. ‚ Other assets with minimal interest-rate sensitivity. We do not include other assets, primarily non-Ñnancial instruments such as Ñxed assets and REO, because we estimate their impact on PMVS and duration gap to be minimal. PMVS Results Table 42 provides estimated point-in-time PMVS-L and PMVS-YC results at December 31, 2007 and 2006. Table 42 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 42, 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 42 Ì PMVS Assuming Shifts of the LIBOR Yield Curve Potential Pre-Tax Loss in Portfolio Market Value PMVS-YC 25 bps PMVS-L 50 bps 100 bps (in millions) At: December 31, 2007 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ December 31, 2006 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $42 $27 $533 $146 $1,681 $ 560 Derivatives have enabled us to keep our interest-rate risk exposure at consistently low levels in a wide range of interest- rate environments. Table 43 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. 85 Freddie Mac Table 43 Ì Derivative Impact on PMVS-L (50 bps) Before Derivatives After Derivatives (in millions) EÅect of Derivatives At: December 31, 2007 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ December 31, 2006 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $1,371 $ 541 $533 $146 $(838) $(395) Duration Gap Results Our estimated average duration gap for the months of December 2007 and 2006 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 period and a pay-Ñxed swap with the same maturity as the last debt 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 our 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 the Euro Interbank OÅered Rate, or Euribor-, based interest-rate swaps; ‚ LIBOR- and Treasury-based options (including swaptions); ‚ LIBOR- and Treasury-based exchange-traded futures; and ‚ Foreign-currency swaps. In addition to swaps, futures and purchased options, our derivative positions include the following: Written Options and Swaptions Written call and put swaptions are sold to counterparties allowing them the option to enter into receive- and pay-Ñxed swaps, respectively. Written call and put options on mortgage-related securities give the counterparty the right to execute a 86 Freddie Mac contract under speciÑed terms, which generally occurs when we are in a liability position. We use these written options and swaptions to manage convexity risk over a wide range of interest rates. Written options lower our overall hedging costs, allow us to hedge the same economic risk we assume when selling guaranteed Ñnal maturity REMICs with a more liquid instrument and allow us to rebalance the options in our callable debt and REMIC portfolios. We may, from time to time, write other derivative contracts such as caps, Öoors, interest-rate futures and options on buy-up and buy-down commitments. 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 issue swap guarantee derivatives that guarantee the payments 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 and (b) 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 the borrower's performance as a counterparty on any related interest-rate swaps used to mitigate interest-rate risk. Credit Derivatives We entered into credit derivatives during 2007, 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 referenced pools of mortgage loans. In addition, we entered into an agreement whereby we assume credit risk for mortgage loans held by third parties for up to a 90-day period in exchange for a monthly fee. Should the mortgage loans become delinquent we are obligated to purchase the loans. In addition, we have also purchased mortgage loans containing debt cancellation contracts, which provide mortgage debt or payment cancellation for borrowers who experience unanticipated losses of income dependent on a covered event. The rights and obligations under these agreements have been assigned to the servicers. However, in the event the servicer does not perform as required by contract, under our guarantee, we would be obligated to make the required contractual payments. 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, 2007, the largest single uncollateralized exposure of our 27 approved OTC counterparties listed in ""Table 44 Ì Derivative Counterparty Credit Exposure'' was related to a AAA-rated counterparty, constituting $174 million, or 51%, 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 our net position with an OTC counterparty subject to a master netting agreement has a market value above zero at a given date (i.e., it is an asset reported as derivative assets, net 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; 87 Freddie Mac ‚ ongoing monitoring of our positions with each counterparty; ‚ managing diversiÑcation mix among counterparties; ‚ 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 OTC 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 44 summarizes our exposure to counterparty credit risk in our derivatives, which represents the net positive fair value of derivative contracts, related accrued interest and collateral held by us from our counterparties, 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. 88 Freddie Mac Table 44 Ì Derivative Counterparty Credit Exposure December 31, 2007 Rating(1) Number of Counterparties(2) Notional Amount AAAÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ AA°ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ AA ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ AA¿ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ A° ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ A ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Subtotal(5) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Other derivatives(6) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Forward purchase and sale commitmentsÏÏÏÏ Swap guarantee derivatives ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total derivatives ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2 3 9 6 5 2 27 $ 1,173 180,939 463,163 160,678 168,680 35,391 1,010,024 238,893 72,662 1,302 $1,322,881 Rating(1) Number of Counterparties(2) Notional Amount AAAÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ AA ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ AA¿ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ A° ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ A¿ ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Subtotal(5) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Other derivatives(6) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Forward purchase and sale commitmentsÏÏÏÏ Swap guarantee derivatives ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total derivatives ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2 8 12 4 1 27 $ 3,408 269,126 278,993 142,332 210 694,069 53,071 10,012 957 $758,109 $ 411 2,134 6,264 1,393 1 10,203 Ì 18 Ì $10,221 Weighted Average Contractual Maturity (in years) Total Exposure at Fair Value(3) $ 174 945 1,347 2,230 1,770 239 6,705 Ì 465 Ì $7,170 Adjusted Total Exposure at Fair Value(3) Exposure, Net of Collateral(4) (dollars in millions) $174 Ì 62 30 54 19 339 Ì 465 Ì $804 December 31, 2006 Exposure, Net of Collateral(4) (dollars in millions) $411 92 161 7 1 672 Ì 18 Ì $690 3.4 4.4 5.3 5.8 6.1 5.7 5.4 1.6 4.7 5.2 6.1 5.0 5.2 Weighted Average Contractual Maturity (in years) Collateral Posting Threshold Mutually agreed upon $10 million or less $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) 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, net), including the related accrued interest receivable/payable (net). (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, certain written options and certain credit derivatives. 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, decreased to $339 million at December 31, 2007 from $672 million at December 31, 2006. This decrease was primarily due to a signiÑcant decrease in uncollateralized exposure to AAA-rated counterparties, which typically are not required to post collateral given their low risk proÑle. At December 31, 2007, the uncollateralized exposure to non-AAA-rated counterparties was primarily due to exposure amounts 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 44, approximately 95% of our counterparty credit exposure for OTC interest-rate swaps, option- based derivatives and foreign-currency swaps was collateralized at December 31, 2007. If all of our counterparties for these derivatives had defaulted simultaneously on December 31, 2007, our maximum loss for accounting purposes would have been approximately $339 million. In the event of counterparty default our economic loss 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 conditions by performing daily market stress tests. These tests 89 Freddie Mac 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. As indicated in Table 44, the total exposure to our forward purchase and sale commitments of $465 million and $18 million at December 31, 2007 and 2006, respectively, was uncollateralized. Because the typical maturity of our forward purchase and sale 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 the counterparties to our forward purchase and sale commitments on an ongoing basis to ensure that they continue to meet our internal risk-management standards. At December 31, 2007, we had a large volume of purchase and sale commitments related to our retained portfolio that increased our exposure to the counterparties to our forward purchase and sale commitment. These commitments settled in January 2008. 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. We are exposed to mortgage credit risk on our total mortgage portfolio because we either hold the mortgage assets or have guaranteed mortgages in connection with the issuance of a PC, Structured Security or other borrower performance commitment. 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. Mortgage and credit market conditions deteriorated rapidly in the second half of 2007 and have continued in 2008. These conditions were brought about by several factors, which increased our exposure to both mortgage credit and institutional credit risks. Factors negatively aÅecting the mortgage and credit markets in recent months include: ‚ signiÑcant volatility; ‚ lower levels of liquidity; ‚ wider credit spreads; ‚ rating agency downgrades of mortgage-related securities or counterparties; ‚ declines in home prices nationally; ‚ higher incidence of institutional insolvencies; and ‚ higher levels of foreclosures and delinquencies, particularly with respect to non-traditional and subprime mortgage loans. 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, home price trends, apartment demand in the area, the number of competing properties in the area (including properties under construction) 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. Underwriting Requirements and Quality Control Standards All mortgages that we purchase for our retained portfolio or our credit guarantee portfolio have an inherent risk of default. We seek to manage the underlying risk by using our underwriting and quality control processes and adequately pricing for the risk. 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.» We use 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, 90 Freddie Mac such as LTV 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, which may increase our credit risk and may result in increased losses. 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 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. We have also engaged third-party underwriters to underwrite mortgages on our behalf. During 2007, we also began a program of delegated underwriting for certain multifamily mortgages we purchase or securitize. Credit Enhancements Our charter requires that single-family mortgages with LTV ratios above 80% at the time of purchase must be covered by one or more of the following: (a) primary mortgage insurance on the portion above 80% guaranteed or insured by a qualiÑed insurer as we determined; (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% 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, 2007 and 2006, credit-enhanced single-family mortgages and mortgage-related securities represented approximately 17% and 16% of the $1,819 billion and $1,541 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 insigniÑcant. See ""MD&A Ì CONSOLIDATED BALANCE SHEETS ANALYSIS Ì Table 22 Ì Characteristics of Mortgage Loans and Mortgage- Related Securities in our 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 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. As of December 31, 2007 and 2006, in connection with PCs and Structured Securities backed by single- family mortgage loans, excluding the loans that are underlying Structured Transactions, we had maximum coverage totaling $51.9 billion and $40.2 billion, respectively, in primary mortgage insurance. Other prevalent types of credit enhancement that we use are lender recourse and indemniÑcation agreements (under which we may require a lender to reimburse us for credit losses realized on mortgages), as well as 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 91 Freddie Mac 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. At December 31, 2007 and 2006, in connection with PCs and Structured Securities backed by single-family mortgage loans, excluding the loans that are underlying Structured Transactions, we had maximum coverage totaling $12.1 billion, and $10.5 billion, respectively, in lender recourse and indemniÑcation agreements; and $3.8 billion and $3.7 billion, respectively, in pool insurance. See ""Institutional Credit Risk Ì Mortgage Insurers'' for further discussion about our mortgage loan insurers. Other forms of credit enhancements on single-family mortgage loans include government guarantees, collateral (including cash or high-quality marketable securities) pledged by a lender, excess interest and subordinated security structures. As of December 31, 2007 and 2006, in connection with PCs and Structured Securities backed by single-family mortgage loans, excluding the loans that are underlying Structured Transactions, we had maximum coverage totaling $0.5 billion and $0.8 billion, respectively, in other credit enhancements. We occasionally use credit enhancements to mitigate risk on multifamily mortgages. These mortgages are in almost all cases without recourse to the borrower, absent borrower misconduct. The types of credit enhancements used for multifamily mortgage loans include recourse to the mortgage seller, 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 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. As of December 31, 2007 and 2006, in connection with PCs and Structured Securities backed by multifamily mortgage loans, excluding the loans that are underlying Structured Transactions, we had maximum coverage totaling $1.2 billion and $1.1 billion, respectively. 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, LTV 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. All credit derivatives were classiÑed as no hedge designation. The fair value of these credit derivatives was not material at either December 31, 2007 or 2006. See ""QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Ì Use of Derivatives and Interest-Rate Risk Management Ì Credit Derivatives'' for further discussion. 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 require us to make payments to the seller/servicer. 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, LTV 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 non-traditional 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 loan products include option ARMs and loans with high LTV ratios, and mortgages originated with limited or no underwriting documentation. 92 Freddie Mac 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. In a rising interest rate 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. The primary mortgage products within our mortgage loan and guaranteed PC and Structured Securities portfolios are conventional Ñxed-rate loans. However, during the past several years, there was a rapid proliferation of non-traditional 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 2007 and 2006. See ""REGULATION AND SUPERVISION Ì OÇce of Federal Housing Enterprise Oversight Ì Guidance on Non-traditional Mortgage Product Risks and Subprime Lending'' and ""RISK FACTORS Ì Legal and Regulatory Risks'' for more information on these products. Despite an increase in the purchase of adjustable-rate mortgages in the last few years, single-family traditional long-term Ñxed-rate mortgages comprised approximately 80% and 82% of our mortgage loans and loans underlying our PCs and Structured Securities at December 31, 2007 and 2006, respectively. Adjustable-Rate, Interest-Only and Option ARM Loans These mortgages are designed to oÅer borrowers greater choices 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. Our purchases of interest-only mortgage products increased in 2007, representing approximately 20% of our total mortgage portfolio purchases as compared to approximately 16% in 2006. Our purchase of option ARM mortgage products decreased in 2007, representing less than 1% and approximately 2% of our total mortgage portfolio purchases in 2007 and 2006, respectively. Interest-only and option ARM loans are considered non- traditional mortgage products as deÑned by the October 2006 Guidance on Non-traditional Mortgage Product Risks. At December 31, 2007 and 2006, interest-only and option ARM loans collectively represented approximately 10% and 6%, 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. Table 45 presents scheduled reset information for single-family mortgage loans underlying our PCs and Structured Securities, excluding Structured Transactions, at December 31, 2007 that contain adjustable payment terms. The reported balances in the table are based on the unpaid principal balances of these loans, aggregated by adjustable-rate loan product type and categorized by year of the next scheduled contractual reset date. The timing of the actual reset dates may diÅer from those presented due to a number of factors, including reÑnancing or exercising of other provisions within the terms of the mortgage. Table 45 Ì Single-Family Scheduled Adjustable-Rate Resets by Year at December 31, 2007(1) 2008 2009 2010 2011 2012 Thereafter Total ARMs/amortizingÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $20,258 2,382 ARMs/interest-only ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Balloon/resets ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 3,236 Adjustable-rate loans(2) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $25,876 $17,945 3,529 3,004 $24,478 $16,751 18,822 6,863 $42,436 (in millions) $12,420 30,105 2,821 $45,346 $ 8,516 32,909 880 $42,305 $14,437 33,857 318 $48,612 $ 90,327 121,604 17,122 $229,053 (1) Based on the unpaid principal balances of mortgage products that contain adjustable-rate interest provisions, excluding $1.9 billion of option ARM loans, as of December 31, 2007. These reported balances are based on the unpaid principal balance of the underlying mortgage loans and do not reÖect the publicly-available security balances we use to report the composition of our PCs and Structured Securities. (2) Represents the portion of the unpaid principal balances that are scheduled to reset during the period speciÑed above. Adjustable-rate mortgages typically have initial periods during which the interest rate is Ñxed. After this initial period, which can typically range from two to ten years, the interest rate on the loan will then periodically reset based on a current market rate. As of December 31, 2007, approximately 22% of the adjustable-rate single-family mortgage loans within our PCs and Structured Securities are scheduled to have interest rates that reset in 2008 or 2009. Subprime Loans Participants in the mortgage market often characterize single-family 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 93 Freddie Mac 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 LTV ratios, low credit 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 broadening the availability of mortgage credit. While we have not historically characterized the single-family loans underlying our PCs and Structured Securities as either prime or subprime, we do monitor the amount of loans we have guaranteed with characteristics that indicate a higher degree of credit risk. See ""Mortgage Portfolio Characteristics Ì Higher Risk Combinations'' for further information. We estimate that approximately $6 billion and $3 billion of loans underlying our Structured Transactions at December 31, 2007 and 2006, respectively, were classiÑed as subprime mortgage loans. To support our mission, we announced in April 2007 that we will purchase up to $20 billion in Ñxed-rate and hybrid ARM products that will provide lenders with more choices to oÅer subprime borrowers. The products are intended to be consumer-friendly mortgages for borrowers that will limit payment shock by oÅering reduced adjustable-rate margins, longer Ñxed-rate terms and longer reset periods than existing similar products. Subsequent to our announcement, we have entered into purchase commitments of $207 million of mortgages on primary residence, single-family properties speciÑcally pursuant to this commitment. We also fulÑll this commitment through purchases of reÑnance mortgages made to credit challenged borrowers, who may have previously been served by the subprime mortgage market. As of December 31, 2007, we have purchased approximately $43 billion of conventional mortgages made to borrowers who otherwise might have been limited to subprime products, including approximately $23 billion of reÑnance mortgages meeting our criteria. With respect to our retained portfolio, at December 31, 2007 and 2006, we held investments of approximately $101 billion and $122 billion, respectively, of non-agency mortgage-related securities backed by subprime loans. These securities include signiÑcant credit enhancement, particularly through subordination, and 81% of these securities were AAA- rated at February 25, 2008. During 2007, we recognized $10 million of credit losses as impairment expense on these securities related to four positions that were below AAA-rated at acquisition. The net unrealized losses, net of tax, on the remaining securities that are below AAA-rated are included in AOCI and totaled $504 million as of December 31, 2007. Between December 31, 2007 and February 25, 2008, credit ratings for mortgage-related securities backed by subprime loans with an aggregate unpaid principal balance of $16 billion were downgraded by at least one nationally recognized statistical rating organization. In addition, there were $5 billion of unrealized losses, net of tax, associated with AAA-rated, non- agency mortgage-related securities backed by subprime collateral that are principally a result of decreased liquidity in the subprime market. The extent and duration of the decline in fair value of these securities relative to our cost have met our criteria that indicate the impairment of these securities is temporary. However, if market conditions continue to deteriorate, further credit downgrades to our non-agency mortgage-related securities backed by subprime loans could occur and may result in additional declines in their fair value. Alt-A Loans Many mortgage market participants classify single-family loans with credit characteristics that range between their prime and subprime categories as Alt-A because these loans have a combination of characteristics of each category or may be underwritten with lower or alternative documentation than a full documentation mortgage loan. Although there is no universally accepted deÑnition of Alt-A, industry participants have used this classiÑcation principally to describe loans for which the underwriting process has been streamlined in order to reduce the documentation requirements of the borrower or allow alternative documentation. We principally acquire Alt-A mortgage loans from our traditional lenders that largely specialize in originating prime mortgage loans. These lenders typically originate Alt-A loans as a complementary product oÅering and generally follow an origination path similar to that used for their prime origination process. In determining our exposure to Alt-A loans in our PC and Structured Securities portfolio, we have classiÑed mortgage loans as Alt-A if the lender that delivers them to us has classiÑed the loans as Alt-A, or if the loans had reduced documentation requirements which indicate that the loans should be classiÑed as Alt-A. We estimate that approximately $154 billion, or 9%, of our single-family PCs and Structured Securities at December 31, 2007 were backed by Alt-A mortgage loans. For these loans, our average credit score was 719, our estimated current average LTV ratio was 72% and our delinquency rate, excluding certain Structured Transactions, was 1.86% at December 31, 2007. We also invest in non-agency mortgage-related securities backed by Alt-A loans in our retained portfolio. We have classiÑed these securities as Alt-A if the securities were labeled as Alt-A when sold to us or we believe the underlying collateral includes a signiÑcant amount of Alt-A loans. We believe that $51 billion and $56 billion of our single-family non- agency mortgage-related securities that are not backed by subprime loans are generally backed by Alt-A mortgage loans at December 31, 2007 and 2006, respectively. We have focused our purchases on credit-enhanced, senior tranches of these securities and more than 99% of these securities were AAA-rated as of December 31, 2007. Between December 31, 2007 94 Freddie Mac and February 25, 2008, credit ratings for mortgage-related securities backed by Alt-A loans with an aggregate unpaid principal balance of $1.1 billion were downgraded from AAA by at least one nationally recognized statistical rating organization. Guidance on Non-traditional Mortgage Product Risks and Subprime Mortgage Lending In October 2006, Ñve federal Ñnancial institution regulatory agencies jointly issued Interagency Guidance that clariÑed how Ñnancial institutions should oÅer non-traditional mortgage products in a safe and sound manner and in a way that clearly discloses the risks that borrowers may assume. In June 2007, the same Ñnancial institution regulatory agencies published the Ñnal interagency Subprime Statement, which addressed risks relating to subprime short-term hybrid ARMs. The Interagency Guidance and the Subprime Statement set forth principles that regulate Ñnancial institutions originating certain non-traditional mortgages and subprime short-term hybrid ARMs with respect to their underwriting practices. These principles included providing borrowers with clear and balanced information about the relative beneÑts and risks of these products suÇciently early in the process to enable them to make informed decisions. OFHEO has directed us to adopt practices consistent with the risk management, underwriting and consumer protection guidelines of the Interagency Guidance and the Subprime Statement. These principles apply to our purchase of non- traditional mortgages and subprime short-term hybrid ARMs and our related investment activities. In response, in July 2007, we informed our customers of new underwriting and disclosure requirements for non-traditional mortgages. In September 2007, we informed our customers and other counterparties of similar new requirements for subprime short-term hybrid ARMs. These new requirements are consistent with our announcement in February 2007 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. See ""RISK FACTORS Ì Legal and Regulatory Risks'' for further discussion Mortgage Portfolio Characteristics As previously noted, all mortgages that we purchase for our retained portfolio or that we 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. Our underwriting process evaluates mortgage loans using several critical risk characteristics, such as credit score, LTV ratio and occupancy type. Table 46 provides characteristics of our single-family new business purchases in 2007 and 2006, and of our single-family mortgage portfolio at December 31, 2007 and 2006. 95 Freddie Mac Table 46 Ì Characteristics of Single-Family Mortgage Portfolio(1) Purchases During the Year Ended December 31, 2006 2005 2007 Portfolio at December 31, 2006 2005 2007 Original 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 Above 100% ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ TotalÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Weighted average original ratio ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Estimated Current LTV Ratio Range(3) 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(4) 18% 19% 21% 14 14 54 49 7 8 6 11 Ì Ì 100% 100% 100% 16 50 7 6 Ì 22% 24% 25% 16 16 46 47 7 8 7 7 Ì Ì 100% 100% 100% 17 44 8 6 Ì 74% 73% 71% 71% 70% 70% 41% 52% 56% 18 15 20 19 8 15 2 7 Ì 3 100% 100% 100% 18 18 6 2 Ì 63% 57% 56% 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% 42% 44% 24 22 19 19 10 11 5 6 Ì Ì 100% 100% 100% 23 19 10 4 Ì 45% 45% 45% 23 23 18 18 9 9 4 4 1 1 100% 100% 100% 23 18 9 4 1 Weighted average credit score ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 718 720 722 723 725 725 Loan Purpose Purchase ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Cash-out reÑnance ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Other reÑnanceÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 47% 53% 44% 32 32 15 21 100% 100% 100% 35 21 40% 37% 32% 29 30 34 30 100% 100% 100% 29 39 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% 89% 91% 6 5 5 6 100% 100% 100% 5 4 91% 92% 93% 5 5 3 4 100% 100% 100% 4 3 (1) Purchases and ending balances are based on the unpaid principal balance of the single-family mortgage portfolio (excluding certain Structured Transactions). Purchases included in the data totaled $467 billion, $358 billion and $396 billion in 2007, 2006 and 2005, respectively. Ending balances included in the data totaled $1,718 billion, $1,482 billion and $1,333 billion at December 31, 2007, 2006 and 2005, respectively. (2) Original LTV ratios are calculated as the amount of the mortgage we guarantee divided by the lesser of the appraised value of the property at time of mortgage origination or the mortgage borrower's purchase price. (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 and excludes any secondary Ñnancing. (4) Credit score data is as of mortgage loan origination for all loans within mortgage pools underlying our issued PCs and Structured Securities, as well as mortgage loans held in our retained portfolio, and is based on the rating system scale developed by Fair, Isaac and Co., Inc., or FICO», scores. 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. Our charter requires that single- family mortgages with LTV ratios above 80% at the time of purchase be covered by one or more of the following: (a) mortgage insurance for mortgage amounts above the 80% threshold; (b) a seller's agreement to repurchase or replace any mortgage upon default; or (c) retention by the seller of at least a 10% participation interest in the mortgages. In addition, we employ other types of credit enhancements, including pool insurance, indemniÑcation agreements, collateral pledged by lenders and subordinated security structures. 96 Freddie Mac 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 these home price changes on the underlying LTV ratio of mortgages in our portfolio. While home prices rose signiÑcantly during the years prior to 2006, growth slowed signiÑcantly during 2006 and home prices generally declined in 2007 across the United States. 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 our risk. Historical experience has shown that defaults are less likely to occur on mortgages with lower estimated current LTV ratios. At December 31, 2007, 2006 and 2005, single-family mortgage portfolio loans with 80% or less in estimated current LTV ratio, totaled 75%, 90% and 92%, respectively, which indicates an increase in our exposure to losses in the event of default. 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 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, 2007, 2006 and 2005, the weighted average credit score for single-family mortgage portfolio (based on the credit score at origination) remained high at 723, 725 and 725, 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. Given similar loan characteristics (e.g., LTV ratios), purchase transactions have the lowest likelihood of default followed by no cash-out reÑnances and then cash-out reÑnances. The amount of purchase mortgages in our single- family mortgage portfolio has been increasing in each of the last three years as homeownership rates in the U.S. have also increased. 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 single-family mortgage portfolio. This diversification generally mitigates credit risks arising from changing local economic conditions. Our single-family mortgage portfolio's geographic distribution was relatively stable from 2005 to 2007, and remains broadly diversified across these regions. See ""NOTE 17: CONCENTRATION OF CREDIT AND OTHER RISKS'' to our consolidated financial statements for more information concerning the distribution of our single-family mortgage portfolio by geographic region. Higher Risk Combinations. Combining certain loan characteristics often can indicate a higher degree of credit risk. For example, mortgages with both high LTV ratios and borrowers who have lower credit scores typically experience higher rates of delinquency, default and credit losses. As of December 31, 2007, approximately 1% of single-family mortgage loans we have guaranteed were made to borrowers with credit scores below 620 and had original LTV ratios above 90% at the time of mortgage origination. In addition, as of December 31, 2007, 4% of Alt-A and interest-only single-family loans we have guaranteed have been made to borrowers with credit scores below 620 at mortgage origination. These combinations of loans represent categories that have inherently greater credit risk, but reÖect our eÅorts to meet increasingly demanding aÅordable housing goals. For the 25% of single-family mortgage loans with greater than 80% estimated current LTV ratios, the borrowers had a weighted average credit score at origination of 708 and 705 at December 31, 2007 and 2006, respectively. Similarly, for the 14% of single-family mortgage loans where the average credit score at origination was less than 660, the average estimated current LTV ratios were 71% and 63% at December 31, 2007 and 2006, respectively. As home prices increased during 2006 and prior years, many borrowers used second liens at the time of purchase to potentially reduce their LTV ratio to below 80%. Including this secondary Ñnancing, we estimate that the percentage of loans we have guaranteed with total LTV ratios above 90% has risen to 14% as of December 31, 2007. 97 Freddie Mac 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 homeownership. Foreclosure alternatives are intended to reduce the number of delinquent mortgages that proceed to foreclosure and, ultimately, mitigate our total credit losses by reducing or eliminating a portion of the costs related to foreclosed properties and avoiding the credit loss in REO. Our foreclosure alternatives include: ‚ Repayment plans are contractual plans to make up past due amounts. They mitigate our credit losses because they assist borrowers in returning to compliance with the original terms of their mortgages. ‚ Loan modiÑcations, which involve adding delinquent interest to the original unpaid principal balance of the loan or changing other terms of a mortgage as an alternative to foreclosure. We examine the borrower's capacity to make payments under the new terms by reviewing the borrower's qualiÑcations, including income and other indebtedness. ‚ Forbearance agreements, under which reduced payments or no payments are required during a deÑned period. They 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. ‚ Pre-foreclosure sales, in which the borrower, working with the servicer, sells the home and pays oÅ all or part of the outstanding loan, accrued interest and other expenses from the sale proceeds. The table below presents the number of loans with foreclosure alternatives for the years ended December 31, 2007, 2006 and 2005. Table 47 Ì Single-Family Foreclosure Alternatives(1) Repayment plans ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Loan modiÑcationsÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Forbearance agreements ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Pre-foreclosure sales ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Foreclosure alternatives ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2007 2005 December 31, 2006 (number of loans) 36,996 9,348 11,152 1,575 59,071 38,740 6,232 13,403 1,672 60,047 38,809 8,105 3,108 2,009 52,031 (1) Based on the single-family mortgage portfolio, excluding non-Freddie Mac mortgage-related securities, Structured Transactions, and that portion of Structured Securities that is backed by Ginnie Mae CertiÑcates. The total number of loans with foreclosure alternatives decreased in 2007, as compared to 2006 and 2005, due to a signiÑcant reduction in the number of forbearance agreements that were extended to single-family borrowers aÅected by Hurricane Katrina in 2005 and 2006. Absent the impact of Hurricane Katrina, the number of foreclosure alternatives increased slightly due to the deterioration of the residential mortgage market during 2007. 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 these actions, 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 the activities of 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. Performing and Non-Performing Assets We have classiÑed loans in our single-family mortgage portfolio that are past due for 90 days or more (seriously delinquent) or whose contractual terms have been modiÑed due to the Ñnancial diÇculties of the borrower as non- performing assets. Similarly, multifamily loans are classiÑed as non-performing assets if they are 60 days or more past due (seriously delinquent), if collectibility of principal and interest is not reasonably assured based on an individual loan level assessment, or if their contractual terms have been modiÑed due to Ñnancial diÇculties of the borrower. Table 48 provides detail on performing and non-performing assets in our total mortgage portfolio. 98 Freddie Mac Table 48 Ì Performing and Non-Performing Assets(1) December 31, 2007 Non-Performing Assets Performing Assets(2) Less Than 90 Days Past Due(3) Seriously Delinquent(4) Total (in millions) Mortgage loans in retained portfolio Multifamily ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Multifamily troubled debt restructurings ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Subtotal, mortgage loans in retained portfolio, multifamilyÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Single-familyÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Single-family loans purchased under Ñnancial guarantees(5) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Single-family troubled debt restructuringsÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Subtotal, mortgage loans in retained portfolio, single-familyÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Subtotal, mortgage loans in retained portfolio ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Guaranteed PCs and Structured Securities Multifamily ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Multifamily troubled debt restructurings ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Single-family(6) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Structured Securities backed by non-Freddie Mac mortgage-related securities(7) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Subtotal, guaranteed PCs and Structured Securities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ REO, NetÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Totals ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 57,295 Ì 57,295 13,591 2,399 Ì 15,990 73,285 10,607 Ì 1,700,543 19,846 1,730,996 Ì $1,804,281 $ Ì 264 264 Ì Ì 2,690 2,690 2,954 Ì 51 Ì Ì 51 Ì $3,005 $ 3 7 10 698 4,602 609 5,909 5,919 Ì Ì 6,141 1,645 7,786 1,736 $15,441 $ 57,298 271 57,569 14,289 7,001 3,299 24,589 82,158 10,607 51 1,706,684 21,491 1,738,833 1,736 $1,822,727 December 31, 2006 (Adjusted) Non-Performing Assets Performing Assets(2) Less Than 90 Days Past Due(3) Seriously Delinquent(4) Total (in millions) Mortgage loans in retained portfolio Multifamily ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Multifamily troubled debt restructurings ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Subtotal, mortgage loans in retained portfolio, multifamilyÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Single-familyÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Single-family loans purchased under Ñnancial guarantees(5) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Single-family troubled debt restructuringsÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Subtotal, mortgage loans in retained portfolio, single-familyÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Subtotal, mortgage loans in retained portfolio ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Guaranteed PCs and Structured Securities Multifamily ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Multifamily troubled debt restructurings ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Single-family(6) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Structured Securities backed by non-Freddie Mac mortgage-related securities(7) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Subtotal, guaranteed PCs and Structured Securities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ REO, NetÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Totals ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 44,845 Ì 44,845 13,843 1,156 Ì 14,999 59,844 8,333 Ì 1,440,585 25,305 1,474,223 Ì $1,534,067 $ Ì 362 362 Ì Ì 2,219 2,219 2,581 Ì 52 Ì Ì 52 Ì $2,633 $ Ì Ì Ì 1,125 1,827 470 3,422 3,422 30 Ì 1,721 997 2,748 743 $ 6,913 $ 44,845 362 45,207 14,968 2,983 2,689 20,640 65,847 8,363 52 1,442,306 26,302 1,477,023 743 $1,543,613 (1) Based on unpaid principal balance. EÅective December 2007, we established securitization trusts for the underlying assets of our PCs and Structured Securities issued. As a result, we adjusted the reported balance of our mortgage portfolios to reÖect the publicly-available security balances of our PCs and Structured Securities. Previously we reported these balances based on the unpaid principal balance of the underlying mortgage loans. (2) Consists of single-family loans that are less than 90 days past due and multifamily loans less than 60 days past due under the original terms of the mortgage as of period end and have not had loan terms modiÑed. (3) Includes single-family loans that were previously reported as seriously delinquent and for which the original loan terms have been modiÑed. (4) Consists of single-family loans 90 days or more delinquent or in foreclosure and multifamily loans 60 days or more delinquent at period end. Delinquency status does not apply to REO; however, REO is included in non-performing assets. (5) Represents those loans purchased from the mortgage pools underlying our PCs, Structured Securities or long-term standby agreements due to the borrower's delinquency. Once we purchase a loan under our Ñnancial guarantee it is placed on non-accrual status as long as it remains greater than 90 days past due. Through November 2007, our general practice was to purchase the mortgage loans out of PCs after the loans became 120 days delinquent. EÅective December 2007, our practice changed to purchase these impaired loans out of our PC pools when the loans have been modiÑed, foreclosure sales occur, or when the loans have been delinquent for 24 months, unless we determine it is economically beneÑcial to do so sooner. (6) Excludes our Structured Securities that we classify separately as Structured Transactions. (7) Consists of our Structured Transactions and that portion of Structured Securities that are backed by Ginnie Mae CertiÑcates. The amount of non-performing assets increased 93% at December 31, 2007, to approximately $18.4 billion, from $9.5 billion at December 31, 2006, due to the continued deterioration in single-family housing market fundamentals which has resulted in higher delinquency transition rates in 2007. This rate increased in 2007, compared to 2006. The changes in 99 Freddie Mac these delinquency transition rates, as compared to our historical experience, have been progressively worse for loans originated in 2006 and 2007. We believe this trend is, in part, due to greater origination volume of non-traditional loans, such as interest-only mortgages, as well as an increase in total LTV ratios for mortgage loans originated in those years. In addition, the average size of the unpaid principal balance related to non-performing assets in our portfolio rose in 2007. As a result, the balance of our REO, net, increased 134% in 2007. Until nationwide home prices return to historical appreciation rates or selected regional economies improve, we expect to continue to experience higher delinquency transition rates than those experienced in 2006 and an increase in non-performing assets. Delinquencies We report single-family delinquency information based on the number of loans 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. 