UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-K

 

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the fiscal year ended December 31, 2009

 

Commission File Number: 000-53330

 

Federal Home Loan Mortgage Corporation

(Exact name of registrant as specified in its charter)

 

Freddie Mac

 

 

Securities registered pursuant to Section 12(b) of the Act:

 

 

Securities registered pursuant to Section 12(g) of the Act: None

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes o   No x

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.  Yes o   No x

 

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes x   No o

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  o Yes  o No

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  x

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.  Large accelerated filer o   Accelerated filer x   Non-accelerated filer (Do not check if a smaller reporting company) o   Smaller reporting company o

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes o   No x

 

The aggregate market value of the common stock held by non-affiliates computed by reference to the price at which the common equity was last sold on June 30, 2009 (the last business day of the registrant’s most recently completed second fiscal quarter) was $401.9 million.

 

As of February 11, 2010, there were 648,377,977 shares of the registrant’s common stock outstanding.

 

DOCUMENTS INCORPORATED BY REFERENCE: The information required by Part III (Items 10, 11, 12, 13 and 14) will be filed in an amendment to this annual report on Form 10-K on or before April 30, 2010.

 

            

 

TABLE OF CONTENTS

 

 

FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

 

 

 

 

Throughout PART I of this Form 10-K, we use certain acronyms and terms which are defined in the Glossary.

 

Our Business and Statutory Mission

 

Freddie Mac was chartered by Congress in 1970 with a public mission to stabilize the nation’s residential mortgage markets and expand opportunities for home ownership and affordable rental housing. Our statutory mission is to provide liquidity, stability and affordability to the U.S. housing market. 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. Through our credit guarantee activities, we securitize mortgage loans by issuing PCs to third-party investors. We also resecuritize mortgage-related securities that are issued by us or Ginnie Mae as well as private, or non-agency, entities by issuing Structured Securities to third-party investors. We 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 reflected as assets on our consolidated balance sheets in this Form 10-K. However, effective January 1, 2010, we will prospectively recognize on our consolidated balance sheets the mortgage loans underlying our issued single-family PCs and certain Structured Transactions as mortgage loans held-for investment by consolidated trusts, at amortized cost. Correspondingly, we will also prospectively recognize single-family PCs and certain Structured Transactions held by third parties on our consolidated balance sheets as debt securities of consolidated trusts held by third parties. See “NOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES — Recently Issued Accounting Standards, Not Yet Adopted Within These Consolidated Financial Statements — Accounting for Transfers of Financial Assets and Consolidation of VIEs” to our consolidated financial statements for additional information regarding these changes and a description of how these changes are expected to impact our results and financial statement presentation.

 

We earn management and guarantee fees for providing our guarantee and performing management activities (such as ongoing trustee services, administration of pass-through amounts, paying agent services, tax reporting and other required services) with respect to issued PCs and Structured Securities.

 

We are focused on meeting the urgent liquidity needs of the U.S. residential mortgage market, lowering costs for borrowers and supporting the recovery of the housing market and U.S. economy. By continuing to provide access to funding for mortgage originators and, indirectly, for mortgage borrowers, and through our role in the Obama Administration’s initiatives, including the MHA Program, we are working to meet the needs of the mortgage market by making home ownership and rental housing more affordable, reducing the number of foreclosures and helping families keep their homes. For more information, see “MD&A — EXECUTIVE SUMMARY — MHA Program.”

 

Conservatorship

 

We continue to operate under the direction of FHFA as our Conservator. We are subject to certain constraints on our business activities by Treasury due to the terms of, and Treasury’s rights under, our Purchase Agreement with Treasury. The conservatorship and related developments have had a wide-ranging impact on us, including our regulatory supervision, management, business, financial condition and results of operations. There is significant uncertainty as to whether or when we will emerge from conservatorship, as it has no specified termination date, and as to what changes may occur to our business structure during or following our conservatorship, including whether we will continue to exist. Our future structure and role are currently being considered by the President and Congress. We have no ability to predict the outcome of these deliberations. However, we are not aware of any immediate plans of our Conservator to significantly change our business structure in the near-term. For information on the conservatorship and the Purchase Agreement, see “Conservatorship and Related Developments.”

 

Our business objectives and strategies have in some cases been altered since we were placed into conservatorship, and may continue to change. Based on our charter, public statements from Treasury and FHFA officials and guidance from our Conservator, we have a variety of different, and potentially competing, objectives. Certain changes to our business objectives and strategies are designed to provide support for the mortgage market in a manner that serves our public mission and other non-financial objectives. In this regard, we are focused on serving our mission, helping families keep their homes and stabilizing the economy by playing a vital role in the Obama Administration’s housing programs. However, these changes to our business objectives and strategies may not contribute to our profitability. Some of these changes increase our expenses, while others require us to forego revenue opportunities in the near-term. In addition, the objectives set forth for us under our charter and by our Conservator, as well as the restrictions on our business under the Purchase Agreement, may adversely impact our financial results, including our segment results. For example, our current business objectives reflect, in part, direction given us by the Conservator. These efforts are expected to help homeowners and the mortgage market and may help

 

to mitigate our credit losses. However, some of our activities are expected to have an adverse impact on our near and long-term financial results. The Conservator and Treasury also did not authorize us to engage in certain business activities and transactions, including the sale of certain assets, which we believe may have had a beneficial impact on our results of operations or financial condition, if executed. Our inability to execute such transactions may adversely affect our profitability, and thus contribute to our need to draw additional funds under the Purchase Agreement.

 

On February 18, 2010, we received a letter from the Acting Director of FHFA stating that FHFA has determined that any sale of the LIHTC investments by Freddie Mac would require Treasury’s consent under the terms of the Purchase Agreement. The letter further stated that FHFA had presented other options for Treasury to consider, including allowing Freddie Mac to pay senior preferred stock dividends by waiving the right to claim future tax benefits of the LIHTC investments. However, after further consultation with Treasury and consistent with the terms of the Purchase Agreement, the Acting Director informed us we may not sell or transfer the assets and that he sees no other disposition options. As a result, we wrote down the carrying value of our LIHTC investments to zero as of December 31, 2009, resulting in a loss of $3.4 billion. This write-down reduces our net worth at December 31, 2009 and, as such, increases the likelihood that we will require additional draws from Treasury under the Purchase Agreement and, as a consequence, increases the likelihood that our dividend obligation on the senior preferred stock will increase. See “NOTE 5: VARIABLE INTEREST ENTITIES” to our consolidated financial statements for additional information.

 

For more information on our current business objectives and the effect of conservatorship on our business, see “MD&A — EXECUTIVE SUMMARY — Business Objectives.”

 

In a letter to the Chairmen and Ranking Members of the Congressional Banking and Financial Services Committees dated February 2, 2010, the Acting Director of FHFA stated that minimizing our credit losses is our central goal and that we will be limited to continuing our existing core business activities and taking actions necessary to advance the goals of the conservatorship. The Acting Director also stated that permitting us to engage in new products is inconsistent with the goals of the conservatorship. This could have an adverse effect on our business and profitability in future periods. See “Conservatorship and Related Developments” for information on the purpose and goals of the conservatorship.

 

The Purchase Agreement was amended in December 2009 to: (i) increase the $200 billion cap on Treasury’s funding commitment under the Purchase Agreement as necessary to accommodate any cumulative reduction in our net worth during 2010, 2011 and 2012; (ii) provide that the annual 10% reduction in the size of our mortgage-related investments portfolio is calculated based on the maximum allowable size of the mortgage-related investments portfolio, rather than the actual unpaid principal balance of the mortgage-related investments portfolio, as of December 31 of the preceding year, and will be determined without giving effect to any change in the accounting standards related to transfers of financial assets and consolidation of VIEs or any similar accounting standard; and (iii) establish that the periodic commitment fee that we must pay to Treasury will be set no later than December 31, 2010 and payable quarterly beginning March 31, 2011. These amendments are discussed in more detail in “MD&A — EXECUTIVE SUMMARY — Government Support for Our Business.”

 

We had positive net worth at December 31, 2009 as our assets exceeded our liabilities by $4.4 billion. Therefore, we did not require additional funding from Treasury under the Purchase Agreement. However, as a result of previous draws under the Purchase Agreement, the aggregate liquidation preference of the senior preferred stock increased from $1.0 billion as of September 8, 2008 to $51.7 billion as of December 31, 2009. We expect to make additional draws under the Purchase Agreement in future periods. Under the Purchase Agreement, our ability to repay the liquidation preference of the senior preferred stock is limited and we may not be able to do so for the foreseeable future, if at all. The aggregate liquidation preference of the senior preferred stock and our related dividend obligations will increase further if additional draws under the Purchase Agreement or any dividends or quarterly commitment fees payable under the Purchase Agreement are not paid in cash. The amounts we are obligated to pay in dividends on the senior preferred stock are substantial and will have an adverse impact on our financial position and net worth and could substantially delay our return to long-term profitability or make long-term profitability unlikely.

 

Our annual dividend obligation on the senior preferred stock, based on the current liquidation preference, is $5.2 billion, which is in excess of our annual historical earnings in most periods. Continued cash payment of senior preferred dividends, combined with potentially substantial quarterly commitment fees payable to Treasury beginning in 2011 (the amounts of which must be determined by December 31, 2010), will have an adverse impact on our future financial condition and net worth.

 

The payment of dividends on our senior preferred stock in cash reduces our net worth. For periods in which our earnings and other changes in equity do not result in positive net worth, draws under the Purchase Agreement effectively fund the cash payment of senior preferred dividends to Treasury.

 

2010 Significant Changes in Accounting Standards

 

Effective January 1, 2010, we adopted amendments to the accounting standards for transfers of financial assets and consolidation of VIEs. The adoption of these amendments will have a significant impact on our consolidated financial statements and other financial disclosures beginning in the first quarter of 2010.

 

Due to the implementation of these changes, we recognized a significant decline in our total equity (deficit) on January 1, 2010, which will increase the likelihood that we will require a draw from Treasury under the Purchase Agreement for the first quarter of 2010. The cumulative effect of these changes in accounting principles as of January 1, 2010 is a net decrease of approximately $11.7 billion to total equity (deficit), which includes the changes to the opening balances of AOCI and retained earnings (accumulated deficit).

 

See “MD&A — EXECUTIVE SUMMARY — 2010 Significant Changes in Accounting Standards — Accounting for Transfers of Financial Assets and Consolidation of VIEs” and “NOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES — Recently Issued Accounting Standards, Not Yet Adopted Within These Consolidated Financial Statements” to our consolidated financial statements for additional information regarding these changes.

 

Our Charter and Statutory 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 “Our Business Segments — Single-Family Guarantee Segment” and “— Multifamily Segment.”

 

Our statutory mission as defined in our charter is:

 

 

Our business objectives continue to evolve under conservatorship. For more information, see “Conservatorship and Related Developments — Impact of Conservatorship and Related Actions on Our Business.”

 

Our Market and Mortgage Securitizations

 

We conduct business in the U.S. residential mortgage market and the global securities market under the direction of our Conservator. These markets continued to remain weak during 2009 and early 2010, as discussed in “MD&A — EXECUTIVE SUMMARY.” The size of the U.S. residential mortgage market is affected by many factors, including changes in interest rates, home ownership rates, home prices, the supply of housing and 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 affected by several factors, including the volume of mortgages meeting the requirements of our charter, (including changes in conforming loan limit sizes by our regulator), our own preference for credit risk reflected in our purchase standards and the mortgage purchase and securitization activity of other financial institutions.

 

At December 31, 2009, our total investments in and guarantees of mortgage-related assets was $2.3 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 — OUR PORTFOLIOS” for further information on the composition of our mortgage portfolios.

 

Table 1 provides important indicators for the U.S. residential mortgage market.

 

Table 1 — Mortgage Market Indicators

 

 

In general terms, the U.S. residential mortgage market consists of a primary mortgage market that links homebuyers and lenders and a secondary mortgage market that links lenders and investors. In the primary mortgage market, residential mortgage lenders such as mortgage banking companies, commercial banks, savings institutions, credit unions and other financial institutions originate or provide mortgages to borrowers. They obtain the funds they lend to mortgage borrowers in a variety of ways, including by selling mortgages or mortgage-related securities into the secondary mortgage market. Our charter does not permit us to originate loans in the primary mortgage market.

 

The secondary mortgage market consists of institutions engaged in buying and selling mortgages in the form of whole loans (i.e., mortgages that have not been securitized) and mortgage-related securities. We participate in the secondary mortgage market by purchasing mortgage loans and mortgage-related securities for investment and by issuing guaranteed mortgage-related securities, principally those we call PCs. We do not lend money directly to homeowners.

 

The following diagram illustrates how we create PCs through mortgage securitizations that can be sold to investors or held by us to provide liquidity to the mortgage market:

 

 

We guarantee the payment of principal and interest of PCs created in this process in exchange for a combination of monthly management and guarantee fees and initial upfront cash payments referred to as delivery fees. Our guarantee increases the marketability of the PCs, providing liquidity to the mortgage market. Various other participants also play significant roles in the residential mortgage market. Mortgage brokers advise prospective borrowers about mortgage products and lending rates, and they connect borrowers with lenders. Mortgage servicers administer mortgage loans by collecting payments of principal and interest from borrowers as well as amounts related to property taxes and insurance. They remit the principal and interest payments to us, less a servicing fee, and we pass these payments through to mortgage investors, less a fee we charge to provide our guarantee (i.e., the management and guarantee fee). In addition, private mortgage insurance companies and other financial institutions sometimes provide third-party insurance for mortgage loans or pools of loans. Most mortgage insurers increased premiums and tightened underwriting standards beginning in 2008. Because of the restrictions of our charter, these actions limit our ability to purchase loans made to borrowers who do not make a down payment at least equal to 20% of the value of the property at the time of loan origination.

 

Our charter generally prohibits us from purchasing first-lien conventional single-family mortgages if the outstanding principal balance of the mortgage at the time of our purchase exceeds 80% of the value of the property securing the mortgage unless we have one of the following credit protections:

 

 

In conjunction with the MHA Program, FHFA determined that, consistent with our charter, until June 10, 2010, we may purchase single-family mortgages that refinance borrowers whose mortgages we currently own or guarantee, without obtaining additional credit enhancement in excess of that already in place for any such loan, provided that the current LTV ratio of the loan at the time of refinance does not exceed 125%.

 

Our charter requirement for credit protection on mortgages with LTV ratios greater than 80% does not apply to multifamily mortgages or to mortgages that have the benefit of any guarantee, insurance or other obligation by the U.S. or any of its agencies or instrumentalities (e.g., the FHA, the VA or the USDA, Rural Development).

 

Under our charter, our mortgage purchase operations are confined, so far as practicable, to mortgages which we deem to be of such quality, type and class as to meet generally the purchase standards of other private institutional mortgage investors. This is a general marketability standard.

 

Government Support for our Business

 

We are dependent upon the continued support of Treasury and FHFA in order to continue operating our business. We also receive substantial support from the Federal Reserve. Our ability to access funds from Treasury under the Purchase Agreement is critical to keeping us solvent and avoiding the appointment of a receiver by FHFA under statutory mandatory receivership provisions. This support includes the following:

 

 

For information on the potential impact of the completion of the Federal Reserve’s mortgage-related securities and debt purchase programs on our business, see “MD&A — LIQUIDITY AND CAPITAL RESOURCES — Liquidity.” We do not believe we have experienced any adverse effects on our business from the expiration of the Lending Agreement (which occurred after the December 2009 amendment to the Purchase Agreement) or the expiration of Treasury’s mortgage-related securities purchase program.

 

For more information on the programs and agreements described above, see “Conservatorship and Related Developments.”

 

Our Customers

 

Our customers are predominantly lenders in the primary mortgage market that originate mortgages for homeowners and owners of rental apartment properties. These lenders include mortgage banking companies, commercial banks, savings banks, community banks, insurance companies, credit unions, state and local housing finance agencies and savings and loan associations.

 

We acquire a significant portion of our mortgages from several large lenders. These lenders are among the largest mortgage loan originators in the U.S. Due to the mortgage and financial market crisis during 2008 and 2009, a number of larger mortgage originators consolidated and, as a result, mortgage origination volume during 2009 was concentrated in a smaller number of institutions. See “RISK FACTORS — Competitive and Market Risks” for further information. In addition, many of our customers experienced financial and liquidity problems that may affect the volume of business they are able to generate. During 2009, two mortgage lenders (Wells Fargo Bank, N.A. and Bank of America, N.A.) each accounted for more than 10% of our single-family mortgage purchase volume. These two lenders collectively accounted for approximately 38% of our single-family mortgage purchase volume for 2009 and our top ten lenders represented approximately 74% of our single-family mortgage purchase volume for the same period. Our top three multifamily lenders (CBRE Melody & Company, Deutsche Bank Berkshire Mortgage and Berkadia Commercial Mortgage LLC, which acquired Capmark Finance Inc. in

 

December 2009) each accounted for more than 10%, and collectively represented approximately 40% of our multifamily purchase volume during 2009.

 

Our Business Segments

 

We manage our business, under the direction of the Conservator, through three reportable segments:

 

 

For a summary and description of our financial performance and financial 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 financial statements.

 

As described below in “Conservatorship and Related Developments — Impact of Conservatorship and Related Actions on Our Business,” we are subject to a variety of different, and potentially competing, objectives in managing our business. These objectives create conflicts in strategic and day-to-day decision making that will likely lead to suboptimal outcomes for one or more, or possibly all, of these objectives.

 

Investments Segment

 

Our Investments business is responsible for investment activity in single-family mortgages and mortgage-related securities, other investments, debt financing, and managing our interest rate risk, liquidity and capital positions. We invest principally in mortgage-related securities and single-family mortgages.

 

Although we are primarily a buy-and-hold investor in mortgage assets, we may sell assets to reduce risk, provide liquidity, support the performance of our PCs or structure certain transactions that are designed to improve our returns. We estimate our expected investment returns using an OAS approach, which is an estimate of the yield spread between a given financial instrument and a benchmark (LIBOR, agency or Treasury) yield curve. In this approach, we consider potential variability in the instrument’s cash flows resulting from any options embedded in the instrument, such as prepayment options. Our Investments segment activities sometimes include the purchase of mortgages and mortgage-related securities with less attractive investment returns and with incremental risk in order to achieve our affordable housing goals and subgoals. Additionally, in this segment we maintain a cash and other investments portfolio, comprised primarily of cash and cash equivalents, non-mortgage-related securities, federal funds sold and securities purchased under agreements to resell, to help manage our liquidity needs.

 

The unpaid principal balance of our mortgage-related investments portfolio, including CMBS held by our Multifamily segment, was $755.3 billion as of December 31, 2009. Under the Purchase Agreement with Treasury and FHFA regulation, the unpaid principal balance of our mortgage-related investments portfolio could not exceed $900 billion as of December 31, 2009, and must decline by 10% per year thereafter until it reaches $250 billion. The annual 10% reduction in the size of our mortgage-related investments portfolio, the first of which is effective on December 31, 2010, is calculated based on the maximum allowable size of the mortgage-related investments portfolio, rather than the actual unpaid principal balance of the mortgage-related investments portfolio, as of December 31 of the preceding year. Due to this restriction, the unpaid principal balance of our mortgage-related investments portfolio may not exceed $810 billion as of December 31, 2010. The Purchase Agreement also limits the amount of indebtedness we can incur. In each case, the limitations will be determined without giving effect to any change in the accounting standards related to transfers of financial assets and consolidation of VIEs or any similar accounting standard.

 

Treasury has stated it does not expect us to be an active buyer to increase the size of our mortgage-related investments portfolio, and also does not expect that active selling will be necessary to meet the required portfolio reduction targets. FHFA has also stated its expectation in the Acting Director’s February 2, 2010 letter that we will not be a substantial buyer or seller of mortgages for our mortgage-related investments portfolio, except for purchases of delinquent mortgages out of PC pools. FHFA has stated that, given the size of our current mortgage-related investments portfolio and the potential volume of delinquent mortgages to be purchased out of PC pools, it expects that any net additions to our mortgage-related investments portfolio would be related to that activity. On February 10, 2010, we announced that we will purchase substantially all of the single-family mortgage loans that are 120 days or more delinquent from our PCs and Structured Securities due to the changing economics of keeping these loans in PCs. As of December 31, 2009, the total unpaid principal balance of such mortgages was approximately $70.2 billion.

 

Debt Financing

 

We fund our on balance sheet investment activities in our Investments and Multifamily segments by issuing short-term and long-term debt. Competition for funding in the capital markets can vary with economic and financial market conditions and regulatory environments. Our access to the debt markets has improved since the height of the credit crisis in the fall of

 

2008, and spreads on our debt remained favorable during 2009. We attribute this improvement to the conservatorship and resulting support we receive from Treasury and the Federal Reserve. Under the amendment to the Purchase Agreement adopted on December 24, 2009, the $200 billion cap on Treasury’s funding commitment will increase as necessary to accommodate any cumulative reduction in our net worth during 2010, 2011 and 2012. We believe that this increased support provided by Treasury will be sufficient to enable us to maintain our access to the debt markets and ensure that we have adequate liquidity to conduct our normal business activities over the next three years. However, the costs of our debt funding could vary.

 

For more information, see “Conservatorship and Related Developments” and “MD&A — LIQUIDITY AND CAPITAL RESOURCES — Liquidity.”

 

Risk Management

 

Our Investments segment has responsibility for managing our interest rate and liquidity risks. 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) hedge forecasted issuances of debt; (c) synthetically create callable and non-callable funding; and (d) hedge foreign-currency exposure. For more information regarding our derivatives, see “QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK” and “NOTE 13: DERIVATIVES” to our consolidated financial statements.

 

PC and Structured Securities Support Activities

 

We seek to support the liquidity of the market for our 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 seek to support the price performance of our PCs through a variety of strategies, including the purchase and sale of PCs and other agency securities, as well as through the issuance of Structured Securities. As discussed in “Single-Family Guarantee Segment,” our Structured Securities represent beneficial interests in pools of PCs and certain other types of mortgage-related assets. Our purchases and sales of mortgage-related securities influence the relative supply and demand for these securities, and the issuance of Structured Securities helps support the price performance of our PCs. This in turn helps our competitiveness in purchasing mortgages from our lender customers, many of which we purchase by swapping PCs for the mortgages. Depending upon market conditions, including the relative prices, supply of and demand for PCs and comparable Fannie Mae securities, as well as other factors, there may be substantial variability in any period in the total amount of securities we purchase or sell, and in the success of our efforts to support the liquidity and price performance of our PCs. We may increase, reduce or discontinue these or other related activities at any time, which could affect the liquidity of the market for PCs. For more information, see “RISK FACTORS — Competitive and Market Risks — It may be difficult to increase our returns on new single-family guarantee business.”

 

Single-Family Guarantee Segment

 

In our Single-family Guarantee segment, we purchase single-family mortgages originated by our lender customers in the primary mortgage market, primarily through our guarantor swap program. We securitize the mortgages we purchase and issue mortgage-related securities that can be sold to investors or held by us in our Investments segment. Earnings for this segment consist primarily of management and guarantee fee revenues, including amortization of upfront payments we receive, less related credit costs and operating expenses. Earnings for this segment also include 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 float benefits. For more information on net float benefits, see “MD&A — CONSOLIDATED RESULTS OF OPERATIONS — Segment Earnings — Segment Earnings — Results — Single-Family Guarantee.”

 

Loan and Security Purchases

 

Our charter establishes requirements for and limitations on the mortgages and mortgage-related securities we may purchase, as described below. In the Single-family Guarantee segment, we purchase and securitize “single-family mortgages,” which are mortgages that are secured by one- to four-family properties. A majority of the single-family mortgages we purchased in 2009 were 30-year and 15-year fixed-rate mortgages.

 

Our charter places an upper limitation, called the “conforming loan limit,” on the original principal balance of single-family mortgage loans we purchase. No comparable limits apply to our purchases of multifamily mortgages. The conforming loan limit is determined annually based on changes in FHFA’s housing price index, a method established and maintained by FHFA for determining the national average single-family house price. Any decreases in the housing price index are accumulated and used to offset any future increases in the housing price index so that loan limits do not decrease from year-to-year. For 2006 to 2009, the base conforming loan limit for a one-family residence was set at $417,000. The base

 

conforming loan limit for a one-family residence for 2010 will remain at $417,000, with higher limits in certain “high-cost” areas.

 

As part of the Economic Stimulus Act of 2008, the conforming loan limits were increased for mortgages originated in certain “high-cost” areas from July 1, 2007 through December 31, 2008 to the higher of the applicable 2008 conforming loan limits, ($417,000 for a one-family residence), or 125% of the median house price for a geographic area, not to exceed $729,750 for a one-family residence. We began accepting these “conforming jumbo” mortgages for securitization as PCs and purchase as mortgage loans held on our consolidated balance sheets in April 2008. We purchased $91 million and $2.6 billion of these loans during 2009 and 2008, respectively.

 

Pursuant to the Reform Act, beginning in 2009, the conforming loan limits were permanently increased for mortgages originated in separately defined “high-cost” areas — where 115% of the median house price exceeds the otherwise applicable conforming loan limit. Under the Reform Act’s permanent high-cost area formula, the loan limit is the lesser of (i) 115% of the median house price or (ii) 150% of the conforming loan limit (currently $625,500 for a one-family residence).

 

However, a series of legislative acts have temporarily restored the high-cost area limit to up to $729,750. On February 17, 2009, President Obama signed the American Recovery and Reinvestment Act of 2009, or Recovery Act, into law. For mortgages originated in 2009, the Recovery Act ensured that the loan limits for the “high-cost” areas determined under the Economic Stimulus Act did not fall below their 2008 levels.

 

On October 30, 2009, a Continuing Resolution extended the loan limits established by the Recovery Act through 2010. With the exception of mortgages purchased under our conforming jumbo offering in 2008 and early 2009, we refer to mortgages with original principal balances in excess of the base conforming loan limits as “super-conforming mortgages.” We purchased $26.3 billion of these loans during 2009.

 

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.

 

Guarantees

 

Through our Single-family Guarantee segment, we historically sought to issue guarantees on our PCs with fee terms we believed would offer attractive long-term returns relative to anticipated credit costs. Under conservatorship, and given the current economic environment and our public mission to provide increased support to the mortgage market, we currently seek to issue guarantees with fee terms that are intended to cover our expected credit costs on new purchases and that cover a portion of our ongoing operating expenses. Specifically, our ability to increase our fees to offset higher than expected credit costs on guarantees issued before 2009 is limited while we operate at the direction of our Conservator, and we currently expect that our fees will not cover such credit costs.

 

We enter into mortgage purchase volume commitments with many of our larger customers in order to have a supply of loans for our guarantee business. These commitments provide for the lenders to deliver us a specified dollar amount or minimum percentage of their total sales of conforming loans. If a mortgage lender fails to meet its contractual commitment, we have a variety of contractual remedies, which may include the right to assess certain fees. Our mortgage purchase contracts contain no penalty or liquidated damages clauses based on our inability to take delivery of presented mortgage loans. However, if we were to fail to meet our contractual commitment, we could be deemed to be in breach of our contract and could be liable for damages in a lawsuit.

 

The purchase and securitization of mortgage loans from customers under these longer-term contracts have pricing schedules for our management and guarantee fees that are negotiated at the outset of the contract with initial terms typically ranging from three months to one year. We call these transactions “flow” 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 management and guarantee fees are negotiated on an individual transaction basis. Mortgage purchase volumes from individual customers can fluctuate significantly. Given the uncertainty of the housing market in 2009, we entered into arrangements with existing customers at their 2009 renewal dates that allow us to change credit and pricing terms faster than in the past; among other things, we are seeking to renew such arrangements for shorter terms than in the past. These arrangements, as well as significant customer consolidation discussed above, may increase volatility of flow-business activity with these customers in the future.

 

Securitization Activities

 

We seek to securitize substantially all of the newly or recently originated single-family mortgages we have purchased and issue PCs that can be sold to investors or held by us. As discussed below, we guarantee these mortgage-related securities in exchange for compensation. We seek to generally hold PCs instead of single-family mortgage loans for investment purposes, primarily to provide us with flexibility in determining what to sell or hold and to allow for more cost effective interest-rate risk management.

 

The compensation we receive in exchange for our guarantee activities consists primarily of a combination of management and guarantee fees paid on a monthly basis as a percentage of the underlying unpaid principal balance of the loans and initial upfront payments referred to as delivery fees. We recognize the fair value of the right to receive ongoing management and guarantee fees as a guarantee asset at the inception of a guarantee. We subsequently account for the guarantee asset like a debt security which performs similarly to an excess-servicing, interest-only mortgage security, classified as trading, and reflect changes in the fair value of the guarantee asset in earnings. We recognize a guarantee obligation at inception equal to the fair value of the compensation received. The guarantee obligation represents deferred revenue that is amortized into earnings as we are relieved from risk under the guarantee. We may also make upfront payments to buy-up the monthly management and guarantee fee rate, or receive upfront payments to buy-down the monthly management and guarantee fee rate. These fees are paid in conjunction with the formation of a PC to provide for a uniform PC coupon rate. For information on how we account for our securitization activities, including changes as a result of amendments to the accounting standards for transfers of financial assets and consolidation of VIEs, see “NOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES” to our consolidated financial statements.

 

The guarantee we provide 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

 

Our PCs are pass-through securities that represent undivided beneficial interests in trusts that own pools of mortgages we have purchased. For our fixed-rate PCs, we guarantee the timely payment of interest and the timely payment of principal. For our ARM PCs, we guarantee the timely payment of the weighted average coupon interest rate for the underlying mortgage loans. We also guarantee the full and final payment of principal for ARM PCs; however, we do not guarantee the timely payment of principal on ARM PCs. In exchange for providing this guarantee, we receive a management and guarantee fee and up-front delivery fees. We issue most of our PCs in transactions in which our customers exchange mortgage loans for PCs. We refer to these transactions as guarantor swaps. The following diagram illustrates a guarantor swap transaction:

 

Guarantor Swap

 

 

We also issue PCs in exchange for cash. The following diagram illustrates an exchange for cash in a “cash auction” of PCs:

 

Cash Auction of PCs

 

 

Institutional and other fixed-income investors, including pension funds, insurance companies, securities dealers, money managers, commercial banks and foreign central banks, purchase our PCs. Treasury and the Federal Reserve have also purchased mortgage-related securities issued by us, Fannie Mae and Ginnie Mae under their purchase programs. Treasury’s purchase program was announced in September 2008 and ended in December 2009. The Federal Reserve’s purchase program was announced in November 2008 and is expected to be completed by the end of the first quarter of 2010. For information on the potential impact of the completion of the Federal Reserve’s mortgage-related securities purchase program on our business, see “MD&A — LIQUIDITY AND CAPITAL RESOURCES — Liquidity.”

 

PCs differ from U.S. Treasury securities and other fixed-income investments in two ways. First, they can be prepaid at any time because homeowners can pay off the underlying mortgages at any time prior to a loan’s maturity. Because homeowners have the right to prepay their mortgage, the securities implicitly have a call option that significantly reduces the average life of the security as compared to the contractual loan maturity. Consequently, mortgage-related securities such as our PCs generally provide a higher nominal yield than certain other fixed-income products. Second, PCs are not backed by the full faith and credit of the United States, as are U.S. Treasury securities.

 

Structured Securities

 

Our Structured Securities represent beneficial interests in pools of PCs and certain other types of mortgage-related assets. We create Structured Securities primarily by using PCs or previously issued Structured Securities as the underlying collateral. Similar to our PCs, we guarantee the payment of principal and interest to the holders of tranches of our Structured Securities. We do not charge a management and guarantee fee for Structured Securities, other than Structured Transactions,

 

because the underlying collateral is already guaranteed. The following diagram provides an example of how we create a Structured Security:

 

Structured Security

 

 

We issue single-class Structured Securities and multi-class Structured Securities. Because the collateral underlying Structured Securities consists of other guaranteed mortgage-related securities, there are no concentrations of credit risk in any of the classes of Structured Securities that are issued, and there are no economic residual interests in the underlying securitization trust.

 

Single-class Structured Securities involve the straight pass through of all of the cash flows of the underlying collateral. Multi-class Structured Securities divide all of the cash flows of the underlying mortgage-related assets into two or more classes designed to meet the investment criteria and portfolio needs of different investors by creating classes of securities with varying maturities, payment priorities and coupons, each of which represents a beneficial ownership interest in a separate portion of the cash flows of the underlying collateral. Usually, the cash flows are divided to modify the relative exposure of different classes to interest-rate risk, or to create various coupon structures. The simplest division of cash flows is into principal-only and interest-only classes. Other securities we issue can involve the creation of sequential payment and planned or targeted amortization classes. In a sequential payment class structure, one or more classes receive all or a disproportionate percentage of the principal payments on the underlying mortgage assets for a period of time until that class or classes is retired, following which the principal payments are directed to other classes. Planned or targeted amortization classes involve the creation of classes that have relatively more predictable amortization schedules across different prepayment scenarios, thus reducing prepayment risk, extension risk, or both.

 

Our principal multi-class Structured Securities qualify for tax treatment as REMICs. 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. For Structured Securities that we issue to third parties in exchange for guaranteed mortgage-related securities, we receive a transaction, or resecuritization, fee. This transaction fee is compensation for facilitating the transaction, as well as future administrative responsibilities. We also sell Structured Securities to securities dealers in exchange for cash.

 

Structured Transactions

 

We also issue Structured Securities to third parties in exchange for non-Freddie Mac mortgage-related securities. We refer to these as Structured Transactions. The non-Freddie Mac mortgage-related securities are transferred to trusts that were specifically created for the purpose of issuing securities, or certificates, in the Structured Transactions. The following diagram illustrates an example of a Structured Transaction:

 

Structured Transactions

 

 

Structured Transactions can generally be segregated into two different types. In one type, we purchase only senior tranches from a non-Freddie Mac senior-subordinated securitization, place these senior tranches into securitization trusts, provide a guarantee of the principal and interest of these senior tranches, and issue the Structured Transaction certificates. For other Structured Transactions, we purchase single-class pass-through securities, place them in securitization trusts, guarantee the principal and interest, and issue the Structured Transaction certificates. In exchange for providing our guarantee, we may receive a management and guarantee fee or other delivery fees.

 

Although Structured Transactions generally have underlying mortgage loans with varying risk characteristics, we do not issue tranches that have concentrations of credit risk beyond that embedded in the underlying assets, as all cash flows of the underlying collateral are passed through to the holders of the securities and there are no economic residual interests in the securitization trusts. Further, the senior tranches we purchase to back the Structured Transactions benefit from credit protections from the related subordinated tranches, which we do not purchase. Additionally, there are other credit enhancements and structural features retained by the seller, such as excess interest or overcollateralization, that provide credit protection to our interests, and reduce the likelihood that we will have to perform under our guarantee of the senior tranches. Structured Transactions backed by single-class pass-through securities do not benefit from structural or other credit enhancement protections.

 

In 2009, we entered into transactions under Treasury’s NIBI, with state and local housing finance agencies, or HFAs, for the partial guarantee of certain single-family and multifamily HFA bonds, which are Structured Transactions with significant credit enhancement provided by Treasury. The securities issued by us pursuant to the NIBI were purchased by Treasury. See “MD&A — MHA PROGRAM AND OTHER EFFORTS TO ASSIST THE U.S. HOUSING MARKET” for further information.

 

We 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. During 2009 and 2008, we

 

permitted lenders to deliver to us a significant portion of the loans covered by the long-term standby commitments to be securitized as PCs or Structured Transactions, which totaled $5.7 billion and $19.9 billion in issuances during 2009 and 2008, respectively.

 

In 2009, we entered into transactions under Treasury’s TCLFI, with certain HFAs for the guarantee of certain variable rate demand obligations, or VRDOs, issued by the HFAs. In these transactions we do not issue a new security, but issue a financial guarantee to credit enhance the bonds for investors and provide liquidity support. At the expiration of each of these facilities, any VRDOs purchased by us will be securitized and sold to Treasury. See “MD&A — MHA PROGRAM AND OTHER EFFORTS TO ASSIST THE U.S. HOUSING MARKET” for further information.

 

For information about the amount of mortgage-related securities we have issued, refer to “MD&A — OUR PORTFOLIOS — Table 79 — Issued Guaranteed PCs and Structured Securities.” For information about the relative performance of these securities, refer to our “MD&A — RISK MANAGEMENT — Credit Risks” section.

 

PC Trust Documents

 

We establish trusts for all of our issued PCs pursuant to our PC master trust agreement. In accordance with the terms of our PC trust documents, we have the option, and in some instances the requirement, to purchase specified mortgage loans from the trust. We purchase these mortgages at an amount equal to the current unpaid principal balance, less any outstanding advances of principal on the mortgage that have been distributed to PC holders. From time to time, we reevaluate our delinquent loan purchase practices and alter them if circumstances warrant. Through November 2007, our general practice was to purchase the mortgage loans out of PCs after the loans became 120 days delinquent. Effective December 2007, our practice is to purchase mortgages from pools underlying our PCs when:

 

 

On February 10, 2010, we announced that we will purchase substantially all single-family mortgage loans that are 120 days or more delinquent underlying our issued PCs and Structured Securities. The decision to effect these purchases was made based on a determination that the cost of guarantee payments to the security holders will exceed the cost of holding non-performing loans on our consolidated balance sheets. The cost of holding non-performing loans on our consolidated balance sheets was significantly affected by the required adoption of new amendments to accounting standards and changing economics. Due to our January 1, 2010 adoption of new accounting standards for transfers of financial assets and the consolidation of VIEs, the cost of purchasing most delinquent loans from PCs will be less than the cost of continued guarantee payments to security holders. As of December 31, 2009, the total unpaid principal balance of such mortgages was approximately $70.2 billion. We will continue to review the economics of purchasing loans 120 days or more delinquent in the future and we may reevaluate our delinquent loans purchase practices and alter them if circumstances warrant.

 

In accordance with the terms of our PC trust documents, we are required to purchase a mortgage loan (or, in some cases, substitute a comparable mortgage loan) from a PC trust in the following situations:

 

 

The To Be Announced (TBA) Market

 

Because our fixed-rate PCs are homogeneous, issued in high volume and highly liquid, they trade on a “generic” basis by PC coupon rate, also referred to as trading in the 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 specific PCs that will be delivered to fulfill the trade obligation, and thus the specific 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 financing, thereby helping us to accomplish our statutory mission.

 

SIFMA publishes guidelines pertaining to the types of mortgages that are eligible for TBA trades. Mortgages eligible for purchase by us due to the temporary increase to the conforming loan limits established by the Economic Stimulus Act of 2008 are not eligible for inclusion in TBA pools. However, SIFMA has permitted mortgages that are eligible for purchase by us due to the increase to loan limits for certain high-cost areas under the Reform Act, which we refer to as “super-conforming” mortgages, to constitute up to 10% of the original principal balance of TBA pools.

 

Credit Risk

 

Our Single-family Guarantee segment is responsible for pricing and managing credit risk related to single-family loans, including single-family loans underlying our PCs. For more information regarding credit risk, see “MD&A — RISK MANAGEMENT — Credit Risks” and “NOTE 7: MORTGAGE LOANS AND LOAN LOSS RESERVES” to our consolidated financial statements.

 

Multifamily Segment

 

Through our Multifamily segment, we guarantee, securitize and invest in multifamily mortgages and CMBS. We also securitize and guarantee the payment of principal and interest on multifamily mortgage-related securities and mortgages underlying multifamily housing revenue bonds. The mortgage loans held in the Multifamily segment are secured by properties with five or more residential rental units. These loans may have either adjustable or fixed interest rates, and some may have an interest-only period that converts to amortizing at a future date. The loans are generally structured as balloon mortgages with terms ranging from five to ten years and include provisions for the payment of yield maintenance fees to us if the mortgage is paid prior to the end of its term. Our multifamily mortgage products, services and initiatives primarily finance rental housing for low- and moderate-income families.