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 our Structured Securities that is backed by Ginnie Mae CertiÑcates and our Structured Transactions. Structured Transactions represented 1%, 2% and 2% of our total mortgage portfolio at December 31, 2007, 2006 and 2005, respectively. 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 49 presents delinquency information for the single-family loans underlying our total mortgage portfolio. Table 49 Ì Single-Family Ì Delinquency Rates, Excluding Structured Transactions Ì by Region December 31, 2007 December 31, 2006 December 31, 2005 Percent of Unpaid Principal Balance(2) Delinquency Rate(3) Percent of Unpaid Principal Balance(2) Delinquency Rate(3) Percent of Unpaid Principal Balance(2) Delinquency Rate(3) Northeast(1) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Southeast(1)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ North Central(1) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Southwest(1) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ West(1) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total non-credit-enhanced Ì all regions ÏÏÏÏÏÏÏ Total credit-enhanced Ì all regionsÏÏÏÏÏÏÏÏÏÏÏ Total single-family portfolio ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 24% 18 20 13 25 100% 0.39% 0.59 0.48 0.32 0.42 0.45 1.62 0.65 24% 18 21 13 24 100% 0.24% 0.30 0.32 0.26 0.12 0.25 1.30 0.42 24% 18 22 13 23 100% 0.22% 0.38 0.30 0.64 0.11 0.30 1.61 0.53 (1) Presentation of non-credit-enhanced delinquency rates with the following regional 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); and Southwest (AR, CO, KS, LA, MO, NE, NM, OK, TX, WY). (2) Percentages are based on mortgage loans in the retained portfolio and total PCs and Structured Securities issued, excluding that portion of our Structured Securities that is backed by Ginnie Mae CertiÑcates. (3) Percentages are based on number of loans and excluding Structured Transactions. During 2007 and continuing into 2008, home prices have continued to decline. In some geographical areas, particularly in the North Central region, this decline has been combined with increased rates of unemployment and weakness in home sales, which has resulted in increases in delinquency rates throughout 2007. We have also experienced increases in delinquency rates in the Northeast, Southeast and West regions in 2007. Although Structured Transactions generally have underlying mortgage loans with a variety of risk characteristics, many of them may aÅord us credit protection from losses due to the underlying structure employed and additional credit enhancement features. Delinquency rates on Structured Transactions were 9.86%, 8.36% and 12.34% at December 31, 2007, 2006 and 2005, respectively. The delinquency rate of the total single-family portfolio, including Structured Transactions, was 0.76%, 0.54% and 0.71% at December 31, 2007, 2006 and 2005, respectively. 100 Freddie Mac Table 50 Ì Single-Family Mortgages by Year of Origination Ì Percentage of Mortgage Portfolio and Non-Credit- Enhanced Delinquency Rates(1) 2007 December 31, 2006 2005 Percent of Single-Family Unpaid Principal Balance Non-Credit- Enhanced Delinquency Rate Percent of Single-Family Unpaid Principal Balance Non-Credit- Enhanced Delinquency Rate Percent of Single-Family Unpaid Principal Balance Non-Credit- Enhanced Delinquency Rate 3% G1 2 6 20 13 18 18 20 100% 0.64% 1.63 0.60 0.37 0.20 0.35 0.51 0.89 0.35 0.45 4% G1 3 9 26 16 23 19 Ì 100% 0.58% 1.83 0.60 0.32 0.15 0.22 0.19 0.09 Ì 0.25 6% G1 4 11 34 21 24 Ì Ì 100% 0.73% 2.09 0.75 0.38 0.17 0.21 0.08 Ì Ì 0.30 Year of Origination Pre-2000 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2000 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2001 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2002 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2003 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2004 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2005 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2006 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2007 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ TotalÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (1) Excludes Structured Transactions. Our single-family mortgage portfolio was aÅected by heavy reÑnance volumes, which have contributed to higher liquidation rates during the last Ñve years. At December 31, 2007, approximately 56% of our single-family mortgage portfolio consisted of mortgage loans originated in 2007, 2006 or 2005. The single-family loans in our retained portfolio and underlying our PCs and Structured Securities that were originated in 2007, 2006 and 2005 have experienced higher rates of delinquency in the earlier years of their terms as compared to our historical experience for newer originations. We attribute this increase to a number of factors, including the expansion of credit terms under which loans are underwritten and an increase in our purchases of adjustable-rate and non-traditional mortgage products that have higher inherent credit risk than traditional Ñxed-rate mortgage products. Table 51 presents the delinquency rates of our single-family retained mortgages and those that underlie our PCs and Structured Securities categorized by product type. 101 Freddie Mac Table 51 Ì Single-Family Ì Delinquency Rates Ì By Product 2007 Non-Credit-Enhanced, December 31, 2006 2005 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/adjustable-rate ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Interest-only ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Balloon/resets ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total mortgage loans, PCs and Structured Securities ÏÏÏÏÏÏÏÏÏÏÏÏ Structured Transactions(2) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total mortgage portfolio ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 60% 29 4 5 1 99 1 100% 0.46% 0.18 0.36 1.85 0.33 0.45 1.88 0.45 Number of single-family loans (in millions)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 10.10 55% 34 6 3 1 99 1 100% 9.23 0.31% 0.14 0.26 0.30 0.19 0.25 0.22 0.25 52% 38 6 1 2 99 1 100% 8.67 0.40% 0.19 0.22 0.04 0.19 0.30 0.10 0.30 2007 Credit-Enhanced(4), December 31, 2006 2005 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/adjustable-rate ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Interest-only ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Balloon/resets ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ FHA/VAÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Rural Housing Service and other federally guaranteed loans ÏÏÏÏ Total mortgage loans, PCs and Structured Securities ÏÏÏÏÏÏÏÏÏÏÏÏ Structured Transactions(2) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total mortgage portfolio ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 80% 5 4 4 G 1 2 1 96 4 100% 1.60% 0.63 1.14 3.11 1.55 2.96 2.85 1.62 13.79 2.14 Number of single-family loans (in millions)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2.23 75% 7 6 3 1 2 1 95 5 100% 1.95 1.32% 0.64 1.21 1.05 0.98 2.99 2.65 1.30 14.43 1.93 72% 9 8 2 1 2 1 95 5 100% 1.92 1.74% 0.81 1.05 0.23 0.91 4.03 3.34 1.61 19.65 2.54 2007 Total, December 31, 2006 2005 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/adjustable-rate ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Interest-only ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Balloon/resets ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ FHA/VAÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Rural Housing Service and other federally guaranteed loans ÏÏÏÏ Total mortgage loans, PCs and Structured Securities ÏÏÏÏÏÏÏÏÏÏÏÏ Structured Transactions(2)(3) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total mortgage portfolio ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 64% 25 4 5 1 G 1 G 1 99 1 100% 0.72% 0.20 0.50 2.03 0.41 2.96 2.85 0.65 9.86 0.76 Number of single-family loans (in millions)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 12.33 Net charge-oÅs (dollars in millions) Mortgage loans, PCs and Structured Securities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Structured Transactions(2)(3)(5) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total mortgage portfolio ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $289 1 $290 60% 29 6 3 1 G 1 G 1 99 1 100% 11.18 $141 1 $142 0.54% 0.16 0.44 0.44 0.25 2.99 2.65 0.42 8.36 0.54 56% 33 7 1 2 G 1 G 1 99 1 100% 10.59 $101 Ì $101 0.72% 0.22 0.39 0.10 0.25 4.03 3.34 0.53 12.34 0.71 (1) Includes 40-year and 20-year Ñxed-rate mortgages. (2) Structured Transactions generally have underlying mortgage loans with a variety of risk characteristics but many provide inherent credit protection from losses due to the structure employed, including subordination, excess interest, overcollateralization and other features. (3) Includes $13 billion, $19 billion and $18 billion of option ARM loans that are underlying our Structured Transactions as of December 31, 2007, 2006 and 2005, respectively. (4) 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, 2007, 2006 and 2005 was $326 billion, $266 billion and $253 billion, respectively, for which the maximum coverage of third party primary liability was $55 billion, $58 billion and $53 billion, respectively. (5) Does not include credit losses related to Structured Transactions that were held in our retained portfolio. 102 Freddie Mac Increases in delinquency rates occurred in all product types in 2007, but were most signiÑcant for interest-only and option ARM mortgages. Delinquency rates for interest-only and option ARM products, increased to 203 and 224 basis points, respectively, compared to 44 and 31 basis points at December 31, 2006, respectively. The delinquency rate on our total single-family portfolio, excluding that portion of Structured Securities that is backed by Ginnie Mae CertiÑcates and Structured Transactions, was 65 basis points at December 31, 2007, as compared to 42 basis points as of December 31, 2006. Although we believe our delinquency rates have remained low relative to conforming loan delinquency rates of other industry participants, we expect our delinquency rates to continue to rise in 2008. Our multifamily delinquency rate remained very low at 0.02%, 0.06% and Ì% at the end of 2007, 2006 and 2005, respectively. Table 52 presents activities related to loans acquired under Ñnancial guarantees in 2007. Table 52 Ì Changes in Loans Purchased Under Financial Guarantees(1) Unpaid Principal Balance Purchase Discount Loan Loss Reserves Net Investment 2007 Beginning balance ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Purchases of loans ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Provision for credit losses ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Principal repayments ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Troubled debt restructurings(2) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Foreclosures, transferred to REOÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Ending balance(3) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 2,983 8,833 Ì (1,486) (694) (2,635) $ 7,001 (in millions) $ (220) (2,364) Ì 197 129 491 $(1,767) $ Ì Ì (12) 4 Ì 6 $ (2) $ 2,763 6,469 (12) (1,285) (565) (2,138) $ 5,232 (1) Consists of seriously delinquent loans purchased in performance of our Ñnancial guarantees since January 1, 2006. (2) Consist of loans that have transitioned into troubled debt restructurings during the stated period. (3) Includes loans that have subsequently returned to current status under the original loan terms at December 31, 2007. We have the right to purchase mortgages that back our PCs and Structured Securities from the underlying loan pools when they are signiÑcantly past due. This right to repurchase collateral is known as our repurchase option. Through November 2007, our general practice was to purchase the mortgage loans out of PCs after the loans became 120 days delinquent. EÅective December 2007, our practice changed to purchase these loans out of our PCs when the loans have been modiÑed, foreclosure sales occur, or when the loans have been delinquent for 24 months, unless we determine it is economically beneÑcial to do so sooner. Consequently, we purchased relatively few impaired loans under our repurchase option in December 2007. We record at fair value loans that we purchase out of our guaranteed PCs and Structured Securities in connection with our repurchase option. We record losses on loans purchased on our consolidated statements of income in order to reduce our net investment in acquired loans to their fair value. The unpaid principal balance of non-performing loans that have been purchased under our Ñnancial guarantees and that have not been modiÑed under troubled debt restructurings increased approximately 135% in 2007. This increase is attributable to an increase in the volume of delinquent loans in 2007 as well as an increase in the average size of the unpaid principal balance of those loans. We purchased approximately $8.8 billion in unpaid principal balances of these loans with a fair value at acquisition of $6.5 billion. Loans acquired in 2007 added approximately $2.4 billion of purchase discount, which is comprised of $0.5 billion that was previously recorded on our consolidated balance sheets as loan loss reserve and $1.9 billion of losses on loans purchased as shown on our consolidated statements of income during 2007. We expect that we will continue to incur losses on the purchase of non-performing loans in 2008. However, the volume and severity of these losses is dependent on many factors, including the eÅects of our change in practice for repurchases and regional changes in home prices. Recoveries on loans impaired upon purchase represent the recapture into income of previously recognized losses on loans purchased and provision for credit losses associated with purchases of delinquent loans from our PCs and Structured Securities in conjunction with our guarantee activities. Recoveries occur when a non-performing loan is repaid in full or when at the time of foreclosure the estimated fair value of the acquired property, less costs to sell, exceeds the carrying value of the loan. During 2007, we recognized recoveries on loans impaired upon purchase of $505 million. For impaired loans where the borrower has made required payments that return to current status, the basis adjustments are accreted into interest income over time as periodic payments are received. We classify loans repaid in full and those returning to current status, including those with modiÑed terms, as cured loans and the cumulative percentage of impaired loans that have cured since our purchase out of our PCs as a cure rate. As of December 31, 2007, the cure rate for non-performing loans purchased out of PCs during 2007 and 2006 was approximately 34% and 56%, respectively. We believe, based on the cure rate experienced on these loans, as well as our access to credit enhancement remedies that we will continue to recognize recoveries on loans impaired upon purchase in 2008. 103 Freddie Mac Credit Loss Performance Table 53 provides detail on our credit loss performance associated with mortgage loans in our retained portfolio, including those purchased out of PCs and Structured Securities. Table 53 Ì Credit Loss Performance REO REO balances: Single-family ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ MultifamilyÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ REO activity (number of properties):(1) Beginning property inventory ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Properties acquired ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Properties disposedÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Ending property inventoryÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Average holding period (in days)(2) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ REO operations income (expense): Single-family ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ MultifamilyÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ CHARGE-OFFS Single-family: Foreclosure alternatives, gross ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Recoveries(3)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Foreclosure alternatives, net ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ REO acquisitions, grossÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Recoveries(3)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ REO acquisitions, net ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Single-family totals: Charge-oÅs, gross(4) (including $372 million, $308 million and $286 million relating to loan loss 2007 December 31, 2006 (dollars in millions) 2005 $ $ 1,736 Ì 1,736 $ $ 734 9 743 $ $ 611 18 629 8,785 22,840 (17,231) 14,394 8,070 16,387 (15,672) 8,785 9,604 15,861 (17,395) 8,070 $ $ $ 167 175 (205) $ (1) (206) $ (61) $ 1 (60) $ (57) $ 19 (38) (471) 219 (252) (50) $ 11 (39) (258) 155 (103) reserves, respectively) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Recoveries(3)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Single-family charge-oÅs, net ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (528) 238 (290) (308) 166 (142) Multifamily: Charge-oÅs, gross(4) (including $4 million, $5 million and $8 million relating to loan loss reserves, respectively) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Recoveries(3)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Multifamily charge-oÅs, net ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (4) 1 (3) (5) Ì (5) Total Charge-oÅs: Charge-oÅs, gross(4) (including $376 million, $313 million and $294 million relating to loan loss reserves, respectively) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (532) (313) Recoveries: Related to primary mortgage insuranceÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Related to other credit enhancements ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total recoveries(3) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Charge-oÅs, net ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ CREDIT LOSSES(5) Single-family ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ MultifamilyÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ In basis points(6) Single-family ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ MultifamilyÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 156 83 239 112 54 166 (293) $ (147) $ (495) $ (4) (499) $ (203) $ (4) (207) $ $ $ $ (3.0) Ì (3.0) (1.4) Ì (1.4) (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. (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. (4) Charge-oÅs represent the amount of the unpaid principal balance of a loan that has been discharged in order to remove the loan from our retained portfolio at the time of resolution, regardless of when the impact of the credit loss was recorded on our consolidated statements of income through the provision for credit losses or losses on loans purchased. The amount of charge-oÅs for credit loss performance is generally derived as the contractual balance of a loan at the date it is discharged less the estimated value in Ñnal disposition. (5) Equal to REO operations income (expense) plus charge-oÅs, net. (6) 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. 104 Freddie Mac 186 (40) Ì (40) (44) 23 (21) (242) 162 (80) (286) 185 (101) (8) Ì (8) (294) 119 66 185 (109) (141) (8) (149) (1.1) Ì (1.1) Our credit loss performance is a historic metric that measures losses at the conclusion of the loan resolution process. Our credit loss performance does not include our provision for credit losses and losses on loans purchased. We expect our credit losses to continue to increase in 2008, especially if market conditions, such as home prices and the rate of home sales, continue to deteriorate. Table 54 and Table 55 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. Table 54 Ì REO Activity by Region(1) 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 2007 December 31, 2006 (number of properties) 2005 8,785 8,070 9,604 2,336 4,942 9,175 3,977 2,410 22,840 (1,484) (4,009) (7,520) (3,488) (730) (17,231) 14,394 1,253 3,970 7,236 3,498 430 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) See ""Table 49 Ì Single-Family Ì Delinquency Rates, Excluding Structured Transactions Ì By Region'' for a description of these regions. Our REO property inventories increased 64% in 2007 reÖecting the impact of the weakening housing market and tightening credit standards. In addition, the impact of a national decline in home prices and a decrease in the volume of home sales activity during 2007 lessens the alternatives to foreclosure for homeowners exposed to temporary deterioration in their Ñnancial condition. Increases in our REO inventories have been most severe in areas of the country where unemployment rates continue to be high, such as the North Central region. The East and West coastal areas of the country also experienced signiÑcant increases in REO in 2007. Table 55 Ì Single-Family Charge-oÅs and Recoveries by Region(1)(2) 2007 Year Ended December 31, 2006 2005 Charge-oÅs, gross Recoveries Charge-oÅs, net Charge-oÅs, gross Northeast ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Southeast ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ North CentralÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Southwest ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ West ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 50 112 219 90 57 $528 $ (21) (60) (92) (45) (20) $(238) $ 29 52 127 45 37 $290 $ 22 72 133 73 8 $308 Recoveries (in millions) $ (9) (42) (66) (44) (5) $(166) Charge-oÅs, net Charge-oÅs, gross Recoveries Charge-oÅs, net $ 13 30 67 29 3 $142 $ 21 76 102 68 19 $286 $ (10) (54) (66) (44) (11) $(185) $ 11 22 36 24 8 $101 (1) See ""Table 49 Ì Single-Family Ì Delinquency Rates, Excluding Structured Transactions 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 71% in 2007 compared to 2006, primarily due to a considerable increase in the volume of REO properties acquired at foreclosure. We expect that the volume of our REO properties will continue to increase if the economic condition of the residential mortgage market does not improve. Higher volumes of foreclosures and higher average loan balances resulted in higher charge-oÅs, on a per property basis, during 2007. 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 mortgages underlying our PCs and Structured Securities. See ""MD&A Ì CRITICAL ACCOUNTING POLICIES AND ESTIMATES Ì Allowance for Loan Losses and Reserve for Guarantee Losses,'' ""NOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES'' and ""NOTE 5: 105 Freddie Mac MORTGAGE LOANS AND LOAN LOSS RESERVES'' to our consolidated Ñnancial statements for further information. Table 56 summarizes our loan loss reserves activity for both reserves in total. Table 56 Ì Loan Loss Reserves Activity 2007 2006 Year Ended December 31, Adjusted 2005 (in millions) Total loan loss reserves:(1) Beginning balance ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Provision (beneÑt) for credit losses ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Charge-oÅs, gross(2) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Recoveries(3) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Charge-oÅs, netÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Adjustment for change in accounting(4) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Transfers, net(5) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Ending balance ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 619 2,854 (376) 239 (137) Ì (514) $2,822 $ 548 296 (313) 166 (147) Ì (78) $ 619 $ 355 307 (294) 185 (109) Ì (5) $ 548 2004 2003 $ 356 164 (300) 160 (140) Ì (25) $ 355 $ 439 (35) (224) 145 (79) 42 (11) $ 356 (1) Includes reserves for loans held for investment in the retained portfolio and reserves for guarantee losses on Participation CertiÑcates. (2) Charge-oÅs related to retained mortgages represent the amount of the unpaid principal balance of a loan that has been discharged using the reserve balance to remove the loan from our retained portfolio at the time of resolution. Charge-oÅs exclude $156 million in 2007 related to reserve amounts previously transferred to reduce the carrying value of loans purchased under Ñnancial guarantees. (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 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) On January 1, 2003, $42 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. (5) Consist of: (a) the transfer of reserves associated with non-performing loans purchased from mortgage pools underlying our PCs, Structured Securities and long-term standby agreements to establish the initial recorded investment in these loans at the date of our purchase; (b) amounts attributable to uncollectible interest on PCs and Structured Securities in our retained portfolio; and (c) other transfers, net. Our total loan loss reserves increased in 2007 as we recorded additional reserves to reÖect increased estimates of incurred losses, an observed increase in delinquency rate and increases in the expected severity of losses on a per-property basis related to our single-family portfolio. In addition, in 2006, we reversed $82 million of our 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. See ""MD&A Ì 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% 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 relating to derivatives, arises from agreements with: ‚ mortgage insurers; ‚ mortgage seller/servicers; ‚ issuers, guarantors or third-party providers of credit enhancements (including bond insurers); ‚ mortgage investors; ‚ multifamily mortgage guarantors, ‚ issuers, guarantors and insurers of investments held in both our retained portfolio and cash and investments portfolio; and ‚ derivative counterparties. A signiÑcant failure by a major entity in one of these categories to perform could have a material adverse eÅect on our retained portfolio, cash and investments portfolio or credit guarantee activities. The recent challenging market conditions 106 Freddie Mac have adversely aÅected, and are expected to continue to adversely aÅect, the liquidity and Ñnancial condition of a number of our counterparties. For example, some of our largest mortgage seller/servicers have experienced ratings downgrades and liquidity constraints and other of our counterparties may also experience these concerns. The weakened Ñnancial condition and liquidity position of some of our counterparties may adversely aÅect their ability to perform their obligations to us, or the quality of the services that they provide to us. During 2007, we terminated our arrangements with certain mortgage seller/servicers due to their failure to meet our eligibility requirements and we continue to closely monitor the eligibility of mortgage seller/servicers under our standards. The failure of any of our primary counterparties to meet their obligations to us could have a material adverse eÅect on our results of operations and Ñnancial condition. Investments in 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. Our non-Freddie Mac mortgage-related securities portfolio consists of both agency and non-agency mortgage-related securities. Agency securities present minimal institutional credit risk due to the prevailing view that these securities have a credit quality at least equivalent to non-agency securities rated AAA (based on the S&P or equivalent rating scale of other nationally recognized statistical rating organizations). We seek to 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. See ""MD&A Ì CONSOLIDATED BALANCE SHEETS ANALYSIS Ì Table 22 Ì Characteristics of Mortgage Loans and Mortgage-Related Securities in our Retained Portfolio'' for more information regarding the non-Freddie Mac securities in our retained portfolio. Mortgage 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. Our monitoring includes regularly performing analysis of the estimated Ñnancial capacity of mortgage insurers under diÅerent adverse economic conditions. 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. Recently the mortgage insurance industry has been subject to increased public and regulatory scrutiny. In addition, certain large insurers have been downgraded by nationally recognized rating agencies. We announced that eÅective June 1, 2008, our private mortgage insurer counterparties may not cede new risk if the gross risk or gross premium ceded to captive reinsurers is greater than 25%. We also announced that we are temporarily suspending certain requirements for our mortgage insurance counterparties that are downgraded below AA¿ or Aa3 by any one of the rating agencies, provided the mortgage insurer commits to providing a remediation plan for our approval within 90 days of the downgrade. We periodically perform 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. In the event one of our mortgage insurers were to become insolvent, the insurer's future premiums would be used to pay claims. 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 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 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% 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 defaulting 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 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 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. 107 Freddie Mac 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 in our retained portfolio expose us to institutional credit risk related to 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 ""MD&A Ì CONSOLIDATED BALANCE SHEETS ANALYSIS Ì Table 22 Ì Characteristics of Mortgage Loans and Mortgage-Related Securities in our 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. Ginnie Mae securities are backed by the full faith and credit of the U.S. 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, 2007, we held approximately $48 billion of agency securities, representing approximately 2% 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. As of December 31, 2007, we had insurance coverage, including secondary policies, on securities totaling $17.9 billion of unpaid principal balance, consisting of $16.1 billion and $1.8 billion, of coverage for bonds in our retained and investment portfolios, respectively. As of December 31, 2007, the top three of our bond insurers, each accounting for more than 20% of our overall bond insurance coverage (including secondary policies), collectively represented approximately 80% of our bond insurance coverage. At December 31, 2007, all 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. However, the bond insurance industry has been adversely aÅected by the increased volatility in the credit and mortgage markets. Consequently, certain large insurers have been downgraded by nationally recognized statistical rating agencies. Subsequent to December 31, 2007, three of those bond insurers, representing approximately 62% of our total bond insurer coverage, have been downgraded below AAA by at least one rating agency. 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 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. 108 Freddie Mac 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. These operational risks may expose us to Ñnancial loss, interfere with our ability to sustain timely Ñnancial reporting, or result in other adverse consequences. Governance over the management of our operational risks takes place through the enterprise risk management framework. 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. While we believe that we have remediated material weaknesses in our information technology general controls, we continue to face challenges in ensuring that the new controls will operate eÅectively (see ""CONTROLS AND PROCEDURES Ì Internal Control Over Financial Reporting'' for more information). Although we have strengthened our model oversight and governance processes to validate model assumptions, code, theory and the system applications that utilize our models, the complexity of the models and the impact of the recent turmoil in the housing and credit markets create additional risk regarding the reliability of our models. We continue to make signiÑcant investments to build new Ñnancial accounting systems and move to more eÅective and eÇcient business processing systems. Until those systems are fully implemented, we continue to remain more reliant on end- user computing systems than is desirable. We are also 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. We are mitigating this risk by improving our documentation and process controls over these end-user computing systems and implementing more rigorous change management controls over certain key end-user systems using change management controls over tools which are subject to our information technology general controls. 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. 109 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. The status of our commitments at December 31, 2007 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 fewer 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% of outstanding PCs and Structured Securities we guaranteed and 4% 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. ‚ During 2007, we did not issue any Freddie SUBS» securities; however, we called $1.9 billion of higher-cost Freddie SUBS» securities. During 2006, we issued approximately $3.3 billion of Freddie SUBS» securities, including approximately $1.5 billion issued in exchange for previously issued Freddie SUBS» securities, and called approximately $1.0 billion of Freddie SUBS» securities. We did not issue, call or repurchase any Freddie SUBS» securities during 2005. ‚ Based upon an amended total capital plus qualifying subordinated debt report, we will report to OFHEO that at December 31, 2007 we had $44.6 billion in total capital plus qualifying subordinated debt, resulting in a surplus of $6.6 billion. During 2007, we submitted our quarterly total capital plus qualifying subordinated debt reports to OFHEO and we will amend these quarterly reports during the Ñrst quarter of 2008 to reÖect our adjusted results. ‚ Each quarter we will submit to OFHEO calculations ‚ We submitted our semi-annual subordinated debt 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 ""QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK 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. 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 year ended December 31, 2007, our duration gap averaged zero months, PMVS-L averaged $261 million and PMVS-YC averaged $31 million. Our 2007 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. 110 Freddie Mac Description Status 4. Credit Risk Disclosures: ‚ We will make quarterly assessments of the impact on expected credit losses from an immediate 5% 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. 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. ‚ Our quarterly credit risk sensitivity estimates are as follows: At: 12/31/07(5) 09/30/07 06/30/07 03/31/07 12/31/06 Before Receipt of Credit Enhancements(1) Net Present Value, or NPV(3) NPV Ratio(4) After Receipt of Credit Enhancements(2) NPV Ratio(4) NPV(3) (dollars in millions) $4,036 $1,959 $1,768 $1,327 $1,128 23.2 bps 11.7 bps 11.0 bps 8.6 bps 7.6 bps $3,087 $1,415 $1,292 $ 929 $ 770 17.8 bps 8.4 bps 8.1 bps 6.0 bps 5.2 bps (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 NPV of the increase in credit losses to the single-family total mortgage portfolio, deÑned in footnote (3) above. (5) The signiÑcant increase in our credit risk sensitivity estimates in Q4 2007 was primarily attributable to changes in our assumptions employed to calculate the credit risk sensitivity disclosure. Given deterioration in housing fundamentals at the end of 2007, we modiÑed our assumptions for forecasted home prices subsequent to the immediate 5% decline. ‚ At February 1, 2008 and December 31, 2007, our ""risk- to-the-government'' rating from S&P was ""AA¿'' with a negative outlook. An S&P rating outlook assesses the potential direction of a long-term credit rating over the intermediate term (typically six months to two years). A modiÑer of ""negative'' means that a rating may be lowered. ‚ At February 1, 2008 and December 31, 2007, Moody's ""Bank Financial Strength'' rating for us was ""A¿'' and ""A¿'' with a negative outlook, respectively. A Moody's rating outlook is an opinion of the likely direction of a rating over the medium term. On January 9, 2008 Moody's placed our ""Bank Financial Strength'' rating on review for possible downgrade, which overrode the negative outlook designation. 111 Freddie Mac FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA 112 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 and its subsidiaries (the ""company'') at December 31, 2007 and 2006, and the results of their operations and their cash Öows for each of the three years in the period ended December 31, 2007 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 in accordance with generally accepted auditing standards as established by the Auditing Standards Board (United States) and in accordance with the auditing standards of the Public Company Accounting Oversight Board (United States). 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 generally accepted auditing standards as established by the Auditing Standards Board (United States) and in accordance with the auditing standards of the Public Company Accounting Oversight Board (United States), the supplemental consolidated fair value balance sheets of the company as of December 31, 2007 and 2006. 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 accounting principles generally accepted in the United States of America. 