 

Prior to 2008, we purchased and held multifamily loans for investment purposes. In 2008, we began purchasing certain multifamily mortgages and designating them as held-for-sale, as part of our expansion of multifamily security products. In 2009, we increased our securitization of multifamily loans through the issuance of Structured Transactions totaling $2.4 billion in unpaid principal balance. We expect to continue purchasing multifamily loans and designating them as held-for-sale as part of our further expansion of multifamily securitization transactions in 2010. We may also sell multifamily loans from time to time.

 

The multifamily property market is affected by the relative affordability of single-family home prices, construction cycles, and general economic factors, such as employment rates, all of which influence the supply and demand for apartments and pricing for rentals. Our multifamily loan volume is largely sourced through established institutional channels where we are generally providing post-construction financing to large apartment project operators with established track records. Property location and rental cash flows provide support to capitalization values on multifamily properties, on which investors base lending decisions.

 

The market for multifamily properties relies on having successful apartment developers and operators to develop, administer and maintain the properties. Many such companies experienced significant financial difficulties in 2009 due to the challenging market conditions. As a result, the ability of multifamily apartment developers and operators to continue to support new property development and invest in existing properties is limited. This could result in lower capacity for industry growth and reduced expenditures on improvements of existing properties.

 

Our Multifamily segment also includes certain investments in LIHTC partnerships formed for the purpose of providing equity funding for affordable multifamily rental properties. In these investments, we provide equity contributions to partnerships designed to sponsor the development and ongoing operations for low- and moderate-income multifamily apartments and, we planned to realize a return on our investment through reductions in income tax expense that result from federal income tax credits and the deductibility of operating losses generated by the partnerships. However, we are no longer investing in these partnerships to support the low- and moderate-income rental markets, because we do not expect to be able to use the underlying federal income tax credits or the operating losses generated from the partnerships as a reduction to our taxable income because of our inability to generate sufficient taxable income. See “NOTE 5: VARIABLE INTEREST ENTITIES” to our consolidated financial statements for additional information.

 

We also guarantee the payment of principal and interest on multifamily mortgage loans and securities that are originated and held by state and municipal housing finance 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. See “MD&A — MHA PROGRAM AND OTHER EFFORTS TO ASSIST THE U.S. HOUSING MARKET” for further information.

 

Our Competition

 

Historically, our principal competitors have been Fannie Mae, the FHLBs, Ginnie Mae and other financial institutions that retain or securitize mortgages, such as commercial and investment banks, dealers, thrift institutions, and insurance companies. Since 2008, most of our competitors, other than Fannie Mae, the FHLBs and Ginnie Mae, have ceased their

 

activities in the residential mortgage securitization business or severely curtailed these activities relative to their previous levels. We compete on the basis of price, products, structure and service.

 

The conservatorship, including direction provided to us by our Conservator, and the restrictions on our activities under the Purchase Agreement may affect our ability to compete in the business of retaining and securitizing mortgages. Ginnie Mae, which became a more significant competitor during 2008, guarantees the timely payment of principal and interest on mortgage-related securities backed by federally insured or guaranteed loans, primarily those insured by FHA or guaranteed by VA. Ginnie Mae’s growth has been primarily due to competitive pricing of Ginnie Mae securities, which are backed by the full faith and credit of the U.S. government, the increase in the FHA loan limit and the availability, through FHA, of a mortgage product for borrowers seeking greater than 80% financing who could not otherwise qualify for conventional mortgages.

 

Employees

 

At February 11, 2010, we had 5,323 full-time and 85 part-time employees. Our principal offices are located in McLean, Virginia.

 

Available Information

 

SEC Reports

 

We file reports, proxy statements and other information with the SEC. We make available free of charge through our website at www.freddiemac.com our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and all other SEC reports and amendments to those reports as soon as reasonably practicable after we electronically file the material with, or furnish it to, the SEC. (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 annual report on Form 10-K to incorporate additional information into this annual report on Form 10-K.) In addition, our Forms 10-K, 10-Q and 8-K, and other information filed with the SEC, are available for review and copying free of charge at the SEC’s Public Reference Room at 100 F Street, N.E., Room 1580, Washington, D.C. 20549. The public may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC also maintains an Internet site (www.sec.gov) that contains reports, proxy and information statements, and other information regarding companies that file electronically with the SEC. 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 Audit, Business and Risk, Compensation, Executive and Nominating and Governance committees of the Board of Directors are also available on our website at www.freddiemac.com.

 

During the conservatorship, we do not expect to prepare or provide proxy statements for the solicitation of proxies from stockholders. Accordingly, rather than incorporating information that is required by Form 10-K by reference to such a proxy statement, we will provide such information by filing an amendment to our Form 10-K on or before April 30, 2010.

 

Information about Certain Securities Issuances by Freddie Mac

 

Pursuant to SEC regulations, public companies are required to disclose certain information when they incur a material direct financial obligation or become directly or contingently liable for a material obligation under an off-balance sheet arrangement. The disclosure must be made in a current report on Form 8-K under Item 2.03 or, if the obligation is incurred in connection with certain types of securities offerings, in prospectuses for that offering that are filed with the SEC.

 

Freddie Mac’s securities offerings are exempted from SEC registration requirements. As a result, we are not required to and do not file registration statements or prospectuses with the SEC with respect to our securities offerings. To comply with the disclosure requirements of Form 8-K relating to the incurrence of material financial obligations, we report our incurrence of these types of obligations either in offering circulars (or supplements thereto) that we post on our website or in a current report on Form 8-K, in accordance with a “no-action” letter we received from the SEC staff. In cases where the information is disclosed in an offering circular posted on our website, the document will be posted on our website within the same time period that a prospectus for a non-exempt securities offering would be required to be filed with the SEC.

 

The website address for disclosure about our debt securities is www.freddiemac.com/debt. From this address, investors can access the offering circular and related supplements for debt securities offerings under Freddie Mac’s global debt facility, including pricing supplements for individual issuances of debt securities.

 

Disclosure about our off-balance sheet obligations pursuant to some of the mortgage-related securities we issue can be found at www.freddiemac.com/mbs. From this address, investors can access information and documents about our mortgage-related securities, including offering circulars and related offering circular supplements.

 

We are providing our website addresses and the website address of the SEC solely for your information. Information appearing on our website or on the SEC’s website is not incorporated into this annual report on Form 10-K.

 

Conservatorship and Related Developments

 

On September 7, 2008, the then Secretary of the Treasury and the then Director of FHFA announced several actions taken by Treasury and FHFA regarding Freddie Mac and Fannie Mae. At that time, FHFA set forth the purpose and goals of the conservatorship as follows: “The purpose of appointing the Conservator is to preserve and conserve the company’s assets and property and to put the company in a sound and solvent condition. The goals of the conservatorship are to help restore confidence in Fannie Mae and Freddie Mac, enhance their capacity to fulfill their mission, and mitigate the systemic risk that has contributed directly to the instability in the current market.” These actions included the following:

 

 

We refer to the Purchase Agreement, the warrant, and the Lending Agreement as the “Treasury Agreements.”

 

Entry Into Conservatorship

 

Upon its appointment, FHFA, as Conservator, immediately succeeded to all rights, titles, powers and privileges of Freddie Mac, and of any stockholder, officer or director of Freddie Mac with respect to Freddie Mac and its assets, and succeeded to the title to all books, records and assets of Freddie Mac held by any other legal custodian or third party. During the conservatorship, the Conservator delegated certain authority to the Board of Directors to oversee, and management to conduct, day-to-day operations so that the company can continue to operate in the ordinary course of business. We describe the terms of the conservatorship and the powers of our Conservator in detail below under “Supervision of our Business During Conservatorship” and “Powers of the Conservator.”

 

There is significant uncertainty as to whether or when we will emerge from conservatorship, as it has no specified termination date, and as to what changes may occur to our business structure during or following our conservatorship, including whether we will continue to exist. However, we are not aware of any immediate plans of our Conservator to significantly change our business structure in the near-term.

 

We receive substantial support from Treasury, FHFA as our Conservator and regulator and the Federal Reserve. We are dependent upon the continued support of Treasury and FHFA in order to continue operating our business. Our ability to access funds from Treasury under the Purchase Agreement is critical to keeping us solvent and avoiding the appointment of a receiver by FHFA under statutory mandatory receivership provisions.

 

Impact of Conservatorship and Related Actions on Our Business

 

Our business objectives and strategies have in some cases been altered since we were placed into conservatorship, and may continue to change. Based on our charter, public statements from Treasury and FHFA officials and guidance from our Conservator, we have a variety of different, and potentially competing, objectives, including:

 

 

These objectives create conflicts in strategic and day-to-day decision making that will likely lead to suboptimal outcomes for one or more, or possibly all, of these objectives. We regularly receive direction from our Conservator on how to pursue these objectives. Given the important role the Obama Administration and our Conservator have placed on Freddie Mac in addressing housing and mortgage market conditions and our public mission, we may be required to take additional actions that could have a negative impact on our business, operating results or financial condition. In a letter to the Chairmen and Ranking Members of the Congressional Banking and Financial Services Committees dated February 2, 2010, the Acting Director of FHFA stated that minimizing our credit losses is our central goal and that we will be limited to continuing our existing core business activities and taking actions necessary to advance the goals of the conservatorship. The Acting Director stated that FHFA does not expect we will be a substantial buyer or seller of mortgages for our mortgage-related investments portfolio, except for purchases of delinquent mortgages out of PC pools. The Acting Director also stated that permitting us to engage in new products is inconsistent with the goals of the conservatorship. This could limit our ability to return to profitability in future periods. For more information on our current business objectives and the effect of conservatorship on our business and our public mission, see “MD&A — EXECUTIVE SUMMARY — Business Objectives.”

 

On February 18, 2009, the Obama Administration announced the MHA Program. Participation in the MHA Program is an integral part of our mission of providing stability to the housing market, including helping families maintain ownership whenever possible and helping maintain the stability of communities. The MHA Program and related initiatives include:

 

 

For more information on these programs, see “MD&A — MHA PROGRAM AND OTHER EFFORTS TO ASSIST THE U.S. HOUSING MARKET.”

 

Because we expect many of these objectives and related initiatives to result in significant costs, there is significant uncertainty as to the ultimate impact these activities will have on our future capital or liquidity needs. However, we believe that the support provided by Treasury, as described in “MD&A — LIQUIDITY AND CAPITAL RESOURCES — Liquidity,” is sufficient to ensure that we maintain our access to the debt markets, maintain positive net worth and have adequate liquidity to continue to conduct our normal business activities over the next three years. Management is continuing its efforts to identify and evaluate actions that could be taken to reduce the significant uncertainties surrounding our business, as well as the level of future draws under the Purchase Agreement; however, our ability to pursue such actions may be limited by market conditions and other factors. Any actions we take will likely require approval by FHFA and Treasury before they are implemented. In addition, FHFA, Treasury or Congress may have a different perspective than management and may direct us to focus our efforts on supporting the mortgage markets in ways that make it more difficult for us to implement any such actions. These actions and objectives also create risks and uncertainties that we discuss in “RISK FACTORS.”

 

Overview of the Purchase Agreement

 

The Conservator, acting on our behalf, entered into the Purchase Agreement on September 7, 2008. The Purchase Agreement was subsequently amended and restated on September 26, 2008, and further amended on May 6, 2009 and December 24, 2009. Under the Purchase Agreement, Treasury made a commitment to provide up to $200 billion in funding under specified conditions. The $200 billion cap on Treasury’s funding commitment will increase as necessary to accommodate any cumulative reduction in our net worth during 2010, 2011 and 2012. The Purchase Agreement requires Treasury, upon the request of the Conservator, to provide funds to us after any quarter in which we have a negative net worth (that is, our total liabilities exceed our total assets, as reflected on our GAAP balance sheet). In addition, the Purchase Agreement requires Treasury, upon the request of the Conservator, to provide funds to us if the Conservator determines, at any time, that it will be mandated by law to appoint a receiver for us unless we receive these funds from Treasury. In exchange for Treasury’s funding commitment, we issued to Treasury, as an aggregate initial commitment fee: (1) one million shares of Variable Liquidation Preference Senior Preferred Stock (with an initial liquidation preference of $1 billion), which we refer to as the senior preferred stock; and (2) a warrant to purchase, for a nominal price, shares of our common stock equal to 79.9% of the total number of shares of our common stock outstanding on a fully diluted basis at the time the warrant is exercised, which we refer to as the warrant. We received no other consideration from Treasury for issuing the senior preferred stock or the warrant.

 

Under the terms of the Purchase Agreement, Treasury is entitled to a dividend of 10% per year, paid on a quarterly basis (which increases to 12% per year if not paid timely and in cash) on the aggregate liquidation preference of the senior preferred stock, consisting of the initial liquidation preference of $1 billion plus funds we receive from Treasury and any dividends and commitment fees not paid in cash. To the extent we draw on Treasury’s funding commitment, the liquidation preference of the senior preferred stock is increased by the amount of funds we receive. The senior preferred stock is senior in liquidation preference to our common stock and all other series of preferred stock. In addition, beginning on March 31, 2011, we are required to pay a quarterly commitment fee to Treasury, which will accrue beginning on January 1, 2011. We are required to pay this fee each quarter for as long as the Purchase Agreement is in effect. The amount of this fee must be determined on or before December 31, 2010.

 

As a result of draws under the Purchase Agreement, the aggregate liquidation preference of the senior preferred stock has increased from $1.0 billion as of September 8, 2008 to $51.7 billion as of December 31, 2009. Our annual dividend obligation on the senior preferred stock, based on that liquidation preference, is $5.2 billion, which is in excess of our annual historical earnings in most periods.

 

Under the Purchase Agreement, our ability to repay the liquidation preference of the senior preferred stock is limited and we may not be able to do so for the foreseeable future, if at all. The aggregate liquidation preference of the senior preferred stock and our related dividend obligations will increase further as a result of any additional draws under the

 

Purchase Agreement or any dividends or quarterly commitment fees payable under the Purchase Agreement that are not paid in cash. The amounts payable for dividends on the senior preferred stock are substantial and will have an adverse impact on our financial position and net worth.

 

The payment of dividends on our senior preferred stock in cash reduces our net worth. For periods in which our earnings and other changes in equity do not result in positive net worth, draws under the Purchase Agreement effectively fund the cash payment of senior preferred dividends to Treasury.

 

The continuing weakness in the financial and housing markets, further GAAP net losses and our implementation on January 1, 2010 of changes to the accounting standards for transfers of financial assets and consolidation of VIEs make it more likely that we will continue to have additional draws under the Purchase Agreement in future periods. There is significant uncertainty as to our future capital structure and long-term financial sustainability, and there are likely to be significant changes to our current capital structure and business model beyond the near-term that we expect to be decided by Congress and the Executive Branch.

 

On February 18, 2010, we received a letter from the Acting Director of FHFA stating that FHFA has determined that any sale of the LIHTC investments by Freddie Mac would require Treasury’s consent under the terms of the Purchase Agreement. The letter further stated that FHFA had presented other options for Treasury to consider, including allowing Freddie Mac to pay senior preferred stock dividends by waiving the right to claim future tax benefits of the LIHTC investments. However, after further consultation with Treasury and consistent with the terms of the Purchase Agreement, the Acting Director informed us we may not sell or transfer the assets and that he sees no other disposition options. As a result, we wrote down the carrying value of our LIHTC investments to zero as of December 31, 2009, resulting in a loss of $3.4 billion. This write-down reduces our net worth at December 31, 2009 and, as such, increases the likelihood that we will require additional draws from Treasury under the Purchase Agreement and, as a consequence, increases the likelihood that our dividend obligation on the senior preferred stock will increase. See “NOTE 5: VARIABLE INTEREST ENTITIES” to our consolidated financial statements for additional information.

 

The Purchase Agreement includes significant restrictions on our ability to manage our business, including limiting the amount of indebtedness we can incur and capping the size of our mortgage-related investments portfolio as of December 31, 2009. See “MD&A — OUR PORTFOLIOS” for a description and composition of our portfolios. While the senior preferred stock is outstanding, we are prohibited from paying dividends (other than on the senior preferred stock) or issuing equity securities without Treasury’s consent.

 

The Purchase Agreement has an indefinite term and can terminate only in limited circumstances, which do not include the end of the conservatorship. The Purchase Agreement therefore could continue after the conservatorship ends. Treasury has the right to exercise the warrant, in whole or in part, at any time on or before September 7, 2028. We provide more detail about the provisions of the Purchase Agreement, the senior preferred stock and the warrant, the limited circumstances under which those agreements terminate, and the limitations they place on our ability to manage our business under “Treasury Agreements” below. See “RISK FACTORS” for a discussion of how the restrictions under the Purchase Agreement may have a material adverse effect on our business.

 

Supervision of our Business During Conservatorship

 

We experienced a change in control when we were placed into conservatorship on September 6, 2008. Under conservatorship, we have additional heightened supervision and direction from our regulator, FHFA, which is also acting as our Conservator. As Conservator, FHFA has succeeded to the powers of our Board of Directors and management, as well as the powers of our stockholders. During the conservatorship, the Conservator delegated certain authority to the Board of Directors to oversee, and management to conduct, day-to-day operations so that the company can continue to operate in the ordinary course of business. The Conservator retains the authority to withdraw its delegations of authority at any time.

 

Because the Conservator succeeded to the powers, including voting rights, of our stockholders, who therefore do not currently have voting rights of their own, we do not expect to hold stockholders’ meetings during the conservatorship, nor will we prepare or provide proxy statements for the solicitation of proxies.

 

Our Board of Directors and Management During Conservatorship

 

While in conservatorship, we can, and have continued to, enter into and enforce contracts with third parties. The Conservator continues to work with the Board of Directors and management to address and determine the strategic direction for the company.

 

The Conservator instructed the Board of Directors that it should consult with and obtain the approval of the Conservator before taking action in the following areas:

 

 

 

 

Powers of the Conservator

 

The Reform Act, which was signed into law on July 30, 2008, replaced the conservatorship provisions previously applicable to Freddie Mac with conservatorship provisions based generally on federal banking law. As discussed below, FHFA has broad powers when acting as our conservator. For more information on the Reform Act, see “Regulation and Supervision.”

 

General Powers of the Conservator

 

Upon its appointment, the Conservator immediately succeeded to all rights, titles, powers and privileges of Freddie Mac, and of any stockholder, officer or director of Freddie Mac with respect to Freddie Mac and its assets. The Conservator also succeeded to the title to all books, records and assets of Freddie Mac held by any other legal custodian or third party.

 

Under the Reform Act, the Conservator may take any actions it determines are necessary and appropriate to carry on our business, support public mission objectives, and preserve and conserve our assets and property. The Conservator’s powers include the ability to transfer or sell any of our assets or liabilities (subject to certain limitations and post-transfer notice provisions for transfers of qualified financial contracts, as defined below under “Special Powers of the Conservator — Security Interests Protected; Exercise of Rights Under Qualified Financial Contracts”) without any approval, assignment of rights or consent of any party. The Reform Act, however, provides that mortgage loans and mortgage-related assets that have been transferred to a Freddie Mac securitization trust must be held for the beneficial owners of the trust and cannot be used to satisfy our general creditors.

 

Under the Reform Act, in connection with any sale or disposition of our assets, the Conservator must conduct its operations to maximize the net present value return from the sale or disposition of such assets, to minimize the amount of any loss realized, and to ensure adequate competition and fair and consistent treatment of offerors. The Conservator is required to maintain a full accounting of the conservatorship and make its reports available upon request to stockholders and members of the public.

 

We remain liable for all of our obligations relating to our outstanding debt and mortgage-related securities. In a Fact Sheet dated September 7, 2008, FHFA indicated that our obligations will be paid in the normal course of business during the conservatorship.

 

Special Powers of the Conservator

 

Disaffirmance and Repudiation of Contracts

 

Under the Reform Act, the Conservator may disaffirm or repudiate contracts (subject to certain limitations for qualified financial contracts) that we entered into prior to its appointment as Conservator if it determines, in its sole discretion, that performance of the contract is burdensome and that disaffirmation or repudiation of the contract promotes the orderly administration of our affairs. The Reform Act requires FHFA to exercise its right to disaffirm or repudiate most contracts within a reasonable period of time after its appointment as Conservator. We can, and have continued to, enter into, perform and enforce contracts with third parties.

 

The Conservator has advised us that it has no intention of repudiating any guarantee obligation relating to Freddie Mac’s mortgage-related securities because it views repudiation as incompatible with the goals of the conservatorship.

 

In general, the liability of the Conservator for the disaffirmance or repudiation of any contract is limited to actual direct compensatory damages determined as of September 6, 2008, which is the date we were placed into conservatorship. The liability of the Conservator for the disaffirmance or repudiation of a qualified financial contract is limited to actual direct compensatory damages (which are deemed to include normal and reasonable costs of cover or other reasonable measure of damages utilized in the industries for such contract and agreement claims paid in accordance with the Reform Act) determined as of the date of the disaffirmance or repudiation. If the Conservator disaffirms or repudiates any lease to or from us, or any contract for the sale of real property, the Reform Act specifies the liability of the Conservator.

 

Limitations on Enforcement of Contractual Rights by Counterparties

 

The Reform Act provides that the Conservator may enforce most contracts entered into by us, notwithstanding any provision of the contract that provides for termination, default, acceleration, or exercise of rights upon the appointment of, or the exercise of rights or powers by, a conservator.

 

Security Interests Protected; Exercise of Rights Under Qualified Financial Contracts

 

Notwithstanding the Conservator’s powers under the Reform Act described above, the Conservator must recognize legally enforceable or perfected security interests, except where such an interest is taken in contemplation of our insolvency or with the intent to hinder, delay or defraud us or our creditors. In addition, the Reform Act provides that no person will be stayed or prohibited from exercising specified rights in connection with qualified financial contracts, including termination or acceleration (other than solely by reason of, or incidental to, the appointment of the Conservator), rights of offset, and rights under any security agreement or arrangement or other credit enhancement relating to such contract. The term qualified financial contract means any securities contract, commodity contract, forward contract, repurchase agreement, swap agreement, and any similar agreement as determined by FHFA by regulation, resolution or order.

 

Avoidance of Fraudulent Transfers

 

Under the Reform Act, the Conservator may avoid, or refuse to recognize, a transfer of any property interest of Freddie Mac or of any of our debtors, and also may avoid any obligation incurred by Freddie Mac or by any debtor of Freddie Mac, if the transfer or obligation was made: (1) within five years of September 6, 2008; and (2) with the intent to hinder, delay, or defraud Freddie Mac, FHFA, the Conservator or, in the case of a transfer in connection with a qualified financial contract, our creditors. To the extent a transfer is avoided, the Conservator may recover, for our benefit, the property or, by court order, the value of that property from the initial or subsequent transferee, other than certain transfers that were made for value, including satisfaction or security of a present or antecedent debt, and in good faith. These rights are superior to any rights of a trustee or any other party, other than a federal agency, under the U.S. bankruptcy code.

 

Modification of Statutes of Limitations

 

Under the Reform Act, notwithstanding any provision of any contract, the statute of limitations with regard to any action brought by the Conservator is: (1) for claims relating to a contract, the longer of six years or the applicable period under state law; and (2) for tort claims, the longer of three years or the applicable period under state law, in each case, from the later of September 6, 2008 or the date on which the cause of action accrues. In addition, notwithstanding the state law statute of limitation for tort claims, the Conservator may bring an action for any tort claim that arises from fraud, intentional misconduct resulting in unjust enrichment, or intentional misconduct resulting in substantial loss to us, if the state’s statute of limitations expired not more than five years before September 6, 2008.

 

Suspension of Legal Actions

 

Under the Reform Act, in any judicial action or proceeding to which we are or become a party, the Conservator may request, and the applicable court must grant, a stay for a period not to exceed 45 days.

 

Treatment of Breach of Contract Claims

 

Under the Reform Act, any final and unappealable judgment for monetary damages against the Conservator for breach of an agreement executed or approved in writing by the Conservator will be paid as an administrative expense of the Conservator.

 

Attachment of Assets and Other Injunctive Relief

 

Under the Reform Act, the Conservator may seek to attach assets or obtain other injunctive relief without being required to show that any injury, loss or damage is irreparable and immediate.

 

Subpoena Power

 

The Reform Act provides the Conservator, with the approval of the Director of FHFA, with subpoena power for purposes of carrying out any power, authority or duty with respect to Freddie Mac.

 

Treasury Agreements

 

The Reform Act granted Treasury temporary authority (through December 31, 2009) to purchase any obligations and other securities issued by Freddie Mac on such terms and conditions and in such amounts as Treasury may determine, upon mutual agreement between Treasury and Freddie Mac. Pursuant to this authority, Treasury entered into several agreements with us, as described below.

 

Purchase Agreement and Related Issuance of Senior Preferred Stock and Common Stock Warrant

 

Purchase Agreement

 

On September 7, 2008, we, through FHFA, in its capacity as Conservator, and Treasury entered into the Purchase Agreement. The Purchase Agreement was subsequently amended and restated on September 26, 2008, and further amended on May 6, 2009 and December 24, 2009. Pursuant to the Purchase Agreement, on September 8, 2008 we issued to Treasury one million shares of senior preferred stock with an initial liquidation preference equal to $1,000 per share (for an aggregate liquidation preference of $1 billion), and a warrant for the purchase of our common stock. The terms of the senior preferred stock and warrant are summarized in separate sections below. We did not receive any cash proceeds from Treasury as a result of issuing the senior preferred stock or the warrant. However, as discussed below, deficits in our net worth have made it necessary for us to make substantial draws on Treasury’s funding commitment under the Purchase Agreement.

 

The senior preferred stock and warrant were issued to Treasury as an initial commitment fee in consideration of the initial commitment from Treasury to provide up to $100 billion (subsequently increased to $200 billion and further modified as described below) in funds to us under the terms and conditions set forth in the Purchase Agreement. Under the amendment to the Purchase Agreement adopted on December 24, 2009, the $200 billion cap on Treasury’s funding commitment will increase as necessary to accommodate any cumulative reduction in our net worth during 2010, 2011, and 2012. Specifically, the Purchase Agreement provides that the aggregate amount that may be funded under Treasury’s commitment may not exceed the greater of (a) $200 billion, or (b) $200 billion plus the cumulative total of deficiency amounts determined for calendar quarters in calendar years 2010, 2011, and 2012, less any surplus amount (defined as the amount by which our total assets exceed our total liabilities, as reflected on our balance sheet in accordance with GAAP) determined as of December 31, 2012.

 

In addition to the issuance of the senior preferred stock and warrant, beginning on March 31, 2011, we are required to pay a quarterly commitment fee to Treasury. This quarterly commitment fee will accrue beginning on January 1, 2011. The fee, in an amount to be mutually agreed upon by us and Treasury and to be determined with reference to the market value of Treasury’s funding commitment as then in effect, will be determined on or before December 31, 2010, and will be reset every five years. Treasury may waive the quarterly commitment fee for up to one year at a time, in its sole discretion, based on adverse conditions in the U.S. mortgage market. We may elect to pay the quarterly commitment fee in cash or add the amount of the fee to the liquidation preference of the senior preferred stock.

 

The Purchase Agreement provides that, on a quarterly basis, we generally may draw funds up to the amount, if any, by which our total liabilities exceed our total assets, as reflected on our GAAP balance sheet for the applicable fiscal quarter (referred to as the deficiency amount), provided that the aggregate amount funded under the Purchase Agreement may not exceed Treasury’s commitment. The Purchase Agreement provides that the deficiency amount will be calculated differently if we become subject to receivership or other liquidation process. The deficiency amount may be increased above the otherwise applicable amount upon our mutual written agreement with Treasury. In addition, if the Director of FHFA determines that the Director will be mandated by law to appoint a receiver for us unless our capital is increased by receiving funds under the commitment in an amount up to the deficiency amount (subject to the maximum amount that may be funded under the agreement), then FHFA, in its capacity as our Conservator, may request that Treasury provide funds to us in such amount. The Purchase Agreement also provides that, if we have a deficiency amount as of the date of completion of the liquidation of our assets, we may request funds from Treasury in an amount up to the deficiency amount (subject to the maximum amount that may be funded under the agreement). Any amounts that we draw under the Purchase Agreement will be added to the liquidation preference of the senior preferred stock. No additional shares of senior preferred stock are required to be issued under the Purchase Agreement. As a result, the expiration on December 31, 2009 of Treasury’s temporary authority to purchase obligations and other securities issued by Freddie Mac does not affect Treasury’s funding commitment under the Purchase Agreement.

 

The Purchase Agreement provides that the Treasury’s funding commitment will terminate under any of the following circumstances: (1) the completion of our liquidation and fulfillment of Treasury’s obligations under its funding commitment at that time; (2) the payment in full of, or reasonable provision for, all of our liabilities (whether or not contingent, including mortgage guarantee obligations); and (3) the funding by Treasury of the maximum amount of the commitment under the Purchase Agreement. In addition, Treasury may terminate its funding commitment and declare the Purchase Agreement null and void if a court vacates, modifies, amends, conditions, enjoins, stays or otherwise affects the appointment of the

 

Conservator or otherwise curtails the Conservator’s powers. Treasury may not terminate its funding commitment under the Purchase Agreement solely by reason of our being in conservatorship, receivership or other insolvency proceeding, or due to our financial condition or any adverse change in our financial condition.

 

The Purchase Agreement provides that most provisions of the agreement may be waived or amended by mutual written agreement of the parties; however, no waiver or amendment of the agreement is permitted that would decrease Treasury’s aggregate funding commitment or add conditions to Treasury’s funding commitment if the waiver or amendment would adversely affect in any material respect the holders of our debt securities or Freddie Mac mortgage guarantee obligations.

 

In the event of our default on payments with respect to our debt securities or Freddie Mac mortgage guarantee obligations, if Treasury fails to perform its obligations under its funding commitment and if we and/or the Conservator are not diligently pursuing remedies in respect of that failure, the holders of these debt securities or Freddie Mac mortgage guarantee obligations may file a claim in the United States Court of Federal Claims for relief requiring Treasury to fund to us the lesser of: (1) the amount necessary to cure the payment defaults on our debt and Freddie Mac mortgage guarantee obligations; and (2) the lesser of: (a) the deficiency amount; and (b) the maximum amount of the commitment less the aggregate amount of funding previously provided under the commitment. Any payment that Treasury makes under those circumstances will be treated for all purposes as a draw under the Purchase Agreement that will increase the liquidation preference of the senior preferred stock.

 

Issuance of Senior Preferred Stock

 

The senior preferred stock issued to Treasury under the Purchase Agreement was issued in partial consideration of Treasury’s commitment to provide funds to us under the terms set forth in the Purchase Agreement.

 

Shares of the senior preferred stock have a par value of $1, and have a stated value and initial liquidation preference equal to $1,000 per share. The liquidation preference of the senior preferred stock is subject to adjustment. Dividends that are not paid in cash for any dividend period will accrue and be added to the liquidation preference of the senior preferred stock. In addition, any amounts Treasury pays to us pursuant to its funding commitment under the Purchase Agreement and any quarterly commitment fees that are not paid in cash to Treasury nor waived by Treasury will be added to the liquidation preference of the senior preferred stock. As described below, we may make payments to reduce the liquidation preference of the senior preferred stock in limited circumstances.

 

Treasury, as the holder of the senior preferred stock, is entitled to receive, when, as and if declared by our Board of Directors, cumulative quarterly cash dividends at the annual rate of 10% per year on the then-current liquidation preference of the senior preferred stock. For the period from but not including September 8, 2008 through and including December 31, 2009, we have paid cash dividends of $4.3 billion at the direction of the Conservator. If at any time we fail to pay cash dividends in a timely manner, then immediately following such failure and for all dividend periods thereafter until the dividend period following the date on which we have paid in cash full cumulative dividends (including any unpaid dividends added to the liquidation preference), the dividend rate will be 12% per year.

 

The senior preferred stock is senior to our common stock and all other outstanding series of our preferred stock, as well as any capital stock we issue in the future, as to both dividends and rights upon liquidation. The senior preferred stock provides that we may not, at any time, declare or pay dividends on, make distributions with respect to, or redeem, purchase or acquire, or make a liquidation payment with respect to, any common stock or other securities ranking junior to the senior preferred stock unless: (1) full cumulative dividends on the outstanding senior preferred stock (including any unpaid dividends added to the liquidation preference) have been declared and paid in cash; and (2) all amounts required to be paid with the net proceeds of any issuance of capital stock for cash (as described in the following paragraph) have been paid in cash. Shares of the senior preferred stock are not convertible. Shares of the senior preferred stock have no general or special voting rights, other than those set forth in the certificate of designation for the senior preferred stock or otherwise required by law. The consent of holders of at least two-thirds of all outstanding shares of senior preferred stock is generally required to amend the terms of the senior preferred stock or to create any class or series of stock that ranks prior to or on parity with the senior preferred stock.

 

We are not permitted to redeem the senior preferred stock prior to the termination of Treasury’s funding commitment set forth in the Purchase Agreement; however, we are permitted to pay down the liquidation preference of the outstanding shares of senior preferred stock to the extent of (1) accrued and unpaid dividends previously added to the liquidation preference and not previously paid down; and (2) quarterly commitment fees previously added to the liquidation preference and not previously paid down. In addition, if we issue any shares of capital stock for cash while the senior preferred stock is outstanding, the net proceeds of the issuance must be used to pay down the liquidation preference of the senior preferred stock; however, the liquidation preference of each share of senior preferred stock may not be paid down below $1,000 per share prior to the termination of Treasury’s funding commitment. Following the termination of Treasury’s funding commitment, we may pay down the liquidation preference of all outstanding shares of senior preferred stock at any time, in

 

whole or in part. If, after termination of Treasury’s funding commitment, we pay down the liquidation preference of each outstanding share of senior preferred stock in full, the shares will be deemed to have been redeemed as of the payment date.

 

Issuance of Common Stock Warrant

 

Pursuant to the Purchase Agreement described above, on September 7, 2008, we, through FHFA, in its capacity as Conservator, issued a warrant to Treasury to purchase common stock. The warrant was issued to Treasury in partial consideration of Treasury’s commitment to provide funds to us under the terms set forth in the Purchase Agreement.

 

The warrant gives Treasury the right to purchase shares of our common stock equal to 79.9% of the total number of shares of our common stock outstanding on a fully diluted basis on the date of exercise. The warrant may be exercised in whole or in part at any time on or before September 7, 2028, by delivery to us of: (a) a notice of exercise; (b) payment of the exercise price of $0.00001 per share; and (c) the warrant. If the market price of one share of our common stock is greater than the exercise price, then, instead of paying the exercise price, Treasury may elect to receive shares equal to the value of the warrant (or portion thereof being canceled) pursuant to the formula specified in the warrant. Upon exercise of the warrant, Treasury may assign the right to receive the shares of common stock issuable upon exercise to any other person.

 

As of February 23, 2010, Treasury has not exercised the warrant.

 

Lending Agreement

 

On September 18, 2008, we entered into the Lending Agreement with Treasury, pursuant to which Treasury established a secured lending credit facility that was available to us as a liquidity back-stop. The Lending Agreement expired on December 31, 2009. Treasury’s temporary authority to enter into such an agreement also expired on December 31, 2009. We did not make any borrowings under the Lending Agreement.

 

Covenants Under Treasury Agreements

 

The Purchase Agreement and warrant contain covenants that significantly restrict our business activities. These covenants, which are summarized below, include a prohibition on our issuance of additional equity securities (except in limited instances), a prohibition on the payment of dividends or other distributions on our equity securities (other than on the senior preferred stock or warrant), a prohibition on our issuance of subordinated debt and a limitation on the total amount of debt securities we may issue. As a result, we can no longer obtain additional equity financing (other than pursuant to the Purchase Agreement) and we are limited in the amount and type of debt financing we may obtain.

 

Purchase Agreement Covenants

 

The Purchase Agreement provides that, until the senior preferred stock is repaid or redeemed in full, we may not, without the prior written consent of Treasury:

 

 

These covenants also apply to our subsidiaries.

 

The Purchase Agreement also provides that we may not own mortgage assets with an unpaid principal balance in excess of: (a) $900 billion on December 31, 2009; or (b) on December 31 of each year thereafter, 90% of the aggregate amount of

 

mortgage assets we are permitted to own as of December 31 of the immediately preceding calendar year, provided that we are not required to own less than $250 billion in mortgage assets. Under the Purchase Agreement, we also may not incur indebtedness that would result in the par value of our aggregate indebtedness exceeding 120% of the amount of mortgage assets we are permitted to own on December 31 of the immediately preceding calendar year. The mortgage asset and indebtedness limitations will be determined without giving effect to any change in the accounting standards related to transfers of financial assets and consolidation of VIEs or any similar accounting standard. Therefore, these limitations will not be affected by our implementation of the changes to the accounting standards for transfers of financial assets and consolidation of VIEs, under which we were required to consolidate our single-family PC trusts and certain of our Structured Transactions in our financial statements as of January 1, 2010.

 

In addition, the Purchase Agreement provides that we may not enter into any new compensation arrangements or increase amounts or benefits payable under existing compensation arrangements of any named executive officer or other executive officer (as such terms are defined by SEC rules) without the consent of the Director of FHFA, in consultation with the Secretary of the Treasury.

 

We are required under the Purchase Agreement to provide annual reports on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K to Treasury in accordance with the time periods specified in the SEC’s rules. In addition, our designated representative (which, during the conservatorship, is the Conservator) is required to provide quarterly certifications to Treasury concerning compliance with the covenants contained in the Purchase Agreement and the accuracy of the representations made pursuant to the agreement. We also are obligated to provide prompt notice to Treasury of the occurrence of specified events, such as the filing of a lawsuit that would reasonably be expected to have a material adverse effect. As of February 23, 2010, we believe we were in compliance with the covenants under the Purchase Agreement.

 

Warrant Covenants

 

The warrant we issued to Treasury includes, among others, the following covenants: (a) our SEC filings under the Exchange Act will comply in all material respects as to form with the Exchange Act and the rules and regulations thereunder; (b) we may not permit any of our significant subsidiaries to issue capital stock or equity securities, or securities convertible into or exchangeable for such securities, or any stock appreciation rights or other profit participation rights; (c) we may not take any action that will result in an increase in the par value of our common stock; (d) we may not take any action to avoid the observance or performance of the terms of the warrant and we must take all actions necessary or appropriate to protect Treasury’s rights against impairment or dilution; and (e) we must provide Treasury with prior notice of specified actions relating to our common stock, such as setting a record date for a dividend payment, granting subscription or purchase rights, authorizing a recapitalization, reclassification, merger or similar transaction, commencing a liquidation of the company or any other action that would trigger an adjustment in the exercise price or number or amount of shares subject to the warrant.

 

As of February 23, 2010, we believe we were in compliance with the covenants under the warrant.

 

Effect of Conservatorship and Treasury Agreements on Existing Stockholders

 

The conservatorship, the Purchase Agreement and the senior preferred stock and warrant issued to Treasury have materially limited the rights of our common and preferred stockholders (other than Treasury as holder of the senior preferred stock) and had the following adverse effects on our common and preferred stockholders:

 

 

 

As described above, the conservatorship and Treasury agreements also impact our business in ways that indirectly affect our common and preferred stockholders. By their terms, the Purchase Agreement, senior preferred stock and warrant will continue to exist even if we are released from the conservatorship. For a description of the risks to our business relating to the conservatorship and Treasury Agreements, see “RISK FACTORS.”

 

Treasury Mortgage-Related Securities Purchase Program

 

On September 7, 2008, Treasury announced a program to purchase GSE mortgage-related securities in the open market. This program expired on December 31, 2009. As of December 31, 2009, according to information provided by Treasury, it held $197.6 billion of GSE mortgage-related securities previously purchased under this program.