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 elected to oÅset amounts related to certain derivative contracts as of October 1, 2007, changed its method of accounting for uncertainty in income taxes as of January 1, 2007, elected to measure newly acquired interests in securitized Ñnancial assets that contain embedded derivatives at fair value as of January 1, 2007, changed its method of accounting for deÑned beneÑt plans as of December 31, 2006, changed its method for determining gains and losses on sales of certain guaranteed securities as of October 1, 2005, and changed its method of accounting for interest expense related to callable debt instruments as of January 1, 2005. As discussed in ""NOTE 20: CHANGES IN ACCOUNTING PRINCIPLES,'' the company changed the manner in which it accounts for the guarantee obligation as of December 31, 2007. McLean, Virginia February 27, 2008 113 Freddie Mac FREDDIE MAC CONSOLIDATED STATEMENTS OF INCOME Year Ended December 31, Adjusted 2007 2005 2006 (dollars in millions, except share- related amounts) Interest income Mortgage loans ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Mortgage-related securities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Cash and investmentsÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total interest income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 4,449 34,893 3,568 42,910 $ 4,152 33,850 4,262 42,264 $ 4,010 28,968 2,606 35,584 Interest expense Short-term debt ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Long-term debtÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total interest expense on debt securities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Due to Participation CertiÑcate investors ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total interest expenseÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Expense related to derivatives ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Net interest incomeÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Non-interest income Management and guarantee income (includes interest on guarantee asset of $549, $580 and $450, respectively) ÏÏÏ Gains (losses) on guarantee asset ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Income on guarantee obligation ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Derivative gains (losses) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Gains (losses) on investment activity ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Gains on debt retirement ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Recoveries on loans impaired upon purchase ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Foreign-currency gains (losses), netÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Other income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Non-interest income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Non-interest expense Salaries and employee beneÑts ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Professional services ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Occupancy expense ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Other administrative expensesÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total administrative expenses ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Provision for credit losses ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Real estate owned operations expense ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Losses on certain credit guarantees ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Losses on loans purchasedÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Low-income housing tax credit partnerships ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Minority interests in earnings of consolidated subsidiariesÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Other expenses ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Non-interest expenseÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Income (loss) before income tax (expense) beneÑt and cumulative eÅect of change in accounting principleÏÏÏÏÏÏ Income tax (expense) beneÑt ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Net income (loss) before cumulative eÅect of change in accounting principle ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Cumulative eÅect of change in accounting principle, net of tax beneÑt of $Ì, $Ì and $32, respectively ÏÏÏÏÏÏÏÏÏ Net income (loss)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Preferred stock dividends and issuance costs on redeemed preferred stock (including $6, $Ì and $Ì of issuance costs on redeemed preferred stock, respectively)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Amount allocated to participating security option holdersÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (404) (5) Net income (loss) available to common stockholders ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ (3,503) Basic earnings (loss) per common share: Earnings (loss) before cumulative eÅect of change in accounting principle ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Cumulative eÅect of change in accounting principle, net of taxes ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Basic earnings (loss) per common share ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Diluted earnings (loss) per common share: Earnings (loss) before cumulative eÅect of change in accounting principle ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Cumulative eÅect of change in accounting principle, net of taxes ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Diluted earnings (loss) per common share ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ $ $ $ (5.37) Ì (5.37) (5.37) Ì (5.37) $ $ $ $ $ Weighted average common shares outstanding (in thousands) BasicÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Diluted ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Dividends per common share ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 651,881 651,881 1.75 $ 680,856 682,664 1.91 $ 691,582 693,511 1.52 $ The accompanying notes are an integral part of these Ñnancial statements. 114 Freddie Mac (8,916) (29,148) (38,064) (418) (38,482) (1,329) 3,099 (8,665) (28,218) (36,883) (387) (37,270) (1,582) 3,412 (6,102) (23,246) (29,348) (551) (29,899) (1,058) 4,627 2,635 (1,484) 1,905 (1,904) 294 345 505 (2,348) 246 194 (896) (443) (64) (271) (1,674) (2,854) (206) (1,988) (1,865) (469) 8 (222) (9,270) (5,977) 2,883 (3,094) Ì $ (3,094) $ 2,393 (978) 1,519 (1,173) (473) 466 Ì 96 236 2,086 (830) (460) (61) (290) (1,641) (296) (60) (406) (148) (407) (58) (200) (3,216) 2,282 45 2,327 Ì 2,327 (270) (6) 2,051 3.01 Ì 3.01 3.00 Ì 3.00 2,076 (1,409) 1,428 (1,321) (97) 206 Ì (6) 126 1,003 (805) (386) (58) (286) (1,535) (307) (40) (272) Ì (320) (96) (530) (3,100) 2,530 (358) 2,172 (59) 2,113 (223) Ì 1,890 2.82 (0.09) 2.73 2.81 (0.08) 2.73 $ $ $ $ $ $ FREDDIE MAC CONSOLIDATED BALANCE SHEETS December 31, Adjusted 2007 2006 (in millions, except share-related amounts) Assets Retained portfolio Mortgage loans: Held-for-investment, at amortized cost (net of allowance for loan losses of $256 and $69, respectively) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Held-for-sale, at lower-of-cost-or-market ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Mortgage loans, netÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 76,347 3,685 80,032 Mortgage-related securities: Available-for-sale, at fair value (includes $17,010 and $20,463, respectively, pledged as collateral that may be repledged) Trading, at fair valueÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total mortgage-related securities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Retained portfolio ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Cash and investments Cash and cash equivalents ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Investments: Non-mortgage-related securities: 615,665 14,089 629,754 709,786 Available-for-sale, at fair value ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Securities purchased under agreements to resell and federal funds sold ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Cash and investments ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Accounts and other receivables, net ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Derivative assets, netÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Guarantee asset, at fair valueÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Real estate owned, net ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Deferred tax asset ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Other assets ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total assetsÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 35,101 6,562 50,237 5,003 827 9,591 1,736 10,304 6,884 $794,368 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, net ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Reserve for guarantee losses on Participation CertiÑcates ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Other liabilities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total liabilitiesÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $295,921 438,147 4,489 738,557 Ì 7,864 13,712 582 2,566 4,187 767,468 Commitments and contingencies (Notes 1, 2, 3, 12 and 13) Minority interests in consolidated subsidiaries ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Stockholders' equity Preferred stock, at redemption valueÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Common stock, $0.21 par value, 806,000,000 and 726,000,000 shares authorized, respectively, 725,863,886 shares issued and 646,266,701 and 661,254,178 shares outstanding, respectively ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 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, 79,597,185 shares and 64,609,708 shares, respectively ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total stockholders' equityÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total liabilities and stockholders' equityÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 176 14,109 152 871 26,909 (7,040) (4,059) (44) (11,143) (4,174) 26,724 $794,368 (3,332) (5,032) (87) (8,451) (3,230) 26,914 $804,910 8,574 11,359 $ 63,697 1,908 65,605 626,731 7,597 634,328 699,933 45,586 23,028 79,973 5,073 665 7,389 743 4,346 6,788 $804,910 $285,264 452,677 6,400 744,341 11,123 8,307 9,482 165 550 3,512 777,480 516 6,109 152 962 31,372 The accompanying notes are an integral part of these Ñnancial statements. 115 Freddie Mac FREDDIE MAC CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY Year Ended December 31, Adjusted 2007 2006 2005 Shares Amount Shares Amount Shares Amount Preferred stock, at redemption value Balance, beginning of year ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Preferred stock issuances ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Preferred stock redemptionsÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 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 stock-based compensation ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 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, as previously reported ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Beginning balance adjustments, net of taxes ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Balance, beginning of year, as adjusted before cumulative eÅect of change in accounting principle ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Cumulative eÅect of change in accounting principle, net of taxes ÏÏÏÏÏÏÏÏÏÏÏÏ Balance, beginning of year, as adjusted ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Net income (loss)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Preferred stock dividends declared ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Common stock dividends declared ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Retained earnings, end of year ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ AOCI, net of taxes Balance, beginning of year, as previously reported ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Beginning balance adjustments, net of taxes ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Balance, beginning of year, as adjusted before cumulative eÅect of change in accounting principle ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 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 deÑned beneÑt plans ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Change 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 132 344 (12) 464 726 726 65 (1) 16 80 (in millions) 92 $ 6,109 8,600 40 (600) Ì 132 14,109 $ 4,609 1,500 Ì 6,109 152 152 726 726 962 81 Ì (116) (42) (14) 871 31,372 181 31,553 (3,094) (398) (1,152) 26,909 (8,451) (3,708) 973 43 (2,692) Ì (11,143) 152 152 924 60 9 (15) (15) (1) 962 30,638 (13) 30,625 2,327 (270) (1,310) 31,372 (9,352) (267) 1,254 (2) 985 (84) (8,451) (3,230) 56 (1,000) (4,174) $26,724 33 (1) 33 65 (1,280) 50 (2,000) (3,230) $26,914 Comprehensive income (loss) Net income (loss)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Changes in other comprehensive income, net of taxes, net of reclassiÑcation adjustments ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total comprehensive income (loss) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $(3,094) (2,692) $(5,786) $ 2,327 985 $ 3,312 92 Ì Ì 92 726 726 $ 4,609 Ì Ì 4,609 152 152 873 67 6 Ì (13) (9) 924 30,728 (904) 29,824 Ì 29,824 2,113 (223) (1,076) 30,638 (3,593) (587) (4,180) (6,816) 1,637 7 (5,172) Ì (9,352) 35 (2) Ì 33 (1,353) 73 Ì (1,280) $25,691 $ 2,113 (5,172) $(3,059) The accompanying notes are an integral part of these Ñnancial statements. 116 Freddie Mac Year Ended December 31, Adjusted 2007 2006 (in millions) 2005 $ (3,094) $ 2,327 $ 2,113 FREDDIE MAC CONSOLIDATED STATEMENTS OF CASH FLOWS Cash Öows from operating activities Net income (loss) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Adjustments to reconcile net income (loss) to net cash provided by operating activities: Cumulative eÅect of change in accounting principle, net ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Hedge accounting gains ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Derivative losses ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Asset related amortization Ì premiums, discounts and basis adjustments ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Debt related amortization Ì premiums and discounts on certain debt securities and basis adjustmentsÏÏÏÏ Net discounts paid on retirements of debtÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Gains on debt retirement ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Provision for credit losses ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Low-income housing tax credit partnerships ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Losses on loans purchasedÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (Gains) losses on investment activity ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Foreign-currency (gains) losses, netÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Deferred income taxes ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Purchases of held-for-sale mortgages ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Sales of held-for-sale mortgages ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Repayments of held-for-sale mortgages ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Due to PCs and Structured Securities TrustÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Change in trading securities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 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, at fair value ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Change in guarantee obligationÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Other, net ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Net cash provided by (used for) operating activities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Ì Ì 2,231 (91) 10,894 (8,405) (345) 2,854 469 1,865 (305) 2,348 (3,943) (21,678) 19,545 138 946 (1,922) (711) (10,624) (263) 134 (2,203) 4,245 565 (7,350) Ì (2) 1,262 128 11,176 (7,429) (466) 296 407 148 538 (96) (1,012) (18,352) 18,710 104 Ì 1,085 (763) 302 718 (282) (1,125) 1,536 (473) 8,737 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 mortgage insurance and sales of real estate owned ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Net (increase) decrease in securities purchased under agreements to resell and Federal funds soldÏÏÏÏÏÏÏ Derivative premiums and terminations and swap collateral, net ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Investments in low-income housing tax credit partnershipsÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Net cash provided by (used for) investing activitiesÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (319,213) 109,973 219,047 (25,059) 9,177 1,798 16,466 (2,484) (158) 9,547 (386,407) 86,737 305,329 (15,382) 10,466 1,486 (7,869) 910 (161) (4,891) 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 Real Estate Investment Trust preferred stock ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Proceeds from the issuance of preferred stock ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Redemption of preferred stock ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Proceeds from issuance of common stock ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Repurchases of common stock ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Payment of cash dividends on preferred stock and common stock ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Excess tax beneÑts associated with stock-based awardsÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Payments of low-income housing tax credit partnerships notes payable ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Increase (decrease) in cash overdraft ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Net cash provided by (used for) 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: Debt interest ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Swap collateral interest ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 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 real estate owned ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Investments in low-income housing tax credit partnerships Ñnanced by notes payable ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 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 Participation CertiÑcates to held-for-investment mortgages ÏÏÏÏÏÏÏÏÏÏÏÏ 1,016,933 (986,489) 183,161 (222,541) Ì (320) 8,484 (600) 14 (1,000) (1,553) 5 (1,068) (8) (4,982) (2,785) 11,359 8,574 37,473 445 (1,070) 927 169 3,130 286 41 Ì 2,229 $ $ 750,201 (767,427) 177,361 (159,204) (468) (27) 1,485 Ì 36 (2,000) (1,579) 14 (1,382) 35 (2,955) 891 10,468 11,359 $ $ 33,973 479 325 1,250 13 1,603 324 123 950 1,304 59 (22) 977 871 9,149 (5,206) (206) 311 320 Ì 267 6 (1,462) (26,763) 23,669 118 Ì 2,594 28 (3,121) 331 607 (726) 1,779 449 6,142 (414,062) 95,029 249,875 (12,826) 11,893 1,679 17,038 (6,859) (127) (58,360) 857,364 (854,665) 153,504 (125,959) (435) (142) Ì Ì 59 Ì (1,299) Ì (940) (54) $ $ 27,433 (24,785) 35,253 10,468 27,186 322 (590) 1,212 175 1,517 1,095 291 Ì 1,354 The accompanying notes are an integral part of these Ñnancial statements. 117 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. EÅective December 31, 2007, we retrospectively applied certain changes to our accounting methods to other allowable methods considered preferable under GAAP. Our current accounting policies are described below; see ""NOTE 20: CHANGES IN ACCOUNTING PRINCIPLES'' for additional information. 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 years ended December 31, 2007 and 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, but are not limited to the following: ‚ estimating fair value for Ñnancial instruments (See ""NOTE 16: FAIR VALUE DISCLOSURES'' for a discussion of our fair value estimates); ‚ estimating the expected amounts of forecasted issuances of debt; ‚ establishing the allowance for loan losses on loans held-for-investment and the reserve for guarantee losses on PCs; ‚ applying the static eÅective yield method of amortizing our guarantee obligation into earnings based on forecasted unpaid principal balances, which requires adjustment when signiÑcant changes in economic events cause a shift in the pattern of our economic release from risk; ‚ applying the eÅective interest method, which requires estimates of the expected future amounts of prepayments of mortgage-related assets; and ‚ assessing when impairments should be recognized on investments in securities. Consolidation and Equity Method of Accounting The consolidated Ñnancial statements include our accounts and those of our subsidiaries. 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. 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 a subsidiary and thus consolidated in our Ñnancial statements. These subsidiaries include entities in which we hold more than 50% of the voting rights or over which we have the ability to exercise control. Accordingly, we consolidate our two majority-owned REITs, Home Ownership Funding Corporation and Home Ownership Funding Corporation II. 118 Freddie Mac The other subsidiaries consisted of variable interest entities, or VIEs, in which we are the primary beneÑciary. 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 provided by any parties or (b) where the group of equity holders does not have (i) the ability to make signiÑcant decisions about the entity's activities, (ii) the obligation to absorb the entity's expected losses or (iii) the right to receive the entity's expected residual returns. We are considered the primary beneÑciary of a VIE and thus consolidate the VIE when we absorb a majority of its expected losses, receive a majority of its expected residual returns (unless another enterprise receives this majority), or both. We determine if we are the primary beneÑciary when we become involved in the VIE. If we are the primary beneÑciary, we reconsider this decision when we sell or otherwise dispose of all or part of our variable interests to unrelated parties or if the VIE issues new variable interests to parties other than us or our related parties. Conversely, if we are not the primary beneÑciary, we reconsider this decision when we acquire additional variable interests in these entities. See ""NOTE 3: VARIABLE INTEREST ENTITIES'' for more information. We regularly invest as a limited partner in qualiÑed low-income housing tax credit, or LIHTC, partnerships that are eligible for federal tax credits and that mostly are VIEs. We are the primary beneÑciary for certain of these LIHTC partnerships. We use the equity method of accounting for entities over which we have the ability to exercise signiÑcant inÖuence, but not control, such as (a) entities that are not VIEs and (b) VIEs in which we have variable interests but are not the primary beneÑciary. 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 (loss), with an oÅset to the recorded investment. Our share of losses is recognized only until the recorded investment is reduced to zero, unless we have guaranteed the obligations of or otherwise committed to provide further Ñnancial support to these entities. 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. In applying the equity method of accounting to the LIHTC partnerships where we are not the primary beneÑciaries, 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. In addition, to the extent our recorded investment 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. Any impairment losses under the equity method for these LIHTC partnerships are included in our consolidated statements of income as part of non-interest expense Ì low-income 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 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 were 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 Financial Accounting Standards Board, or 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 119 Freddie Mac consolidated balance sheet purposes as reserve for guarantee losses on PCs. 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 fair value. 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 other assets; and (c) primary loan-level mortgage insurance is recognized at inception as a component of the recognized guarantee obligation. Because guarantee asset, guarantee obligation and credit enhancement-related assets 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 losses on certain credit guarantees. 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 if we contribute collateral. 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 120 Freddie Mac in connection with structuring-related services we rendered to third parties, is recognized immediately in earnings as other non-interest income. Subsequent Measurement of Recognized Guarantee-Related Assets and Liabilities Recognized Guarantee Asset We account for a guarantee asset like a debt instrument classiÑed as trading under SFAS No. 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 our guarantee obligation under the static eÅective yield method. The static eÅective yield will be calculated and Ñxed at inception of the guarantee based on forecasted unpaid principal balances. The static eÅective yield will be evaluated and adjusted when signiÑcant changes in economic events cause a shift in the pattern of our economic release from risk. For example, certain market environments may lead to sharp and sustained changes in home prices or prepayments of mortgages, leading to the need for an adjustment in the static eÅective yield for speciÑc mortgage pools underlying the guarantee. When a change is required, a cumulative catch-up adjustment, which could be signiÑcant in a given period, will be recognized and a new static eÅective yield will be used to determine our guarantee obligation amortization. The resulting recorded amortization reÖects our economic release from risk under changing economic scenarios. Periodic amortization of both our performance obligation and deferred income are reÖected as components of the income on guarantee obligation. Separately, the subsequent measurement of our contingent obligation to make guarantee payments is further discussed below in ""Allowance for Loan Losses and Reserve for Guarantee Losses.'' See ""NOTE 20: CHANGES IN ACCOUNTING PRINCIPLES'' for further information regarding our guarantee obligation. Recognized Credit Enhancements Credit enhancements that are separately recognized as other assets are amortized into earnings as other non-interest expense under the static eÅective yield method in the same manner as our guarantee obligation. 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. Due to Participation CertiÑcate Investors Beginning December 2007 we introduced separate legal entities, trusts, into our securities issuance process for the purpose of managing the receipt and payments of cash Öow of our PCs and Structured Securities. In connection with the establishment of these trusts, we also established a separate custodial account in which cash remittances received on the underlying assets of our PCs and Structured Securities are deposited. These cash remittances include both scheduled and unscheduled principal and interest payments. The funds held in this account are segregated and are not commingled with our general operating funds. As securities administrator, we invest the cash held in the custodial account, pending distribution to our PC and Structured Securities holders, in short-term, risk-free investments and are entitled to trust management fees on the trust's assets which was recorded as other non-interest income. The funds are maintained in this separate custodial account until they are due to the PC and Structured Securities holders on their respective security payment dates. Prior to December 2007, we managed the timing diÅerences that exist for cash receipts from servicers on assets underlying our PCs and Structured Securities and the subsequent pass through of those payments on PCs owned by third- party investors. In those cases, the PC balances were not reduced for payments of principal received from servicers in a given month until the Ñrst day of the next month and we did not release the cash received (principal and interest) to the PC investors until the Ñfteenth day of that next month. We generally invested the principal and interest amounts we received in short-term investments from the time the cash was received until the time we paid the PC investors. In addition, for unscheduled principal prepayments on loans underlying our PCs and Structured Securities, these timing diÅerences resulted in expenses, since the related PCs continued 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 no interest is received from the mortgage on that prepayment amount during that period. The expense recognized upon prepayment was reported in interest expense Ì due to Participation CertiÑcate investors. We report PC coupon interest amounts relating to our investment in PCs consistent with the method used for PCs held by third party investors. 121 Freddie Mac Mortgage Loans Upon loan acquisition, we classify the loan as either held-for-sale or held-for-investment. Mortgage loans that we have the ability and intent to hold for the foreseeable future are classiÑed as held-for-investment. Held-for-investment mortgage loans are reported at their outstanding unpaid principal balances, net of deferred fees and cost basis adjustments (including unamortized 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. We recognize interest on mortgage loans on an accrual basis, except when we believe the collection of principal or interest is not probable. Mortgage loans not classiÑed as held-for-investment are classiÑed as held-for-sale. 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. Allowance for Loan Losses and Reserve for Guarantee Losses We maintain an allowance for loan losses on mortgage loans held-for-investment and a reserve for guarantee losses on PCs, collectively referred to as our loan loss reserves, to provide for credit losses when it is probable that a loss has been incurred. The held-for-investment loan portfolio is shown net of the allowance for loan losses on the consolidated balance sheets. The reserve for guarantee losses is a liability account on our consolidated balance sheets. Increases in loan loss reserves are reÖected in earnings as the provision for credit losses, while decreases are reÖected through charging-oÅ such balances (net of recoveries) when realized losses are recorded or as a reduction in the provision for credit losses. For both single-family and multifamily mortgages where the original terms of the mortgage loan agreement are modiÑed, resulting in a concession to the borrower experiencing Ñnancial diÇculties, losses are recorded at the time of modiÑcation and the loans are subsequently accounted for as troubled debt restructurings, or TDRs. We estimate credit losses related to homogeneous pools of single-family and multifamily loans in accordance with SFAS No. 5, ""Accounting for Contingencies'' or SFAS 5. In accordance with SFAS 5, we recognize credit losses when it is probable that a loss has been incurred and the amount of the loss can be reasonably estimated. We also estimate credit losses in accordance with SFAS No. 114,""Accounting by Creditors for Impairment of a Loan'' or SFAS 114. Loans evaluated under SFAS 114, include single-family loans and multifamily loans whose contractual terms have previously been modiÑed due to credit concerns (including TDRs), certain multifamily loans with observable collateral deÑciencies or that become 60 days past due for principal and interest. In accordance with SFAS 114, we consider all available evidence, such as the present value of discounted expected future cash Öows, the fair value of collateral for collateral dependent loans, and third-party credit enhancements, when establishing the loan loss reserves. Determining the adequacy of the loan loss reserves is a complex process that is subject to numerous estimates and assumptions requiring signiÑcant judgment. Loans not deemed to be impaired under SFAS 114 are grouped with other loans that share common characteristics for evaluation under SFAS 5. Single-Family Loan Portfolio We estimate loan loss reserves on homogeneous pools of single-family loans using statistically 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 single-family loans at the balance sheet date, we evaluate factors including, but not limited to: ‚ the year of loan origination; ‚ geographic location; ‚ actual and estimated amounts for loss severity trends for similar loans; ‚ default experience; ‚ expected ability to partially mitigate losses through a level of estimated successful loan modiÑcation or other alternatives to foreclosure; ‚ expected proceeds from credit enhancements, including primary mortgage insurance, a seller's agreement to repurchase or replace any mortgage in default and other loss mitigation activities; 122 Freddie Mac ‚ pre-foreclosure real estate taxes and insurance; and ‚ estimated selling costs should the underlying property ultimately be sold. Our credit loss reserves reÖect our best estimates of incurred losses. Our reserve estimate includes projections related to strategic loss mitigation activities, including a higher rate of loan modiÑcations for troubled borrowers, and projections of recoveries through repurchases by seller/servicers of defaulted loans due to failure to follow contractual underwriting requirements at the time of the loan origination. Our reserve estimate also reÖects our best projection of defaults we believe are likely to occur as a result of loss events that have occurred through December 31, 2007. However, the unprecedented deterioration in the national housing market and the uncertainty in other macro economic factors makes forecasting of default rates increasingly imprecise. The inability to realize the beneÑts of our loss mitigation plans, a lower realized rate of seller/servicer repurchases or default rates that exceed our current projections will cause our losses to be signiÑcantly higher than those currently estimated. We 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 that impact the quality of the portfolio including regional housing trends, applicable home price indices, unemployment and employment dislocation trends, consumer credit statistics and the extent of third party insurance. We determine our loan loss reserves based on our assessment of these factors. Multifamily Loan Portfolio We estimate loan loss reserves on the multifamily loan portfolio based on all available evidence, including but not limited to, 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 and rental rates. Non-Performing Loans Non-performing loans consist of: (a) loans whose terms have been modiÑed due to previous delinquency or risk of delinquency (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 past due or in foreclosure. 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 includes single-family and multifamily loans 90 days or more past due. Impaired Loans A loan is considered impaired when it is probable to not receive all amounts due (principal and interest), in accordance with the contractual terms of the original loan agreement. Impaired loans include single-family loans, both performing and non-performing, that are troubled debt restructurings, delinquent loans purchased from PC pools whose fair value was less than acquisition cost at the date of purchase and loans subject to AICPA Statement of Position 03-3, ""Accounting for Certain Loans or Debt Securities Acquired in a Transfer'' or SOP 03-3. Multifamily impaired loans include loans whose contractual terms have previously been modiÑed due to credit concerns (including TDRs), certain loans with observable collateral deÑciencies and loans 60 days or more past due (except for certain credit-enhanced loans). 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. Through November 2007, our general practice was to purchase the mortgage loans out of pools after the loans were 120 days delinquent. EÅective December 2007, our general practice was changed to purchase loans from pools when the loans have been modiÑed or foreclosure sales occur, or when the loans have been delinquent for 24 months, unless we determine it is economically beneÑcial to do so sooner. 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. We record realized losses on loans purchased when, upon purchase, the fair value is less than the unpaid principal balance, net of related reserves. Recoveries on loans impaired upon purchase represent the recapture into income of basis adjustments recorded upon purchases of delinquent loans from our PCs and Structured Securities in conjunction with our guarantee activities. These basis adjustments were previously reÖected on our income statements as expenses through a combination of provision for credit losses and losses on loans purchased. Recoveries occur when a non-performing loan is repaid in full or when at the time of foreclosure the estimated fair value of the acquired property, less costs to sell, exceeds the carrying value of the loan. For impaired loans where the borrower has made required payments that return to current status, the basis adjustments are accreted into interest income over time, as periodic payments are received. 123 Freddie Mac 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 Accumulated other comprehensive income (loss), net of taxes, or AOCI, net of taxes, 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. 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 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. 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. While market prices and rating agency actions are factors that are considered in the impairment analysis, cash Öow analysis based on default and prepayment assumptions serves as an important factor in determining if an other than temporary impairment has occurred. We recognize impairment losses when quantitative and qualitative factors indicate that it is probable that the security will suÅer a contractual principal loss or interest shortfall. 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 our retained portfolio and we typically retain the majority of the cash Öows from resecuritization transactions in the form of Structured Securities. Certain securities in our 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. 124 Freddie Mac 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. Debt Securities Issued Debt securities that we issue are classiÑed on our consolidated balance sheets as either short-term (due within one year) or long-term (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. 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 resulting gains or losses are reported in non-interest income (loss) Ì foreign-currency gains (losses), net. 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. These items are amortized and reported through interest expense using the eÅective interest method over the contractual life of the related indebtedness. Amortization of premiums, discounts and issuance costs begins at the time of debt issuance. Amortization of hedging-related basis adjustments is initiated upon the termination of the related hedge relationship. When debt securities are extinguished prior to its contractual maturity, the balances of deferred items remaining are reÖected in earnings in the period of extinguishment as a component of gains (losses) on debt retirement. 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 either extinguishments or exchanges. If the debt instruments have substantially diÅerent terms, the transaction is accounted as an extinguishment with recognition of any gains or losses in earnings. If not, the transaction is accounted for as an exchange. In an exchange, the following are considered to be 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: the fees associated with the new debt obligation and any existing unamortized premium or discount, concession fees and hedge gains and losses on the existing debt obligation. Derivatives We account for our derivatives pursuant to SFAS 133, as amended. Derivatives are reported at their fair value on our consolidated balance sheets. Derivatives in an asset position, including net derivative interest receivable or payable, are reported as derivative assets, net. Similarly, derivatives in a net liability position, including net derivative interest receivable or payable, are reported as derivative liabilities, net. We oÅset fair value amounts recognized for the right to reclaim cash collateral or the obligation to return cash collateral against fair value amounts recognized for derivative instruments executed with the same counterparty under a master netting agreement, in accordance with FASB Interpretation No. 39-1, ""Amendment of FASB Interpretation No. 39,'' or FSP FIN 39-1. Changes in fair value and interest accruals on derivatives are recorded as derivative gains (losses) in our consolidated statements of income. We evaluate whether Ñnancial instruments that we purchase or issue contain embedded derivatives. In connection with the adoption of SFAS No. 155, ""Accounting for Certain Hybrid Financial Instruments, an amendment of FASB Statements No. 133 and 140,'' or SFAS 155, on January 1, 2007, we elected to measure newly acquired or issued Ñnancial instruments that contain embedded derivatives at fair value, with changes in fair value recorded in our consolidated statements of income. At December 31, 2007, we do not have any embedded derivatives that are bifurcated and accounted for as freestanding derivatives. At December 31, 2007, we did not have any derivatives in hedge accounting relationships; however, there are amounts recorded in AOCI related to terminated or de-designated cash Öow hedge relationships. These deferred gains and losses on closed cash Öow hedges are recognized in earnings as the originally forecasted transactions aÅect earnings. If it is probable the originally forecasted transaction will not occur, the associated deferred gain or loss in AOCI would be reclassiÑed to earnings immediately. When market conditions warrant, we may enter into certain commitments to forward sell mortgage- related securities that we will account for as cash Öow hedges. During 2006 and 2005, our hedge accounting relationships primarily consisted of hedging interest-rate risk related to the forecasted issuances of debt that were designated as cash Öow hedges, and fair value hedges of benchmark interest-rate risk and/or foreign currency risk on existing Ñxed-rate debt. The changes in fair value of the derivatives in cash Öow hedge relationships were recorded as a separate component of AOCI to the extent the hedge relationships were eÅective, and amounts were reclassiÑed to earnings when the forecasted transaction aÅects earnings. 125 Freddie Mac The changes in fair value of the derivatives in fair value relationships were recorded in earnings along with the change in the fair value of the hedged debt. Any diÅerence was reÖected as hedge ineÅectiveness and was recorded in other income. Real Estate Owned Real estate owned, or REO, is initially recorded at fair value, net of estimated disposition costs and is subsequently carried at the lower-of-cost-or-market. When a loan is transferred to REO, losses arise when the carrying basis of the loan (including accrued interest) exceeds the fair value of the foreclosed property, net of estimated costs to sell and credit enhancements. Losses are charged-oÅ against the allowance for loan losses at the time of transfer. 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). 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. We account for tax positions taken or expected to be taken (and any associated interest and penalties) in accordance with FASB Interpretation No. 48,""Accounting for Uncertainty in Income Taxes, an interpretation of FASB Statement No. 109,'' or FIN 48. In particular, we recognize a tax position so long as it is more likely than not that it will be sustained upon examination, including resolution of any related appeals or litigation processes, based on the technical merits of the position. We measure the tax position at the largest amount of beneÑt that is greater than 50% likely of being realized upon ultimate settlement. See ""NOTE 13: INCOME TAXES'' for additional information related to FIN 48. 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, if any, and (b) current tax expense, which represents the amount of tax currently payable to or receivable from a tax authority including any related interest and penalties plus amounts accrued for unrecognized tax beneÑts (also including any 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 10: 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 126 Freddie Mac 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. 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 and vested restricted stock units 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 and changes in deÑned beneÑt plans. Reportable Segments We have three business segments 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. See ""NOTE 15: SEGMENT REPORTING'' for additional information. Recently Adopted Accounting Standards Accounting for Employers' DeÑned BeneÑt Pension and Other Postretirement Plans On December 31, 2006, we adopted SFAS 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. 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. 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. Accounting for Uncertainty in Income Taxes On January 1, 2007, we adopted FIN 48. FIN 48 provides a single model to account for uncertain tax positions and clariÑes accounting for income taxes by prescribing a minimum threshold that 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. As a result of the adoption of FIN 48, we recorded a $181 million increase to retained earnings at January 1, 2007. See ""NOTE 13: INCOME TAXES'' for additional information related to FIN 48. Accounting for Certain Hybrid Instruments On January 1, 2007, we adopted SFAS 155. SFAS 155 permits the fair value measurement for any hybrid Ñnancial instrument with an embedded derivative that otherwise would require bifurcation. In addition, this statement requires an evaluation of interests in securitized Ñnancial assets to identify instruments that are freestanding derivatives or that are hybrid Ñnancial instruments containing an embedded derivative requiring bifurcation. We adopted SFAS 155 prospectively, 127 Freddie Mac and, therefore, there was no cumulative eÅect of a change in accounting principle. In connection with the adoption of SFAS 155 on January 1, 2007, we elected to measure newly acquired interests in securitized Ñnancial assets that contain embedded derivatives requiring bifurcation at fair value, with changes in fair value reÖected in our consolidated statements of income. See ""NOTE 4: RETAINED PORTFOLIO AND CASH AND INVESTMENTS PORTFOLIO'' for additional information. OÅsetting of Amounts Related to Certain Contracts On October 1, 2007, we adopted FSP FIN 39-1, which permits a reporting entity to oÅset fair value amounts recognized for the right to reclaim cash collateral or the obligation to return cash collateral against fair value amounts recognized for derivative instruments executed with the same counterparty under a master netting agreement. When oÅsetting of fair value amounts recognized for derivative instruments is elected, as permitted under a master netting agreement, the position requires the oÅsetting of amounts recognized for cash collateral held or posted when the collateral represents ""fair value amounts.'' Our adoption of FSP FIN 39-1 resulted in a decrease to total assets and total liabilities of $8.7 billion. In conjunction with our adoption of FSP FIN 39-1, we elected to reclassify net derivative interest receivable or payable and, where applicable, cash collateral held or posted on our consolidated balance sheets to derivative asset, net and derivative liability, net, as applicable. Prior to adoption these amounts were recorded in accounts and other receivables, net, accrued interest payable, other assets and senior debt: due within one year, as applicable. Certain amounts in prior periods' consolidated balance sheets and consolidated statements of cash Öows have been reclassiÑed to conform to the current presentation. There was no impact to our consolidated statements of income. Recently Issued Accounting Standards, Not Yet Adopted Fair Value Measurements 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 adopted SFAS 157 on January 1, 2008 and the implementation did not result in a material diÅerence to our fair value measurements. The Fair Value Option for Financial Assets and Financial Liabilities 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. We adopted SFAS 159 on January 1, 2008 and elected the fair value option for certain available-for-sale mortgage- related securities that were identiÑed as economic oÅsets to the changes in fair value of the guarantee asset, foreign-currency denominated debt, and investments in securities classiÑed as available-for-sale securities and identiÑed as within the scope of 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. As a result of the adoption, we recognized a $1.0 billion after-tax increase to our beginning retained earnings at January 1, 2008, representing the eÅect of changing our measurement basis to fair value for the above items with the fair value option elected. Our election of the fair value option for the items discussed above was made in an eÅort to better reÖect, in the Ñnancial statements, the economic oÅsets that exist related to items that were not previously recognized as changes in fair value through the income statement. We elected the fair value option for certain other available-for-sale securities held in the retained portfolio to better reÖect the natural oÅset these securities provide to fair value changes recorded on the guarantee asset. We record fair value changes on our guarantee asset through the income statement. However, we historically classiÑed virtually all of our securities as available-for-sale and recorded those fair value changes in AOCI. The securities selected for the fair value option include principal only strips and certain pass-through and Structured Securities that contain positive duration features that provide oÅset to the negative duration associated with our guarantee asset. We will continually evaluate new security purchases to identify the appropriate security mix to classify as trading to match the changing duration features of the guarantee asset and the securities that provide oÅset. 128 Freddie Mac In the case of foreign currency denominated debt, we have entered into derivative transactions that eÅectively convert these instruments to US dollar denominated Öoating rate instruments. We have historically recorded the fair value changes on these derivatives through the income statement in accordance with SFAS 133. However, the corresponding oÅsetting change in fair value that occurred in the debt was not permitted to be recorded in the income statement unless we pursued hedge accounting. As a result, our income statement reÖected only the fair value changes of the derivatives and not the oÅsetting fair value changes in the debt. Therefore, we have elected the fair value option on the debt instruments to better reÖect the economic oÅset that naturally results from the debt due to changes in interest rates. We currently do not issue foreign currency denominated debt and use of the fair value option in the future for these types of instruments will be evaluated on a case-by-case basis for any new issuances of this type of debt. For available-for-sale securities identiÑed as in the scope of EITF 99-20, we elected the fair value option to better reÖect the economic recapture of losses that occur subsequent to impairment write-downs recorded on these instruments. Under EITF 99-20 for available-for-sale securities, when an impairment is considered other-than-temporary, the impairment amount is recorded in the income statement and subsequently accreted back through interest income as long as the contractual cash Öows occur. Any subsequent periodic increases in the value of the security are recognized through AOCI. By electing the fair value option for these instruments, we will reÖect any recapture of impairment losses through the income statement in the period they occur. We intend to classify all future purchases of securities identiÑed as in the scope of impairment analysis under EITF 99-20 as trading securities on a going forward basis. Business Combinations and Noncontrolling Interests In December 2007, the FASB issued SFAS No. 141(R), ""Business Combinations,'' or SFAS 141(R), and SFAS No. 160, ""Noncontrolling Interests in Consolidated Financial Statements, an amendment of ARB No. 51,'' or SFAS 160. SFAS 141(R) provides guidance relating to recognition of assets acquired and liabilities assumed in a business combination. SFAS 160 provides guidance related to accounting for noncontrolling (minority) interests as equity in the consolidated Ñnancial statements. SFAS 141(R) and SFAS 160 are eÅective for Ñscal years beginning on or after December 15, 2008. We have not yet determined the impact on our consolidated Ñnancial statements of adopting these accounting standards. NOTE 2: FINANCIAL GUARANTEES AND TRANSFERS OF SECURITIZED INTERESTS IN MORTGAGE-RELATED ASSETS Financial Guarantees Guaranteed PCs, Structured Securities and Other Mortgage Guarantees As discussed in ""NOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES,'' we issue two types of mortgage-related securities: PCs and Structured Securities. We guarantee the payment of principal and interest on issued PCs and Structured Securities that are backed by pools of mortgage loans, and we are obligated to purchase delinquent loans that are covered by long-term standby commitments. At December 31, 2007 and 2006, we had $1,738.8 billion and $1,477.0 billion, respectively, of issued PCs and Structured Securities and such other mortgage guarantees of which $357.0 billion and $354.3 billion were held in our retained portfolio at December 31, 2007 and 2006, respectively. There were $1,518.8 billion and $1,240.2 billion at December 31, 2007 and 2006, respectively, of Structured Securities backed by resecuritized PCs and other previously issued Structured Securities. These restructured 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. Our guarantee obligation represents the recognized liability associated with our guarantee of PCs and Structured Securities net of cumulative amortization. At December 31, 2007 and 2006, our guarantee obligation includes our estimate of performance and other related costs of approximately $9.9 billion and $5.8 billion, respectively, and deferred guarantee income of $3.8 billion and $3.6 billion, respectively. In addition to our guarantee obligation, we recognized a reserve for guarantee losses on PCs that totaled $2.6 billion and $0.6 billion at December 31, 2007 and 2006, respectively. Our guaranteed PCs, Structured Securities and other mortgage guarantees issued include single-family long-term stand-by commitments and multifamily housing revenue bonds issued by third parties, which totaled $37.9 billion and $6.7 billion at December 31, 2007 and 2006, respectively. Our guarantee of single-family long-term stand-by commitments was $32.2 billion and $0.7 billion at December 31, 2007 and 2006, respectively. Our guarantee of multifamily housing revenue bonds issued by third parties was $5.7 billion and $6.0 billion at December 31, 2007 and 2006, respectively. Our approach for estimating the fair value of the guarantee obligation makes use of third-party market data as practicable. We divide 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. 129 Freddie Mac For performing loans, we use capital markets information and rating agency models to estimate subordination levels and dealer price quotes on proxy non-agency 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. For non-performing loans, we utilize a diÅerent method for estimating the fair value of the guarantee obligation. For loans that are extremely delinquent and have been purchased out of pools, we obtained dealer indications that reÖect their non-performing status. For delinquent loans remaining in PCs, we began 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). For manufactured housing, we developed an approach, subject to our judgment, for estimating the incremental credit costs associated with the manufactured housing portfolio. For approximately 0.5% of our total guarantee portfolio and 9.3% of the fair value of the guarantee obligation, we determined that there is not suÇciently reliable market data to estimate the appropriate credit costs associated with the guarantee obligation for the manufactured housing portfolio. As such, we estimated 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. 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. We recognize guarantee assets and guarantee obligations for PCs in conjunction with transfers accounted for as sales under SFAS 140, ""Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities Ì a replacement of FASB Statement No. 125,'' or SFAS 125/140, as well as, beginning on January 1, 2003, transactions that do not qualify as sales, but are accounted for as guarantees pursuant to the requirements of FIN 45, ""Guarantor's Accounting and Disclosure Requirement for 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. At December 31, 2007 and 2006, approximately 91% and 88%, respectively, of our guaranteed PCs and Structured Securities issued had a corresponding guarantee asset or guarantee obligation recognized on our consolidated balance sheets. Derivative Instruments Derivative instruments include written options, written swaptions, interest-rate swap guarantees and guarantees of stated Ñnal maturity of certain of our Structured Securities. In addition, we have entered into mortgage credit agreements whereby we assume default risk for mortgage loans held by third parties for up to a 90-day period in exchange for a monthly fee. We guarantee the performance of interest-rate swap contracts in three circumstances. First, as part of a resecuritization transaction, we transfer certain swaps and related assets to a third party. We guarantee that interest income generated from the assets will be suÇcient to cover the required payments under the interest-rate swap contracts. Second, we guarantee that a borrower will perform under an interest-rate swap contract linked to a customer's adjustable-rate mortgage. And third, in connection with certain Structured Securities, we guarantee that the sponsor of the securitized multifamily housing revenue bonds will perform under the interest-rate swap contract linked to the variable-rate certiÑcates we issued, which are backed by the bonds. In addition, we issue credit derivatives that guarantee the payments 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) Freddie Mac pass-through certiÑcates which are backed by tax-exempt multifamily housing revenue bonds and related taxable bonds and/or loans; and (c) the reimbursement of certain losses incurred by third party providers of letters of credit secured by multifamily housing revenue bonds. We issue Structured Securities with stated Ñnal maturities that are shorter than the stated maturity of the underlying mortgage loans. If the underlying mortgage loans to these 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 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. Our maximum exposure represents the outstanding unpaid principal balance of the underlying mortgage loans. 130 Freddie Mac Servicing-Related Premium Guarantees 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. The liability associated with these agreements was not material at December 31, 2007 and 2006. Table 2.1 below presents our maximum potential amount of future payments, our recognized liability and the maximum remaining term of these guarantees. Table 2.1 Ì Financial Guarantees Financial Guarantees: December 31, 2007 Adjusted December 31, 2006 Maximum Exposure Recognized Liability Maximum Remaining Term Maximum Exposure Recognized Liability Maximum Remaining Term (dollars in millions, terms in years) Guaranteed PCs, Structured Securities and other mortgage guarantees issued(1)(2) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $1,738,833 32,538 37 Derivative instruments ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Servicing-related premium guarantees ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $13,712 129 Ì 40 30 5 $1,477,023 28,832 44 $9,482 13 Ì 40 28 5 (1) Exclude mortgage loans and mortgage-related securities traded, but not yet settled. (2) EÅective December 2007, we established securitization trusts for the underlying assets of our PCs and Structured Securities issued. As a result, we adjusted the reported balance of our mortgage portfolios to reÖect the publicly-available security balances of our PCs and Structured Securities. Previously, we reported these balances based on the unpaid principal balance of the underlying mortgage loans. With the exception of interest-rate swap guarantees included in derivative instruments in Table 2.1, maximum exposure represents the contractual amounts that could be lost under the guarantees if underlying borrowers defaulted, without consideration of possible recoveries under recourse provisions or from collateral held or pledged. The maximum exposure related to interest-rate swap guarantees is based on contractual rates and without consideration of recovery under recourse provisions. The maximum exposure disclosed above is not representative of the actual loss we are likely to incur, based on our historical loss experience and after consideration of proceeds from related collateral liquidation. Other Financial Commitments As part of the guarantee arrangements pertaining to multifamily housing revenue bonds, we provided commitments to advance funds, commonly referred to as ""liquidity guarantees,'' totaling $8.0 billion and $5.8 billion at December 31, 2007 and 2006, respectively. These guarantees enable the repurchase of any 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 funding until the time when the securities could be remarketed. We have not made any payments to date under these liquidity guarantees. Gains and Losses on Transfers of PCs and Structured Securities that are Accounted for as Sales We recognized gains (losses) on transfers of PCs and Structured Securities that were accounted for as sales under SFAS 125/140. In 2007, 2006 and 2005, these adjusted net pre-tax gains (losses) were approximately $141 million, $235 million and $181 million, respectively. Valuation of Guarantee Asset Guarantee Asset Our approach for estimating the fair value of the guarantee asset at December 31, 2007 uses third-party market data as practicable. For approximately 74% of the fair value of the guarantee asset, the valuation approach involved 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 26% 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 cash Öow approach with market input assumptions extracted from the dealer quotes provided on the more liquid products, reduced by an estimated liquidity discount. 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 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 periods are those implied by our fair value 131 Freddie Mac 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 and have not been similarly adjusted. At December 31, 2007 and 2006, our guarantee asset totaled $9.6 billion and $7.4 billion, respectively, on our consolidated balance sheets, of which approximately $0.2 billion, or 2%, related to PCs and Structured Securities backed by multifamily 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 relate solely to the guarantee asset associated with PCs and other Ñnancial guarantees backed by single-family mortgage loans. Table 2.2 Ì Key Assumptions Utilized in Fair Value Measurements of the Guarantee Asset Adjusted Mean Valuation Assumptions(1) IRRs(2)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 6.4% 8.3% 8.4% Prepayment rates(3) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 17.1% 15.8% 17.3% Weighted average lives (years)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2005 2007 2006 5.2 5.5 5.1 (1) Mean values represent the weighted average of all IRRs, prepayment rate and weighted average lives assumptions. (2) IRR assumptions represent an unpaid principal balance weighted average of the discount rates inherent in the fair value of the recognized guarantee asset. Weighted average lives assumptions reÖect prepayment rate assumptions. (3) Although prepayment rates are simulated monthly, the assumptions above represent annualized prepayment rates based on unpaid principal balances. 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 our guarantee asset for changes in key assumptions. Table 2.3 Ì Sensitivity Analysis of the Guarantee Asset (Single-Family Mortgages) Fair value ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Weighted average IRR assumptions: ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Impact on fair value of 100 bps unfavorable change ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Impact on fair value of 200 bps unfavorable change ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Weighted average prepayment rate assumptions: ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Impact on fair value of 10% unfavorable change ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Impact on fair value of 20% unfavorable change ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Valuation of Other Retained Interests December 31, 2007 Adjusted 2006 (dollars in millions) $7,225 $9,417 8.1% $ (389) $ (746) 16.5% $ (516) $ (977) 7.1% $ (269) $ (519) 18.4% $ (368) $ (695) Other retained interests include securities we issued 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 provided prices. To report the hypothetical sensitivity of the carrying value of other retained interests, we used internal models adjusted where necessary to align with 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. Table 2.4 Ì Sensitivity Analysis of Other Retained Interests(1) December 31, 2007 2006 (dollars in millions) Fair value ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $107,931 Weighted average IRR assumptions:ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 5.5% Impact on fair value of 100 bps unfavorable changeÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ (4,109) Impact on fair value of 200 bps unfavorable changeÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ (7,928) 8.7% (30) (57) Impact on fair value of 10% unfavorable changeÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ Impact on fair value of 20% unfavorable changeÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ Weighted average prepayment rate assumptions:ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $127,490 5.6% $ (4,551) $ (8,813) 11.0% (66) (132) $ $ (1) The sensitivity analysis includes only other retained interests whose fair value is impacted as a result of changes in IRR and prepayment assumptions. At December 31, 2007 and 2006, the fair values of other retained interests not included in the sensitivity analysis above were $44 million and $52 million, respectively. 132 Freddie Mac Cash Flows on Transfers of Securitized Interests and Corresponding Retained Interests Table 2.5 below summarizes cash Öows on retained interests as well as the amount of cash payments made to acquire delinquent loans to satisfy our Ñnancial performance obligations. Table 2.5 Ì Details of Cash Flows Year Ended December 31, Adjusted 2007 2006 (in millions) 2005 Cash Öows from: Transfers of Freddie Mac securities that were accounted for as sales ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $62,644 Cash Öows received on the guarantee asset(1) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2,288 22,713 Other retained interests principal and interestÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (9,011) Purchases of delinquent or foreclosed loans ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $79,565 1,873 24,784 (4,698) $93,828 1,565 25,612 (4,366) (1) Represents contractual guarantee fees received by us in connection with the recognized guarantee asset. Credit Protection and Other Forms of Recourse In connection with our guaranteed PCs and Structured Securities issued, we have credit protection in the form of primary mortgage insurance, pool insurance, recourse to lenders and other forms of credit enhancements. Table 2.6 presents the amounts of potential loss recovery by type of credit protection. Table 2.6 Ì Credit Protection and Other Forms of Recourse(1) December 31, 2007 Adjusted 2006 (in millions) PCs and Structured Securities: Single-family: Primary mortgage insurance ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $51,897 12,085 Lender recourse and indemniÑcations ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 3,813 Pool insurance ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 549 Other credit enhancementsÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $40,208 10,493 3,669 757 Multifamily: Credit enhancementsÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Structured Securities backed by Ginnie Mae CertiÑcates(2) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 1,233 1,268 1,093 1,510 (1) Exclude credit enhancements related to Structured Transactions, which had unpaid principal balances that totaled $20.2 billion and $24.8 billion at December 31, 2007 and 2006, respectively. (2) Ginnie Mae CertiÑcates are backed by the full faith and credit of the U.S. government. At December 31, 2007 and 2006, we recorded $655 million and $440 million, respectively, in total assets on our consolidated balance sheets related to these credit enhancements on securitized mortgages. IndemniÑcations In connection with various business transactions, we may provide indemniÑcation to counterparties for claims arising out of breaches of certain obligations (e.g., those arising from representations and warranties) 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. 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. At December 31, 2007, our assessment is that the risk of any material loss from such a claim for indemniÑcation is remote and there are no probable and estimable losses associated with these contracts. We have not recorded any liabilities related to these indemniÑcations on our consolidated balance sheets at December 31, 2007 and 2006. NOTE 3: VARIABLE INTEREST ENTITIES We are a party to numerous entities that are considered to be VIEs. 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 non-mortgage-related, asset-backed investment 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. Accordingly, we do not consolidate these securities. Additionally, 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 133 Freddie Mac ACCOUNTING POLICIES Ì Consolidation and Equity Method of Accounting'' for further information regarding the consolidation practices of our VIEs. LIHTC Partnerships We invest as a limited partner in LIHTC partnerships formed for the purpose of providing funding for aÅordable multifamily rental properties. The LIHTC partnerships invest as limited partners in lower-tier partnerships, which own and operate multifamily rental properties. These 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. The investments in LIHTC partnerships, in which we were either the primary beneÑciary or had a signiÑcant variable interest, were made between 1989 and 2007. At December 31, 2007 and 2006, we did not guarantee any obligations of these LIHTC partnerships and our exposure was limited to the amount of our investment. At December 31, 2007 and 2006, we were the primary beneÑciary of investments in six 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. 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, 2007 2006 (in millions) Cash and cash equivalents ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Accounts and other receivables, net ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total assets of consolidated VIEs ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 41 153 $194 $ 44 173 $217 VIEs Not Consolidated LIHTC Partnerships At December 31, 2007 and 2006, we had unconsolidated investments in 189 and 179 LIHTC partnerships, respectively, in which we had a signiÑcant variable interest. The size of these partnerships at December 31, 2007 and 2006, as measured in total assets, was $10.3 billion and $8.9 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 both December 31, 2007 and 2006, our maximum exposure to loss on unconsolidated LIHTC partnerships, in which we had a signiÑcant variable interest, was $3.7 billion. 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, 2007 and 2006, we did not have a signiÑcant variable interest in and were not the primary beneÑciary of any asset-backed investment trusts. Structured Transactions We periodically issue securities in Structured Transactions, which are backed by mortgage loans or non-Freddie Mac mortgage-related securities using collateral pools transferred to a trust speciÑcally created for the purpose of issuing securities. These trusts also issue various senior interests and subordinated interests. We purchase interests, including senior interests, of the trusts and 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, an interpretation of ARB No. 51,'' or FIN 46(R). However, at December 31, 2007 and 2006, we had interests in one and two Structured Transactions, respectively, that did not fall within this scope exception and in which we had a signiÑcant variable interest. Our involvement in this one Structured 134 Freddie Mac Transaction at December 31, 2007 began in 2002. The sizes of the one Structured Transaction at December 31, 2007 and the two Structured Transactions at December 31, 2006, as measured in total assets, were $40 million and $67 million, respectively. At December 31, 2007 and 2006, our maximum exposure to loss on these transactions was $37 million and $55 million, respectively, consisting of the book value of our investments plus incremental guarantees of the senior interests that are held by third parties. At December 31, 2007 and 2006, we were not the primary beneÑciary of any such transactions. NOTE 4: RETAINED PORTFOLIO AND CASH AND INVESTMENTS PORTFOLIO Table 4.1 summarizes amortized cost, estimated fair values and corresponding gross unrealized gains and gross unrealized losses for available-for-sale securities by major security type. Table 4.1 Ì Available-For-Sale Securities Amortized Cost Gross Unrealized Gains Gross Unrealized Losses Fair Value (in millions) December 31, 2007 Retained portfolio: Mortgage-related securities issued by: Freddie MacÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $346,569 45,688 Federal National Mortgage Association, or Fannie Mae ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Ginnie Mae ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 545 218,848 OtherÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 14,783 Obligations of states and political subdivisions ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 626,433 Total mortgage-related securitiesÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Cash and investments portfolio: Non-mortgage-related securities: Asset-backed securities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Commercial paper ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total non-mortgage-related securities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 16,644 18,513 35,157 Total available-for-sale securitiesÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $661,590 Adjusted December 31, 2006 Retained portfolio: Mortgage-related securities issued by: Freddie MacÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $348,591 44,223 Fannie Mae ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 720 Ginnie Mae ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 224,642 OtherÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Obligations of states and political subdivisions ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 13,622 631,798 Total mortgage-related securitiesÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Cash and investments portfolio: Non-mortgage-related securities: Asset-backed securities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Commercial paper ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Obligations of states and political subdivisions ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total non-mortgage-related securities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 32,179 11,191 2,273 45,643 Total available-for-sale securitiesÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $677,441 $2,981 513 19 673 146 4,332 25 Ì 25 $4,357 $1,438 323 17 553 334 2,665 23 Ì Ì 23 $2,688 $ (2,583) (344) (2) (11,820) (351) (15,100) $346,967 45,857 562 207,701 14,578 615,665 (81) Ì (81) $(15,181) 16,588 18,513 35,101 $650,766 $ (5,941) (660) (4) (1,096) (31) (7,732) $344,088 43,886 733 224,099 13,925 626,731 (80) Ì Ì (80) $ (7,812) 32,122 11,191 2,273 45,586 $672,317 135 Freddie Mac Table 4.2 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 4.2 Ì Available-For-Sale Securities in a Gross Unrealized Loss Position December 31, 2007 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 $ 22,546 Fannie Mae ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 4,728 2 Ginnie Mae ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Other ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 129,600 7,735 Obligations of states and political subdivisions ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total mortgage-related securitiesÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 164,611 Cash and investments portfolio: Non-mortgage-related securities: $ (254) $135,966 15,214 (17) 74 Ì 45,969 1,286 198,509 (10,215) (264) (10,750) $(2,329) $158,512 19,942 76 175,569 9,021 363,120 (327) (2) (1,605) (87) (4,350) $ (2,583) (344) (2) (11,820) (351) (15,100) Asset-backed securitiesÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total non-mortgage-related securities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 8,236 8,236 Total available-for-sale securities in a gross unrealized loss position ÏÏÏÏÏÏ $172,847 (63) (63) 3,222 3,222 $(10,813) $201,731 (18) (18) 11,458 11,458 $(4,368) $374,578 (81) (81) $(15,181) Adjusted December 31, 2006 Retained portfolio: Mortgage-related securities issued by: 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) Freddie Mac ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $41,249 5,604 Fannie Mae ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 146 Ginnie Mae ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 35,228 Other ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 959 Obligations of states and political subdivisions ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 83,186 Total mortgage-related securitiesÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $(290) (69) Ì (110) (7) (476) $204,715 22,567 99 36,072 1,245 264,698 $(5,651) $245,964 28,171 245 71,300 2,204 347,884 (591) (4) (986) (24) (7,256) $(5,941) (660) (4) (1,096) (31) (7,732) 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 $89,588 (7) (7) $(483) 9,141 9,141 $273,839 (73) (73) 15,543 15,543 $(7,329) $363,427 (80) (80) $(7,812) At December 31, 2007, gross unrealized losses on available-for-sale securities were $15.2 billion, or approximately 4% of the fair value of such securities in an unrealized loss position, as noted in Table 4.2. The gross unrealized losses relate to approximately 69 thousand individual lots representing approximately 15 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 for determining that the impairment of these securities is temporary. ‚ 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 for determining that the impairment of these securities is temporary and no other facts or circumstances existed to suggest that the 136 Freddie Mac 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 decreased liquidity and larger risk premiums in the subprime market. Our review of these securities included cash Öow analyses based on default and prepayment assumptions that 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 and Poor's, or S&P, or equivalent scale). For the years ended December 31, 2007, 2006 and 2005, we recorded impairments related to investments in securities of $399 million, $404 million and $292 million, respectively. Table 4.3 below illustrates the gross realized gains and gross realized losses received from the sale of available-for-sale securities. Table 4.3 Ì Gross Realized Gains and Gross Realized Losses on Available-For-Sale Securities Gross realized gainsÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Gross realized (losses) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Net realized gains (losses) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Year Ended December 31, Adjusted 2007 $688 (456) $232 2006 (in millions) $ 376 (516) $(140) 2005 $762 (392) $370 137 Freddie Mac Table 4.4 summarizes, by major security type, the remaining contractual maturities and weighted average yield of available-for-sale securities. Table 4.4 Ì Maturities and Weighted Average Yield of Available-For-Sale Securities December 31, 2007 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 $ 550 1,776 25,486 598,621 $626,433 $ 548 1,810 25,659 587,648 $615,665 4.12% 5.77 5.32 5.39 5.38 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 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 $ Ì $ 11,327 4,665 652 16,644 18,513 Ì Ì Ì 18,513 18,513 11,327 4,665 652 $ 35,157 $ 19,063 13,103 30,151 599,273 $661,590 Ì 11,302 4,640 646 16,588 18,513 Ì Ì Ì 18,513 18,513 11,302 4,640 646 $ 35,101 $ 19,061 13,112 30,299 588,294 $650,766 Ì 4.99 5.04 4.98 5.00 5.93 Ì Ì Ì 5.93 5.93 4.99 5.04 4.98 5.49 5.88 5.10 5.28 5.38 5.39 (1) The weighted average yield is calculated based on a yield for each individual lot held at December 31, 2007. 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 2007 (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. 138 Freddie Mac Table 4.5 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 federal statutory tax rate of 35%. 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 federal statutory tax rate of 35%, 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 4.5 Ì AOCI, Net of Taxes, Related to Available-For-Sale Securities Year Ended December 31, Adjusted 2006 (in millions) Beginning balanceÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $(3,332) $(3,065) (551) 284 Net unrealized holding losses, net of tax(1) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Net reclassiÑcation adjustment for net realized losses (gains), net of tax(2)(3) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (3,792) 2007 84 Ending balance ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $(7,040) $(3,332) 2005 $ 3,751 (6,755) (61) $(3,065) (1) Net of tax beneÑt of $2.0 billion, $0.3 billion and $3.6 billion for the years ended December 31, 2007, 2006 and 2005, respectively. (2) Net of tax beneÑt (expense) of $45 million, $153 million and $(33) million for the years ended December 31, 2007, 2006 and 2005, respectively. (3) Includes the reversal of previously recorded unrealized losses that have been recognized on our consolidated statements of income as impairment losses on available-for-sale securities of $234 million, $193 million and $180 million, net of taxes, for the years ended December 31, 2007, 2006 and 2005, respectively. Table 4.6 summarizes the estimated fair values by major security type for trading securities held in our retained portfolio. Table 4.6 Ì Trading Securities in our Retained Portfolio December 31, 2007 2006 (in millions) Mortgage-related securities issued by: Freddie MacÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Fannie Mae ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Ginnie Mae ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ OtherÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total trading securities in our retained portfolio ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $12,216 1,697 175 1 $14,089 $6,573 802 222 Ì $7,597 For the years ended December 31, 2007, 2006 and 2005 we recorded net unrealized gains (losses) on trading securities held at December 31, 2007, 2006 and 2005 of $539 million, $(7) million and $(278) million, respectively. Total trading securities in our retained portfolio include $4.2 billion of SFAS 155 related assets as of December 31, 2007. Gains (losses) on trading securities on our consolidated statements of income include gains of $324 million related to these SFAS 155 trading securities for the year ended December 31, 2007. Retained Portfolio Voluntary Growth Limit We are currently operating under a voluntary, temporary limit on the growth of our retained portfolio that we instituted in response to a request by the OÇce of Federal Housing Enterprise Oversight, or OFHEO. Under this voluntary, temporary growth limit, the growth of our retained portfolio is limited to 2.0% annually. On September 19, 2007, OFHEO provided an interpretation regarding the calculation methodology of the voluntary, temporary growth limit. The interpretation changed the methodology for measuring the growth limit of our retained portfolio to be based on an unpaid principal balance measurement from a GAAP measurement. Compliance with the growth limit will not take into account any net increase in delinquent loan balances in the retained portfolio after September 30, 2007. The average unpaid principal balance for the six months ended December 31, 2007, calculated using cumulative average month-end portfolio balances, was $26.9 billion below our voluntary growth limit of $742.4 billion. Collateral Pledged Collateral Pledged to Freddie Mac Our counterparties are required to pledge collateral for reverse repurchase transactions and most interest-rate swap transactions subject to collateral posting thresholds generally related to a counterparty's credit rating. Although it is our practice not to repledge assets held as collateral, a portion of the collateral may be repledged based on master agreements related to our interest-rate swap transactions. At December 31, 2007 and 2006, we did not have collateral in the form of securities pledged to and held by us under interest-rate swap agreements. 