 

Federal Reserve Debt and Mortgage-Related Securities Purchase Program

 

On November 25, 2008, the Federal Reserve announced a program to purchase up to $100 billion (subsequently increased to $200 billion) of direct obligations of Freddie Mac, Fannie Mae and the FHLBs, and up to $500 billion (subsequently increased to $1.25 trillion) of mortgage-related securities issued by Freddie Mac, Fannie Mae and Ginnie Mae. According to the Federal Reserve, the goal of this program is to reduce the cost and increase the availability of credit for the purchase of houses, which, in turn, should support housing markets and foster improved conditions in financial markets more generally. According to the Federal Reserve, its purchases of direct obligations of Freddie Mac, Fannie Mae and the FHLBs are intended to reduce the interest rate spreads between these direct obligations and debt issued by Treasury. The Federal Reserve is purchasing these direct obligations and mortgage-related securities from primary dealers. The Federal Reserve began purchasing direct obligations and mortgage-related securities under the program in December 2008 and January 2009, respectively. On September 23, 2009, the Federal Reserve announced that it would gradually slow the pace of purchases under the program in order to promote a smooth transition in markets and anticipates that its purchases under this program will be completed by the end of the first quarter of 2010. On November 4, 2009, the Federal Reserve announced that it was reducing the maximum amount of its purchases of direct obligations of Freddie Mac, Fannie Mae and the FHLBs under this program to $175 billion. As of February 10, 2010, according to information provided by the Federal Reserve, it held $64.1 billion of our direct obligations and purchased $400.9 billion of our mortgage-related securities under this program.

 

Regulation and Supervision

 

We experienced a number of significant changes in our regulatory and supervisory environment as a result of the enactment of the Reform Act, which was signed into law on July 30, 2008 as part of The Housing and Economic Recovery Act of 2008, as well as our entry into conservatorship. The Reform Act consolidated regulation of Freddie Mac, Fannie Mae and the FHLBs into a single regulator, FHFA.

 

Federal Housing Finance Agency

 

FHFA is an independent agency of the federal government responsible for oversight of the operations of Freddie Mac, Fannie Mae and the FHLBs. FHFA has a Director appointed by the President and confirmed by the Senate for a five-year term, removable only for cause. In the discussion below, we refer to Freddie Mac and Fannie Mae as the “enterprises.”

 

The Reform Act established the Federal Housing Finance Oversight Board, or the Oversight Board, which is responsible for advising the Director of FHFA with respect to overall strategies and policies. The Oversight Board consists of the Director of FHFA as Chairperson, the Secretary of the Treasury, the Chair of the SEC and the Secretary of HUD.

 

The Reform Act provided FHFA with new safety and soundness authority that is comparable to, and in some respects, broader than that of the federal banking agencies. The Reform Act also gave FHFA enhanced powers that, even if we were not placed into conservatorship, include the authority to raise capital levels above statutory minimum levels, regulate the size and content of our mortgage-related investments portfolio, and approve new mortgage products.

 

FHFA is responsible for implementing the various provisions of the Reform Act. In general, we remain subject to existing regulations, orders and determinations until new ones are issued or made.

 

Receivership

 

Under the Reform Act, FHFA must place us into receivership if FHFA determines in writing that our assets are less than our obligations for a period of 60 days. FHFA has notified us that the measurement period for any mandatory receivership determination with respect to our assets and obligations would commence no earlier than the SEC public filing deadline for

 

our quarterly or annual financial statements and would continue for 60 calendar days after that date. FHFA has also advised us that, if, during that 60-day period, we receive funds from Treasury in an amount at least equal to the deficiency amount under the Purchase Agreement, the Director of FHFA will not make a mandatory receivership determination.

 

In addition, we could be put into receivership at the discretion of the Director of FHFA at any time for other reasons, including conditions that FHFA has already asserted existed at the time the then Director of FHFA placed us into conservatorship. These include: a substantial dissipation of assets or earnings due to unsafe or unsound practices; the existence of an unsafe or unsound condition to transact business; an inability to meet our obligations in the ordinary course of business; a weakening of our condition due to unsafe or unsound practices or conditions; critical undercapitalization; the likelihood of losses that will deplete substantially all of our capital; or by consent.

 

Capital Standards

 

FHFA has suspended capital classification of us during conservatorship in light of the Purchase Agreement. The existing statutory and FHFA-directed regulatory capital requirements will not be binding during the conservatorship. We continue to provide our regular submissions to FHFA on both minimum and risk-based capital. FHFA continues to publish relevant capital figures (minimum capital requirement, core capital, and GAAP net worth) but does not publish our critical capital, risk-based capital or subordinated debt levels during conservatorship.

 

On October 9, 2008, FHFA also announced that it will engage in rule-making to revise our minimum capital and risk-based capital requirements. The Reform Act provides that FHFA may increase minimum capital levels from the existing statutory percentages either by regulation or on a temporary basis by order. On February 8, 2010, FHFA issued a notice of proposed rulemaking setting forth procedures and standards for such a temporary increase in minimum capital levels. FHFA may also, by regulation or order, establish capital or reserve requirements with respect to any product or activity of an enterprise, as FHFA considers appropriate. In addition, under the Reform Act, FHFA must, by regulation, establish risk-based capital requirements to ensure the enterprises operate in a safe and sound manner, maintaining sufficient capital and reserves to support the risks that arise in their operations and management. In developing the new risk-based capital requirements, FHFA is not bound by the risk-based capital standards in effect prior to the enactment of the Reform Act.

 

Our regulatory minimum capital is a leverage-based measure that is generally calculated based on GAAP and reflects a 2.50% capital requirement for on-balance sheet assets and 0.45% capital requirement for off-balance sheet obligations. Based upon our adoption of amendments to the accounting standards for transfers of financial assets and consolidation of VIEs, we determined that, under the new consolidation guidance, we are the primary beneficiary of our single-family PC trusts and certain Structured Transactions and, therefore, effective January 1, 2010, we consolidated on our balance sheet the assets and liabilities of these trusts. Pursuant to regulatory guidance from FHFA, our minimum capital requirement will not automatically be affected by adoption of these amendments on January 1, 2010. Specifically, upon adoption of these amendments, FHFA directed us, for purposes of minimum capital, to continue reporting single-family PCs and certain Structured Transactions held by third parties using a 0.45% capital requirement. Notwithstanding this guidance, FHFA reserves the authority under the Reform Act to raise the minimum capital requirement for any of our assets or activities.

 

For additional information, see “MD&A — LIQUIDITY AND CAPITAL RESOURCES — Capital Resources” and “NOTE 11: REGULATORY CAPITAL” to our consolidated financial statements. Also, see “RISK FACTORS — Legal and Regulatory Risks” for more information.

 

Affordable Housing Goals

 

Prior to the enactment of the Reform Act, HUD had authority over Freddie Mac’s charter compliance and housing mission, including authority over our affordable housing goals, whereas the Office of Federal Housing Enterprise Oversight was the safety and soundness regulator over Freddie Mac. Those roles are now combined in FHFA.

 

Until 2009, our annual affordable housing goals, which are set as a percentage of the total number of dwelling units underlying our total mortgage purchases, had 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 defined 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 affordable” housing goal. This special affordable housing goal also includes a multifamily annual minimum dollar volume target of qualifying multifamily mortgage purchases. In addition, three subgoals were established that are expressed as percentages of the total number of mortgages we purchased that finance the purchase of single-family, owner-occupied properties located in metropolitan areas.

 

On July 28, 2009, FHFA issued a final rule that adjusted our goals for 2009 to the levels set forth in the table below. Except for the multifamily special affordable volume target, FHFA decreased all of the goals, as compared to those in effect for 2008.

 

Table 2 — Affordable Housing Goals for 2008 and 2009⁽¹⁾

 

 

The 2009 rule and related FHFA guidance permits loans we own or guarantee that are modified in accordance with the MHA Program to be treated as mortgage purchases and count toward the housing goals. In addition, the rule excludes “super-conforming” mortgages from the 2009 housing goals.

 

Effective beginning calendar year 2010, the Reform Act requires that FHFA establish, by regulation, four single-family housing goals, one multifamily special affordable housing goal and requirements relating to multifamily housing for very low-income families. In addition, the Reform Act establishes a duty for Freddie Mac and Fannie Mae to serve three underserved markets (manufactured housing, affordable housing preservation and rural areas) by developing loan products and flexible underwriting guidelines to facilitate a secondary market for mortgages for very low-, low- and moderate-income families in those markets. Effective for 2010, FHFA is required to establish a manner for annually: (1) evaluating whether and to what extent Freddie Mac and Fannie Mae have complied with the duty to serve underserved markets; and (2) rating the extent of compliance.

 

In a letter to the Chairmen and Ranking Members of the Congressional Banking and Financial Services Committees dated February 2, 2010, the Acting Director of FHFA stated that FHFA will in the near future publish for public comment a proposed rule setting the housing goals for 2010 and 2011 that will establish the framework for ensuring that our participation in the mortgage market includes support for the affordable housing segments of the market, consistent with our mission and with safety and soundness. The Acting Director also stated that FHFA does not intend for us to undertake uneconomic or high-risk activities in support of the housing goals nor does it intend for the state of conservatorship to be a justification for withdrawing our support from these market segments. The letter also stated that maintaining sound underwriting discipline going forward is important for conserving assets and supporting our mission in a sustainable manner.

 

On February 17, 2010, FHFA announced that it had sent to the Federal Register a proposed rule for public comment that would establish new affordable housing goals for 2010 and 2011. For 2010 and 2011, FHFA is proposing levels for three single-family home purchase goals: low-income families, very low-income families, and families in low-income/high minority/disaster areas. The proposed rule also contains goals for single-family refinance mortgages for low-income families. FHFA is also proposing separate multifamily goals for low-income families and for very low-income families. The proposed goals and the proposed rules governing our performance under such goals differ substantially from those in effect prior to 2010.

 

Our performance with respect to the affordable housing goals for 2007 and 2008 is summarized in the table below. FHFA determined that we met the goals for 2007, except for the low- and moderate-income home purchase subgoal and the special affordable home purchase subgoal, which were determined to be infeasible. In March 2009, we reported to FHFA that we achieved the 2008 multifamily special affordable dollar volume subgoal, but did not meet the other 2008 goals. We believe that achievement of these goals was infeasible in 2008 under the terms of the GSE Act, and accordingly submitted an infeasibility analysis to FHFA. In March 2009, FHFA notified us that it had determined that achievement of these goals was infeasible, with the exception of the underserved areas goal. Based on our financial condition in 2008, FHFA concluded that achievement by us of the underserved areas goal was feasible, but challenging. Accordingly, FHFA decided not to require us to submit a housing plan.

 

We expect to report our performance with respect to the 2009 affordable housing goals in March 2010. At this time, based on preliminary information, we believe we did not achieve certain of the goals for 2009. We believe, however, that achievement of such goals was infeasible under the terms of the GSE Act, due to market and economic conditions and our financial condition. Accordingly, we have submitted an infeasibility analysis to FHFA, which is reviewing our submission.

 

Table 3 — Affordable Housing Goals and Reported Results for 2007 and 2008⁽¹⁾

 

Housing Goals and Actual Results

 

 

We make adjustments to our mortgage loan sourcing and purchase strategies due to the goals. 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 the goals. Efforts to meet the goals could further increase our credit losses. We continue to evaluate the cost of these activities.

 

We anticipate that the difficult market conditions and our financial condition will continue to affect our affordable housing activities in 2010. See also “RISK FACTORS — Legal and Regulatory Risks.” However, we view the purchase of mortgage loans that are eligible to count toward our affordable housing goals to be a principal part of our mission and business and we are committed to facilitating the financing of affordable housing for low- and moderate-income families.

 

If the Director of FHFA finds 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 Director may require the submission of a housing plan with respect to the housing goal for approval by the Director. The housing plan must describe the actions we would take to achieve the unmet goal in the future. FHFA has the authority to take 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 effort to comply with a plan approved by FHFA; or (b) fail to submit certain data relating to our mortgage purchases, information or reports as required by law. See “RISK FACTORS — Legal and Regulatory Risks.”

 

New Products

 

The Reform Act requires the enterprises to obtain the approval of FHFA before initially offering any product, subject to certain exceptions. The Reform Act provides for a public comment process on requests for approval of new products. FHFA may temporarily approve a product without soliciting public comment if delay would be contrary to the public interest. FHFA may condition approval of a product on specific terms, conditions and limitations. The Reform Act also requires the enterprises to provide FHFA with written notice of any new activity that we or Fannie Mae consider not to be a product.

 

On July 2, 2009, FHFA published an interim final rule on prior approval of new products, implementing the new product provisions for us and Fannie Mae in the Reform Act. The rule establishes a process for Freddie Mac and Fannie Mae to provide prior notice to the Director of FHFA of a new activity and, if applicable, to obtain prior approval from the Director if the new activity is determined to be a new product. On August 31, 2009, Freddie Mac and Fannie Mae filed joint public comments on the interim final rule with FHFA. FHFA has stated that permitting us to engage in new products is inconsistent with the goals of conservatorship and has instructed us not to submit such requests under the interim final rule. This could have an adverse effect on our business and profitability in future periods. We cannot currently predict when or if FHFA will permit us to engage in new products under the interim final rule.

 

Affordable Housing Allocations

 

The Reform Act requires us to set aside in each fiscal year an amount equal to 4.2 basis points for each dollar of the unpaid principal balance of total new business purchases, and allocate or transfer such amount (i) to HUD to fund a Housing Trust Fund established and managed by HUD and (ii) to a Capital Magnet Fund established and managed by Treasury. FHFA has the authority to suspend our allocation upon finding that the payment would contribute to our financial instability, cause

 

us to be classified as undercapitalized or prevent us from successfully completing a capital restoration plan. In November 2008, FHFA advised us that it has suspended the requirement to set aside or allocate funds for the Housing Trust Fund and the Capital Magnet Fund until further notice.

 

Prudential Management and Operations Standards

 

The Reform Act requires FHFA to establish prudential standards, by regulation or by guideline, for a broad range of operations of the enterprises. These standards must address internal controls, information systems, independence and adequacy of internal audit systems, management of interest rate risk exposure, management of market risk, liquidity and reserves, management of asset and investment portfolio growth, overall risk management processes, investments and asset acquisitions, management of credit and counterparty risk, and recordkeeping. FHFA may also establish any additional operational and management standards the Director of FHFA determines appropriate.

 

Portfolio Activities

 

The Reform Act requires FHFA to establish, by regulation, criteria governing portfolio holdings to ensure the holdings are backed by sufficient capital and consistent with the enterprises’ mission and safe and sound operations. In establishing these criteria, FHFA must consider the ability of the enterprises to provide a liquid secondary market through securitization activities, the portfolio holdings in relation to the mortgage market and the enterprises’ compliance with the prudential management and operations standards prescribed by FHFA.

 

On January 30, 2009, FHFA issued an interim final rule adopting the portfolio holdings criteria established in the Purchase Agreement, as it may be amended from time to time, for so long as we remain subject to the Purchase Agreement. FHFA requested public comments on the interim final rule and on the criteria governing portfolio holdings that will apply when we are no longer subject to the Purchase Agreement.

 

See “Our Business and Statutory Mission — Our Business Segments — Investments Segment” for additional information on restrictions to our portfolio activities.

 

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. These policies include processes related to the delivery, validation and certification of loans sold to us. In addition to the purchase policies we have instituted, we promote consumer education and financial literacy efforts 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 financing options.

 

Subordinated Debt

 

FHFA directed us to continue to make interest and principal payments on our subordinated debt, even if we fail to maintain required capital levels. As a result, the terms of any of our subordinated debt that provide for us to defer payments of interest under certain circumstances, including our failure to maintain specified capital levels, are no longer applicable. In addition, the requirements in the agreement we entered into with FHFA in September 2005 with respect to issuance, maintenance, and reporting and disclosure of Freddie Mac subordinated debt have been suspended during the term of conservatorship and thereafter until directed otherwise. See “NOTE 11: REGULATORY CAPITAL — Subordinated Debt Commitment” to our consolidated financial statements for more information regarding subordinated debt.

 

Department of Housing and Urban Development

 

HUD has regulatory authority over Freddie Mac with respect to 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 with which we do business and requires us to undertake remedial actions against such 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 anti-discrimination provisions of the GSE Act.

 

Department of the Treasury

 

Treasury has significant rights and powers with respect to our company as a result of the Purchase Agreement. In addition, 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 offerings with Treasury funding activities. In addition, our charter authorizes Treasury to purchase Freddie Mac debt obligations not exceeding $2.25 billion in aggregate principal amount at any time.

 

The Reform Act granted the Secretary of the Treasury authority to purchase any obligations and securities issued by us and Fannie Mae until December 31, 2009 on such terms and conditions and in such amounts as the Secretary may determine, provided that the Secretary determined the purchases were necessary to provide stability to the financial markets, prevent disruptions in the availability of mortgage finance, and protect taxpayers. For information on how Treasury used this authority, which has now expired, see “Conservatorship and Related Developments — Treasury Agreements.”

 

Securities and Exchange Commission

 

We are subject to the financial reporting requirements applicable to registrants under the Exchange Act, including the requirement to file with the SEC annual reports on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K. Although our common stock is required to be registered under the Exchange Act, we continue to be exempt from certain federal securities law requirements, including the following:

 

 

Legislative Developments

 

Congress is currently considering legislation that would overhaul the regulatory structure of the financial services industry. On December 11, 2009, the House of Representatives passed comprehensive financial services regulatory reform legislation, which would, among other things, create new standards related to regulatory oversight of systemically important financial institutions, asset-backed securitization, consumer financial protection, over-the-counter derivatives and mortgage lending. Comparable legislation has been offered, but not yet considered, in the Senate. If enacted, these proposals would result in significant changes in the regulation of the financial services industry and would affect the business and operation of Freddie Mac including by potentially subjecting us to new and additional regulatory oversight and standards related to our activities, products and capital adequacy, among other areas.

 

In addition, a number of states have enacted laws allowing localities to create energy loan assessment programs for the purpose of financing energy efficient home improvements. While the specific terms may vary, these laws allow for the creation of a new lien to secure the financing that is senior to any existing Freddie Mac mortgage lien, which could have a negative impact on Freddie Mac’s credit losses.

 

Various states, cities, and counties have also implemented mediation programs that could delay or otherwise change their foreclosure processes. The programs are designed to bring servicers and borrowers together to negotiate foreclosure alternatives; however, these actions could increase our expenses, including by potentially delaying the final resolution of delinquent mortgage loans and the disposition of non-performing assets.

 

Forward-Looking Statements

 

We regularly communicate information concerning our business activities to investors, the news media, securities analysts and others as part of our normal operations. Some of these communications, including this Form 10-K, contain “forward-looking statements” pertaining to the conservatorship and our current expectations and objectives for our efforts under the MHA Program and other programs to assist the U.S. residential mortgage market, future business plans, liquidity, capital management, economic and market conditions and trends, market share, legislative and regulatory developments, implementation of new accounting standards, credit losses, internal control remediation efforts, and results of operations and financial condition on a GAAP, Segment Earnings and fair value basis. Forward-looking statements are often accompanied by, and identified with, terms such as “objective,” “expect,” “trend,” “forecast,” “believe,” “intend,” “could,” “future” and similar phrases. These statements are not historical facts, but rather represent our expectations based on current information, plans, judgments, assumptions, estimates and projections. Forward-looking statements involve known and unknown risks and uncertainties, some of which are beyond our control. You should not unduly rely on our forward-looking statements. Actual results may differ significantly from those described in or implied by such forward-looking statements due to various factors and uncertainties, including those factors described in the “RISK FACTORS” section of this Form 10-K and:

 

 

 

 

 

 

We undertake no obligation to update forward-looking statements we make to reflect events or circumstances after the date of this Form 10-K or to reflect the occurrence of unanticipated events.

 

Before you invest in our securities, you should know that making such an investment involves risks, including the risks described below and in “BUSINESS,” “MD&A,” and elsewhere in this Form 10-K. These risks and uncertainties could, directly or indirectly, adversely affect our business, financial condition, results of operations, cash flows, strategies and/or prospects.

 

Conservatorship and Related Developments

 

We expect to make additional draws under the Purchase Agreement in future periods, which will adversely affect our future results of operations and financial condition.

 

It is likely that we will continue to record significant losses in future periods, which will lead us to require additional draws under the Purchase Agreement. Due to the implementation of changes to the accounting standards for transfers of financial assets and consolidation of VIEs, we recorded a significant decrease in our total equity (deficit) on January 1, 2010, which increases the likelihood that we will require a draw from Treasury under the Purchase Agreement for the first quarter of 2010. The cumulative effect of these changes in accounting principles as of January 1, 2010 is a net decrease of approximately $11.7 billion to total equity (deficit), which includes the changes to the opening balances of AOCI and retained earnings (accumulated deficit). In addition, a variety of other factors could lead us to make additional draws under the Purchase Agreement in the future, including:

 

 

Under the amendment to the Purchase Agreement adopted on December 24, 2009, the $200 billion cap on Treasury’s funding commitment will increase as necessary to accommodate any cumulative reduction in our net worth during 2010, 2011 and 2012. Although additional draws under the Purchase Agreement will allow us to remain solvent and avoid mandatory receivership, they will also increase the liquidation preference of, and the dividends we owe on, the senior preferred stock. Based on the aggregate liquidation preference of the senior preferred stock of $51.7 billion as of December 31, 2009, Treasury is entitled to annual cash dividends of $5.2 billion, which exceeds our annual historical earnings in most periods. Increases in the already substantial liquidation preference and senior preferred dividend obligation, along with limited flexibility to redeem the senior preferred stock, will adversely affect our results of operations and financial condition and add to the significant uncertainty regarding our long-term financial sustainability.

 

Our business objectives and strategies have in some cases been significantly altered since we were placed into conservatorship, and may continue to change, in ways that negatively affect our future financial condition and results of operations.

 

FHFA, as Conservator, has directed the company to focus on managing to a positive stockholders’ equity. At the direction of the Conservator, we have made changes to certain business practices that are designed to provide support for the mortgage market in a manner that serves our public mission and other non-financial objectives but may not contribute to our

 

goal of managing to a positive stockholders’ equity. Some of these changes have increased our expenses or caused us to forego revenue opportunities. For example, FHFA, has directed that we implement various initiatives under the MHA Program. We expect to incur significant costs associated with the implementation of these initiatives and it is not possible at present to estimate whether, and the extent to which, costs, incurred in the near term, will be offset by the prevention or reduction of potential future costs of loan defaults and foreclosures due to these initiatives. We are also providing significant support to state and local housing finance agencies pursuant to the Housing Finance Agency Initiative. The Conservator and Treasury did not authorize us to engage in certain business activities and transactions, including the sale of certain assets, which we believe may have had a beneficial impact on our results of operations or financial condition, if executed. Our inability to execute such transactions may adversely affect our profitability. Other agencies of the U.S. government, as well as Congress, also may have an interest in the conduct of our business. We do not know what actions they may request us to take.

 

In view of the conservatorship and the reasons stated by FHFA for its establishment, it is likely that our business model and strategic objectives will continue to change, possibly significantly, including in pursuit of our public mission and other non-financial objectives. Among other things, we could experience significant changes in the size, growth and characteristics of our guarantor and investment activities, and we could further change our operational objectives, including our pricing strategy in our core mortgage guarantee business. Accordingly, our strategic and operational focus going forward may not be consistent with the investment objectives of our investors. It is possible that we will make material changes to our capital strategy and to our accounting policies, methods, and estimates. It is also possible that the company could be restructured and its statutory mission revised. In addition, we may be directed to engage in activities that are operationally difficult or costly to implement.

 

In a letter to the Chairmen and Ranking Members of the Congressional Banking and Financial Services Committees dated February 2, 2010, the Acting Director of FHFA stated that minimizing our credit losses is our central goal and that we will be limited to continuing our existing core business activities and taking actions necessary to advance the goals of the conservatorship. The Acting Director stated that FHFA does not expect we will be a substantial buyer or seller of mortgages for our mortgage-related investments portfolio, except for purchases of delinquent mortgages out of PC pools. The Acting Director also stated that permitting us to engage in new products is inconsistent with the goals of the conservatorship. These restrictions could limit our ability to return to profitability in future periods.

 

As our Conservator, FHFA possesses all of the powers of our stockholders, officers and directors. During the conservatorship, the Conservator has delegated certain authority to the Board of Directors to oversee, and management to conduct, day-to-day operations so that the company can continue to operate in the ordinary course of business. FHFA has the ability to withdraw its delegations of authority and override actions of our Board of Directors at any time. In addition, FHFA has the power to take actions without our knowledge, that could be material to investors and could significantly affect our financial performance.

 

FHFA is also Conservator of Fannie Mae, our primary competitor. We do not know the impact on our business of FHFA’s serving as Conservator of Fannie Mae.

 

These changes and other factors could have material adverse effects on, among other things, our portfolio growth, net worth, credit losses, net interest income, guarantee fee income, net deferred tax assets, and loan loss reserves, and could have a material adverse effect on our future results of operations and financial condition. In light of the significant uncertainty surrounding these changes, there can be no assurances regarding when, or if, we will return to profitability.

 

We are subject to significant limitations on our business activities under the Purchase Agreement which could have a material adverse effect on our results of operations and financial condition.

 

The Purchase Agreement includes significant restrictions on our ability to manage our business, including limitations on the amount of indebtedness we may incur, the size of our mortgage-related investments portfolio and the circumstances in which we may pay dividends, raise capital and pay down the liquidation preference on the senior preferred stock. In addition, the Purchase Agreement provides that we may not enter into any new compensation arrangements or increase amounts or benefits payable under existing compensation arrangements of any executive officers without the consent of the Director of FHFA, in consultation with the Secretary of the Treasury. In deciding whether or not to consent to any request for approval it receives from us under the Purchase Agreement, Treasury has the right to withhold its consent for any reason and is not required by the agreement to consider any particular factors, including whether or not management believes that the transaction would benefit the company. The limitations under the Purchase Agreement could have a material adverse effect on our future results of operations and financial condition.

 

On February 18, 2010, we received a letter from the Acting Director of FHFA stating that FHFA has determined that any sale of the LIHTC investments by Freddie Mac would require Treasury’s consent under the terms of the Purchase Agreement. The letter further stated that FHFA had presented other options for Treasury to consider, including allowing

 

Freddie Mac to pay senior preferred stock dividends by waiving the right to claim future tax benefits of the LIHTC investments. However, after further consultation with Treasury and consistent with the terms of the Purchase Agreement, the Acting Director informed us we may not sell or transfer the assets and that he sees no other disposition options. As a result, we wrote down the carrying value of our LIHTC investments to zero as of December 31, 2009, resulting in a loss of $3.4 billion. This write-down reduces our net worth at December 31, 2009 and, as such, increases the likelihood that we will require additional draws from Treasury under the Purchase Agreement and, as a consequence, increases the likelihood that our dividend obligation on the senior preferred stock will increase. See “NOTE 5: VARIABLE INTEREST ENTITIES” to our consolidated financial statements for additional information.

 

The conservatorship is indefinite in duration and the timing, conditions and likelihood of our emerging from conservatorship are uncertain. Even if the conservatorship is terminated, we would remain subject to the Purchase Agreement, senior preferred stock and warrant.

 

FHFA has stated that there is no exact time frame as to when the conservatorship may end. Termination of the conservatorship (other than in connection with receivership) also requires Treasury’s consent under the Purchase Agreement. There can be no assurance as to when, and under what circumstances, Treasury would give such consent. There is also significant uncertainty as to what changes may occur to our business structure during or following our conservatorship, including whether we will continue to exist. It is possible that the conservatorship will end with us being placed into receivership.

 

In addition, Treasury has the ability to acquire a majority of our common stock for nominal consideration by exercising the warrant we issued to it pursuant to the Purchase Agreement. Consequently, the company could effectively remain under the control of the U.S. government even if the conservatorship was ended and the voting rights of common stockholders restored. The warrant held by Treasury, the restrictions on our business contained in the Purchase Agreement and the senior status of the senior preferred stock issued to Treasury under the Purchase Agreement, if the senior preferred stock has not been redeemed, also could adversely affect our ability to attract new private sector capital in the future should the company be in a position to seek such capital. Moreover, our draws under Treasury’s funding commitment and the senior preferred dividend obligation could permanently impair our ability to build independent sources of capital.

 

Our regulator may, and in some cases must, place us into receivership, which would result in the liquidation of our assets and terminate all rights and claims that our stockholders and creditors may have against our assets or under our charter; if we are liquidated, there may not be sufficient funds to pay the secured and unsecured claims of the company, repay the liquidation preference of any series of our preferred stock or make any distribution to the holders of our common stock.

 

Under the Reform Act, FHFA must place us into receivership if FHFA determines in writing that our assets are less than our obligations for a period of 60 days. FHFA has notified us that the measurement period for any mandatory receivership determination with respect to our assets and obligations would commence no earlier than the SEC public filing deadline for our quarterly or annual financial statements and would continue for 60 calendar days after that date. FHFA has also advised us that, if, during that 60-day period, we receive funds from Treasury in an amount at least equal to the deficiency amount under the Purchase Agreement, the Director of FHFA will not make a mandatory receivership determination.

 

In addition, we could be put into receivership at the discretion of the Director of FHFA at any time for other reasons, including conditions that FHFA has already asserted existed at the time the then Director of FHFA placed us into conservatorship. These include: a substantial dissipation of assets or earnings due to unsafe or unsound practices; the existence of an unsafe or unsound condition to transact business; an inability to meet our obligations in the ordinary course of business; a weakening of our condition due to unsafe or unsound practices or conditions; critical undercapitalization; the likelihood of losses that will deplete substantially all of our capital; or by consent. A receivership would terminate the conservatorship. The appointment of FHFA (or any other entity) as our receiver would terminate all rights and claims that our stockholders and creditors may have against our assets or under our charter arising as a result of their status as stockholders or creditors, other than the potential ability to be paid upon our liquidation. Unlike a conservatorship, the purpose of which is to conserve our assets and return us to a sound and solvent condition, the purpose of a receivership is to liquidate our assets and resolve claims against us.

 

In the event of a liquidation of our assets, there can be no assurance that there would be sufficient proceeds to pay the secured and unsecured claims of the company, repay the liquidation preference of any series of our preferred stock or make any distribution to the holders of our common stock. To the extent that we are placed in receivership and do not or cannot fulfill our guarantee to the holders of our mortgage-related securities, such holders could become unsecured creditors of ours with respect to claims made under our guarantee. Only after paying the secured and unsecured claims of the company, the administrative expenses of the receiver and the liquidation preference of the senior preferred stock, which ranks prior to our common stock and all other series of preferred stock upon liquidation, would any liquidation proceeds be available to repay the liquidation preference on any other series of preferred stock. Finally, only after the liquidation preference on all series of

 

preferred stock is repaid would any liquidation proceeds be available for distribution to the holders of our common stock. The aggregate liquidation preference on the senior preferred stock owned by Treasury was $51.7 billion as of December 31, 2009. The liquidation preference will increase further if we make additional draws under the Purchase Agreement, if we do not pay dividends owed on the senior preferred stock in cash or if we do not pay the quarterly commitment fee to Treasury under the Purchase Agreement.

 

We have a variety of different, and potentially competing, objectives that may adversely affect our financial results and our ability to maintain positive net worth.

 

Based on our charter, public statements from Treasury and FHFA officials and guidance from our Conservator, we have a variety of different, and potentially competing, objectives. These objectives include providing liquidity, stability and affordability in the mortgage market; continuing to provide additional assistance to the struggling housing and mortgage markets; reducing the need to draw funds from Treasury pursuant to the Purchase Agreement; returning to long-term profitability; and protecting the interests of the taxpayers. These objectives create conflicts in strategic and day-to-day decision making that will likely lead to suboptimal outcomes for one or more, or possibly all, of these objectives. Current portfolio investment and mortgage guarantee activities, liquidity support, and loan modification and foreclosure forbearance initiatives, including our efforts under the MHA Program and the Housing Finance Agency Initiative, are intended to provide support for the mortgage market in a manner that serves our public mission and other non-financial objectives under conservatorship, but may negatively impact our financial results and net worth.

 

We have experienced significant management changes which could increase our control risks and have a material adverse effect on our ability to do business and our results of operations.

 

Since September 2008, we have had numerous changes in our senior management and governance structure, including FHFA becoming our Conservator, a reconstituted Board of Directors, three changes in our Chief Executive Officer, three changes in our Chief Financial Officer and a new Chief Operating Officer. The magnitude of these changes and the short time interval in which they have occurred, particularly during the ongoing housing and economic crisis, add to the risks of control failures, including a failure in the effective operation of our internal control over financial reporting or our disclosure controls and procedures. Control failures could result in material adverse effects on our financial condition and results of operations.

 

A new senior management team was installed between August and October 2009. It may take time for this new team to become sufficiently familiar with our business and each other to effectively develop and implement our business strategies. This turnover of key management positions could further harm our financial performance and results of operations. Management attention may be diverted from regular business concerns by reorganizations and the need to operate under the framework of conservatorship.

 

The conservatorship and uncertainty concerning our future may have an adverse effect on the retention and recruitment of management and other valuable employees.

 

Our ability to recruit, retain and engage management and other valuable employees with the necessary skills to conduct our business may be adversely affected by the conservatorship, the uncertainty regarding its duration and the potential for future legislative or regulatory actions that could significantly affect our status as a GSE and our role in the secondary mortgage market. The actions taken by Treasury and the Conservator to date, or that may be taken by them or other government agencies in the future, may have an adverse effect on the retention and recruitment of senior executives and others in management. For example, we are subject to restrictions on the amount of compensation we may pay our executives under conservatorship. In addition, new statutory and regulatory requirements restricting executive compensation at institutions that have received federal financial assistance, even if not expressly applicable to us, may be interpreted by FHFA or Treasury as limiting the compensation that we are able to provide to our executive officers and other employees. Although we have established compensation programs designed to help retain key employees, we are not currently in a position to offer employees financial incentives that are equity-based and, as a result of this and other factors relating to the conservatorship that may affect our attractiveness as an employer, we may be at a competitive disadvantage compared to other potential employers. Uncertainty about the future of the GSEs affects all of our operations and heightens the risks related to retention of management and other valuable employees. A recovering economy is likely to put additional pressures on turnover in 2010, as other attractive opportunities may become available to people we want to retain. Accordingly, we may not be able to retain or replace executives or other employees with key skills and our ability to conduct our business effectively could be adversely affected.

 

The conservatorship and investment by Treasury has had, and will continue to have, a material adverse effect on our common and preferred stockholders.

 

Prior to our entry into conservatorship, the market price for our common stock declined substantially. After our entry into conservatorship, the market price of our common stock continued to decline (to less than $1 per share for an extended period) and the investments of our common and preferred stockholders have lost substantial value, which they may never recover. There is significant uncertainty as to what changes may occur to our business structure during or following our conservatorship, including whether we will continue to exist. Therefore, it is likely that our shares could further diminish in value, or cease to have any value.

 

The conservatorship and investment by Treasury has had, and will continue to have, other material adverse effects on our common and preferred stockholders, including the following:

 

Dividends have been eliminated.  The Conservator has eliminated dividends on Freddie Mac common and preferred stock (other than dividends on the senior preferred stock) during the conservatorship. In addition, under the terms of the Purchase Agreement, dividends may not be paid to common or preferred stockholders (other than on the senior preferred stock) without the consent of Treasury, regardless of whether or not we are in conservatorship.

 

Warrant may substantially dilute investment of current stockholders.  If Treasury exercises its warrant to purchase shares of our common stock equal to 79.9% of the total number of shares of our common stock outstanding on a fully diluted basis, the ownership interest in the company of our then existing common stockholders will be substantially diluted. It is possible that stockholders, other than Treasury, will not own more than 20.1% of our total common stock for the duration of our existence.

 

No longer managed to maximize stockholder returns.  Because we are in conservatorship, we are no longer managed with a strategy to maximize stockholder returns.

 

No voting rights during conservatorship.  The rights and powers of our stockholders are suspended during the conservatorship. During the conservatorship, our common stockholders do not have the ability to elect directors or to vote on other matters unless the Conservator delegates this authority to them.

 

Competitive and Market Risks

 

The future growth of our mortgage-related investments portfolio is significantly limited under the Purchase Agreement and by FHFA regulation, which will result in greater reliance on our guarantee activities to generate revenue.

 

Under the Purchase Agreement and FHFA regulation, the unpaid principal balance of our mortgage-related investments portfolio could not exceed $900 billion as of December 31, 2009, and must decline by 10% per year thereafter until it reaches $250 billion. Due to this restriction, the unpaid principal balance of our mortgage-related investments portfolio may not exceed $810 billion as of December 31, 2010. In addition, under the Purchase Agreement, without the prior consent of Treasury, we may not increase our total indebtedness above a specified limit or become liable for any subordinated indebtedness. Treasury has stated it does not expect us to be an active buyer to increase the size of our mortgage-related investments portfolio, but also does not expect that active selling will be necessary to meet the required portfolio reduction targets. In addition, FHFA has stated that, given the size of our current mortgage-related investments portfolio and the potential volume of delinquent mortgages to be purchased out of PC pools, it expects that any net additions to our mortgage-related investments portfolio would be related to that activity. Therefore, our ability to take advantage of opportunities to purchase mortgage assets at attractive prices may be limited. In addition, notwithstanding the expectations expressed by Treasury and FHFA regarding future selling activity, we can provide no assurance that the cap on our mortgage-related investments portfolio will not, over time, force us to sell mortgage assets at unattractive prices, particularly given the potential in coming periods for significant increases in loan modifications and purchases of delinquent loans, both of which result in the purchase of mortgage loans from our PCs for our mortgage-related investments portfolio.

 

These limitations will reduce the earnings capacity of our mortgage-related investments portfolio business and require us to place greater emphasis on our guarantee activities to generate revenue. However, under conservatorship, our ability to generate revenue through guarantee activities may be limited, as we may be required to adopt business practices that provide support for the mortgage market in a manner that serves our public mission and other non-financial objectives, but that may negatively impact our financial results. For example, as a result of the conservatorship and the current economic environment, we currently seek to issue guarantees with fee terms that are intended to cover our expected credit costs on new purchases and that cover a portion of our ongoing operating expenses. Specifically, our ability to increase our fees to offset higher than expected credit costs on guarantees issued before 2009 is limited while we operate at the direction of our Conservator, and we currently expect that our fees will not cover such credit costs. The combination of the restrictions on our business activities under the Purchase Agreement and under FHFA regulation, combined with our potential inability to generate sufficient revenue through our guarantee activities to offset the effects of those restrictions, may have an adverse effect on our results of operations and financial condition.

 

It may be difficult to increase our returns on new single-family guarantee business.

 

Current profitability levels in our new single-family guarantee business are designed to cover expected default costs on the new business and contribute to covering the company’s operating expenses. Any contribution to capital is likely to be well below the level we expect would be necessary to attract private equity capital. Despite this, our current market share relative to Fannie Mae is at the low end of historical averages.

 

Efforts we may make to increase the profitability of new single-family guarantee business, such as by tightening credit standards, could cause our market share to further decrease and the volume of our single-family guarantee business to decline. Currently, our ability to increase the income generated by our single-family guarantee business by increasing contractual guarantee and management fee rates is limited due to competitive pressures and other factors. The appointment of FHFA as Conservator and the Conservator’s subsequent directive that we provide increased support to the mortgage market has affected our guarantee pricing decisions by limiting our ability to adjust our fees for current expectations of credit risk, and will likely continue to do so.

 

Our competitiveness in purchasing single-family mortgages from our lender customers, and thus the relative profitability of new single-family business, can be directly affected by the relative price performance of our PCs and comparable Fannie Mae securities. Increasing demand for our PCs helps support the price performance of our PCs, which in turn helps us compete with Fannie Mae and others in purchasing mortgages. Various factors, including market conditions, affect the relative price performance of our PCs. While we employ a variety of strategies to support the price performance of our PCs, any such strategies may fail. In recent periods, the price performance of our PCs has declined relative to comparable Fannie Mae securities, which has negatively impacted the management and guarantee fees we have been able to charge for new single-family mortgages, many of which we purchase by swapping PCs for the mortgages.