139 Freddie Mac 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. The level of collateral pledged related to our interest-rate swap agreements is determined after giving consideration to our credit rating. As of December 31, 2007, we had two uncommitted intraday lines of credit with third parties, both of which are secured. In certain limited circumstances, the lines 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. Table 4.7 summarizes all securities pledged as collateral by us, including assets that the secured party may repledge and those that may not be repledged. Table 4.7 Ì Collateral in the Form of Securities Pledged December 31, 2007 2006 (in millions) Securities pledged with ability for secured party to repledge Available-for-saleÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $17,010 $20,463 Securities pledged without ability for secured party to repledge Available-for-saleÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 793 Total securities pledgedÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $17,803 225 $20,688 NOTE 5: MORTGAGE LOANS AND LOAN LOSS RESERVES We own both single-family mortgage loans, which are secured by one to four family residential properties, and multifamily mortgage loans, which are secured by properties with Ñve or more residential rental units. The following table summarizes the types of loans within our retained mortgage loan portfolio as of December 31, 2007 and 2006. These balances do not include mortgage loans underlying our guaranteed PCs and Structured Securities, since these are not consolidated on our balance sheets. See ""NOTE 2: FINANCIAL GUARANTEES AND TRANSFERS OF SECURITIZED INTERESTS IN MORTGAGE-RELATED ASSETS'' for information on our securitized mortgage loans. Table 5.1 Ì Mortgage Loans within the Retained Portfolio December 31, 2007 2006 (in millions) Single-family(1): Conventional Fixed-rate ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $20,707 Adjustable-rateÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2,700 23,407 Total conventional ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 311 FHA/VA Ì Fixed-rateÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Rural Housing Service and other federally guaranteed loans ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 871 24,589 Total single-familyÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $18,427 1,233 19,660 196 784 20,640 Multifamily(1): Conventional Fixed-rate ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Adjustable-rateÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total conventional ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Rural Housing Service ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total multifamily ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total unpaid principal balance of mortgage loans ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Deferred fees, unamortized premiums, discounts and other cost basis adjustments ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Lower of cost or market adjustments on loans held-for-sale ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Allowance for loan losses on loans held-for-investment ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 53,111 4,455 57,566 3 57,569 82,158 (1,868) (2) (256) Total mortgage loans, net of allowance for loan losses ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $80,032 41,863 3,341 45,204 3 45,207 65,847 (171) (2) (69) $65,605 (1) Based on unpaid principal balances and excludes mortgage loans traded, but not yet settled. For the years ended December 31, 2007 and 2006, we transferred $41 million and $123 million, respectively, of held-for- sale mortgage loans to held-for-investment. For the years ended December 31, 2007 and 2006, we transferred $Ì and $950, respectively, of held-for-investment mortgage loans to held-for-sale. 140 Freddie Mac Loan Loss Reserves We maintain an allowance for loan losses on mortgage loans that we classify as held-for-investment and a reserve for guarantee losses for mortgage loans that underlie guaranteed PCs and Structured Securities, collectively referred to as loan loss reserves. Loan loss reserves are established to provide for credit losses when it is probable that a loss has been incurred. Table 5.2 summarizes loan loss reserve activity: Table 5.2 Ì Detail of Loan Loss Reserves 2007 Reserves related to: Year Ended December 31, 2006 (Adjusted) 2005 (Adjusted) Reserves related to: Reserves related to: Retained Mortgages PCs and Structured Securities Total Loan Loss Retained Reserves Mortgages Beginning balance ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Provision for credit losses ÏÏÏÏÏÏÏÏÏÏ Charge-oÅs(1)(2) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Recoveries(1)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Transfers, net(3) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Ending balanceÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 69 321 (373) 239 Ì $ 256 $ 550 2,533 (3) Ì (514) $2,566 $ 619 2,854 (376) 239 (514) $2,822 $ 118 98 (313) 166 Ì 69 $ PCs and Structured Securities (in millions) $430 198 Ì Ì (78) $550 Total Loan Loss Retained Reserves Mortgages PCs and Structured Securities Total Loan Loss Reserves $ 548 296 (313) 166 (78) $ 619 $ 115 112 (294) 185 Ì $ 118 $240 195 Ì Ì (5) $430 $ 355 307 (294) 185 (5) $ 548 (1) Charge-oÅs or recoveries are presented in the retained mortgages columns above when credit losses related to oÅ-balance sheet PCs have been preceded by the purchase of a delinquent mortgage loan from the PC pool. (2) Charge-oÅs related to retained mortgages represent the amount of the unpaid principal balance of a loan that has been discharged using the reserve balance to remove the loan from our retained portfolio at the time of resolution. Charge-oÅs exclude $156 million in 2007 related to reserve amounts previously transferred to reduce the carrying value of loans purchased under Ñnancial guarantees. (3) Consist of: (a) the transfer of reserves associated with non-performing loans purchased from mortgage pools underlying our PCs, Structured Securities and long-term standby agreements to establish the initial recorded investment in these loans at the date of our purchase; (b) amounts attributable to uncollectible interest on PCs and Structured Securities in our retained portfolio; and (c) other transfers, net. Impaired Loans Single-family impaired loans include performing and non-performing troubled debt restructurings, as well as delinquent loans that were purchased from mortgage pools underlying our PCs and Structured Securities and long-term standby agreements. Multifamily impaired loans include loans whose contractual terms have previously been modiÑed due to credit concerns (including TDRs), certain loans with observable collateral deÑciencies, loans impaired based on management's judgments around other known facts and circumstances associated with those loans, and loans 60 days or more past due (except for certain credit-enhanced loans). Recorded investment on impaired loans includes the unpaid principal balance plus amortized basis adjustments, which are modiÑcations to the loan's carrying value. Total loan loss reserves, as presented in ""Table 5.2 Ì Detail of Loan Loss Reserves,'' consists of a speciÑc valuation allowance related to impaired loans, which is presented in Table 5.3, and an additional reserve for other probable incurred losses, which totaled $2,809 million, $613 million and $532 million at December 31, 2007, 2006 and 2005, respectively. Our recorded investment in impaired loans and the related valuation allowance are summarized in Table 5.3. Table 5.3 Ì Impaired Loans Recorded Investment 2007 SpeciÑc Reserve December 31, 2006 (Adjusted) Net Investment Recorded Investment SpeciÑc Reserve (in millions) Net Investment Recorded Investment 2005 SpeciÑc Reserve Net Investment Impaired loans having: Related-valuation allowance ÏÏÏÏÏÏÏÏÏÏ No related-valuation allowance(1) ÏÏÏÏÏ Total ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 155 8,579 $8,734 $(13) Ì $(13) $ 142 8,579 $8,721 $ 86 5,818 $5,904 $(6) Ì $(6) $ 80 5,818 $5,898 $ 54 2,536 $2,590 $(16) Ì $(16) $ 38 2,536 $2,574 (1) Impaired loans with no related valuation allowance primarily represent performing single-family troubled debt restructuring loans and those delinquent loans purchased out of PC pools that have not been impaired subsequent to acquisition. For the years ended December 31, 2007, 2006 and 2005, the average recorded investment in impaired loans was $7.5 billion, $4.4 billion and $2.6 billion, respectively. The increase in impaired loans in 2007 is attributed to an increase in the average size of the unpaid principal balance for loans originated in 2006 and 2007, and higher delinquency rates overall, but especially for loans originated in these years. The increase in impaired loans in 2006 is primarily attributed to higher volumes of delinquent loans in the North Central region, which was aÅected by a downturn in that area's economy. 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 $22 million, $25 million and $24 million for the years ended December 31, 2007, 2006 and 2005, respectively. We recorded interest 141 Freddie Mac income on impaired single-family loans that totaled $382 million, $177 million and $149 million for the years ended December 31, 2007, 2006 and 2005, respectively. Interest income and management and guarantee income foregone on impaired loans approximated $141 million, $23 million and $128 million in 2007, 2006 and 2005, respectively. Loans Acquired under Financial Guarantees We have the option under our PC agreements to purchase mortgage loans from the loan pools that underlie our guarantees and standby commitments under certain circumstances to resolve an existing or impending delinquency or default. EÅective December 2007, our general practice is to purchase loans that are delinquent from pools when the loans have been modiÑed or foreclosure sales occur, or when the loans have been delinquent for 24 months, unless we determine it is economically beneÑcial to do so sooner. Prior to December 2007, our general practice was to purchase the mortgage loans when the loans were signiÑcantly past due, generally after 120 days of delinquency. Loans purchased from PC pools that underlie our guarantees or that are covered by our standby commitments are recorded at fair value. We recognize losses on loans purchased in our consolidated statements of income if our net investment in the acquired loan is higher than its fair value. At December 31, 2007 and 2006, the unpaid principal balances of these loans were $7.0 billion and $3.0 billion, respectively, while the carrying amounts of these loans were $5.2 billion and $2.8 billion, respectively. We account for loans acquired in accordance with SOP 03-3 if, at acquisition, the loans had credit deterioration and we do not consider it probable that we will collect all contractual cash Öows from the borrower. The following table provides details on impaired loans acquired under Ñnancial guarantees. Table 5.4 Ì Loans Acquired Under Financial Guarantees and Accounted for in Accordance with SOP 03-3 Year Ended December 31, 2007 Adjusted 2006 (in millions) Contractual principal and interest payments at acquisition ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 9,735 (549) Non-accretable diÅerence ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 9,186 Cash Öows expected to be collected at acquisitionÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Accretable balance ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (2,717) Initial investment in acquired loans at acquisition ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 6,469 $5,223 (142) 5,081 (648) $4,433 The excess of contractual principal and interest over the undiscounted amount of cash Öows we expect to collect represents a non-accretable diÅerence that is not accreted to interest income nor displayed on the consolidated balance sheets. The amount that may be accreted into interest income on such loans is limited to the excess of our estimate of undiscounted expected principal, interest and other cash Öows from the loan over our initial investment in the loan. We consider estimated prepayments when calculating the accretable balance and the non-accretable diÅerence. While these loans are seriously delinquent, no amounts are accreted to interest income. Subsequent changes in estimated future cash Öows to be collected related to interest-rate changes are recognized prospectively in interest income over the remaining contractual life of the loan. Decreases in estimated future cash Öows to be collected due to further credit deterioration are recognized as provision for credit losses and increase our loan loss reserve. Subsequent to acquisition, we recognized $12 million in provision for credit losses on our consolidated statement of income related to these loans in 2007. The following table provides changes in the accretable balance of these loans. Table 5.5 Ì Changes in Accretable Balance Year Ended December 31, 2007 Adjusted 2006 (in millions) Beginning balance ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 510 2,717 Additions from new acquisitions ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (193) Accretion during the period ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Reductions(1) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (504) Change in estimated cash Öows(2)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 121 ReclassiÑcations to or from nonaccretable diÅerence ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (244) Ending balance ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $2,407 $ Ì 648 (104) (58) 31 (7) $ 510 (1) Represents the recapture of losses previously recognized due to borrower repayment or foreclosure on the loan. During 2006, these recoveries were included within our losses on loans purchased. (2) Represents the change in expected cash Öows due to troubled debt restructurings or change in prepayment assumptions of the related loans. 142 Freddie Mac Delinquency Rates Table 5.6 summarizes the delinquency performance for our total mortgage portfolio, excluding non-Freddie Mac mortgage-related securities and that portion of Structured Securities backed by Ginnie Mae CertiÑcates. Table 5.6 Ì Delinquency Performance Delinquencies: Single-family:(1) At December 31, 2006 2007 2005 Non-credit-enhanced portfolio Ì excluding Structured Transactions: Delinquency rateÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total number of delinquent loans ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 44,948 0.45% 0.25% 0.30% 22,671 25,977 Credit-enhanced portfolio Ì excluding Structured Transactions: Delinquency rateÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total number of delinquent loans ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 34,621 1.62% 1.30% 1.61% 24,106 29,336 Total portfolio Ì excluding Structured Transactions: Delinquency rateÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total number of delinquent loans ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 79,569 0.65% Structured Transactions(2): Total single-family portfolio(2): Multifamily:(3) Delinquency rateÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total number of delinquent loans ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 14,122 9.86% Delinquency rateÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total number of delinquent loans ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 93,691 0.76% 0.42% 0.53% 46,777 55,313 8.36% 12.34% 13,770 19,625 0.54% 0.71% 60,547 74,938 Delinquency rateÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Net carrying value of delinquent loans (in millions) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 0.02% 10 0.06% 30 $ $ Ì% 2 (1) Based on the number of mortgages 90 days or more delinquent or in foreclosure. Delinquencies on mortgage loans underlying certain Structured Securities, long-term standby commitments and Structured Transactions may be reported on a diÅerent schedule due to variances in industry practice. (2) Structured Transactions generally have underlying mortgage loans with higher risk characteristics but may provide inherent credit protections from losses due to underlying subordination, excess interest, overcollateralization and other features. Previously reported delinquency data for Structured Transactions excluded certain information when underlying loan servicing data was not previously available. Prior period information has been revised to conform to the current period presentation, which includes loan servicing data for all Structured Transactions. (3) Multifamily delinquency performance is based on net carrying value of mortgages 60 days or more delinquent, and excludes multifamily Structured Transactions, which are approximately 1%, 2% and Ì% of our total multifamily portfolio as of December 31, 2007, 2006 and 2005, respectively. There were no delinquencies for our multifamily Structured Transactions as of December 31, 2007, 2006 and 2005. NOTE 6: 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, 2007 and 2006, the weighted average holding period for our disposed REO properties was less than one year. Table 6.1 provides a summary of our REO activity. Table 6.1 Ì Real Estate Owned Balance, December 31, 2005 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ Additions ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Dispositions and write-downs ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Balance, December 31, 2006 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ Additions ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Dispositions and write-downs ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 744 1,484 (1,357) 871 2,906 (1,710) Balance, December 31, 2007 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 2,067 REO, Gross Valuation Allowance (in millions) $(115) (85) 72 $(128) (175) (28) $(331) REO, Net $ $ 629 1,399 (1,285) 743 2,731 (1,738) $ 1,736 We recognized net losses of $120 million, $59 million and $67 million on REO dispositions for the years ended December 31, 2007, 2006 and 2005, respectively, which are included in REO operations expense. The number of REO property additions increased by 39% in 2007 compared to those in 2006. Our REO additions have continued to be greatest in the North Central region of the U.S. and approximately 43% of our REO property count balance relates to properties located in this region. 143 Freddie Mac NOTE 7: DEBT SECURITIES AND SUBORDINATED BORROWINGS Table 7.1 summarizes the balances and eÅective interest rates for debt securities, as well as subordinated borrowings. Table 7.1 Ì Total Debt Securities, Net 2007 Balance, Net(1) December 31, 2006 Balance, EÅective Net(1) Rate(2) (dollars in millions) EÅective Rate(2) Senior debt, due within one year: Short-term debt securitiesÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $197,601 98,320 Current portion of long-term debt ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 295,921 Senior debt, due within one year ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 4.52% $167,385 117,879 4.44 285,264 4.49 438,147 Senior debt, due after one year ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 4,489 Subordinated debt, due after one yearÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Senior and subordinated debt, due after one year ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 442,636 Total debt securities, net ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $738,557 5.24 5.84 5.25 452,677 6,400 459,077 $744,341 5.14% 4.10 4.71 5.08 5.86 5.09 (1) Represents par value, net of associated discounts, premiums and foreign-currency-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. Senior Debt, Due Within One Year As indicated in Table 7.2, 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. At both December 31, 2007 and 2006, the balance of securities sold under agreements to repurchase and federal funds purchased was $Ì. Table 7.2 provides additional information related to our debt securities due within one year. Table 7.2 Ì Senior Debt, Due Within One Year 2007 Balance, Net(1) Par Value EÅective Rate Par Value 2006 Balance, Net(1) EÅective Rate December 31, Reference Bills» securities and discount notes(2) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $198,323 $196,426 Medium-term notes(2) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 1,175 197,601 Short-term debt securities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Current portion of long-term debt ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 98,320 Senior debt, due within one year ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $296,760 $295,921 1,175 199,498 97,262 (dollars in millions) 4.52% 4.36 4.52 4.44 4.49 $159,503 $157,553 9,832 9,832 167,385 169,335 117,972 117,879 $287,307 $285,264 5.14% 5.16 5.14 4.10 4.71 (1) Represents par value, net of associated discounts, premiums and foreign-currency-related basis adjustments. (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. 144 Freddie Mac Senior and Subordinated Debt, Due After One Year Table 7.3 summarizes our senior and subordinated debt, due after one year. Table 7.3 Ì Senior and Subordinated Debt, Due After One Year Senior debt, due after one year:(3) December 31, 2007 2006 Contractual Balance, Maturity(1) Par Value Net(2) Interest Rates Balance, Par Value Net(2) Interest Rates (dollars in millions) Fixed-rate: Medium-term notes Ì callable(4) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2009 Ó 2037 $169,588 $169,519 3.00% Ó 7.50% $183,611 $183,532 2.57% Ó 7.50% 5,798 1.00% Ó 10.27% Medium-term notes Ì non-callable ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2009 Ó 2028 194,772 2.75% Ó 7.00% U.S. dollar Reference Notes» securities Ì non-callable ÏÏÏ 2009 Ó 2032 4Reference Notes» securities Ì non-callable ÏÏÏÏÏÏÏÏÏÏÏÏ 2009 Ó 2014 16,878 3.50% Ó 5.75% 5,764 201,745 3.38% Ó 7.00% 195,289 16,912 7,122 202,139 9,670 9,649 3.75% Ó 5.75% 7,399 1.00% Ó 14.32% Variable-rate: Medium-term notes Ì callable(5) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2009 Ó 2030 Medium-term notes Ì non-callable ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2009 Ó 2026 Zero-coupon: Medium-term notes Ì callable(6) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2014 Ó 2037 Medium-term notes Ì non-callable(7) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2009 Ó 2037 Foreign-currency-related and hedging-related basis adjustments Total senior debt, due after one year ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 22,913 2,653 22,909 2,688 Various Various 28,617 421 28,616 460 Various Various 45,725 14,493 N/A 474,303 9,544 9,556 5,138 438,147 Ì% Ì% 43,248 10,535 N/A 484,397 8,610 6,204 7,807 452,677 Ì% Ì% Subordinated debt, due after one year: Fixed-rate(8)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2011 Ó 2018 Zero-coupon(9)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total subordinated debt, due after one yearÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total senior and subordinated debt, due after one year ÏÏÏÏÏÏÏÏ 2019 4,452 332 4,784 101 4,489 $479,087 $442,636 4,388 5.00% Ó 8.25% 6,309 5.00% Ó 8.25% Ì% Ì% 6,382 332 6,714 91 6,400 $491,111 $459,077 (1) Represents contractual maturities at December 31, 2007. (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 NotesSM securities and FreddieNotes» securities of $14.1 billion and $13.0 billion at December 31, 2007 and 2006, 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 NotesSM securities and FreddieNotes» securities of $6.3 billion and $7.8 billion at December 31, 2007 and 2006. (6) The eÅective rates for zero-coupon medium-term notes Ì callable ranged from 5.57% Ó 7.17% at both December 31, 2007 and 2006. (7) The eÅective rates for zero-coupon medium-term notes Ì non-callable ranged from 3.46% Ó 10.68% and 2.65% Ó 10.68% at December 31, 2007 and 2006, respectively. (8) Balance, net includes callable subordinated debt of $Ì and $1.9 billion at December 31, 2007 and 2006, respectively. (9) The eÅective rate for zero-coupon subordinated debt, due after one year was 10.20% at both December 31, 2007 and 2006. 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 7.4 summarizes the contractual maturities of long-term debt securities (including current portion of long-term debt) and subordinated borrowings outstanding at December 31, 2007, assuming callable debt is paid at contractual maturity. Table 7.4 Ì Senior and Subordinated Debt, Due After One Year (including current portion of long-term debt) Annual Maturities 2008 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2009 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2010 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2011 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2012 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Thereafter ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total(1)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Net discounts, premiums and foreign-currency-related basis adjustments(2) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Senior and subordinated debt, due after one year, including current portion of long-term debt ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Contractual Maturity(1)(2) (in millions) $ 97,262 79,316 63,911 45,966 52,317 237,577 576,349 (35,393) $540,956 (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 basis adjustments. 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, 2007, we had two secured, uncommitted lines of credit totaling $17 billion. No amounts were drawn on these lines of credit at December 31, 2007. We expect to 145 Freddie Mac 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 8: STOCKHOLDERS' EQUITY During 2007, we completed Ñve preferred stock oÅerings consisting of Ñve classes. We had two preferred stock oÅerings consisting of three classes during 2006. All 24 classes of preferred stock outstanding at December 31, 2007 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 24 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 8.1 provides a summary of our preferred stock outstanding at December 31, 2007. Table 8.1 Ì Preferred Stock Issue Date Shares Authorized 1996 Variable-rate(4) ÏÏÏÏÏÏ April 26, 1996 October 27, 1997 5.81% ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ March 23, 1998 5% ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 1998 Variable-rate(6) ÏÏÏÏÏÏ September 23 and 29, 1998 September 23, 1998 5.10% ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ October 28, 1998 5.30% ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ March 19, 1999 5.10% ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ July 21, 1999 5.79% ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 1999 Variable-rate(7) ÏÏÏÏÏÏ November 5, 1999 2001 Variable-rate(8) ÏÏÏÏÏÏ January 26, 2001 2001 Variable-rate(9) ÏÏÏÏÏÏ March 23, 2001 March 23, 2001 5.81% ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ May 30, 2001 6% ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2001 Variable-rate(10)ÏÏÏÏÏÏ May 30, 2001 October 30, 2001 5.70% ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ January 29, 2002 5.81% ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2006 Variable-rate(11)ÏÏÏÏÏÏ July 17, 2006 July 17, 2006 6.42% ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ October 16, 2006 5.90% ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ January 16, 2007 5.57% ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ April 16, 2007 5.66% ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ July 24, 2007 6.02% ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 6.55% ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ September 28, 2007 2007 Fixed-to-Öoating 5.00 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 44.00 20.00 20.00 20.00 Redemption Price per Share Total Outstanding Balance(1) $ Total Par Value Shares Outstanding (in millions, except redemption price per share) 5.00 $ 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 44.00 20.00 20.00 20.00 $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 25.00 25.00 25.00 25.00 5.00 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 44.00 20.00 20.00 20.00 250 150 400 220 400 200 150 250 287 325 230 173 173 201 300 300 750 250 500 1,100 500 500 500 Redeemable On or After(2) NYSE Symbol(3) June 30, 2001 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 December 31, 2011 March 31, 2012 June 30, 2012 September 30, 2017 FRE.prB (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 FRE.prV FRE.prW FRE.prX FRE.prY Rate(12) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ December 4, 2007 240.00 464.17 240.00 464.17 240.00 $464.17 25.00 6,000 $14,109 December 31, 2012 FRE.prZ (1) Amounts stated at redemption value. (2) As long as the capital monitoring framework established by OFHEO in January 2004 remains in eÅect, any preferred stock redemption will require prior approval by OFHEO. See ""NOTE 9: 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% divided by 1.377, and is capped at 9.00%. (5) Not listed on any exchange. (6) Dividend rate resets quarterly and is equal to the sum of three-month LIBOR plus 1% divided by 1.377, and is capped at 7.50%. (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%. 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%, and is capped at 11.00%. 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%, and is capped at 11.00%. 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%, and is capped at 11.00%. 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% but not less than 4.00%. (12) Dividend rate is set at an annual Ñxed rate of 8.375% from December 4, 2007 through December 31, 2012. For the period beginning on or after January 1, 2013, dividend rate resets quarterly and is equal to the higher of (a) the sum of three-month LIBOR plus 4.16% per annum or (b) 7.875% per annum. Optional redemption on December 31, 2012, and on December 31 every Ñve years thereafter. Stock Repurchase and Issuance Programs During 2007, we completed Ñve non-cumulative, perpetual preferred stock oÅerings with aggregate proceeds of $8.6 billion, including $6.0 billion of Ñxed-to-Öoating to increase our capital position and $500 million of 6.55% non- cumulative, perpetual preferred stock for general corporate purposes. We also issued $500 million of 6.02% and $500 million of 5.66% non-cumulative, perpetual preferred stock and repurchased $1.0 billion (approximately 16.1 million shares) of outstanding common stock, thereby completing our plan announced in March 2007 to replace $1.0 billion of common stock 146 Freddie Mac with an equal amount of preferred stock. In addition, we issued $1.1 billion of 5.57% non-cumulative, perpetual preferred stock, consisting of $500 million to complete our plan announced in October 2005 to replace $2.0 billion of common stock with an equal amount of preferred stock and $600 million to replace higher-cost preferred stock that we redeemed. 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 our plan announced in October 2005 to replace $2.0 billion of common stock with an equal amount of preferred stock. In accordance with OFHEO's capital monitoring framework, we obtained OFHEO's approval for the preferred stock redemption and common stock repurchase activities described above. Common Stock Dividends Declared Common stock dividends declared per share were $1.75, $1.91 and $1.52 for 2007, 2006 and 2005, respectively. Regulatory Capital Standards NOTE 9: 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% of aggregate on-balance sheet assets and approximately 0.45% of the sum of our PCs and Structured Securities outstanding 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% 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% of aggregate on-balance sheet assets and approximately 0.25% of the sum of our PCs and Structured Securities outstanding 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% additional capital to provide for management and operations risk. The adverse interest-rate conditions prescribed by the GSE Act include an ""up-rate scenario'' in which 10-year Treasury yields rise by as much as 75% and a ""down-rate scenario'' in which they fall by as much as 50%. The credit risk component of the stress tests 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. If we were classiÑed as adequately capitalized, we generally could pay a dividend on our common or preferred stock or make other capital distributions (which includes common stock repurchases and preferred stock redemptions) without prior 147 Freddie Mac 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 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 compliance with the minimum, critical and risk-based capital requirements. Table 9.1 summarizes our regulatory capital requirements and surpluses. Table 9.1 Ì Regulatory Capital Requirements(1) December 31, 2007 (Adjusted) 2006 (in millions) Minimum capital requirement(2) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Core capital(2) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Minimum capital surplus(2) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Critical capital requirement(2) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Core capital(2) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Critical capital surplus(2)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Risk-based capital requirement(3)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total capital(3) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Risk-based capital surplus(3)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $26,473 37,867 11,394 $13,618 37,867 24,249 N/A N/A N/A $25,607 35,365 9,758 $13,119 35,365 22,246 $15,320 36,742 21,422 (1) OFHEO is the authoritative source of the capital calculations that underlie our capital classiÑcations. (2) Amounts for 2007 and 2006 are based on amended reports we will submit to OFHEO. (3) OFHEO determines the amounts reported with respect to our risk-based capital requirement. Amounts for 2007 are not yet available and amounts for 2006 are those calculated by OFHEO prior to the adjustment of our 2006 Ñnancial results. Factors that could adversely aÅect the adequacy of our capital in future periods include GAAP net losses; continued declines in home prices; increases in our credit and interest-rate risk proÑles; adverse changes in interest-rate or implied volatility; adverse option-adjusted spread, or OAS, changes; legislative or regulatory actions that increase capital requirements; or changes in accounting practices or standards. See ""NOTE 1: SUMMARY OF SIGNIFICANT 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 OAS can also aÅect the amount of our core capital, because OAS 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 fewer than two nationally recognized 148 Freddie Mac 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% of our PCs and Structured Securities outstanding and 4% of our 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% of our 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 9.2 summarizes our compliance with our subordinated debt commitment. Table 9.2 Ì Subordinated Debt Commitment December 31, 2007 (Adjusted) 2006 (in millions) Total on-balance sheet assets and PCs and Structured Securities outstanding target(1)(2) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total capital plus qualifying subordinated debt(2) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Surplus(2) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $38,000 44,559 6,559 $37,249 41,997 4,748 (1) Equals the sum of 0.45% of our PCs and Structured Securities held by third parties and 4% of on-balance sheet assets. (2) Amounts for 2007 and 2006 are based on amended reports we will submit to OFHEO. Regulatory Capital Monitoring Framework In a letter dated January 28, 2004, OFHEO created a framework for monitoring our capital. The letter directed that we maintain a 30% mandatory target capital surplus 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 30% 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, including common stock repurchases, redemption of any preferred stock or payment of dividends on preferred stock above stated contractual rates. 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 9.3 summarizes our compliance with the 30% mandatory target capital surplus portion of OFHEO's capital monitoring framework. Table 9.3 Ì Mandatory Target Capital Surplus December 31, 2007 (Adjusted) 2006 (in millions) Minimum capital requirement plus 30% add-on(1)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Core capital(1) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Surplus(1) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $34,415 37,867 3,452 $33,289 35,365 2,076 (1) Amounts for 2007 and 2006 are based on amended reports we will submit to OFHEO. NOTE 10: 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. 149 Freddie Mac 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 2007, we granted restricted stock units as stock- based awards. Such awards, discussed below, are generally forfeitable for at least one year after the grant date, with vesting provisions contingent upon service requirements. 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. Stock-Based Compensation Plans 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% 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, 2007, the maximum number of shares of common stock authorized for grant to employees totaled 6.8 million shares, of which approximately 0.7 million shares had been issued and approximately 6.1 million shares remained available for grant. At December 31, 2007, 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, 2007, no stock appreciation rights had been granted under the 2004 Employee Plan. At December 31, 2007, the maximum number of shares of common stock authorized for grant to employees in accordance with the 2004 Employee Plan totaled 14.5 million shares, of which approximately 4.2 million shares had been issued and approximately 10.3 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, 2007, 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. 150 Freddie Mac 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; (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 10.1 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 10.1 Ì Assumptions and Valuations 2007 ESPP 2006 2005 Employee Plans and Directors' Plan 2006 2007(1) 2005(2) (dollars in millions, except share-related amounts) Assumptions: Expected volatilityÏÏÏÏÏÏÏÏÏÏÏÏÏ 11.1% to 45.4% 11.2% to 18.7% 16.8% to 21.1% 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 26.22% 3.44% 3 months 4.57% $11.25 $2 15.7% 2.98% 3 months 4.82% $11.20 $3 19.7% 2.15% 3 months 3.20% $11.56 $2 N/A N/A N/A N/A N/A N/A $7 27.8% to 28.9% 18.4% to 30.3% 28.7% 3.09% 7.1 years 4.91% $16.78 $20 30.0% Ì 7.4 years 4.23% $26.84 $32 (1) No options were granted under the Employee Plans and Directors' Plan. (2) 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 Ì%. 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%, (b) expected dividend yield of 2.96%, (c) expected life of 5.1 years and (d) risk-free interest rate of 4.34%. Subsequent to November 30, 2005, dividend equivalent rights are no longer granted in connection with new awards of stock options to grantees. Table 10.2 provides a summary of activity under the ESPP for the year ended December 31, 2007 and those options to purchase stock that are exercisable at December 31, 2007. Table 10.2 Ì ESPP Activity Outstanding at January 1, 2007(1) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Granted(1) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Exercised ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Forfeited or expired ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Outstanding at December 31, 2007(1) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Exercisable at December 31, 2007 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Options to Purchase Stock 52,898 277,091 (238,913) (8,510) 82,566 Ì Weighted Average Exercise Price Weighted Average Remaining Contractual Term Aggregate Intrinsic Value (dollars in millions, except share-related amounts) $58.09 49.73 50.73 51.78 42.71 Ì 1 month Ì $Ì $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. 151 Freddie Mac Table 10.3 provides a summary of option activity under the Employee Plans and Directors' Plan for the year ended December 31, 2007, and options exercisable at December 31, 2007. Table 10.3 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, 2007 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ GrantedÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Exercised ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Forfeited or expiredÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Outstanding at December 31, 2007 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 5,851,925 Ì (390,891) (366,179) 5,094,855 Exercisable at December 31, 2007 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 4,070,825 $58.43 Ì 45.67 61.73 59.17 58.84 4.82 years 4.25 years $Ì $Ì We received cash of $18 million from the exercise of stock options under the Employee Plans and the Directors' Plan during 2007. We realized a tax beneÑt of $2 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 2007. During 2007 and 2006, we did not pay cash to settle share-based liability awards granted under share-based payment arrangements associated with the Employee Plans and the Directors' Plan. During 2005, we paid $1 million to settle share-based awards. Table 10.4 provides a summary of activity related to restricted stock units and restricted stock under the Employee Plans and the Directors' Plan. Table 10.4 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 Outstanding at January 1, 2007 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Granted(1)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Lapse of restrictions ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Forfeited ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Outstanding at December 31, 2007ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2,404,575 1,592,659 (773,660) (325,681) 2,897,893 $63.35 58.84 63.76 61.37 60.96 41,160 Ì Ì Ì 41,160 $60.75 Ì Ì Ì 60.75 (1) During 2007, restricted stock units granted under the Employee Plans and the Directors' Plan were 1,572,232 and 20,427, respectively. The total fair value of restricted stock units vested during 2007, 2006 and 2005 was $44 million, $24 million and $42 million, respectively. No restricted stock vested in 2007. The total fair value of restricted stock vested during 2006 and 2005 was $2 million and $5 million, respectively. We realized a tax beneÑt of $15 million and $9 million, respectively, 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 2007 and 2006. Table 10.5 provides information on compensation expense related to stock-based compensation plans. Table 10.5 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, 2006 (in millions) $60 3 $63 $21 5 2005 $67 2 $69 $23 5 2007 $81 1 $82 $28 7 (1) For 2007 and 2006, primarily consisted 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, 2007, $107 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 2007, the modiÑcations of individual awards, which provided for continued or accelerated vesting, were made to fewer than 60 employees and resulted in a reduction of compensation expense of $0.3 million. 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. 152 Freddie Mac 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 11: 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. At December 31, 2007, we did not have any derivatives in hedge accounting relationships. However, there are amounts recorded in AOCI related to terminated or de-designated cash Öow relationships. These deferred gains and losses on closed cash Öow hedges are recognized in earnings as the originally forecasted transactions aÅect earnings. During 2006 and 2005, we discontinued hedge accounting for substantially all of our hedge 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. The carrying value of our derivatives on our consolidated balance sheets is equal to their fair value, including net derivative interest receivable or payable and is net of cash collateral held or posted, where allowable by a master netting agreement. Derivatives in a net asset position are reported as derivative assets, net. Similarly, derivatives in a net liability position are reported as derivative liabilities, net. Cash collateral we obtained from counterparties to derivative contracts that has been oÅset against derivative assets, net at December 31, 2007 and December 31, 2006 was $6.5 billion and $9.6 billion, respectively. Cash collateral we posted to counterparties to derivative contracts that has been oÅset against derivative liabilities, net at December 31, 2007 and December 31, 2006 was $344 million and $57 million, respectively. At December 31, 2007 and December 31, 2006, there were no amounts of cash collateral that were not oÅset against derivative assets, net or derivative liabilities, net, as applicable. See ""NOTE 17: CONCENTRATION OF CREDIT AND OTHER RISKS'' for further information related to our derivative counterparties. As shown in Table 11.1, the total AOCI, net of taxes, related to cash Öow hedge relationships was a loss of $4.1 billion at December 31, 2007, 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, 2008, we estimate that approximately $865 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 26 years. However, over 70% and 90% of the AOCI, net of taxes, balance relating to cash Öow hedges at December 31, 2007 is linked to forecasted transactions occurring in the next Ñve and ten 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 11.1 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 federal statutory tax rate of 35%, 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 federal statutory tax rate of 35%, 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 deferred gain or loss associated with the hedge related to the forecasted transaction would be reclassiÑed into earnings immediately. 