 

Increased competition from Fannie Mae, FHA and other institutions may alter our product mix, lower volumes and reduce revenues on new single-family guarantee business.

 

We are subject to mortgage credit risks, including mortgage credit risk relating to off-balance sheet arrangements; increased credit costs related to these risks could adversely affect our financial condition and/or results of operations.

 

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, exposing us to the risk of credit losses and credit-related expenses. We are exposed to mortgage credit risk with respect to: (i) single-family and multifamily loans and guaranteed single-family and multifamily PCs and Structured Securities that we hold on our consolidated balance sheets; and (ii) single-family and multifamily loans through PCs, Structured Securities and other mortgage-related guarantees that are not reflected as assets on our consolidated balance sheets in this Form 10-K. Our off-balance sheet exposure includes 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. At December 31, 2009, the unpaid principal balance of PCs and Structured Securities held by third parties was $1.5 trillion.

 

Factors that affect the level of our mortgage credit risk include the credit profile of the borrower, home prices, the features of the mortgage loan, the type of property securing the mortgage, and local and regional economic conditions, including regional changes in unemployment rates. While mortgage interest rates remained low in 2009, many borrowers may not have been able to refinance into lower interest mortgages due to substantial declines in home values, market uncertainty and increases in unemployment. Therefore, there can be no assurance that continued low mortgage interest rates or efforts to modify and refinance mortgages pursuant to the MHA Program will result in a decrease in our overall mortgage credit risk.

 

Effective January 1, 2010, the concept of a QSPE was removed from GAAP and entities previously considered QSPEs must be evaluated for consolidation. As a result, commencing in the first quarter of 2010, we have consolidated our single-family PC trusts and certain of our Structured Transactions on our consolidated balance sheets on a prospective basis, which will significantly reduce the amount of our off-balance sheet arrangements but will not alter our exposure to mortgage credit risk on the loans underlying these securities. See “MD&A− OUR PORTFOLIOS,” “MD&A — OFF-BALANCE SHEET ARRANGEMENTS” and “NOTE 3: FINANCIAL GUARANTEES AND MORTGAGE SECURITIZATIONS” to our consolidated financial statements for additional information regarding our guarantees and off-balance sheet exposures.

 

Loans with Alt-A and interest-only characteristics individually made up 8% and 7% of our single-family mortgage portfolio as of December 31, 2009, respectively (a single loan may have both Alt-A and interest-only characteristics, and thus would be reflected in both the Alt-A and interest-only figures). These loans collectively accounted for 44% of our credit losses in 2009. Our purchases of these mortgages and issuances of guarantees of them expose us to greater credit risks than do other types of mortgages. Our holdings of these loan groups are concentrated in the West region where home prices have experienced steep declines. The West region accounted for approximately 52% of our credit losses in 2009. We have also experienced increases in delinquency rates for prime mortgages, due to continued low housing prices and increasing

 

unemployment rates during 2009. See “MD&A — CONSOLIDATED BALANCE SHEETS ANALYSIS — Mortgage Loans — Credit Performance of Certain Higher Risk Single-Family Mortgage Loans on our Consolidated Balance Sheets” for information on our classification of loans and mortgage-related securities as Alt-A.

 

For a significant percentage of the mortgages we purchase, we have agreed to permit our seller/servicers to underwrite the loans using alternative automated underwriting systems. These alternative systems may use different standards than our own, including, in some cases, lower standards with respect to borrower credit characteristics. Those differences may increase our credit risk and may result in increases in credit losses.

 

Beginning in 2008, the conforming loan limits were significantly increased for mortgages originated in certain “high cost” areas (the initial increases applied to loans originated after July 1, 2007). Due to our relative lack of experience with these larger loans, purchases pursuant to the high cost conforming loan limits may also expose us to greater credit risks.

 

We are exposed to increased credit risk related to the subprime, Alt-A and option ARM loans that back our non-agency mortgage-related securities investments.

 

Our investments in non-agency mortgage-related securities have included securities that are backed by subprime, Alt-A and option ARM loans. In the past several years, mortgage loan delinquencies and credit losses in the U.S. mortgage market have substantially increased, particularly in the subprime, Alt-A and option ARM sectors of the residential mortgage market. In addition, home prices declined significantly, after extended periods during which home prices appreciated. If delinquency and loss rates on subprime, Alt-A and option ARM loans continue to increase, or there is a further decline in home prices, we could experience additional GAAP losses due to other-than-temporary impairments on our investments in these non-agency mortgage-related securities. In addition, the fair value of these investments has declined and may decline further due to additional ratings downgrades or market events. Any credit enhancements covering these securities, including subordination, may not prevent us from incurring losses. During 2009, we experienced a rapid depletion of credit enhancements on certain of the securities backed by subprime first lien, option ARM and Alt-A loans due to poor performance in the underlying collateral. See “MD&A — CONSOLIDATED BALANCE SHEETS ANALYSIS — Investments in Securities” for information about the credit ratings for these securities and the extent to which these securities have been downgraded.

 

The credit losses we experience in future periods as a result of the housing and economic crisis are likely to be larger, perhaps substantially larger, than our current loan loss reserves.

 

Our loan loss reserves, as reflected on our consolidated balance sheets, do not reflect our estimate of the future credit losses inherent in our single-family and multifamily mortgage loans, including those underlying our financial guarantees. Rather, pursuant to GAAP, our reserves only reflect probable losses we believe we have already incurred as of the balance sheet date. Because of the housing and economic crisis, there is significant uncertainty regarding the full extent of future credit losses. The credit losses we experience in future periods will adversely affect our business, results of operations, financial condition, liquidity and net worth.

 

Further declines in U.S. home prices or other adverse changes in the U.S. housing market could negatively impact our business and increase our losses.

 

Throughout 2009, the U.S. housing market continued to experience adverse trends, including continued price depreciation, and rising delinquency and default rates. These conditions, coupled with high unemployment, led to significant increases in our loan delinquencies and credit losses and higher provisioning for loan losses, all of which have adversely affected our financial condition and results of operations. We expect that national home prices will continue to decrease in 2010, which 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. For more information, see “MD&A — RISK MANAGEMENT — Credit Risks.” Government programs designed to strengthen the U.S. housing market, such as the MHA Program, may fail to achieve expected results, and new programs could be instituted that cause our credit losses to increase.

 

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 was (1.3)% in 2009 compared to (0.4)% in 2008. If total outstanding U.S. residential mortgage debt were to continue to decline, there could be fewer mortgage loans available for us to purchase, and we could face more competition to purchase a smaller number of loans.

 

Due to a weakening employment market in the U.S. and other factors, apartment market fundamentals continued to deteriorate in 2009, as reflected by increased property vacancy rates and declining average monthly rent levels. Given the significant weakness currently being experienced in the U.S. economy, it is likely that apartment fundamentals will continue to deteriorate during 2010, which could increase delinquencies and cause us to incur additional credit losses relating to our multifamily activities.

 

We depend on our institutional counterparties to provide services that are critical to our business, and our results of operations or financial condition may be adversely affected 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. We face similar risks with respect to contracts or arrangements we enter into on behalf of our securitization trusts. Our primary exposures to institutional counterparty risk are with:

 

 

In some cases, our business with institutional counterparties is concentrated. A significant failure by a major institutional counterparty could have a material adverse effect on our investments in mortgage loans, investments in securities, our derivative portfolio or our credit guarantee activities. See “NOTE 19: CONCENTRATION OF CREDIT AND OTHER RISKS” to our consolidated financial statements for additional information.

 

Some of our counterparties also may become subject to serious liquidity problems affecting, either temporarily or permanently, their businesses, which may adversely affect their ability to meet their obligations to us. Challenging market conditions have adversely affected and are expected to continue to adversely affect the liquidity and financial 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, and certain large lenders have failed. A default by a counterparty with significant obligations to us could adversely affect our ability to conduct our operations efficiently and at cost-effective rates, which in turn could adversely affect our results of operations or our financial condition. Many of our counterparties provide several types of services to us. Accordingly, if one of these counterparties were to become insolvent or otherwise default on its obligations to us, it could harm our business and financial results in a variety of ways. See “MD&A — RISK MANAGEMENT — Credit Risks — Institutional Credit Risk” for additional information regarding our credit risks to our counterparties and how we seek to manage them, and recent consolidation among some of our institutional counterparties.

 

Our financial condition or results of operations may be adversely affected if mortgage seller/servicers fail to repurchase loans sold to us in breach of representations and warranties or to perform their obligations to service loans in our single-family and multifamily mortgage portfolios.

 

We require seller/servicers to make certain representations and warranties regarding the loans they sell to us. If loans are sold to us in breach of those representations and warranties, we have the contractual right to require the seller/servicer to repurchase those loans from us. In lieu of repurchase, we may choose to allow a seller/servicer to indemnify us against losses on such mortgages. Sometimes a seller/servicer sells us mortgages with recourse, meaning that the seller/servicer agrees to repurchase any mortgage that is delinquent for more than a specified period (usually 120 days), regardless of whether there has been a breach of representations and warranties.

 

Some of our seller/servicers failed to perform their repurchase obligations due to lack of financial capacity, while many of our larger, higher credit-quality institutions have not fully performed their repurchase obligations in a timely manner. As of December 31, 2009 and 2008, we had outstanding repurchase requests to our seller/servicers with respect to loans with an unpaid principal balance of approximately $4 billion and $3 billion, respectively. At December 31, 2009, nearly 30% of our outstanding repurchase requests were outstanding for more than 90 days. Our credit losses may increase to the extent our seller/servicers do not fully meet their repurchase obligations. Enforcing repurchase obligations with lender customers who have the financial capacity to perform those obligations could also negatively impact our relationships with such customers and ability to retain market share.

 

If a servicer is unable to fulfill its repurchase or other responsibilities, we may be unable to sell the applicable servicing rights to a successor servicer and recover, from the sale proceeds, amounts owed to us by the defaulting servicer. The ongoing weakness in the housing market has negatively affected the market for mortgage servicing rights, which increases the risk that we may be unable to sell such rights or may not receive a sufficient price for them. Increased industry

 

consolidation, bankruptcies of mortgage bankers or bank failures may also make it more difficult for us to sell such rights, because there may not be sufficient capacity in the market, particularly in the event of multiple failures.

 

Our seller/servicers also have a significant role in servicing loans in our single-family mortgage portfolio, which includes an active role in our loss mitigation efforts. Therefore, a decline in their performance could impact the overall quality of our credit performance, which could adversely affect our financial condition or results of operations and have significant impacts on our ability to mitigate credit losses. The risk of such a failure remains high as weak economic conditions continue to affect the liquidity and financial condition of many of our seller/servicers, including some of our largest seller/servicers.

 

The inability to realize the anticipated benefits of our loss mitigation plans, a lower realized rate of seller/servicer repurchases or default rates and severity that exceed our current projections could cause our losses to be significantly higher than those currently estimated.

 

Our seller/servicers also have a significant role in servicing loans in our multifamily mortgage portfolio. We are exposed to the risk that multifamily seller/servicers may come under financial pressure due to the current stressful economic environment and weak real estate markets, which could cause degradation in the quality of servicing they provide.

 

See “MD&A — RISK MANAGEMENT — Credit Risks — Institutional Credit Risk — Mortgage Seller/Servicers” for additional information on our institutional credit risk related to our mortgage seller/servicers.

 

Our financial condition or results of operations may be adversely affected by the financial distress of our derivative and other counterparties.

 

We use derivatives for several purposes, including to rebalance our funding mix in order to more closely match changes in the interest rate characteristics of our mortgage-related assets and to hedge forecasted issuances of debt. Our exposure to derivative counterparties remains highly concentrated as compared to historical levels. Four of our derivative counterparties each accounted for greater than 10% and collectively accounted for 92% of our net uncollateralized exposure, excluding commitments, at December 31, 2009. For a further discussion of our derivative counterparty exposure see “MD&A — RISK MANAGEMENT — Credit Risks — Institutional Credit Risk — Derivative Counterparties” and “NOTE 19: CONCENTRATION OF CREDIT AND OTHER RISKS” to our consolidated financial statements.

 

Some of our derivative and other counterparties have experienced various degrees of financial distress in the past few years, including liquidity constraints, credit downgrades and bankruptcy. Our financial condition and results of operations may be adversely affected by the financial distress of these derivative and other counterparties to the extent that they fail to meet their obligations to us. For example, we may incur losses if collateral held by us cannot be liquidated at prices that are sufficient to recover the full amount of the loan or derivative exposure due us.

 

In addition, our ability to engage in routine derivatives, funding and other transactions could be adversely affected by the actions and commercial soundness of other financial institutions. Financial services institutions are interrelated as a result of trading, clearing, counterparty or other relationships. As a result, defaults by, or even rumors or questions about, one or more financial services institutions, or the financial services industry generally, could lead to market-wide disruptions in which it may be difficult for us to find acceptable counterparties for such transactions.

 

We also use derivatives to synthetically create the substantive economic equivalent of various debt funding structures. Thus, if our access to the derivative markets were disrupted, it may become more difficult or expensive to fund our business activities and achieve the funding mix we desire, which could adversely affect our business and results of operations. The use of these derivatives may also expose us to additional counterparty credit risk.

 

Our credit and other losses could increase if our mortgage or bond insurers become insolvent or fail to perform their obligations to us.

 

We are exposed to risk relating to the potential insolvency or non-performance of mortgage insurers that insure single-family mortgages we purchase or guarantee and bond insurers that insure bonds we hold as investment securities on our consolidated balance sheets. Most of our mortgage insurer and bond insurer counterparties experienced ratings downgrades during 2009, and several of them announced comprehensive restructuring plans. The weakened financial condition and liquidity position of these counterparties increases the risk that these entities will fail to reimburse us for claims under insurance policies.

 

As a guarantor, we remain responsible for the payment of principal and interest if a mortgage insurer fails to meet its obligations to reimburse us for claims. Thus, if any of our mortgage insurers fails to fulfill its obligation, we could experience increased credit-related costs. We believe that several of our mortgage insurance counterparties are at risk of falling out of compliance with regulatory capital requirements, which may result in regulatory actions that could restrict the mortgage insurer’s ability, in certain states, to write new business, and thus could negatively impact our access to mortgage insurance for high LTV loans. In addition, if a regulator determined that a mortgage insurer lacked sufficient capital to pay

 

all claims when due, the regulator could take action that might impact the timing and amount of claim payments made to us. Further, we independently assess the financial condition, including the claims-paying resources, of each mortgage insurer. Based on our analysis of the financial condition of a mortgage insurer and pursuant to our eligibility requirements for mortgage insurers, we could take action against a mortgage insurer intended to protect our interests that may impact the timing and amount of claims payments received from that insurer. Mortgage insurer rescissions of mortgage insurance coverage are also on the rise.

 

In the event one or more of our bond insurers were to become insolvent, it is likely that we would not collect all of our claims from the affected insurer, and it would impact our ability to recover certain unrealized losses on our investments in non-agency mortgage-related securities. We believe that some of our bond insurers lack sufficient ability to fully meet all of their expected lifetime claims-paying obligations to us as they emerge. In 2009, regulators deemed the financial condition of certain bond insurers to be impaired and ordered such insurers to restructure to relieve the impairment. We are concerned that other bond insurers may be subject to a similar assessment in 2010, and some or all may be unable to restructure to relieve the impairment and may be deemed to be insolvent.

 

If mortgage insurers continue to tighten their standards, the volume of high LTV mortgages available for us to purchase could be reduced, which could negatively affect our business and make it more difficult for us to meet our affordable housing goals.

 

Our charter requires that single-family mortgages with LTV ratios above 80% at the time of purchase be covered by specified credit enhancements or participation interests. In the current environment, many mortgage insurers are restricting the issuance of insurance on new mortgages with higher LTV ratios or with lower borrower credit scores or on select property types, which has contributed to the reduction in our business volumes for loans with LTV ratios over 80%. If our mortgage insurer counterparties further restrict their eligibility requirements or new business volumes for high LTV ratio loans, or if we are no longer willing or able to obtain mortgage insurance from these counterparties, and we are not able to avail ourselves of suitable alternative methods of obtaining credit enhancement for these loans, we may be further restricted in our ability to purchase or securitize loans with LTV ratios over 80% at the time of purchase. For example, where mortgage insurance or another charter-acceptable credit enhancement is not available, we may be hindered in our ability to purchase high LTV ratio loans that refinance mortgages we do not own or guarantee into more affordable loans. The unavailability of suitable credit enhancement could also negatively impact our ability to pursue new business opportunities relating to high LTV ratio and other higher risk loans and therefore harm our competitive position and our earnings. This could also impact our ability to meet our affordable housing goals, as purchases of loans with high LTV ratios can contribute to our performance under those goals.

 

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 flow of mortgage loans. We purchase a significant percentage of our single-family mortgages from several large mortgage originators. During 2009 and 2008, approximately 74% and 84%, respectively, of our guaranteed mortgage securities issuances originated from purchase volume associated with our ten largest customers. Two of our single-family customers each accounted for greater than 10% of our mortgage securitization volume for 2009. Similarly, we acquire a significant portion of our multifamily mortgage loans from several large lenders. We enter into mortgage purchase volume commitments with many of our single-family customers that provide for the customers to deliver to us a specified dollar amount or minimum percentage of their total sales of conforming loans. There is a risk that we will not be able to enter into a new commitment with a key customer that will maintain mortgage purchase volume following the expiration of the existing commitment. 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 major lenders could adversely affect our market share, our revenues and the credit loss performance of our single-family mortgage portfolio.

 

Changes in general business and economic conditions in the U.S. and abroad may adversely affect our business and results of operations.

 

Our business and results of operations may continue to be adversely affected by changes in general business and economic conditions, including changes in the international markets for our investments or our mortgage-related and debt securities. These conditions include employment rates, fluctuations in both debt and equity capital markets, the value of the U.S. dollar as compared to foreign currencies, the strength of the U.S. financial markets and national economy and the local economies in which we conduct business, and the economies of other countries that purchase our mortgage-related and debt securities. In addition, if weak general market conditions continue to negatively impact national and regional economic conditions, we could experience significantly higher delinquencies and credit losses which will likely increase our losses in future periods and will adversely affect our results of operations or financial condition.

 

The mortgage credit markets experienced very difficult conditions and volatility during 2008 and 2009. The deteriorating conditions in these markets resulted in a decrease in availability of corporate credit and liquidity within the

 

mortgage industry, causing disruptions to normal operations of major mortgage originators, including some of our largest customers, and have resulted in the insolvency, closure or acquisition of a number of major financial institutions. These conditions also resulted in greater volatility, widening of credit spreads and a lack of price transparency and are expected to contribute to further consolidation within the financial services industry. We operate in these markets and continue to be subject to adverse effects on our financial condition and results of operations due to our activities involving securities, mortgages, derivatives and other mortgage commitments with our customers.

 

Competition from banking and non-banking companies may harm our business.

 

Competition in the secondary mortgage market combined with a decreased rate of growth in residential mortgage debt outstanding may make it more difficult for us to purchase mortgages. Furthermore, competitive pricing pressures may make our products less attractive in the market and negatively impact our financial results. Increased competition from Fannie Mae and Ginnie Mae may alter our product mix, lower volumes and reduce revenues on new business. Ginnie Mae guarantees the timely payment of principal and interest on mortgage-related securities backed by federally insured or guaranteed loans, primarily those insured by FHA or guaranteed by VA. Historically, we also competed with other financial institutions that retain or securitize mortgages, such as commercial and investment banks, dealers, thrift institutions, and insurance companies. While many of these institutions have ceased or substantially reduced their activities in the secondary market since 2008, it is possible that these institutions will reenter the secondary market.

 

Our business may be adversely affected by limited availability of financing, increased funding costs and uncertainty in our securitization financing.