153 Freddie Mac Table 11.1 Ì AOCI, Net of Taxes, Related to Cash Flow Hedge Relationships Year Ended December 31, Adjusted Beginning balance(1) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Net change in fair value related to cash Öow hedging activities, net of tax(2) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Net reclassiÑcations of losses to earnings, net of tax(3) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Ending balance(1)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2005 2007 2006 (in millions) $(5,032) $(6,286) $(7,923) (8) 66 1,571 1,262 $(4,059) $(5,032) $(6,286) (30) 1,003 (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. (2) Net of tax (beneÑt) expense of $(16) million, $(5) million, and $36 million for years ended December 31, 2007, 2006 and 2005, respectively. (3) Net of tax beneÑt of $540 million, $680 million and $846 million for years ended December 31, 2007, 2006 and 2005, respectively. During 2006 and 2005, our hedge accounting relationships primarily consisted of hedging benchmark interest-rate risk related to the forecasted issuances of debt that were designated as cash Öow hedges, and fair value hedges of benchmark interest-rate risk and/or foreign currency risk on existing Ñxed-rate debt. Table 11.2 summarizes certain gains (losses) and hedge ineÅectiveness recognized related to our hedge accounting categories. Table 11.2 Ì Hedge Accounting Categories Information Year Ended December 31, 2006 (in millions) 2007 2005 Fair value hedges Hedge ineÅectiveness recognized in other income Ì pre-tax(1) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Cash Öow hedges Hedge ineÅectiveness recognized in other income Ì pre-tax(1) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Ì Ì Net pre-tax gains (losses) resulting from the determination that it was probable that forecasted transactions would not $Ì $2 occur(2) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Ì Ì (25) $22 Ì (1) No amounts have been excluded from the assessment of eÅectiveness. (2) These forecasted transactions relate to the purchase or sale of mortgage loans and mortgage-related securities. NOTE 12: 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 indemniÑcation against liability arising from their wrongful actions. 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. Recent Putative Securities Class Action Lawsuits. Reimer vs. Freddie Mac, Syron, Cook, Piszel and McQuade and Ohio Public Employees Retirement System vs. Freddie Mac, Syron, et al. Two virtually identical putative securities class action lawsuits were Ñled against Freddie Mac and certain of our current and former oÇcers alleging that the defendants violated federal securities laws by making ""false and misleading statements concerning our business, risk management and the procedures we put into place to protect the company from problems in the mortgage industry.'' One suit was Ñled on November 21, 2007 in the US District Court for the Southern District of New York and the other was Ñled on January 18, 2008 in the US District Court for the Northern District of Ohio. The plaintiÅs are seeking unspeciÑed damages and interest, reasonable costs including attorneys' fees and equitable and other injunctive relief. At present, it is not possible to predict the probable outcomes of these lawsuits or any potential impact on our business, Ñnancial condition, or results of operation. Recent Shareholder Demand Letters. In late 2007, the Board of Directors received two letters from purported shareholders of Freddie Mac alleging corporate mismanagement and breaches of Ñduciary duty in connection with the company's risk management. One letter demands that the Board commence an independent investigation into the alleged conduct, institute legal proceedings to recover damages from the responsible individuals, and implement corporate governance initiatives to ensure that the alleged problems do not recur. The other letter demands that Freddie Mac 154 Freddie Mac commence legal proceedings to recover damages from responsible Board members, senior oÇcers, Freddie Mac's outside auditors, and other parties who allegedly aided or abetted the improper conduct. The Board of Directors formed a special committee to investigate the purported shareholders' allegations. 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 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. Securities Class Action Lawsuits. In June 2003 and thereafter, securities class action lawsuits were brought against us and certain former executive oÇcers in connection with the restatement and eventually were consolidated 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. The New York Attorney General's Investigation. In connection with the New York Attorney General's suit Ñled against eAppraiseIT and its parent corporation, First American, alleging appraisal fraud in connection with loans originated by Washington Mutual, in November 2007, the New York Attorney General demanded that we either retain an independent examiner to investigate our mortgage purchases from Washington Mutual supported by appraisals conducted by eAppraiseIT, or immediately cease and desist from purchasing or securitizing Washington Mutual loans and any loans supported by eAppraiseIT appraisals. We also received a subpoena from the New York Attorney General's oÇce for information regarding appraisals and property valuations as they relate to our mortgage purchases and securitizations from January 1, 2004 to the present. Currently, we are discussing with the New York Attorney General and OFHEO resolution of the matter. Settlement of the SEC Investigation. On September 27, 2007, we reached an agreement with the SEC to settle its investigation relating to the restatement of our previously issued consolidated Ñnancial statements for 2000, 2001, and the Ñrst three quarters of 2002, and the revision of fourth quarter and full-year consolidated Ñnancial statements for 2002. Under the terms of the settlement, Freddie Mac neither admitted nor denied allegations of federal securities law violations. The settlement included a payment of $50 million. 155 Freddie Mac We are exempt from state and local income taxes. Table 13.1 presents the components of our provision for income taxes NOTE 13: INCOME TAXES for 2007, 2006, and 2005. Table 13.1 Ì Provision for Federal Income Taxes Year Ended December 31, Adjusted 2007 2006 (in millions) 2005 Current income tax expense (beneÑt) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 1,060 Deferred income tax expense (beneÑt) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (3,943) $ Total income tax expense (beneÑt)(1) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $(2,883) $ 966 (1,011) (45) $ 1,820 (1,462) 358 $ (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. A reconciliation between our federal statutory income tax rate and our eÅective tax rate for 2007, 2006, and 2005 is presented in Table 13.2. Table 13.2 Ì Reconciliation of Statutory to EÅective Tax Rate Year Ended December 31, (Adjusted) 2007 2006 2005 Amount Percent Amount Percent (dollars in millions) Amount Percent Statutory corporate tax rate ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Tax credits ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Tax-exempt interest ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Unrecognized tax beneÑts and related interest/contingency reserves ÏÏÏÏÏÏÏÏÏÏÏ Penalties ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Other ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ EÅective tax rate ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $(2,092) (534) (255) 32 Ì (34) $(2,883) 35.0% $ 799 8.9 4.3 (0.5) Ì 0.5 (461) (255) (135) Ì 7 48.2% $ (45) 35.0% $ 885 (20.2) (11.2) (5.9) Ì 0.3 (365) (221) 49 1 9 (2.0)% $ 358 35.0% (14.4) (8.7) 1.9 0.1 0.3 14.2% Our eÅective tax rate diÅers from the federal statutory tax rate of 35% primarily due to the beneÑts of our investments in LIHTC partnerships and tax-exempt housing-related securities. In 2006, we released $174 million of tax reserves primarily as a result of a U.S. Tax Court decision and a separate settlement with the IRS. The sources and tax eÅects of temporary diÅerences that give rise to signiÑcant portions of deferred tax assets and liabilities for the years ended December 31, 2007 and 2006 are presented in Table 13.3. Table 13.3 Ì Deferred Tax Assets and (Liabilities) December 31, 2007 (Adjusted) 2006 (in millions) Deferred tax assets: Deferred fees related to securitizationsÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 3,680 3,477 Basis diÅerences related to derivative instruments ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 1,013 Credit related items and reserve for loan losses ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 196 Employee compensation and beneÑt plans ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 3,791 Unrealized (gains) losses related to available-for-sale securitiesÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 12,157 Total deferred tax asset ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Deferred tax liabilities: (1,380) Premium and discount amortization ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (431) Basis diÅerences related to assets held for investment ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (42) Other items, net ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total deferred tax (liability) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (1,853) Net deferred tax asset/(liability) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $10,304 $ 2,146 1,698 226 195 1,794 6,059 (1,320) (341) (52) (1,713) $ 4,346 Management believes that the realization of our gross deferred tax asset of $12 billion at December 31, 2007 is more likely than not. We are in a cumulative loss position for the three years ended December 31, 2007 due to the loss incurred in 2007. However, we believe we will generate suÇcient taxable income in the future to realize these deferred tax assets. In making this determination we considered the nature of the book losses, our earnings history, forecasts of future proÑtability, capital adequacy, management's intent to hold investments until losses can be recovered and the duration of statutory 156 Freddie Mac carryback and carryforward periods. If future events signiÑcantly diÅer from our current forecasts, a valuation allowance may need to be established. As of December 31, 2007, based on estimates of taxable income, we have no tax credit carryforwards. However, management expects that our ability to use all of the tax credits generated by existing or future investments in LIHTC partnerships to reduce our federal income tax liability may be limited by the alternative minimum tax in future years. We adopted the provisions of FIN 48 eÅective January 1, 2007 and as a result recorded a $181 million increase to retained earnings. A reconciliation of the balance of unrecognized tax beneÑts from January 1, 2007 to December 31, 2007 is presented in Table 13.4. Table 13.4 Ì Unrecognized Tax BeneÑts (in millions) Balance at January 1, 2007 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Increases based on tax positions prior to 2007ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Decreases based on tax positions prior to 2007 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Change to tax positions that only aÅect timing ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Increases based on tax positions related to 2007 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Balance at December 31, 2007 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $677 Ì Ì (40) Ì $637 At December 31, 2007, we had total unrecognized tax beneÑts, exclusive of interest, of $637 million. Included in the $637 million are $76 million of unrecognized tax beneÑts that, if recognized, would favorably aÅect our eÅective tax rate. The remaining $561 million of unrecognized tax beneÑts relate to tax positions for which ultimate deductibility is highly certain, but for which there is uncertainty as to the timing of such deductibility. Recognition of these tax beneÑts, other than applicable interest, would not aÅect our eÅective tax rate. We recognize interest and penalties, if any, in income tax expense. As of December 31, 2007, we had total accrued interest receivable, net of tax eÅect, of $55 million. Amounts included in total accrued interest relate to: (a) unrecognized tax beneÑts; (b) pending claims with the IRS for open tax years; (c) the tax beneÑt related to tax refund claims; and (d) the impact of payments made to the IRS in prior years in anticipation of potential tax deÑciencies. Of the $55 million of accrued interest receivable as of December 31, 2007, approximately $137 million of accrued interest payable, net of tax eÅect, is allocable to unrecognized tax beneÑts. During 2007 we recognized within tax expense $32 million of interest expense allocable to unrecognized tax beneÑts. We have no amount accrued for penalties. The statute of limitations for federal income tax purposes is open on corporate income tax returns Ñled for years 1985 to 2006. The IRS is currently examining tax years 2003 to 2005. The IRS has completed its examination of years 1998 to 2002. The principal matter in controversy as the result of the examination involves questions of timing and potential penalties regarding our tax accounting method for certain hedging transactions. Tax years 1985 to 1997 are before the U.S. Tax Court. We are currently in settlement discussions with the IRS regarding the tax treatment of the customer relationship intangible asset recognized upon our transition from non-taxable to taxable status in 1985. We believe it is reasonably possible that signiÑcant changes in the gross balance of unrecognized tax beneÑts may occur within the next 12 months that could have a material impact on income tax expense or beneÑt in the period the issue is resolved; however, we cannot predict the amount of such change or the range of potential changes. DeÑned BeneÑt Plans NOTE 14: EMPLOYEE BENEFITS 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 primarily of funds consisting of listed stocks and corporate bonds. In addition to our Pension Plan, we maintain a nonqualiÑed, unfunded deÑned beneÑt pension plan for our oÇcers, as part of 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 was 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 the deÑned beneÑt plans. 157 Freddie Mac 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 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 2007, 2006 and 2005 presented in the following tables were calculated using assumptions as of September 30, 2006, 2005 and 2004, respectively. The funded status of our deÑned beneÑt plans for 2007 and 2006 presented in the following tables was calculated using assumptions as of September 30, 2007 and 2006, respectively. Table 14.1 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, 2007 and 2006, respectively. Table 14.1 Ì Obligation and Funded Status of our DeÑned BeneÑt Plans Pension BeneÑts 2006 2007 Postretirement Health BeneÑts 2006 2007 (in millions) Change in beneÑt obligation: BeneÑt obligation at October 1 (prior year) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Service cost ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Interest cost ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Net actuarial gain ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ BeneÑts paidÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ BeneÑt obligation at September 30 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Change in plan assets: Fair value of plan assets at October 1 (prior year) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Actual return on plan assetsÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Employer contributions ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ BeneÑts paidÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Fair value of plan assets at September 30 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Funded status at September 30 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $504 34 30 (21) (8) 539 $501 65 1 (8) 559 $ 20 $457 31 26 (1) (9) 504 $333 31 146 (9) 501 $ (3) $ 121 9 7 (9) (1) 127 $ 110 9 6 (3) (1) 121 $(127) $(121) Amounts recognized on our consolidated balance sheets at December 31: Other assets ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Other liabilities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ AOCI, net of taxes related to deÑned beneÑt plans: Net actuarial lossÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Prior service cost (credit)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total AOCI, net of taxes(1) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 77 (57) $ 42 (45) $ Ì $ Ì (121) (127) $ 37 1 $ 38 $ 72 1 $ 73 $ $ 8 (2) 6 $ $ 17 (3) 14 (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. The accumulated beneÑt obligation for all deÑned beneÑt pension plans was $393 million and $362 million at September 30, 2007 and 2006, 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. Table 14.2 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, 2007, with the projected beneÑt obligation included for illustrative purposes. Table 14.2 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 $482 $559 353 $206 2007 SERP $ 57 Pension Plan Total (in millions) $539 $458 40 $ Ì $559 393 $(40) $166 $501 329 $172 2006 SERP Total $ 46 $504 33 $ Ì $501 362 $(33) $139 158 Freddie Mac The measurement of our beneÑt obligations includes assumptions about the rate of future compensation increases included in Table 14.3. Table 14.3 Ì Weighted Average Assumptions Used to Determine Projected and Accumulated BeneÑt Obligations Pension BeneÑts September 30, Postretirement Health BeneÑts September 30, 2007 2006 2007 2006 Discount rateÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Rate of future compensation increase ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 6.25% 5.10% to 6.50% 6.00% 5.10% to 6.50% 6.25% Ì 6.00% Ì Table 14.4 presents the components of the net periodic beneÑt cost with respect to pension and postretirement health care beneÑts for the years ended December 31, 2007, 2006 and 2005. Net periodic beneÑt cost is included in salaries and employee beneÑts on our consolidated statements of income. Table 14.4 Ì Net Periodic BeneÑt Cost Detail Pension BeneÑts Year Ended December 31, 2006 2007 2005 (in millions) Postretirement Health BeneÑts Year Ended December 31, 2005 2006 2007 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 $ 34 30 (37) 4 Ì $ 31 $ 31 26 (24) 6 Ì $ 39 $ 27 22 (18) 5 1 $ 37 $ 9 7 Ì 1 (1) $16 $ 9 6 Ì 2 (1) $16 $ 9 6 Ì 3 (1) $17 Table 14.5 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 federal statutory tax rate of 35%. Table 14.5 Ì AOCI, Net of Taxes, Related to DeÑned BeneÑt Plans Beginning balance ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Amounts recognized in AOCI, net of tax: Net reclassiÑcation adjustments, net of tax:(2) Recognized net gain (loss)(1) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Recognized net loss (gain)(3) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Recognized prior service cost (credit) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Ending balance ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Year Ended December 31, 2007 (in millions) $(87) 41 3 (1) $(44) (1) Includes the correction of deferred taxes of $5 million related to previously recorded Medicare Part D subsidies from prior years. Net of tax expense of $18 million for the year ended December 31, 2007. (2) Represent amounts subsequently recognized as adjustments to other comprehensive income as those amounts are recognized as components of net periodic beneÑt cost. (3) Net of tax beneÑt of $2 million for the year ended December 31, 2007. Table 14.6 includes the assumptions used in the measurement of our net periodic beneÑt cost. Table 14.6 Ì Weighted Average Assumptions Used to Determine Net Periodic BeneÑt Cost Pension BeneÑts Year Ended December 31, 2007 2006 2005 Postretirement Health BeneÑts Year Ended December 31, 2005 2006 2007 Discount rate ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Rate of future compensation increase ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 5.10% to 6.50% Expected long-term rate of return on plan assets ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 7.50% 6.00% 5.75% 5.10% to 6.50% 7.25% 5.75% 6.00% 5.75% 5.75% 4.50% Ì 7.00% Ì Ì Ì Ì Ì For the 2007 and 2006 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. 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. 159 Freddie Mac The assumed health care cost trend rates used in measuring the accumulated postretirement beneÑt obligation as of September 30, 2007 are 9% in 2008, gradually declining to an ultimate rate of 5% in 2012 and remaining at that level thereafter. Table 14.7 sets forth the eÅect on the accumulated postretirement beneÑt obligation for health care beneÑts as of September 30, 2007, and the eÅect on the service cost and interest cost components of the net periodic postretirement health beneÑt cost that would result from a 1% increase or decrease in the assumed health care cost trend rate. Table 14.7 Ì Selected Data Regarding our Retiree Medical Plan 1% Increase 1% Decrease (in millions) EÅect on the accumulated postretirement beneÑt obligation for health care beneÑts ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ EÅect on the service and interest cost components of the net periodic postretirement health beneÑt cost ÏÏÏÏÏÏÏÏÏ $28 4 $(22) (3) Plan Assets Table 14.8 sets forth our Pension Plan asset allocations, based on fair value, at September 30, 2007 and 2006, and target allocation by asset category. Table 14.8 Ì Pension Plan Assets by Category Asset Category Equity securitiesÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Debt securities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Other(1) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Target Allocation 65.0% 35.0 Ì 100.0% Plan Assets at September 30, 2007 2006 66.5% 33.4 0.1 49.6% 25.9 24.5 100.0% 100.0% (1) Consists of cash contributions made on September 29, 2006, 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 beneÑt commitments, demographics and actuarial 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 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, 2007 and 2006. 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 2007, we made no contributions to our Pension Plan. During 2006, we made two contributions totaling $143 million to our Pension Plan. We have not yet determined whether a contribution to our Pension Plan is required for the 2008 plan year. In addition to the Pension Plan contributions noted above, we paid $1 million during 2007 and $3 million during 2006 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 14.9 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, 2007. Table 14.9 Ì Estimated Future BeneÑt Payments Pension BeneÑts Postretirement Health BeneÑts (in millions) 2008 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2009 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2010 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2011 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2012 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Years 2013-2017ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 9 12 12 14 16 140 $ 2 2 3 3 4 27 160 Freddie Mac 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% to 25% of their eligible compensation to the Savings Plan, subject to limits set by the Internal Revenue Code. We match employees' contributions up to 6% of their eligible compensation per year, with such matching contributions being made each 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. EÅective January 1, 2007, employees become vested in our discretionary contributions ratably over such employee's Ñrst Ñve years of service, after which time employees are fully vested in their discretionary contribution accounts. 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 $36 million, $34 million and $31 million for the years ended December 31, 2007, 2006 and 2005, 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 allowed 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 in 2007, as well as substantially all or a portion of their annual salary and cash bonus, for any number of years speciÑed by the employee. However, under no circumstances may the period elected exceed his or her life expectancy. As of January 1, 2008, only oÇcers are permitted to participate in the Executive Deferred Compensation Plan. 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 15: SEGMENT REPORTING EÅective December 1, 2007, management determined that our operations consist of three reportable segments. As discussed below, we use Adjusted operating income to measure and assess the Ñnancial performance of our segments. Adjusted operating income is calculated for the segments by adjusting net income for certain investment-related activities and credit guarantee-related activities. Prior to December 1, 2007, we reported as a single segment using GAAP-basis income. We have revised the Ñnancial information and disclosures for prior periods to reÖect the segment disclosures as if they had been in eÅect throughout all periods reported. Segments Our business operations include three reportable segments, which are based on the type of business activities each performs Ì Investments, Single-family Guarantee and Multifamily. Certain activities that are not part of a segment are included in the All Other category, which primarily includes certain unallocated corporate items, such as costs associated with remediating our internal controls and near-term restructuring costs, costs related to the resolution of certain legal matters and certain income tax items. We evaluate our performance and allocate resources based on Adjusted operating income, which we describe and present in this note. We do not consider our assets by segment when making these evaluations or allocations. Investments In this segment, we invest principally in mortgage-related securities and single-family mortgage loans through our mortgage-related investment portfolio. Adjusted operating income consists primarily of the returns on these investments, less the related Ñnancing costs and administrative expenses. Within this segment, our activities may include the purchase of mortgage loans and mortgage-related securities with less attractive investment returns and with incremental risk in order to achieve our aÅordable housing goals and subgoals. We maintain a cash and a non-mortgage-related securities investment portfolio in this segment to help manage our liquidity. We Ñnance these activities primarily through issuances of short- and long-term debt in the public markets. Results also include derivative transactions we enter into to help manage interest-rate and other market risks associated with our debt Ñnancing and mortgage-related investment portfolio. Single-family Guarantee In this segment, we guarantee the payment of principal and interest on single-family mortgage-related securities, including those held in our retained portfolio, in exchange for guarantee fees received over time and other up-front 161 Freddie Mac compensation. Earnings for this segment consist of guarantee fee revenues less the related credit costs (i.e., provision for credit losses) and operating expenses. Also included is the interest earned on assets held in the Investments segment related to single-family guarantee activities, net of allocated funding costs and amounts related to net Öoat beneÑts. Float arises from timing diÅerences between when the borrower makes principal payments on the loan and the reduction of the PC balance. Multifamily In this segment, we purchase multifamily mortgages for our retained portfolio and guarantee the payment of principal and interest on multifamily mortgage-related securities and mortgages underlying multifamily housing revenue bonds. These activities support our mission to supply Ñnancing for aÅordable rental housing. This segment also includes certain equity investments in various limited partnerships that sponsor low- and moderate-income multifamily rental apartments, which beneÑt from low-income housing tax credits. Also included is the interest earned on assets held in the Investments segment related to multifamily guarantee activities, net of allocated funding costs. All Other All Other includes corporate-level expenses not allocated to any of our reportable segments such as costs associated with remediating our internal controls and near-term restructuring costs, and costs related to the resolution of certain legal matters and certain income tax items. Segment Allocations Results of each reportable segment include directly attributable revenues and expenses. Administrative expenses that are not directly attributable to a segment are allocated ratably using alternative quantiÑable measures such as headcount distribution or segment usage if considered semi-direct or on a pre-determined basis if considered indirect. Expenses not allocated to segments consist primarily of costs associated with remediating our internal controls and near-term restructuring costs and are included in the All Other category. Net interest income for each segment includes an allocation related to investments and debt based on each segment's assets and oÅ-balance sheet obligations. The LIHTC tax beneÑt is allocated to the Multifamily segment. All remaining taxes are calculated based on a 35% federal statutory rate as applied to Adjusted operating income. Adjusted Operating Income In managing our business, we present the operating performance of our segments using Adjusted operating income. Adjusted operating income diÅers signiÑcantly from, and should not be used as a substitute for net income (loss) before cumulative eÅect of change in accounting principle or net income (loss) as determined in accordance with GAAP. There are important limitations to using Adjusted operating income as a measure of our Ñnancial performance. Among other things, our regulatory capital requirements are based on our GAAP results. Adjusted operating income adjusts for the eÅects of certain gains and losses and mark-to-market items which, depending on market circumstances, can signiÑcantly aÅect, positively or negatively, our GAAP results and which, in recent periods, have caused us to record GAAP net losses. GAAP net losses will adversely impact our regulatory capital, regardless of results reÖected in Adjusted operating income. Also, our deÑnition of Adjusted operating income may diÅer from similar measures used by other companies. However, we believe that the presentation of Adjusted operating income highlights the results from ongoing operations and the underlying results of the segments in a manner that is useful to the way we manage and evaluate the performance of our business. The objective of Adjusted operating income is to present our results on an accrual basis as the cash Öows from our segments are earned over time. We are primarily a buy and hold investor in mortgage assets, and given our business objectives, we believe it is meaningful to measure performance of our investment business using long-term returns, not on a short-term fair value basis. The business model for our investment activity is one where we generally hold our investments for the long term, fund the investments with debt and derivatives to minimize interest rate risk, and generate net interest income in line with our return on equity objectives. The business model for our credit guarantee activity is one where we are a long-term guarantor of the conforming mortgage markets, manage credit risk, and generate guarantee and credit fees, net of incurred credit losses. As a result of these business models, we believe that an accrual-based metric is a meaningful way to present the emergence of our results as actual cash Öows are realized, net of credit losses and impairments. In summary, adjusted operating results provide a view of our Ñnancial results that is more consistent with our business objectives, which helps us better evaluate the performance of our business, both from period to period and over the longer term. As described below, Adjusted operating income is calculated for the segments by adjusting net income (loss) before cumulative eÅect of change in accounting principle for certain investment-related activities and credit guarantee-related activities. Adjusted operating income includes certain reclassiÑcations among income and expense categories that have no impact on net income (loss) but provide us with a meaningful metric to assess the performance of each segment and the company as a whole. 162 Freddie Mac Investment Activity-Related Adjustments The most signiÑcant risk inherent in our investing activities is interest-rate risk, including duration, convexity and volatility. We actively manage these risks through asset selection and structuring, Ñnancing asset purchases with a broad range of both callable and non-callable debt and the use of interest-rate derivatives, designed to economically hedge a signiÑcant portion of our interest-rate exposure. Our interest-rate derivatives include interest-rate swaps, exchange-traded futures, and both purchased and written options (including swaptions). GAAP-basis earnings related to investment activities of our Investments segment, and to a lesser extent, our Multifamily segment, are subject to signiÑcant period-to-period variability, which we believe is not necessarily indicative of the risk management techniques that we employ and the performance of these segments. Our derivative instruments are adjusted to fair value under GAAP with resulting gains or losses recorded in GAAP- basis income. Certain other assets are also adjusted to fair value under GAAP with resulting gains or losses recorded in GAAP-basis income. These assets consist primarily of mortgage-related securities classiÑed as trading and mortgage-related securities classiÑed as available-for-sale when a decline in fair value of available-for-sale securities is deemed to be other than temporary. To help us assess the performance of our investment-related activities, we make the following adjustments to earnings as determined under GAAP. We believe this measure of performance, which we call Adjusted operating income, enhances the understanding of operating performance for speciÑc periods, as well as trends in results over multiple periods, as this measure is consistent with assessing our performance against our investment objectives and the related risk-management activities. ‚ Derivative and foreign currency translation-related adjustments: ‚ Fair value adjustments on derivative positions, recorded pursuant to GAAP, are not recognized in Adjusted operating income as these positions economically hedge our investment activities. ‚ Payments or receipts to terminate derivative positions are amortized prospectively into Adjusted operating income on a straight-line basis over the associated term of the derivative instrument. ‚ Payments of up-front premiums (e.g., payments made to third parties related to purchased swaptions) are amortized prospectively on a straight-line basis into Adjusted operating income over the contractual life of the instrument. The up-front payments, primarily for option premiums, are amortized to reÖect the periodic cost associated with the protection provided by the option contract. ‚ Foreign-currency translation gains and losses associated with foreign-currency denominated debt along with the foreign currency derivatives gains and losses are excluded from Adjusted operating income because the fair value adjustments on the foreign-currency swaps that we use to manage foreign-currency exposure are also excluded through the fair value adjustment on derivative positions as described above as the foreign currency exposure is economically hedged. ‚ Investment sales, debt retirements and fair value-related adjustments: ‚ Gains and losses on investment sales and debt retirements that are recognized at the time of the transaction pursuant to GAAP are not immediately recognized in Adjusted operating income. Gains and losses on securities sold out of the retained portfolio and cash and investments portfolio are amortized prospectively into Adjusted operating income on a straight-line basis over Ñve years and three years, respectively. Gains and losses on debt retirements are amortized prospectively into Adjusted operating income on a straight-line basis over the original terms of the repurchased debt. ‚ Trading losses or impairments that reÖect expected or realized credit losses are realized immediately pursuant to GAAP and in Adjusted operating income since they are not economically hedged. Fair value adjustments to trading securities related to investments that are economically hedged are not included in Adjusted operating income. Similarly, non-credit related impairment losses on securities are not included in Adjusted operating income. These amounts are deferred and amortized prospectively into Adjusted operating income on a straight- line basis over Ñve years for securities in the retained portfolio and over three years for securities in the cash and investments portfolio. GAAP-basis accretion income that may result from impairment adjustments is also not included in Adjusted operating income. ‚ Fully taxable-equivalent adjustment: ‚ Interest income generated from tax-exempt investments is adjusted in Adjusted operating income to reÖect its equivalent yield on a fully taxable basis. We fund our investment assets with debt and derivatives to minimize interest-rate risk as evidenced by our PMVS and duration gap metrics. As a result, in situations where we record gains and losses on derivatives, securities or debt buybacks, 163 Freddie Mac these gains and losses are oÅset by economic hedges that we do not mark-to-market for GAAP purposes. For example, when we realize a gain on the sale of a security, the debt which is funding the security has an embedded loss that is not recognized under GAAP, but instead over time as we realize the interest expense on the debt. As a result, in Adjusted operating income, we defer and amortize the security gain to interest income to match the interest expense on the debt that funded the asset. Because of our risk management strategies, we believe that amortizing gains or losses on economically hedged positions in the same periods as the oÅsetting gains or losses is a meaningful way to assess performance of our investment activities. We believe it is useful to measure our performance using long-term returns, not on a short-term fair value basis. Fair value Öuctuations in the short-term are not an accurate indication of long-term returns. In calculating Adjusted operating income, we make adjustments to our GAAP-basis results that are designed to provide a more consistent view of our Ñnancial results, which helps us better assess the performance of our business segments, both from period to period and over the longer term. The adjustments we make to present our Adjusted operating income results are consistent with the Ñnancial objectives of our investment activities and related hedging transactions and provide us with a view of expected investment returns and eÅectiveness of our risk management strategies that we believe is useful in managing and evaluating our investment-related activities. Although we seek to mitigate the interest-rate risk inherent in our investment-related activities, our hedging and portfolio management activities do not eliminate risk. We believe that a relevant measure of performance should closely reÖect the economic impact of our risk management activities. Thus, we amortize the impact of terminated derivatives, as well as gains and losses on asset sales and debt retirements, into Adjusted operating income. Although our interest-rate risk and asset/liability management processes ordinarily involve active management of derivatives as well as asset sales and debt retirements, we believe that Adjusted operating income, although it diÅers signiÑcantly from, and should not be used as a substitute for GAAP-basis results, is indicative of the longer-term time horizon inherent in our investment-related activities. Credit Guarantee Activity-Related Adjustments Credit guarantee activities consist largely of our guarantee of the payment of principal and interest on mortgages and mortgage-related securities in exchange for guarantee and other fees. Over the longer-term, earnings consist almost entirely of the guarantee fee revenues we receive less related credit costs (i.e., provision for credit losses) and operating expenses. Our measure of Adjusted operating income for these activities consists primarily of these elements of revenue and expense. We believe this measure is a relevant indicator of operating performance for speciÑc periods, as well as trends in results over multiple periods because it more closely aligns with how we manage and evaluate the performance of the credit guarantee business. We purchase mortgages from sellers/servicers in order to securitize and issue PCs and Structured Securities. See ""NOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES'' for a discussion of the accounting treatment of these transactions. In addition to the components of earnings noted above, GAAP-basis earnings for these activities include gains or losses upon the execution of such transactions, subsequent fair value adjustments to the guarantee asset and amortization of the guarantee obligation. Our credit-guarantee activities also include the purchase of signiÑcantly past due mortgage loans from loan pools that underlie our guarantees. Pursuant to GAAP, at the time of our purchase, the loans are recorded at fair value. To the extent the adjustment of a purchased loan to market value exceeds our own estimate of the losses we will ultimately realize on the loan, as reÖected in our loan loss reserve, an additional loss is recorded in our GAAP-basis results. When we determine Adjusted operating income for our credit guarantee-related activities, the adjustments we apply to earnings computed on a GAAP-basis include the following: ‚ Amortization and valuation adjustments pertaining to the guarantee asset and guarantee obligation are excluded from Adjusted operating income. Cash compensation exchanged at the time of securitization, excluding buy-up and buy- down fees, is amortized into earnings. ‚ The initial recognition of gains and losses in connection with the execution of either securitization transactions that qualify as sales or guarantor swap transactions, such as losses on certain credit guarantees, is excluded from Adjusted operating income. ‚ Fair value adjustments recorded upon the purchase of delinquent loans from pools that underlie our guarantees are excluded from Adjusted operating income. However, for Adjusted operating income reporting, our GAAP-basis loan loss provision is adjusted to reÖect our own estimate of the losses we will ultimately realize on such items. While both GAAP-basis results and Adjusted operating income reÖect a provision for credit losses determined in accordance with SFAS No. 5, GAAP-basis results also include, as noted above, measures of future cash Öows (the Guarantee asset) that are recorded at fair value and, therefore, are subject to signiÑcant adjustment from period-to-period as 164 Freddie Mac market conditions, such as interest rates, change. Over the longer-term, Adjusted operating income and GAAP-basis income both capture the aggregate cash Öows associated with our guarantee-related activities. Although Adjusted operating income diÅers signiÑcantly from, and should not be used as a substitute for GAAP-basis income, we believe that excluding the impact of changes in the fair value of expected future cash Öows from our Adjusted operating income provides a meaningful measure of performance for a given period as well as trends in performance over multiple periods because it more closely aligns with how we manage and evaluate the performance of the credit guarantee business. Table 15.1 reconciles Adjusted operating income to GAAP net income (loss). Table 15.1 Ì Reconciliation of Adjusted Operating Income to GAAP Net Income (Loss) Adjusted operating income (loss) after taxes: Investments ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Single-family Guarantee ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Multifamily ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ All Other ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total Adjusted operating income, net of taxes ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Reconciliation to GAAP net income (loss): Derivative- and foreign currency translation-related adjustments ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Credit guarantee-related adjustments ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Investment sales, debt retirements and fair value-related adjustmentsÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Fully taxable-equivalent adjustments ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total pre-tax adjustments ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Tax-related adjustmentsÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total reconciling items, net of taxesÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Net income (loss)(1) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2007 Year Ended December 31, 2006 (in millions) 2005 $ 2,028 (256) 398 (103) 2,067 (5,667) (3,268) 987 (388) (8,336) 3,175 (5,161) $(3,094) $ 2,111 1,289 434 19 3,853 (2,371) (201) 231 (388) (2,729) 1,203 (1,526) $ 2,284 965 363 (437) 3,175 (1,644) (458) 570 (336) (1,868) 865 (1,003) $ 2,327 $ 2,172 (1) Net income (loss) reÖects the impact of the adjustments described in ""NOTE 20: CHANGES IN ACCOUNTING PRINCIPLES.'' Additionally, Net income (loss) is presented before the cumulative eÅect of a change in accounting principle related to 2005. 165 Freddie Mac Table 15.2 presents certain Ñnancial information for our reportable segments and All Other. Table 15.2 Ì Adjusted Operating Income Results and Reconciliation to GAAP Results Year Ended December 31, 2007 Net Interest Management and Guarantee Income Income (Expense) Other Non-Interest Income (Loss) Administrative Expenses Provision for Credit Operations REO Losses Expense Other LIHTC LIHTC Partnerships Non-Interest Partnerships Tax BeneÑt Expense Income Tax (Expense) BeneÑt Net Income (Loss) Investments ÏÏÏÏÏÏÏÏÏÏÏÏÏ Single-family Guarantee ÏÏ Multifamily ÏÏÏÏÏÏÏÏÏÏÏÏÏ All Other ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total Adjusted operating income (loss), net of taxes ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Reconciliation to GAAP net income (loss): Derivative- and foreign currency translation- related adjustmentsÏÏÏ Credit guarantee-related adjustments ÏÏÏÏÏÏÏÏÏ Investment sales, debt retirements and fair value-related adjustments ÏÏÏÏÏÏÏÏÏ Fully taxable-equivalent adjustments ÏÏÏÏÏÏÏÏÏ ReclassiÑcations(1) ÏÏÏÏÏ Tax-related adjustments Total reconciling $ 3,626 703 426 (1) $ Ì 2,889 59 Ì 4,754 2,948 $ 40 117 24 11 192 (1,066) Ì (4,601) (106) (342) 266 (388) (361) Ì Ì Ì 29 Ì 915 721 Ì 332 Ì items, net of taxes (1,655) (313) (2,633) (in millions) $ (515) (806) (189) (164) $ Ì $ Ì (3,014) (38) Ì (205) (1) Ì $ Ì Ì (469) Ì $ (31) (78) (21) (4) $ Ì Ì 534 Ì $(1,092) 138 73 55 $ 2,028 (256) 398 (103) (1,674) (3,052) (206) (469) (134) 534 (826) 2,067 Ì Ì Ì Ì Ì Ì Ì Ì 198 Ì Ì Ì Ì 198 Ì Ì Ì Ì Ì Ì Ì Ì Ì Ì Ì Ì Ì Ì Ì (3,933) Ì Ì Ì Ì (3,933) Ì Ì Ì Ì Ì Ì Ì Ì Ì Ì Ì Ì 3,175 (5,667) (3,268) 987 (388) Ì 3,175 3,175 (5,161) Total per consolidated statement of income(2) ÏÏ $ 3,099 $2,635 $(2,441) $(1,674) $(2,854) $(206) $(469) $(4,067) $534 $ 2,349 $(3,094) Net Interest Management and Guarantee Income Income (Expense) Other Non-Interest Income (Loss) Administrative Expenses Provision for Credit Operations REO Losses Expense Other LIHTC LIHTC Partnerships Non-Interest Partnerships Tax BeneÑt Expense Income Tax (Expense) BeneÑt Net Income (Loss) Year Ended December 31, 2006 Investments ÏÏÏÏÏÏÏÏÏÏÏÏÏ Single-family Guarantee ÏÏ Multifamily ÏÏÏÏÏÏÏÏÏÏÏÏÏ All Other ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total Adjusted operating income (loss), net of taxes ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Reconciliation to GAAP net income (loss): Derivative- and foreign currency translation- related adjustmentsÏÏÏ Credit guarantee-related adjustments ÏÏÏÏÏÏÏÏÏ Investment sales, debt retirements and fair value-related adjustments ÏÏÏÏÏÏÏÏÏ Fully taxable-equivalent adjustments ÏÏÏÏÏÏÏÏÏ ReclassiÑcations(1) ÏÏÏÏÏ Tax-related adjustments Total reconciling $ 3,736 556 479 (3) $ Ì 2,541 61 Ì 4,768 2,602 $ 38 159 28 15 240 (1,215) Ì (1,156) (12) (172) 600 315 (388) (56) Ì Ì Ì (37) Ì (84) Ì 93 Ì items, net of taxes (1,356) (209) (547) $ (495) (815) (182) (149) (in millions) $ Ì (61) 1 Ì $ Ì (313) (4) Ì $ Ì Ì (407) Ì $ (31) (84) (17) (42) $ Ì Ì 461 Ì $(1,137) (694) 14 198 $ 2,111 1,289 434 19 (1,641) (317) (60) (407) (174) 461 (1,619) 3,853 Ì Ì Ì Ì Ì Ì Ì Ì 21 Ì Ì Ì Ì 21 Ì Ì Ì Ì Ì Ì Ì Ì Ì Ì Ì Ì Ì Ì Ì (638) Ì Ì Ì Ì (638) Ì Ì Ì Ì Ì Ì Ì Ì Ì Ì Ì Ì 1,203 (2,371) (201) 231 (388) Ì 1,203 1,203 (1,526) Total per consolidated statement of income(2) ÏÏ $ 3,412 $2,393 $ (307) $(1,641) $(296) $ (60) $(407) $(812) $461 $ (416) $ 2,327 166 Freddie Mac Year Ended December 31, 2005 Net Interest Management and Guarantee Income Income (Expense) Other Non-Interest Income (Loss) Administrative Expenses Provision for Credit Operations REO Losses Expense Other LIHTC LIHTC Partnerships Non-Interest Partnerships Tax BeneÑt Expense Income Tax (Expense) BeneÑt Net Income (Loss) $ 4,117 349 417 (3) $ Ì 2,341 59 Ì $ (74) 78 19 (7) $ (466) (767) (151) (151) (in millions) $ Ì (40) Ì Ì $ Ì (447) (7) Ì $ Ì Ì (320) Ì $ (63) (30) (20) (436) $ Ì Ì 365 Ì $(1,230) (519) 1 160 $ 2,284 965 363 (437) 4,880 2,400 16 (1,535) (454) (40) (320) (549) 365 (1,588) 3,175 (694) (131) 562 (336) 346 Ì Ì (315) Ì Ì (9) Ì (950) 190 8 Ì (337) Ì (253) (324) (1,089) Ì Ì Ì Ì Ì Ì Ì Ì 147 Ì Ì Ì Ì 147 Ì Ì Ì Ì Ì Ì Ì Ì Ì Ì Ì Ì Ì Ì Ì (349) Ì Ì Ì Ì (349) Ì Ì Ì Ì Ì Ì Ì Ì Ì Ì Ì Ì 865 865 (1,644) (458) 570 (336) Ì 865 (1,003) $ 4,627 $2,076 $(1,073) $(1,535) $(307) $(40) $(320) $(898) $365 $ (723) $ 2,172 Investments ÏÏÏÏÏÏÏÏÏÏÏÏÏ Single-family Guarantee ÏÏ Multifamily ÏÏÏÏÏÏÏÏÏÏÏÏÏ All Other ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total Adjusted operating income (loss), net of taxes ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Reconciliation to GAAP net income (loss): Derivative- and foreign currency translation- related adjustmentsÏÏÏ Credit guarantee-related adjustments ÏÏÏÏÏÏÏÏÏ Investment sales, debt retirements and fair value-related adjustments ÏÏÏÏÏÏÏÏÏ Fully taxable-equivalent adjustments ÏÏÏÏÏÏÏÏÏ ReclassiÑcations(1) ÏÏÏÏÏ Tax-related adjustments Total reconciling items, net of taxes Total per consolidated statement of income(2) ÏÏ (1) Includes the reclassiÑcation of: a) the accrual of periodic cash settlements of all derivatives not in qualifying hedge accounting relationships from Other non-interest income (loss) to Net interest income (expense) within the Investments segment; b) implied guarantee fees on whole loans from Investments segment's Net interest income (expense) to Single-family Guarantee segment's Other non-interest income (loss); and c) net buy-up and buy-down fees from Single-family Guarantee segment's Management and guarantee income to Investments segment's Net interest income (expense). (2) Total per consolidated statement of income reÖects the impact of the adjustments described in ""NOTE 20: CHANGES IN ACCOUNTING PRINCIPLES.'' Additionally, Net income (loss) is presented before the cumulative eÅect of a change in accounting principle related to 2005. We conduct our operations solely in the United States and its territories. Therefore, we do not generate any revenue from geographic locations outside of the United States and its territories. 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, 2007 and 2006. 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 ""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,'' (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. 167 Freddie Mac Table 16.1 Ì Consolidated Fair Value Balance Sheets(1) December 31, 2007 2006 (adjusted) Carrying Amount(2) Fair Value Carrying Amount(2) Fair Value (in billions) Assets Mortgage loans ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Mortgage-related securities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Retained portfolioÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Cash and cash equivalents ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ InvestmentsÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Securities purchased under agreements to resell and federal funds sold ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Derivative assets, net ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Guarantee asset(3) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Other assets(4)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total assets ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Liabilities and minority interests Total debt securities, net ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Guarantee obligation ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Derivative liabilities, net ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Reserve for guarantee losses on PCs ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Other liabilitiesÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 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 assetsÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total liabilities, minority interests and net assets ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 80.0 629.8 709.8 8.6 35.1 6.6 0.8 9.6 23.9 $794.4 $738.6 13.7 0.6 2.6 12.0 0.2 767.7 14.1 12.6 26.7 $794.4 $ 76.8 629.8 706.6 8.6 35.1 6.6 0.8 10.4 31.8 $799.9 $749.3 26.2 0.6 Ì 11.0 0.2 787.3 12.3 0.3 12.6 $799.9 $ 65.6 634.3 699.9 11.4 45.6 23.0 0.7 7.4 16.9 $804.9 $744.3 9.5 0.2 0.6 22.9 0.5 778.0 6.1 20.8 26.9 $804.9 $ 65.4 634.3 699.7 11.4 45.6 23.0 0.7 8.3 14.4 $803.1 $742.7 6.1 0.2 Ì 21.8 0.5 771.3 5.8 26.0 31.8 $803.1 (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) Equals 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 PCs that were issued prior to the implementation of FIN 45 in 2003 and thus are not recognized on our GAAP consolidated balance sheets. (4) Fair values include estimated income taxes calculated using the 35% federal 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, ""Disclosures about Fair Value of Financial Instruments,'' or 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 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. During the second half of 2007, the market for non-agency securities has become signiÑcantly less liquid, which has resulted in lower transaction volumes, wider credit spreads and less transparency with pricing for these assets. In addition, we have observed more variability in the quotations received from dealers and third-party pricing services. However we believe that these quotations provide reasonable estimates of fair value. If quoted 168 Freddie Mac 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. The following methods and assumptions were used to estimate the fair value of assets and liabilities at December 31, 2007 and 2006. Mortgage Loans Mortgage loans represent single-family and multifamily mortgage 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 mortgage 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.'' 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 mortgage 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 mortgage 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 mortgage loans is also net of the related credit and other components inherent in our guarantee obligation. For single-family mortgage loans, the process for estimating the related credit and other guarantee obligation components is described in the ""Guarantee Obligation'' section. For multifamily mortgage loans, through the second quarter of 2007, 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 the third quarter of 2007, the process was modiÑed to include all related credit and other guarantee obligation components within the value of multifamily whole loans. Mortgage-Related Securities 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 OAS approach based on observable market parameters is used to estimate fair value. OAS for certain securities are estimated by deriving the OAS 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 OAS 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. 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, 2007 and 2006, 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 same methods described above in ""Mortgage-Related Securities.'' 169 Freddie Mac 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, Net Derivative assets largely consist of interest-rate swaps, option-based derivatives, futures and forward purchase and sale commitments that we account for as derivatives. The carrying value of our derivatives on our consolidated balance sheets is equal to their fair value, including net derivative interest receivable or payable and is net of cash collateral held or posted, where allowable by a master netting agreement. Derivatives in net unrealized gain position are reported as derivative assets, net. Similarly, derivatives in a net unrealized loss position are reported as derivative liabilities, net. As of October 1, 2007, we elected to reclassify net derivative interest receivable or payable and cash collateral held or posted on our consolidated balance sheets to derivative asset, net and derivative liability, net, as applicable. Prior to this reclassiÑcation these amounts were recorded in accounts and other receivables, net, accrued interest payable, other assets and senior debt, due within one year, as applicable. Certain amounts in prior periods' consolidated balance sheets have been reclassiÑed to conform to the current presentation. 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, 2007 and 2006, approximately 91% and 88%, respectively, of PCs and Structured Securities issued had a corresponding guarantee asset recognized on our consolidated balance sheets. For more information regarding the accounting for the guarantee asset related to PCs and Structured Securities, see ""NOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES.'' For fair value balance sheet purposes, the guarantee asset is reÖected for all PCs and Structured Securities 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: FINANCIAL GUARANTEES AND TRANSFERS OF SECURITIZED INTERESTS IN MORTGAGE-RELATED ASSETS.'' Other Assets Other assets consists of 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. 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 170 Freddie Mac 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. 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 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. 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 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 our guarantees of mortgage assets, see ""NOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES,'' and ""NOTE 2: FINANCIAL GUARANTEES AND TRANSFERS OF SECURITIZED INTERESTS IN MORTGAGE-RELATED ASSETS.'' Derivative Liabilities, Net See discussion under ""Derivative Assets, Net'' 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 the contingent losses contained in the loans that back our PCs. This line item has no basis on our consolidated fair value balance sheets, because the estimated fair value of all expected default losses (both contingent and non-contingent) 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 171 Freddie Mac 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. In addition, eÅective December 2007, we established securitization trusts for the assets underlying our PCs and Structured Securities. Consequently, we hold remittances in a segregated account and administer payments due to the PC investors. Other liabilities at December 31, 2007 does not reÖect amounts due to PC investors since this is a liability of the oÅ-balance sheet trusts. 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. 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. 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: ‚ $1.3 billion and $1.5 billion of mortgage-related securities issued by Ginnie Mae that back Structured Securities at December 31, 2007 and 2006, respectively, because these securities do not expose us to meaningful amounts of credit risk; ‚ $47.8 billion and $45.4 billion of other agency mortgage-related securities at December 31, 2007 and 2006, respectively, because these securities do not expose us to meaningful amounts of credit risk; and ‚ $233.8 billion and $238.5 billion of non-agency mortgage-related securities held in the retained portfolio at December 31, 2007 and 2006, 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 4: RETAINED PORTFOLIO AND CASH AND INVESTMENTS PORTFOLIO'' and ""NOTE 5: MORTGAGE LOANS AND LOAN LOSS RESERVES'' for more information about the securities and loans, respectively, we hold on our consolidated balance sheets. 172 Freddie Mac Table 17.1 Ì Concentration of Credit Risk December 31, 2007 2006 Amount(1)(2) Percentage Amount(1)(2) Percentage (dollars in millions) By Region(3) West ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 455,051 443,813 Northeast ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 353,522 North Central ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 335,386 Southeast ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 231,951 Southwest ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $1,819,723 By State California ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 243,225 124,092 Florida ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 91,835 IllinoisÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 91,130 Texas ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 90,686 New York ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 1,178,755 All others ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $1,819,723 25% 24 19 19 13 100% 13% 7 5 5 5 65 100% $ 366,492 375,844 324,255 279,984 194,785 $1,541,360 $ 195,964 101,901 80,130 74,764 77,614 1,010,987 $1,541,360 24% 24 21 18 13 100% 13% 7 5 5 5 65 100% (1) Calculated as total mortgage portfolio less Structured Securities backed by Ginnie Mae CertiÑcates and non-Freddie Mac mortgage-related securities held in the retained portfolio. (2) EÅective December 2007, we established securitization trusts for the underlying assets of our guaranteed PCs and Structured Securities issued. As a result, we adjusted the reported balance of our mortgage portfolios to reÖect the publicly-available security balances of guaranteed PCs and Structured Securities. Previously we reported these balances based on the unpaid principal balance of the underlying mortgage loans. The trust holds remittances from loans underlying our securities in a segregated account. Consequently, we no longer commingle those funds with our general operating funds. (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). Higher-Risk Mortgage Loans There have been an increasing amount of residential loan products originated in the mortgage industry that are designed to oÅer borrowers greater choices 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. The minimum payment alternative for option ARM loans allows 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. At December 31, 2007 and 2006, interest-only and option ARM loans collectively represented approximately 10% and 7%, respectively, of loans underlying our issued guaranteed PCs and Structured Securities. In addition to these products, there has been an increase of residential mortgage loans originated in the market with lower or alternative documentation requirements than full documentation mortgage loans. These reduced documentation mortgages have been categorized in the mortgage industry as Alt-A loans. We have classiÑed mortgage loans as Alt-A if the lender that delivers them to us has classiÑed the loans as Alt-A, or if the loans had reduced documentation requirements that indicate that the loans should be classiÑed as Alt-A. As of December 31, 2007, approximately 9% of our single-family PCs and Structured Securities were backed by Alt-A mortgage loans. A combination of certain loan characteristics with any mortgage loan product often can indicate a higher degree of credit risk. For example, mortgages with both high loan-to-value, or LTV ratios and borrowers who have lower credit scores typically experience higher rates of delinquency, default and credit losses. As of December 31, 2007, approximately 1% of single-family mortgage loans we have guaranteed were made to borrowers with credit scores below 620 and had original LTV ratios above 90% at the time of mortgage origination. In addition, as of December 31, 2007, 4% of the Alt-A and interest-only single-family loans we have guaranteed have been made to borrowers with credit scores below 620 at mortgage origination. As home prices increased during 2006 and prior years, many borrowers used second liens at the time of purchase to potentially reduce their LTV ratio to below 80%. Including this secondary Ñnancing, we estimate that the percentage of loans we have guaranteed with total LTV ratios above 90% was 14% as of December 31, 2007. 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. Our largest mortgage lender in 2007 reduced its minimum mortgage volume commitment to us upon renewal of its contract at July 1, 2007. In addition, ABN Amro Mortgage Group, Inc., which accounted for more than 8% of our mortgage purchase volume for the six months ended June 30, 2007, was 173 Freddie Mac acquired and its contract was not renewed when it expired in the third quarter 2007. During 2007, three mortgage lenders each accounted for 12% or more of our mortgage purchase volume. These lenders collectively accounted for approximately 45% of this volume. In addition, in 2007, our top ten single-family lenders represented approximately 79% of our single- family mortgage purchase volume. In 2007, our top three multifamily lenders collectively represented approximately 44% of our multifamily purchase volume and top ten multifamily lenders represented approximately 80% of our multifamily 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. Excluding insurers of our non-agency mortgage-related securities portfolio at December 31, 2007, our top four mortgage insurers, each accounted for more than 10% of our overall mortgage insurance coverage, collectively represented approximately 75% of our overall mortgage insurance coverage. Bond insurers For certain non-agency securities in both our retained and investment portfolios, we rely on subordination and bond insurance of the trust issuing the security as credit enhancement to provide protection from credit loss. In those instances where we seek further protection, we may obtain additional credit enhancement with secondary bond insurance; however this increases our exposure to the risks related to the bond insurer's ability to satisfy claims. As of December 31, 2007, we had insurance coverage, including secondary policies, on securities totaling $17.9 billion of unpaid principal balance, consisting of $16.1 billion and $1.8 billion, of coverage for bonds in our retained and investment portfolio, respectively. As of December 31, 2007, the top three of our bond insurers, each accounting for more than 20% of our overall bond insurance coverage (including secondary policies), collectively represented approximately 80% of our bond 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 our 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, although U.S. Treasury securities, our PCs and Structured Securities or our debt securities may also be posted. 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 sell the collateral and transfer the proceeds to us. 174 Freddie Mac Our uncollateralized exposure to counterparties for OTC interest-rate swaps, option-based derivatives and foreign- currency swaps, after applying netting agreements and collateral, was $339 million and $672 million at December 31, 2007 and 2006, respectively. In the event that all of our counterparties for these derivatives were to have defaulted simultaneously on December 31, 2007, our maximum loss for accounting purposes would have been approximately $339 million. Our exposure to counterparties for OTC forward purchase and sale commitments treated as derivatives was $465 million and $18 million at December 31, 2007 and 2006, 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% of which is held by us) and a total of $4.0 billion of perpetual, step-down preferred stock issued to outside investors. Beginning in 2007, the dividend rate on the step-down preferred stock was 1.0%. The dividend rate on the step-down preferred stock was 13.3% from initial issuance through December 2006 (the initial term). Dividends on this preferred stock 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 $167 million and $503 million at December 31, 2007 and 2006, respectively. 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 SHARE We have participating securities related to options with dividend equivalent rights that receive dividends as declared on an equal basis with common shares. Consequently, in accordance with Emerging Issues Task Force, or EITF, No. 03-6, ""Participating Securities and the Two-Class Method under FASB Statement No. 128'', we use the ""two-class'' method of computing earnings per share. Participating security option holders are not obligated to participate in undistributed net losses. Basic earnings per common share are computed by dividing net income (loss) available per common share by weighted average common shares outstanding Ì basic for the period. Diluted earnings (loss) per common share are computed as net income (loss) available to common stockholders divided by weighted average common shares outstanding Ì diluted for the period, which consider the eÅect of dilutive common equivalent shares outstanding. For periods with net income the eÅect of dilutive common equivalent shares outstanding includes: (a) the weighted average shares related to stock options (including the Employee Stock Purchase Plan) 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 the weighted average common shares outstanding Ì basic. Table 19.1 Ì Earnings (Loss) Per Common Share Ì Basic and Diluted Year Ended December 31, Adjusted 2007 2006 (dollars in millions, except per share amounts) 2005 Net income (loss) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ (3,094) (404) Preferred stock dividends and issuance costs on redeemed preferred stock ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Amounts allocated to participating security option holders(1) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (5) Net income (loss) available to common shareholders Ì basic(2) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ (3,503) 651,881 Weighted average common shares outstanding Ì basic (in thousands) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Ì Dilutive potential common shares (in thousands) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 651,881 Weighted average common shares outstanding Ì diluted (in thousands) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ $ 2,327 (270) (6) 2,051 680,856 1,808 682,664 $ $ 2,113 (223) Ì 1,890 691,582 1,929 693,511 Antidilutive potential common shares excluded from the computation of dilutive potential common shares (in thousands)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 6,161 Basic earnings (loss) per common share ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ (5.37) (5.37) Diluted earnings (loss) per common share ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 1,892 3.01 3.00 $ $ 2,297 2.73 2.73 $ $ (1) Participating security option holders do not participate in undistributed earnings during periods of net losses. (2) Includes distributed and undistributed earnings to common shareholders. 175 Freddie Mac NOTE 20: CHANGES IN ACCOUNTING PRINCIPLES EÅective December 31, 2007, we retrospectively changed our method of accounting for our guarantee obligation: 1) to a policy of no longer extinguishing our guarantee obligation when we purchase all or a portion of a guaranteed PC and Structured Security, or PC, from a policy of eÅective extinguishment through the recognition of a Participation CertiÑcate residual, or PC residual, and 2) to a policy that amortizes our guarantee obligation into earnings in a manner that corresponds more closely to our economic release from risk under our guarantee than our former policy, which amortized our guarantee obligation according to the contractual expiration of our guarantee as observed by the decline in the unpaid principal balance of securitized mortgage loans. While our previous accounting is acceptable, we believe the newly adopted method of accounting for our guarantee obligation is preferable in that it signiÑcantly enhances the transparency and understandability of our Ñnancial results, promotes uniformity in the accounting model for the credit risk retained in our primary credit guarantee business, better aligns revenue recognition to the release from economic risk of loss under our guarantee, and increases comparability with other similar Ñnancial institutions. Comparative Ñnancial statements of prior periods have been adjusted to apply the new methods, retrospectively. Summarized impacts of the changes in accounting principles are as follows: Table 20.1 Ì Net Income (Expense) Impact of Changes in Accounting Principles 2007 2006 (in millions) 2005 Changes in accounting principles: Guarantee obligation no longer extinguished when a PC is purchased ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 2,289 922 Guarantee obligation amortization methodology ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 3,211 Total pre-tax impact of changes in accounting principles ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Tax impact of changes in accounting principles ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (1,124) Total net income impact of changes in accounting principles ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 2,087 $(461) 640 179 (63) $ 116 $(545) 519 (26) 9 $ (17) Changes in Accounting Principles Guarantee Obligation No Longer Extinguished When PC is Purchased The change to no longer extinguish our guarantee obligation when we purchase all or a portion of a PC reÖects changes made to our PC issuance process, including introducing the use of securitization trusts that are qualifying special purpose entities, or QSPE, upon PC issuance. When we subsequently purchase a PC, our guarantee obligation remains outstanding to the QSPE, an unconsolidated entity, and consequently our guarantee obligations remain outstanding. The guarantee asset also continues to remain outstanding. Application of a model that does not extinguish our guarantee asset and guarantee liability is consistent with predominant industry practice for similar transactions. Under this new model, PCs held by us are accounted for as guaranteed securities; accordingly, credit losses are recognized on an incurred basis in the provision for credit losses rather than through the recognition of a PC residual at fair value with changes in earnings or through security impairments. We applied the change to no longer extinguish our guarantee obligation retrospectively in accordance with SFAS 154, ""Accounting Changes and Error Corrections, a replacement of APB Opinion No. 20 and FASB Statement No. 3,'' or SFAS 154. This presentation signiÑcantly enhances the transparency and understandability of our Ñnancial statements in that our guarantee obligation is presented as a separate liability relative to all PCs outstanding (whether held by third parties or us). Consequently, all credit losses, except for initial losses on loans purchased as impaired loans under SOP 03-3, stemming from guarantee-related activities are now accounted for in our provision for credit losses using a single measurement attribute (i.e., an incurred loss model). Gains and losses related to our previous extinguishment model have been eliminated. As such, the results of our guarantee business are less diÇcult to compare to other Ñnancial guarantors. Our previous accounting method resulted in a mixed model with a portion of our guarantee obligation recorded at fair value through earnings when we held PCs, and a portion of the guarantee obligation carried at historical cost subject to credit losses recognized for probable incurred losses when the PCs were held by third parties. Under the previous model, we reÖected PCs held by us as unguaranteed securities. Accordingly, these securities were subject to security impairments and the guarantee fees received reÖected additional interest income. Guarantee Obligation Amortization Method The change in the method of amortizing our guarantee obligation into earnings uses a static eÅective yield calculated and Ñxed at inception of the guarantee based on forecasted unpaid principal balances. The static eÅective yield will be evaluated and adjusted when signiÑcant changes in economic events cause a shift in the pattern of our economic release from risk. For example, certain market environments may lead to sharp and sustained changes in home prices or prepayments of mortgages, leading to the need for an adjustment in the static eÅective yield for speciÑc mortgage pools underlying the guarantee. When a change is required, a cumulative catch-up adjustment, which could be signiÑcant in a 176 Freddie Mac given period, will be recognized and a new static eÅective yield will be used to determine our guarantee obligation amortization. The new method amortizes our guarantee obligation into earnings commensurate with our economic release from risk under changing economic conditions and is more consistent with our competitors than the prior amortization method. The new method has been retrospectively applied to all prior periods. The previous method amortized our guarantee obligation according to the contractual expiration of the guarantee as observed by the decline in the unpaid principal balance of securitized mortgage loans. The previous method amortized our guarantee obligation in a manner that was reÖective of the pattern of economic release from risk in periods of normal or high prepayments and normal or high house price appreciation. However, the new amortization method more closely aligns our guarantee obligation amortization with our economic release from risk, particularly in periods of slowing prepayments and slowing house price appreciation (or house price depreciation in some areas) such as experienced during the fourth quarter of 2007. Financial Statement Impacts of the Accounting Changes Retrospective adoption of the accounting changes impacted several Ñnancial statement line items. Because our guarantee asset and guarantee obligation remain outstanding whether held by us or third parties, line item impacts include: 1) reduced gains (losses) on investment activity resulting from the removal of PC residual fair value changes, 2) increased gains (losses) on guarantee asset relating to PCs held by us that were previously recognized as part of PC residual, 3) increased income on guarantee obligation reÖecting both a change in our guarantee obligation balance resulting from no longer extinguishing our guarantee obligation and a change in our amortization policy for the guarantee obligation to one that recognizes revenue in a manner that corresponds more closely to our economic release from risk under the guarantee, 4) increased management and guarantee income and reduced interest income resulting from the reclassiÑcation of guarantee and delivery fees on PCs held by us previously recognized as interest income when our guarantee was considered extinguished, 5) increased provision for credit losses relating to additional PCs subject to our loan loss reserve model, 6) increased losses on loans purchased relating to PCs held by us that were previously recognized as part of PC residual, 7) reduced gains (losses) on investment activity resulting from the removal of adjustments to the carrying value of our securities that were previously recognized upon purchase related to the extinguishment of deferred income items and 8) reduced gains (losses) on investment activity resulting from elimination of impairments on PCs held by us that are now subject to a guarantee. With respect to 3) above, it is important to note that the accounting change from the previous model results in an increase in our guarantee obligation balance for PCs held by us and a decrease in our guarantee obligation balance because our guarantee obligation is not re-measured at fair value when PCs previously purchased by us are subsequently sold. As such, the change in the income on guarantee obligation line item is not distinguished between no longer extinguishing our guarantee obligation and our guarantee obligation amortization change, as doing so is not operationally feasible given activity levels in the various periods presented. This diÇculty highlights the fact that the change will provide Ñnancial statement users with improved transparency of operating results under the new method, in that it presents results using a single model. Other Changes in Accounting Principles On October 1, 2007, we adopted FSP FIN 39-1 which permits a reporting entity to oÅset fair value amounts recognized for the right to reclaim cash collateral or the obligation to return cash collateral against fair value amounts recognized for derivative instruments executed with the same counterparty under a master netting agreement. We elected to reclassify net derivative interest receivable or payable and cash collateral held or posted, on our consolidated balance sheets, to derivative asset, net and derivative liability, net, as applicable. Prior to reclassiÑcation, these amounts were recorded on our consolidated balance sheets in accounts and other receivables, net, accrued interest payable, other assets and senior debt, due within one year, as applicable. The change resulted in a decrease to total assets and total liabilities of $8.7 billion at the date of adoption, October 1, 2007, and $7.2 billion at December 31, 2007. The adoption of FSP FIN 39-1 had no eÅect on our consolidated statements of income. On January 1, 2007, we adopted FIN 48, and as a result of adoption, we recorded a $181 million increase to retained earnings at January 1, 2007. See ""NOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES'' for more information. At December 31, 2006, we adopted 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. As a result of the adoption, we recorded the funded status of each of our deÑned beneÑt plans as an asset or liability on our consolidated balance sheet with a corresponding oÅset, net of taxes, recorded in AOCI within stockholders' equity, resulting in an after- tax decrease in equity of $84 million at December 31, 2006. 177 Freddie Mac 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. Beginning October 1, 2005, we changed our method for determining gains and losses upon the resale of PCs 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. 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 retrospectively. 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. Tax Adjustments As a result of the changes in accounting principles, our cumulative income tax expense increased by $0.7 billion resulting in a deferred tax asset decrease of $0.7 billion at December 31, 2007. In addition, due to the changes in accounting principles, our deferred tax asset related to our AOCI increased by $0.1 billion. Table 20.2 summarizes the eÅect of the changes in accounting principles related to our guarantee obligation on the consolidated statements of income line items for 2007, 2006 and 2005. Table 20.2 Ì EÅect of Changes in Accounting Principles to Consolidated Statements of Income As computed without changes in accounting principles 2007 As reported with changes in accounting principles Interest income: Mortgage loans ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Mortgage-related securitiesÏÏÏÏÏÏÏÏÏÏÏÏÏ Management and guarantee income ÏÏÏÏÏÏÏÏÏ Gains (losses) on guarantee asset ÏÏÏÏÏÏÏÏÏÏÏ Income on guarantee obligationÏÏÏÏÏÏÏÏÏÏÏÏÏ Derivative gains (losses)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Gains (losses) on investment activity ÏÏÏÏÏÏÏÏ Recoveries on loans impaired upon purchase ÏÏ Other income(1) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Provision for credit losses ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Losses on certain credit guarantees(1) ÏÏÏÏÏÏÏÏ Losses on loans purchased(1) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Other expensesÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Income tax (expense) beneÑt ÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Net income (loss) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Basic earnings (loss) per common share ÏÏÏÏÏ Diluted earnings (loss) per common share ÏÏÏ $ 4,446 35,707 2,010 (1,212) 985 (1,906) (3,310) 438 246 (2,371) (1,992) (1,419) (223) 4,007 (5,181) (8.58) (8.58) $ 4,449 34,893 2,635 (1,484) 1,905 (1,904) 294 505 246 (2,854) (1,988) (1,865) (222) 2,883 (3,094) (5.37) (5.37) EÅect of Changes $ 3 (814) 625 (272) 920 2 3,604 67 Ì (483) 4 (446) 1 (1,124) 2,087 3.21 3.21 Year Ended December 31, 2006 2005 As Previously Reported EÅect of Changes (in millions, except per share amounts) As Adjusted As Previously Reported As Adjusted EÅect of Changes $ 4,152 34,673 1,672 (800) 867 (1,164) (474) Ì 252 (215) (350) (126) (190) 108 2,211 2.84 2.84 $ 4,152 33,850 2,393 (978) 1,519 (1,173) (473) Ì 236 (296) (406) (148) (200) 45 2,327 3.01 3.00 $ Ì (823) 721 (178) 652 (9) 1 Ì (16) (81) (56) (22) (10) (63) 116 0.17 0.16 $ 4,037 29,684 1,450 (1,064) 920 (1,357) (127) Ì 177 (251) (234) Ì (537) (367) 2,130 2.76 2.75 $ 4,010 28,968 2,076 (1,409) 1,428 (1,321) (97) Ì 126 (307) (272) Ì (530) (358) 2,113 2.73 2.73 $ (27) (716) 626 (345) 508 36 30 Ì (51) (56) (38) Ì 7 9 (17) (0.03) (0.02) (1) Hedge accounting gains previously reported separately are included in other income. Foreign-currency gains (losses), net is excluded from Other income to conform to current period presentation. Similarly, losses on certain credit guarantees and losses on loans purchased are presented separately to conform to current period presentation. 178 Freddie Mac Table 20.3 summarizes the eÅect of the changes in accounting principles related to our guarantee obligation and adoption of FSP FIN 39-1 on the consolidated balance sheet line items as of December 31, 2007 and 2006. Table 20.3 Ì EÅect of Changes in Accounting Principles to Consolidated Balance Sheets Assets: Mortgage loans, netÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total mortgage-related securities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Accounts and other receivables, net ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Derivative assets, netÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Guarantee asset, at fair valueÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Deferred tax asset ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Other assets ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total assetsÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Liabilities: Total debt securities, net ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Accrued interest payable ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Guarantee obligation ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Derivative liabilities, net ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Reserve for guarantee losses on Participation CertiÑcates ÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Other liabilities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total liabilities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Stockholders' Equity: Retained earnings ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ AOCI, net of taxes ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total stockholders' equity ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ As computed without changes in accounting principles 2007 As reported with changes in accounting principles $ 80,167 626,427 6,953 5,760 8,056 10,903 7,270 797,509 745,105 8,132 11,565 975 2,001 3,942 771,720 $ 80,032 629,754 5,003 827 9,591 10,304 6,884 794,368 738,557 7,864 13,712 582 2,566 4,187 767,468 25,627 (10,972) 25,613 26,909 (11,143) 26,724 December 31, 2006 EÅect of Changes As Previously Reported As Adjusted EÅect of Changes (in millions) $ (135) 3,327 (1,950) (4,933) 1,535 (599) (386) (3,141) (6,548) (268) 2,147 (393) 565 245 (4,252) 1,282 (171) 1,111 $ 65,618 634,925 7,461 7,908 6,070 3,600 6,783 813,081 753,938 8,345 7,117 179 350 3,212 784,264 $ 65,605 634,328 5,073 665 7,389 4,346 6,788 804,910 744,341 8,307 9,482 165 550 3,512 777,480 32,177 (7,869) 28,301 31,372 (8,451) 26,914 $ (13) (597) (2,388) (7,243) 1,319 746 5 (8,171) (9,597) (38) 2,365 (14) 200 300 (6,784) (805) (582) (1,387) Table 20.4 summarizes the eÅect of the changes in accounting principles related to our guarantee obligation on the eÅected consolidated statements of stockholders' equity line items for 2007, 2006 and 2005. Table 20.4 Ì EÅect of Changes in Accounting Principles to Consolidated Statements of Stockholders' Equity As computed without changes in accounting principles 2007 As reported with changes in accounting principles Year Ended December 31, 2006 2005 EÅect of Changes As Previously Reported As Adjusted (in millions) EÅect of Changes As Previously Reported As Adjusted EÅect of Changes $ 32,177 (5,181) 25,627 $ 31,372 (3,094) 26,909 $ (805) 2,087 1,282 $31,559 2,211 32,177 $30,638 2,327 31,372 $(921) 116 (805) $30,728 2,130 31,559 $29,824 2,113 30,638 $(904) (17) (921) (7,869) (8,451) (582) (8,773) (9,352) (579) (3,593) (4,180) (587) (4,108) (3,708) 400 (264) (267) (3) (6,824) (6,816) 8 962 (10,972) 973 (11,143) 11 (171) 1,254 (7,869) 1,254 (8,451) Ì (582) 1,637 (8,773) 1,637 (9,352) Ì (579) Retained earnings: Balance, beginning of year ÏÏÏÏÏÏÏÏÏ Net income (loss) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Retained earnings, end of year ÏÏÏÏÏÏ AOCI, net of taxes: Balance, beginning of year ÏÏÏÏÏÏÏÏÏ Changes in unrealized gains (losses) related to available-for- sale securities, net of reclassiÑcation adjustmentsÏÏÏÏÏÏÏ Changes in unrealized gains (losses) related to cash Öow hedge relationships, net of reclassiÑcation adjustmentsÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ AOCI, net of taxes, end of yearÏÏÏÏÏ 179 Freddie Mac Table 20.5 summarizes the eÅect of the changes in accounting principles related to our guarantee obligation and adoption of FSP FIN 39-1 on the consolidated statement of cash Öow line items for 2007, 2006, and 2005. Table 20.5 Ì EÅect of Changes in Accounting Principles to Consolidated Statements of Cash Flows 2007 As computed without changes in accounting principles As reported with changes in accounting EÅect of principles(1) Changes Year Ended December 31, 2006 2005 As Previously Reported As Adjusted(1) (in millions) EÅect of Changes As Previously Reported As Adjusted(1) EÅect of Changes $ (5,181) $ (3,094) $ 2,087 $ 2,211 $ 2,327 $ 116 $ 2,130 $ 2,113 $ (17) 1,253 26 215 126 494 (1,074) 18,722 Ì (1,237) 713 (987) 1,540 6 445 1,262 128 296 148 538 (1,012) 18,711 Ì (763) 718 (1,125) 1,536 Ì (489) 9 102 81 22 44 62 (11) Ì 474 5 (138) (4) (6) (934) 1,014 791 260 Ì 343 (1,452) 23,662 2,598 661 282 (567) 1,413 112 43 977 881 311 Ì 267 (1,462) 23,669 2,594 470 290 (726) 1,779 Ì 339 (37) 90 51 Ì (76) (10) 7 (4) (191) 8 (159) 366 (112) 296 477 22,453 22,275 (178) 31,290 31,502 212 2,275 (91) 2,854 1,865 (305) (3,958) Ì (1,922) (5) 172 483 446 (814) 1,124 Ì (9) (711) (263) (2,454) 38 (217) (270) (2,416) 2,312 (2,203) 4,245 Ì 3,443 2,135 2,280 (263) 2,371 1,419 509 (5,082) Ì (1,913) 1,743 (301) (1,986) 4,515 2,416 1,131 1,658 109,967 219,263 109,973 6 86,745 86,745 94,961 95,029 219,047 (216) 833 (2,484) (3,317) Ì (97) Ì 910 Ì Ì 1,007 68 Ì Ì (6,859) (7,791) Ì 932 330,063 326,536 (3,527) 86,648 87,655 1,007 95,893 88,170 (7,723) 1,018,040 (990,646) 1,016,933 (986,489) (1,107) 4,157 Ì (766,598) Ì (767,427) Ì (829) Ì (862,176) Ì (854,665) Ì 7,511 Cash Öows from operating activities Net Income (loss) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Adjustments to reconcile net income (loss) to net cash provided by operating activities: Derivative losses ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Asset related amortization ÏÏÏÏÏÏÏÏÏ Provision for credit losses ÏÏÏÏÏÏÏÏÏÏ Losses on loans purchased ÏÏÏÏÏÏÏÏÏ Gains (losses) on investment activity Deferred income taxes ÏÏÏÏÏÏÏÏÏÏÏÏ Sales of held-for-sale mortgages ÏÏÏÏ Change in trading securities ÏÏÏÏÏÏÏÏ Change in accounts and other receivables, netÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Change in accrued interest payableÏÏ Change in guarantee asset, at fair value ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Change in guarantee obligation ÏÏÏÏÏ Participation CertiÑcate residuals, at fair valueÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Other, net ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Net cash provided by (used for) operating activities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Cash Öows from investing activities Proceeds from sales of available-for- sale securities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Proceeds from maturities of available- for-sale securities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Derivative premiums and terminations and swap collateral, netÏÏÏÏÏÏÏÏÏÏÏÏ Net cash provided by (used for) investing activities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Cash Öows from Ñnancing activities Proceeds from issuance of short-term debt ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Repayments of short-term debt ÏÏÏÏÏÏÏ Net cash provided by (used for) Ñnancing activitiesÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 27,394 30,444 3,050 (766,598) (767,427) (829) (862,176) (854,665) 7,511 Net change in cash and cash equivalents $ 359,115 $ 359,115 $ 0 $(657,497) $(657,497) $ 0 $(734,993) $(734,993) $ 0 Supplemental cash Öow information Cash paid (received) for: Debt interest ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Swap collateral interestÏÏÏÏÏÏÏÏÏÏÏÏ 37,918 Ì 37,473 445 (445) 445 34,452 Ì 33,973 479 (479) 479 26,797 Ì 26,467 322 (330) 322 (1) 2007 As reported with changes in accounting principles and 2006 and 2005 As Adjusted amounts exclude adjustments which were made to our consolidated Statement of Cash Flows to conform to current period presentation. END OF FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA 180 Freddie Mac QUARTERLY SELECTED FINANCIAL DATA The unaudited Ñnancial data for each quarter and full-year 2007 and 2006 reÖects the reconciliation of previously reported to adjusted captions on the consolidated statements of income. See ""NOTE 20: CHANGES IN ACCOUNTING PRINCIPLES'' to our consolidated Ñnancial statements for more information regarding the adjustments. 2007 3Q (in millions, except share-related amounts) 4Q 2Q Net interest income, as computed without changes in accounting principles ÏÏÏÏÏÏÏÏ Impact of changes in accounting principles Net interest income, as adjusted ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 1Q $ $ 978 (207) 771 Non-interest income (loss), as computed without changes in accounting principlesÏÏ $ (554) Impact of changes in accounting principles Non-interest income (loss), as adjusted ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 477 (77) Non-interest expense, as computed without changes in accounting principles ÏÏÏÏÏÏÏ Impact of changes in accounting principles Non-interest expense, as adjusted ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Income tax (expense) beneÑt, as computed without changes in accounting principlesÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Impact of changes in accounting principles ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Income tax (expense) beneÑt, as adjusted ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $(1,074) (150) $(1,224) $ $ 439 (42) 397 Net income (loss), as computed without changes in accounting principles ÏÏÏÏÏÏÏÏÏ $ (211) Impact of changes in accounting principles 78 Net income (loss), as adjusted ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ (133) Basic earnings (loss) per common share, as computed without changes in accounting principles(1) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Impact of changes in accounting principles(1) Basic earnings (loss) per common share, as adjusted(1) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Diluted earnings (loss) per common share, as computed without changes in accounting principles(1) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Impact of changes in accounting principles(1) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Diluted earnings (loss) per common share, as adjusted(1) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ (0.46) 0.11 $ (0.35) $ (0.46) 0.11 $ (0.35) $ $ 973 (180) 793 $ 1,282 267 $ 1,549 $(1,378) (141) $(1,519) $ (113) 19 (94) 764 (35) 729 1.02 (0.05) 0.97 1.02 (0.06) 0.96 $ $ $ $ $ $ $ Full-Year $ 3,910 (811) $ 3,099 $(4,752) 4,946 194 $ $(8,346) (924) $(9,270) $ 4,007 (1,124) $ 2,883 $(5,181) 2,087 $(3,094) $ (8.58) 3.21 $ (5.37) $ (8.58) 3.21 $ (5.37) $ $ 972 (198) 774 $(3,815) 2,420 $(1,395) $(3,163) (294) $(3,457) $ 2,301 (675) $ 1,626 $(3,705) 1,253 $(2,452) $ (5.91) 1.94 $ (3.97) $ (5.91) 1.94 $ (3.97) $ $ 987 (226) 761 $(1,665) 1,782 117 $ $(2,731) (339) $(3,070) $ 1,380 (426) 954 $ $(2,029) 791 $(1,238) $ (3.29) 1.22 $ (2.07) $ (3.29) 1.22 $ (2.07) 2006 3Q 1Q 2Q 4Q Full-Year Net interest income, as previously reported ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Impact of changes in accounting principles Net interest income, as adjusted ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Non-interest income (loss), as previously reported ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Impact of changes in accounting principles Non-interest income (loss), as adjusted ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Non-interest expense, as previously reported ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Impact of changes in accounting principles Non-interest expense, as adjusted ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Income tax (expense) beneÑt, as previously reported ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Impact of changes in accounting principles ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Income tax (expense) beneÑt, as adjusted ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Net income (loss), as previously reported ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Impact of changes in accounting principles Net income (loss), as adjusted ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Basic earnings (loss) per common share, as previously reported(1) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Impact of changes in accounting principles(1) Basic earnings (loss) per common share, as adjusted(1) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Diluted earnings (loss) per common share, as previously reported(1) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Impact of changes in accounting principles(1) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Diluted earnings (loss) per common share, as adjusted(1) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $1,131 (192) $ 939 $1,347 201 $1,548 $ (584) (30) $ (614) $ 115 (46) 69 $ $2,009 (67) $1,942 $ 2.81 (0.10) $ 2.71 $ 2.80 (0.09) $ 2.71 (in millions, except share-related amounts) $1,172 (189) $ 983 $ 979 199 $1,178 $ (714) (35) $ (749) $ (40) (36) $ (76) $1,397 (61) $1,336 $ 1.93 (0.09) $ 1.84 $ 1.93 (0.09) $ 1.84 $ 959 (230) $ 729 $ (868) 404 $ (464) $ (827) (19) $ (846) $ $ 21 10 31 $ (715) 165 $ (550) $(1.17) 0.25 $(0.92) $(1.17) 0.25 $(0.92) $ $ 973 (212) 761 $ (543) 367 $ (176) $ (922) (85) $(1,007) $ $ 12 9 21 $ (480) 79 $ (401) $ (0.85) 0.12 $ (0.73) $ (0.85) 0.12 $ (0.73) $ 4,235 (823) $ 3,412 $ 915 1,171 $ 2,086 $(3,047) (169) $(3,216) $ $ 108 (63) 45 $ 2,211 116 $ 2,327 $ $ $ $ 2.84 0.17 3.01 2.84 0.16 3.00 (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. 181 Freddie Mac CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None. Disclosure Controls and Procedures CONTROLS AND PROCEDURES Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that the information we are required to disclose in our Ñnancial reports is accumulated and communicated to senior management as appropriate to allow timely decisions regarding required disclosure. We have documented our disclosure controls and procedures. We are currently in the process of assessing the eÅectiveness of our disclosure controls and procedures. Internal Control Over Financial Reporting During 2007 and continuing into 2008 we have continued to execute our plan to remediate known material weaknesses and signiÑcant deÑciencies in internal control over Ñnancial reporting, improve our Ñnancial reporting processes and infrastructure, and review our processes and controls over the recording, processing and reporting of Ñnancial transactions (""business process design review''). Management believes the measures that we have implemented during 2007 to remediate the material weaknesses in internal control over Ñnancial reporting have had a positive impact on our internal control over Ñnancial reporting. The changes we have made in our internal control over Ñnancial reporting from January 1, 2007 through the date of this report that have aÅected, or are reasonably likely to aÅect, our internal control over Ñnancial reporting are described below. We have: ‚ designed and implemented the controls we believe are necessary to remediate all known material weaknesses; ‚ remediated, through demonstration of the operating eÅectiveness of the controls we implemented, material weaknesses around adequacy of staÇng; IT general controls over access to data, security administration and change management, but identiÑed certain new signiÑcant deÑciencies in IT General Controls in connection with testing the controls implemented by the company; ‚ implemented new Ñnancial accounting applications for guarantee asset valuation in the fourth quarter of 2007 and for our entire mortgage-related securities portfolio and credit guarantees as of January 1, 2008; ‚ made several changes in our accounting policies that simpliÑed our accounting processes (see ""NOTE 20: CHANGES IN ACCOUNTING PRINCIPLES'' to our consolidated Ñnancial statements for additional information on our accounting changes); and ‚ substantially completed our business process design review through which we assessed signiÑcant risks to the business processes that are important to our Ñnancial reporting process, identiÑed the controls to mitigate those risks, and identiÑed for remediation any deÑciencies in the design of those controls. As discussed below, as of December 31, 2007, we have either remediated or implemented the activities we believe are necessary to remediate the material weaknesses in our internal control over Ñnancial reporting. Because we have not yet conducted a complete evaluation of the operating eÅectiveness of our internal control over Ñnancial reporting, which would include comprehensive testing of the operating eÅectiveness of individual controls, we cannot conclude on the eÅectiveness of our internal control over Ñnancial reporting. We may identify additional control issues when we perform operating eÅectiveness testing of controls or from on-going remediation activities. However, we have identiÑed no additional material weaknesses through our remediation activities, business process design review or other assessment activities we have undertaken. In the course of their audit of our consolidated Ñnancial statements, our external auditors have not evaluated our internal control over Ñnancial reporting or the speciÑc controls we have implemented through the remediation activities discussed below. While we have made signiÑcant progress toward addressing our material weaknesses and signiÑcant deÑciencies in internal control over Ñnancial reporting, we continued to perform extensive veriÑcation and validation procedures to compensate for those deÑciencies during 2007. In view of our remediation eÅorts through December 31, 2007 and the additional veriÑcation and validation procedures we performed, we believe that our consolidated Ñnancial statements for the year ended December 31, 2007, have been prepared in conformity with GAAP. Material Weaknesses and Progress toward Remediation As disclosed in our 2006 Annual Report, we had the following material weaknesses in internal control over Ñnancial reporting as of December 31, 2006: Integration between Operations and Finance. Our systems and processes related to our operational and Ñnancial accounting systems, business units and external service providers were not adequately integrated. This inadequate integration increased the risk of error in our Ñnancial reporting due to: (a) the potential failure to correctly pass information between 182 Freddie Mac systems and processes; (b) incompatibility of data between systems; (c) incompatible systems; or (d) a lack of clarity in process ownership. We deÑned four components of this weakness for purposes of planning our remediation eÅort: ‚ Data Hand-oÅs Ì Controls over data hand-oÅs between business units and from external providers needed to be improved. ‚ Financial Close Process Ì The Ñnancial close process needed better coordination between business unit accounting teams and corporate accounting and reporting teams, and improved monitoring of the process. ‚ Complex Transactions Processing Ì Controls over the processing of complex structured securitization transactions needed to be improved. ‚ Accounting Policy Linkage Ì Processing performed by Ñnancial applications needed to be evaluated for appropriate linkage to accounting policies. Monitoring Controls within Financial Operations. The controls we used 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. Information Technology General Controls Ì Access to Data and Security Administration. Our controls over information systems security administration and management functions needed 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 have allowed unauthorized users to access, enter, delete or change data in these systems, as well as increased the possibility that entries could be duplicated or omitted inadvertently. Information Technology General Controls Ì Change Management. Our controls over managing the introduction of program and data changes needed improvement. Weaknesses in these controls included a lack of consistent standards and inadequate testing of changes prior to deployment; an environment and processes that increased the diÇculties of establishing and maintaining internal control; and issues that arose from inherent system limitations. Management Self-Assessment. We did not have a self-assessment process for our internal control over Ñnancial reporting that would 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. Adequacy of StaÇng. Vacancies in leadership and key staÅ positions increased operational risk in our Ñnancial reporting processes. Undesirable voluntary turnover strained existing resources and contributed to increased operational risk. Furthermore, our standards of performance needed to be enforced in order to create a more eÅective culture of accountability. We report progress towards remediation of material weaknesses and signiÑcant deÑciencies in the following stages: ‚ In process Ì We are in the process of designing and implementing controls to correct identiÑed internal control deÑciencies and conducting ongoing evaluations to ensure all deÑciencies have been identiÑed. ‚ Remediation activities implemented Ì We have designed and implemented the controls that we believe are necessary to remediate the identiÑed internal control deÑciencies. ‚ Remediated Ì After a suÇcient period of operation of the controls implemented to remediate the control deÑciencies, management has evaluated the controls and found them to be operating eÅectively. 183 Freddie Mac Our progress toward remediation of these material weaknesses is summarized below. Integration between Operations and Finance ‚ Data Hand-oÅs Material Weaknesses ‚ Financial Close Process ‚ Complex Transactions Processing ‚ Accounting Policy Linkage Monitoring Controls within Financial Operations Information Technology General Controls Ì Access to Data and Security Administration Information Technology General Controls Ì Change Management Management Self-Assessment Remediation Progress as of December 31, 2007 Remediation Progress as of February 28, 2008 Remediation activities implemented Remediated Remediated Remediated Remediation activities implemented Remediation activities implemented Remediation activities implemented Remediation activities implemented Remediation activities implemented Remediated Remediated Remediated Remediation activities implemented Remediated(1) Remediated(1) Remediation activities implemented Adequacy of StaÇng Remediated Remediated (1) This material weakness has been remediated but operational issues we identiÑed in evaluating the controls we implemented have been classiÑed as two signiÑcant deÑciencies and are discussed below under ""Material Weaknesses We Remediated.'' Material Weaknesses We Remediated Integration between Operations and Finance We completed remediation of three of the four components of this material weakness as described below. ‚ Financial Close Process Ì We have made signiÑcant improvements in the coordination and execution of and control over our Ñnancial close process. These improvements include substantive enhancements to the coordination of our close process activities among our business unit accounting teams and corporate accounting and reporting teams as well as improvements in monitoring controls around critical elements of the Ñnancial close process. Based on our evaluation of the changes to the Ñnancial close process and related monitoring controls over the 2007 quarterly reporting cycles, we have concluded that the process and controls are operating eÅectively. Although we are continuing our eÅorts to improve the timeliness of our Ñnancial reporting, we have concluded that this component of the material weakness is remediated. ‚ Complex Transactions Processing Ì We performed an in-depth review of our controls related to the processing and reporting of our more complex structured securitization transactions. For the speciÑc deÑciencies identiÑed, we designed and implemented the controls that we believe are necessary for remediation. We have tested those controls and concluded that they are operating eÅectively. ‚ Accounting Policy Linkage Ì We reviewed and ranked the relative risk of our Ñnancial applications for their impact on the application of our accounting policies. We have evaluated the higher risk Ñnancial applications and concluded that those applications are appropriately applying our accounting policies. Information Technology General Controls Ì Access to Data and Security Administration We completed the design assessment of our information technology general controls over security administration utilizing the Information Technology Governance Institute's» Control Objectives for Information and related Technology» framework. We have designed and implemented controls, where necessary, to ensure that data is secure and available only to authorized and appropriate users. We have evaluated these controls, which identiÑed certain operational issues around shared system and user IDs and periodic recertiÑcation of application level and technical platform user access rights. While we believe these operational issues constitute two signiÑcant deÑciencies that warrant the attention of senior management, we have concluded that they do not, in the aggregate, represent a material weakness. Accordingly, we believe this material weakness is remediated. 184 Freddie Mac Information Technology General Controls Ì Change Management We developed and deployed a new change management process and a new systems development life cycle process that are based on methodologies acquired from a third party. We now require adherence to these processes and related controls for new systems development projects. Critical Ñnancial projects that were already in progress were subject to a management evaluation of compliance with speciÑc development control requirements prior to implementation. We have evaluated these controls, which identiÑed certain operational issues around the inclusion of process controls in the business requirements for new Ñnancial projects and the suÇciency of testing of application functionality and approval prior to deployment. While we believe these operational issues constitute two signiÑcant deÑciencies that warrant the attention of senior management, we have concluded that they do not, in the aggregate, represent a material weakness. Accordingly, we believe this material weakness is remediated. Adequacy of StaÇng We Ñlled our leadership and critical staÅ position vacancies and have made signiÑcant progress in resolving single- person critical dependencies. We also implemented an on-going process designed to identify and resolve critical vacancies in an expeditious manner through better coordination between our human resources professionals and our business units. In addition, we developed and have initiated a series of programs designed to enhance our management of human resources and to create and sustain a more eÅective culture of accountability. These programs include improvements to our performance management process, development of broad-based risk and control training programs and more eÅective workforce planning. Management has evaluated these programs and concluded they are eÅective. Progress Toward Remediation of Other Material Weaknesses The remaining material weaknesses are pending a suÇcient period of operation of the controls we have implemented to resolve the deÑciencies to enable us to evaluate whether those controls are operating eÅectively. Until we evaluate operational eÅectiveness of those controls, we cannot conclude that these material weaknesses have been remediated. The discussion below describes the actions that we have taken to resolve these material weaknesses. Integration between Operations and Finance Ì Data Hand-oÅs We developed policies and standards to deÑne control objectives related to hand-oÅs of information between people, processes and systems. We identiÑed the controls in place over higher risk hand-oÅs through the business process review as well as focused data hand-oÅ assessments and identiÑed deÑciencies in the design of controls at the data hand-oÅ level. For speciÑc control deÑciencies identiÑed, we designed and implemented controls in the process to remediate the deÑciencies. Additionally, in the fourth quarter of 2007, we implemented a new Ñnancial accounting application for guarantee asset valuation and began parallel processing of a new Ñnancial accounting application for our entire mortgage-related securities portfolio, which became our system of record as of January 1, 2008. Monitoring Controls within Financial Operations We developed and implemented monitoring controls and standards to support the accounting processes at both the business unit and corporate levels, including a more structured, in-depth analytics process. These monitoring controls, combined with a newly implemented governance and review structure, have been designed and implemented to provide for detection, escalation and remediation of accounting and reporting issues prior to external disclosure of Ñnancial results. We believe that additional operational enhancements and repeated control execution are necessary to support the evaluation of operational eÅectiveness and achieve remediation of this weakness. Management Self-Assessment We designed a management self-assessment process that will provide more timely and eÅective identiÑcation, documentation and remediation of control deÑciencies within the Ñnancial reporting process. The process assigns accountability for assessment of control design and operating eÅectiveness to business oÇcers who have organizational oversight responsibility for business, information technology and entity-level processes that impact the Ñnancial reporting process. We have established a centralized internal control oÇce to govern and manage the management self-assessment process, as well as a formal assessment reporting, aggregation and review process. We have deployed the management self- assessment process across the organization for the fourth quarter 2007. The process has not yet operated for a suÇcient period of time for us to evaluate its operating eÅectiveness. SigniÑcant DeÑciencies and Progress Toward Remediation In addition to the material weaknesses discussed above, we are also remediating signiÑcant deÑciencies in our internal controls over Ñnancial reporting that existed at December 31, 2006 or that were subsequently identiÑed through our material 185 Freddie Mac weakness remediation eÅorts. Those signiÑcant deÑciencies and progress toward their remediation are summarized in the table below: SigniÑcant DeÑciencies that Existed as of December 31, 2006 Guarantee Asset/Guarantee Obligation Governance Our process for valuation of and accounting for our guarantee asset and guarantee obligation was complex, manually intensive and dependent on end-user computing solutions, resulting in an unacceptable likelihood of risk of signiÑcant error. End-User Computing Controls Our Ñnancial reporting processes relied on models and end-user computing solutions (exclusive of those addressed through the Guarantee Asset/Guarantee Obligation Governance signiÑcant deÑciency described above) that were not subject to adequate controls over their development, nor were they subject to adequate change control procedures. New Products Governance Our policies and procedures for the introduction of new products were insuÇcient and related governance processes did not adequately ensure adherence to policies and procedures. Tax Basis Balance Sheet We do not maintain a tax basis balance sheet to support deferred tax accounting under GAAP, which could result in balance sheet misclassiÑcations and potential income statement adjustments. Controls over Data Quality Controls over the quality of data used in our Ñnancial reporting process were not eÅective. Simplifying Assumptions Our Ñnancial reporting process was over-reliant on simplifying assumptions, or manual work around solutions, in the application of our accounting policies. In addition, we did not adequately monitor the potential impact of these simplifying assumptions on the Ñnancial statements. Oversight of Models and Model Applications Our model governance and monitoring procedures (exclusive of those addressed through the Guarantee Asset/Guarantee Obligation Governance signiÑcant deÑciency described above) did not eÅectively ensure that changes to and our use of models in our Ñnancial reporting process are appropriate. Subsequently IdentiÑed SigniÑcant DeÑciencies IT Security Ì Shared IDs We have not consistently executed security controls over system and user accounts that can be used by multiple individuals. User Access RecertiÑcation We have not eÅectively executed periodic review and recertiÑcation of user access to Ñnancial applications and related technical platforms. Consideration of Controls in Application Design Our business or technical design requirements for Ñnancial application development projects have not adequately considered requirements for automating process controls. Pre-Deployment Application Testing and Maintenance Approval We have not consistently executed the appropriate testing of new Ñnancial applications prior to their deployment nor have we consistently obtained the appropriate approvals of application maintenance changes. Remediation Progress as of December 31, 2007 Remediation Progress as of February 28, 2008 Remediation activities implemented In process Remediation activities implemented Remediation activities implemented Remediated Remediated In process In process Remediation activities implemented Remediated Remediation activities implemented Remediated Remediation activities implemented Remediation activities implemented (1) (1) (1) (1) In process In process In process In process (1) These signiÑcant deÑciencies were identiÑed through the material weakness remediation eÅorts related to Information Technology General Controls Ì Access to Data and Security Administration and Information Technology General Controls Ì Change Management. Therefore, ""Remediation Progress as of December 31, 2007'' is not applicable. 186 Freddie Mac DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE Our Board of Directors (as of the date of this report)(1) Thomas S. JohnsonA, B, D Retired Chairman and Chief Executive OÇcer GreenPoint Financial Corporation A Ñnancial services company New York, New York William M. Lewis, Jr.C, E Managing Director and Co-Chairman of Investment Banking Lazard Ltd. An investment banking company New York, New York Shaun F. O'Malley (Lead Director)A, B, D Chairman Emeritus Price Waterhouse LLP An accounting and consulting Ñrm Philadelphia, Pennsylvania Nicholas P. RetsinasC, E Director Joint Center for Housing Studies Harvard University Cambridge, Massachusetts 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. AlexanderB, D, E Independent Consultant Monarch Beach, California GeoÅrey T. BoisiB, D, E Chairman and CEO 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 Variable Fund L.L.C. Each an investment company Lansing, Michigan Robert R. GlauberA, C Retired Chairman and Chief Executive OÇcer National Association of Securities Dealers, Inc. A former 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 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 the date of this report. 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 6, 2008, and is incorporated here 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 here by reference. Information regarding the procedures for stockholder nominations to our Board of Directors is set forth in our proxy statement, incorporated here 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 on our website 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. 187 Freddie Mac EXECUTIVE COMPENSATION Information regarding executive compensation is set forth in our proxy statement and is incorporated here by reference. 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, 2007 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. 188 Freddie Mac RATIO OF EARNINGS TO FIXED CHARGES Year Ended December 31, Adjusted 2007(1) 2006 2005 2004 2003 (dollars in millions) Net income (loss) before cumulative eÅect of change in accounting principle ÏÏÏÏÏÏÏÏÏ $(3,094) $ 2,327 $ 2,172 Add: $ 2,603 $ 4,809 Income tax expense (beneÑt) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Minority interests in earnings of consolidated subsidiariesÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Low-income housing tax credit partnerships ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total interest expenseÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Interest factor in rental expenses ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 358 96 320 29,899 6 Earnings, as adjusted ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $32,973 $40,023 $32,851 (45) 58 407 37,270 6 (2,883) (8) 469 38,482 7 Fixed charges: Total interest expenseÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $38,482 $37,270 $29,899 6 Interest factor in rental expenses ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Ì Capitalized interestÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total Ñxed charges ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $38,489 $37,276 $29,905 Ratio of earnings to Ñxed charges(2)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 6 Ì 7 Ì 1.07 1.10 Ì 609 129 282 26,566 6 $30,195 $26,566 6 1 $26,573 2,198 157 199 26,509 5 $33,877 $26,509 5 Ì $26,514 1.14 1.28 (1) For the Ratio of earnings to Ñxed charges to equal 1.00, Earnings, as adjusted must increase by $5.5 billion. (2) 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 (loss) before cumulative eÅect of change in accounting principle ÏÏÏÏÏÏÏÏÏ $(3,094) $ 2,327 $ 2,172 Add: $ 2,603 $ 4,809 Year Ended December 31, Adjusted 2007(1) 2006 2005 2004 2003 (dollars in millions) Income tax expense (beneÑt) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Minority interests in earnings of consolidated subsidiariesÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Low-income housing tax credit partnerships ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total interest expenseÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Interest factor in rental expenses ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 358 96 320 29,899 6 Earnings, as adjusted ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $32,973 $40,023 $32,851 (45) 58 407 37,270 6 (2,883) (8) 469 38,482 7 Fixed charges: Total interest expenseÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $38,482 $37,270 $29,899 6 Interest factor in rental expenses ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Ì Capitalized interestÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Preferred stock dividends(2) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 260 Total Ñxed charges including preferred stock dividends ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $38,887 $37,546 $30,165 Ratio of earnings to combined Ñxed charges and preferred stock dividends(3) ÏÏÏÏÏÏÏÏÏÏ 7 Ì 398 6 Ì 270 1.07 1.09 Ì 609 129 282 26,566 6 $30,195 $26,566 6 1 260 $26,833 2,198 157 199 26,509 5 $33,877 $26,509 5 Ì 315 $26,829 1.13 1.26 (1) For the Ratio of earnings to combined Ñxed charges and preferred stock dividends to equal 1.00, Earnings, as adjusted must increase by $5.9 billion. (2) Preferred stock dividends represent pre-tax earnings required to cover any preferred stock dividend requirements computed using our eÅective tax rate, whenever there is an income tax provision, for the relevant periods. (3) 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. ADDITIONAL INFORMATION ANNUAL MEETING The annual meeting of Freddie Mac's stockholders will be held: June 6, 2008 8000 Jones Branch Drive McLean, Virginia 22102 Proxy materials will be mailed to stockholders of record in accordance with Freddie Mac's bylaws and NYSE Euronext requirements. DIVIDEND PAYMENTS Approved by Freddie Mac's board of directors, dividends on the company's common stock and non-cumulative, preferred stock in 2007 were paid on: March 30, 2007 June 29, 2007 September 28, 2007 December 31, 2007 Subject to approval by Freddie Mac's board of directors, dividends on the company's common stock and non-cumulative, preferred stock in 2008 are expected to be paid on or about: March 31, 2008 June 30, 2008 September 30, 2008 December 31, 2008 189 Freddie Mac I, Richard F. Syron, certify that: CERTIFICATION* 1. I have reviewed this Information Statement of the Federal Home Loan Mortgage Corporation, or Freddie Mac; 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: February 28, 2008 Richard F. Syron Chairman and Chief Executive OÇcer I, Anthony S. Piszel, certify that: CERTIFICATION* 1. I have reviewed this Information Statement of the Federal Home Loan Mortgage Corporation, or Freddie Mac; 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: February 28, 2008 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 ""CONTROLS AND PROCEDURES.'' 190 Freddie Mac 8200 Jones Branch Drive, McLean, Virginia 22102 n FreddieMac.com 

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