 

The amount, type and cost of our funding, including financing from other financial institutions and the capital markets, directly impacts our interest expense and results of operations. A number of factors could make such financing more difficult to obtain, more expensive or unavailable on any terms, both domestically and internationally (where funding transactions may be on terms more or less favorable than in the U.S.), including:

 

 

Our ability to obtain funding in the public debt markets or by pledging mortgage-related securities as collateral to other financial institutions could cease or change rapidly and the cost of the available funding could increase significantly due to changes in market confidence and other factors. For example, in the fall of 2008, we experienced significant deterioration in our access to the unsecured medium- and long-term debt markets, and were forced to rely on short-term debt to fund our purchases of mortgage assets and refinance maturing debt and to rely on derivatives to synthetically create the substantive economic equivalent of various debt funding structures.

 

Since 2008, the ratings on our non-agency mortgage-related securities backed by Alt-A, subprime and option ARM loans have decreased, limiting their availability as a significant source of liquidity for us through sales or use as collateral in secured lending transactions. In addition, adverse market conditions have negatively impacted our ability to enter into secured lending transactions using agency mortgage-related securities as collateral. These trends are likely to continue in the future.

 

Government Support

 

Changes or perceived changes in the government’s support of us could have a severe negative effect on our access to the debt markets and our debt funding costs. Under the amendment to the Purchase Agreement adopted on December 24, 2009, the $200 billion cap on Treasury’s funding commitment will increase as necessary to accommodate any cumulative reduction in our net worth during 2010, 2011 and 2012. While we believe that this increased support provided by Treasury will be sufficient to enable us to maintain our access to the debt markets and ensure that we have adequate liquidity to conduct our normal business activities over the next three years, the costs of our debt funding could vary. For example, our funding costs for debt with maturities beyond 2012 could be high. In addition, uncertainty about the future of the GSEs could affect our debt funding costs. The cost of our debt funding could increase if debt investors believe that the risk that we could be placed into receivership is increasing. The completion of the Federal Reserve’s debt purchase program could negatively affect the availability of longer-term debt funding as well as the spreads on our debt, and thus increase our debt funding costs.

 

Due to the expiration of the Lending Agreement, we no longer have a liquidity backstop available to us (other than draws from Treasury under the Purchase Agreement and Treasury’s ability to purchase up to $2.25 billion of our obligations under its permanent statutory authority) if we are unable to obtain funding from issuances of debt or other conventional sources. At present, we are not able to predict the likelihood that a liquidity backstop will be needed, or to identify the alternative sources of liquidity that might be available to us if needed, other than from Treasury as referenced above.

 

Demand for Debt Funding

 

The willingness of domestic and foreign investors to purchase and hold our debt securities can be influenced by many factors, including changes in the world economy, changes in foreign-currency exchange rates, regulatory and political factors, as well as the availability of and preferences for other investments. If investors were to divest their holdings or reduce their purchases of our debt securities, our funding costs could increase. The willingness of investors to purchase or hold our debt securities, and any changes to such willingness, may materially affect our liquidity, our business and results of operations.

 

Competition for Debt Funding

 

We compete for low-cost debt funding with Fannie Mae, the FHLBs and other institutions. Competition for debt funding from these entities can vary with changes in economic, financial market and regulatory environments. Increased competition for low-cost debt funding may result in a higher cost to finance our business, which could negatively affect our financial results. An inability to issue debt securities at attractive rates in amounts sufficient to fund our business activities and meet our obligations could have an adverse effect on our liquidity, financial condition and results of operations. See “MD&A — LIQUIDITY AND CAPITAL RESOURCES — Liquidity — Debt Securities” for a more detailed description of our debt issuance programs.

 

Our funding costs may also be affected by changes in the amount of, and demand for, debt issued by Treasury.

 

Line of Credit

 

We maintain a secured intraday line of credit to provide additional intraday liquidity to fund our activities through the Fedwire system. This line of credit requires us to post collateral to a third party. In certain circumstances, this secured counterparty may be able to repledge the collateral underlying our financing without our consent. In addition, because the secured intraday line of credit is uncommitted, we may not be able to continue to draw on it if and when needed.

 

PCs and Structured Securities

 

Our PCs and Structured Securities are an integral part of our mortgage purchase program. Any decline in the price performance of or demand for our PCs could have an adverse effect on our securitization activities, because we purchase many mortgages by swapping PCs for them. There is a risk that our PC and Structured Securities support activities may not be sufficient to support the liquidity and depth of the market for PCs.

 

Our business may be adversely affected by the completion of the Federal Reserve program to purchase GSE mortgage-related securities.

 

In November 2008, the Federal Reserve implemented a program to purchase GSE mortgage-related securities. The Federal Reserve has announced that it would gradually slow the pace of purchases under the program in order to promote a smooth transition in markets and anticipates that purchases under such program will be completed by the end of the first quarter of 2010. It is difficult at this time to predict the impact that the completion of the Federal Reserve’s mortgage-related securities purchase program will have on our business and the U.S. mortgage market. It is possible that interest-rate spreads on mortgage-related securities could widen, which could result in additional unrealized losses on our available-for-sale securities. This, in turn, could negatively affect our net worth, and thus contribute to the need to make additional draws under the Purchase Agreement. The completion of this program could also result in less demand for our PCs in the market, and negatively affect the relative price performance of our PCs versus comparable Fannie Mae securities. We purchase many of our new single-family mortgages by swapping PCs for the mortgages. Therefore, a decline in our relative price performance could adversely affect our competitiveness in purchasing new single-family mortgages from our lender customers, and thus negatively impact the relative profitability of new single-family business.

 

A reduction in the credit ratings for our debt could adversely affect our liquidity.

 

Nationally recognized statistical rating organizations play an important role in determining, by means of the ratings they assign to issuers and their debt, the availability and cost of debt funding. We currently receive ratings from three nationally recognized statistical rating organizations for our unsecured borrowings. Our credit ratings are important to our liquidity. Actions by governmental entities or others, additional GAAP losses, additional draws under the Purchase Agreement and other factors could adversely affect the credit ratings on our debt. A reduction in our credit ratings could adversely affect our liquidity, competitive position, or the supply or cost of debt financing available to us. A significant increase in our borrowing costs could cause us to sustain additional GAAP losses or impair our liquidity by requiring us to seek other sources of financing, which may be difficult to obtain.

 

Mortgage fraud could result in significant financial losses and harm to our reputation.

 

We rely on representations and warranties by seller/servicers about the characteristics of the single-family mortgage loans we purchase and securitize, and we do not independently verify most of the information that is provided to us. This exposes us to the risk that one or more of the parties involved in a transaction (such as the borrower, seller, broker, appraiser,

 

title agent, loan officer, lender or servicer) will engage in fraud by misrepresenting facts about a mortgage loan or a borrower. We may experience significant financial losses and reputational damage as a result of such mortgage fraud.

 

The value of mortgage-related securities guaranteed by us and held as investments in securities may decline if we did not or were unable to perform under our guarantee or if investor confidence in our ability to perform under our guarantee were to diminish.

 

We classify our investments in mortgage-related securities as either available-for-sale or trading, and account for them at fair value on our consolidated balance sheets. A portion of our investments in mortgage-related securities are securities guaranteed by us. Our valuation of these securities is consistent with GAAP and the legal structure of the guarantee transaction, which includes the Freddie Mac guarantee to the securitization trusts and on the assets transferred to the securitization trusts (i.e., Freddie Mac guaranteed PCs and Structured Securities). The valuation of our guaranteed mortgage securities necessarily reflects investor confidence in our ability to perform under our guarantee and the liquidity that our guarantee provides. If we did not or were unable to perform under our guarantee, or if investor confidence in our ability to perform under our guarantee were to diminish, the value of our guaranteed securities may decline, thereby reducing the value of the securities reported on our consolidated balance sheets and our ability to sell or otherwise use these securities for liquidity purposes, and adversely affecting our financial condition and results of operations.

 

Changes in interest rates could negatively impact our results of operations, stockholders’ equity (deficit) and fair value of net assets.

 

Our investment activities and credit guarantee activities expose us to interest rate and other market risks. Changes in interest rates, up or down, could adversely affect 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, due to the timing of maturities or rate reset dates on variable-rate instruments, when interest rates rise, our funding costs may rise faster than the yield we earn on our assets. This rate change could cause our net interest yield to compress until the effect of the increase is fully reflected in asset yields. Changes in the slope of the yield curve could also reduce our net interest yield.

 

Changes in interest rates could increase our GAAP net loss or deficit in total equity (deficit) materially. Changes in interest rates may also affect prepayment assumptions, thus potentially impacting the fair value of our assets, including our investments in mortgage-related securities and unsecuritized mortgage loans. When interest rates fall, borrowers are more likely to prepay their mortgage loans by refinancing 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 investments in such loans.

 

Interest rates can fluctuate for a number of reasons, including changes in the fiscal and monetary policies of the federal government and its agencies, such as the Federal Reserve. Federal Reserve policies directly and indirectly influence the yield on our interest-earning assets and the cost of our interest-bearing liabilities. The availability of derivative financial instruments (such as options and interest rate and foreign currency swaps) from acceptable counterparties of the types and in the quantities needed could also affect our ability to effectively manage the risks related to our investment funding. Our strategies and efforts to manage our exposures to these risks may not be as effective 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 seek to manage those risks.

 

Changes in OAS as a result of the completion of the Federal Reserve’s mortgage-related securities purchase program or other events could materially impact our fair value of net assets and affect future results of operations, stockholders’ equity (deficit) and fair value of net assets.

 

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 significantly affect 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 fluctuations 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 fluctuations in OAS. A widening of the OAS on a given asset, which typically causes a decline in the current fair value of that asset, may cause significant mark-to-fair value losses, and may adversely affect our financial results and stockholders’ equity (deficit), but may increase the number of attractive investment opportunities in mortgage loans and mortgage-related securities. 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 investment opportunities in mortgage loans and mortgage-related securities. Consequently, a tightening of the OAS

 

may adversely affect our future financial results and stockholders’ equity (deficit). See “MD&A — CONSOLIDATED FAIR VALUE BALANCE SHEETS ANALYSIS — Discussion of Fair Value Results” for a more detailed description of the impacts of changes in mortgage-to-debt OAS.

 

The Federal Reserve’s program to purchase GSE mortgage-related securities is expected to be completed by the end of the first quarter of 2010. This could reduce demand for mortgage assets, and could cause mortgage-to-debt OAS to widen. If this occurs, we could experience additional unrealized losses on our available-for-sale securities. While wider spreads might create favorable investment opportunities, we may be limited in our ability to take advantage of any such opportunities in future periods because, under the Purchase Agreement and FHFA regulation, the unpaid principal balance of our mortgage-related investments portfolio must decline by 10% per year beginning in 2010 until it reaches $250 billion. FHFA has stated its expectation in the Acting Director’s February 2, 2010 letter that any net additions to our mortgage-related investments portfolio would be related to purchasing delinquent mortgages out of PC pools.

 

We could experience significant reputational harm, which could affect the future of our company, if our efforts under the MHA Program, the Housing Finance Agency Initiative and other initiatives to support the U.S. residential mortgage market do not succeed.

 

We are focused on the MHA Program, the Housing Finance Agency Initiative and other initiatives to support the U.S. residential mortgage market. If these initiatives do not achieve their desired results, or are otherwise perceived to have failed to achieve their objectives, we may experience damage to our reputation, which may impact the extent of future government support for our business and government decisions with respect to the future status and role of Freddie Mac.

 

Negative publicity causing damage to our reputation could adversely affect our business prospects, financial results or net worth.

 

Reputation risk, or the risk to our financial results and net worth from negative public opinion, is inherent in our business. Negative public opinion could adversely affect our ability to keep and attract customers or otherwise impair our customer relationships, adversely affect our ability to obtain financing, impede our ability to hire and retain qualified personnel, hinder our business prospects or adversely impact the trading price of our securities. Perceptions regarding the practices of our competitors or the financial services and mortgage industries as a whole, particularly as they relate to the current economic downturn, may also adversely impact our reputation. Adverse reputation impacts on third parties with whom we have important relationships may impair market confidence or investor confidence 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, and could affect what changes may occur to our business structure during or following conservatorship, including whether we will continue to exist. These adverse consequences could result from perceptions concerning our activities and role in addressing the mortgage market crisis or our actual or alleged action or failure to act in any number of activities, including corporate governance, regulatory compliance, financial 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.

 

Business and Operational Risks

 

The MHA Program and other efforts to reduce foreclosures, modify loan terms and refinance mortgages may fail to mitigate our credit losses and may adversely affect our results of operations or financial condition.

 

The MHA Program and other loss mitigation activities are a key component of our strategy for managing and resolving troubled assets and lowering credit losses. However, there can be no assurance that any of our loss mitigation strategies will be successful and that credit losses will not escalate. To the extent that borrowers participate in this program in large numbers, it is likely that the costs we incur related to loan modifications and other activities under HAMP may be substantial because we will bear the full cost of the monthly payment reductions related to modifications of loans we own or guarantee, and all servicer and borrower incentive fees. We will not receive a reimbursement of these costs from Treasury.

 

It is possible that Treasury could make changes to HAMP that could make the program more costly to us, both in terms of credit expenses and the cost of implementing and operating the program. For example, we could be required to use principal reduction to achieve reduced payments for borrowers. This would further increase our losses, as we would bear the full costs of such reductions.

 

A significant number of loans are in the trial period of HAMP. Although the ultimate completion rate remains uncertain, it is possible that a large number of loans will fail to complete the trial period or qualify for any of our other loan modification and loss mitigation programs. For these loans, HAMP will have effectively delayed the foreclosure process and could increase our losses, to the extent the prices we ultimately receive for the foreclosed properties are less than the prices we could have received had we foreclosed upon the properties earlier, due to continued home price declines. These delays in foreclosure could also cause our REO operations expense to increase, perhaps substantially.

 

Our seller/servicers have a key role in the success of our loss mitigation activities. The continued increases in delinquent loan volume and the ongoing weak conditions of the mortgage market during 2009 placed a strain on the loss mitigation resources of many of our seller/servicers. A decline in the performance of seller/servicers in mitigation efforts could result in missed opportunities for successful loan modifications, an increase in our credit losses and damage to our reputation.

 

Depending on the type of loss mitigation activities we pursue, those activities could result in accelerating or slowing prepayments on our PCs or Structured Securities, either of which could negatively affect the pricing of such PCs or Structured Securities.

 

We are devoting significant internal resources to the implementation of the various initiatives under the MHA Program, which will increase our expenses. The size and scope of our effort under the MHA Program may also limit our ability to pursue other important corporate opportunities or initiatives.

 

Our relationships with our customers could be harmed by our actions as the compliance agent under HAMP, which could negatively affect our ability to purchase loans from them in the future.

 

We are the compliance agent for certain foreclosure avoidance activities under HAMP. In this role, we conduct examinations and review servicer compliance with the published requirements for the program. It is unclear how servicers will perceive our actions as compliance agent. It is possible that this could impair our relationships with our lender customers, which could negatively affect our ability to purchase loans from them in the future.

 

We may experience further write-downs and losses relating to our assets, including our investment securities, net deferred tax assets, REO properties or mortgage loans, that could materially adversely affect our business, results of operations, financial condition, liquidity and net worth.

 

We experienced a significant increase in losses and write-downs relating to our assets during 2008 and 2009, including significant declines in market value, impairments of our investment securities, market-based write-downs of REO properties, losses on non-performing loans purchased out of PC pools, and impairments on other assets.

 

A substantial portion of our impairment losses and write-downs relate to our investments in non-agency mortgage-related securities backed by subprime, Alt-A and option ARM mortgage loans. We also incurred significant losses during 2008 and 2009 relating to our investments in non-mortgage-related securities, primarily as a result of a substantial decline in the market value of these assets due to the deteriorating economy and ongoing weakness in the financial markets. The fair value of our investments in securities, including CMBS, may be further adversely affected by continued weakness in the economy, further deterioration in the housing and financial markets, additional ratings downgrades or other events.

 

We increased our valuation allowance for our deferred tax assets, net by $2.7 billion during 2009. The future status and role of Freddie Mac could be affected by actions of the Conservator, and legislative and regulatory action that alters the ownership, structure and mission of the company. The uncertainty of these developments could materially affect our operations, which could in turn affect our ability or intent to hold investments until the recovery of any temporary unrealized losses. If future events significantly alter our current outlook, a valuation allowance may need to be established for the remaining deferred tax asset.

 

Due to the ongoing weaknesses in the economy and in the housing and financial markets, we may experience additional write-downs and losses relating to our assets, including those that are currently AAA-rated, and the fair values of our assets may continue to decline. This could adversely affect our results of operations, financial condition, liquidity and net worth. In addition, many of these assets do not trade in a liquid secondary market and the size of our holdings relative to normal market activity is such that, if we were to attempt to sell a significant quantity of assets, the pricing in such markets could be significantly disrupted and the price we ultimately realize may be materially lower than the value at which we carry these assets on our consolidated balance sheets.

 

The price and trading liquidity of our common stock and our NYSE-listed issues of preferred stock may be adversely affected if those securities are delisted from the NYSE.

 

If we do not satisfy the minimum share price, corporate governance and other requirements of the continued listing standards of the NYSE, our common stock and NYSE-listed issues of preferred stock could be delisted from the NYSE. In November 2008, the NYSE notified us that we had failed to satisfy one of the NYSE’s standards for continued listing of our common stock. Specifically, the NYSE advised us that we were “below criteria” for the NYSE’s price criteria for common stock because the average closing price of our common stock over a consecutive 30 trading-day period was less than $1 per share. In September 2009, the NYSE notified us that we had returned to compliance with the NYSE’s minimum share price listing requirement.

 

If our common stock price again fails to meet the NYSE’s minimum price criteria, our common stock could be delisted from the NYSE, and this would also likely result in the delisting of our NYSE-listed preferred stock. The delisting of our

 

common stock or NYSE-listed preferred stock would require any trading in these securities to occur in the over-the-counter market and could adversely affect the market prices and liquidity of these securities. The closing price of our common stock on February 19, 2010 was $1.23 per share.

 

Ineffective internal control over financial reporting and disclosure controls could result in errors and inadequate disclosures, affect operating results and cause investors to lose confidence in our reported results.

 

We face continuing challenges because of deficiencies in our controls and the operational and financial accounting complexities of our business. Control deficiencies could result in errors, affect operating results and cause investors to lose confidence in our reported results. For information about the material weaknesses that we remediated during the quarter and our remaining material weakness, see “CONTROLS AND PROCEDURES — Changes to Internal Control Over Financial Reporting During the Quarter Ended December 31, 2009.”

 

There are a number of factors that may impede our efforts to establish and maintain effective disclosure controls and internal control over financial reporting, including: the nature of the conservatorship and our relationship with FHFA; the complexity of, and significant changes in, our business activities and related GAAP requirements; significant turnover in our senior management in 2009; uncertainty regarding the sustainability of newly established controls; and the uncertain impacts of the ongoing housing and credit market volatility on the reliability of our models used to develop our accounting estimates. We cannot be certain that our efforts to improve and maintain our internal control over financial reporting will ultimately be successful.

 

Effectively designed and operated internal control over financial reporting provides only reasonable assurance that material errors in our financial statements will be prevented or detected on a timely basis. A failure to establish and maintain effective internal control over financial reporting increases the risk of a material error in our reported financial results and delay in our financial reporting timeline. Depending on the nature of a control failure and any required remediation, ineffective controls could have a material adverse effect on our business.

 

Delays in meeting our financial reporting obligations could affect our ability to maintain the listing of our securities on the NYSE. Ineffective controls could also cause investors to lose confidence in our reported financial information, which may have an adverse effect on the trading price of our securities.

 

Recent market conditions have added to the uncertainty about the results of the internal models that we use for financial accounting and reporting purposes, to make business decisions and to manage risks, and our business could be adversely affected if those models fail to produce reliable results.

 

The severe deterioration of the housing and credit markets has created additional risk associated with our model results. Our models may not perform as well in situations for which there are few or no recent historical precedents. The increased risk that models will not produce reliable results creates additional risk regarding the reliability of our financial statements and our ability to manage risks. We have adjusted our models in response to recent events, but the added uncertainty about model results remains.

 

We make significant use of business and financial models for financial accounting and reporting purposes and to manage risk. For example, we use models in determining the fair value of financial instruments for which independent price quotes are not available or reliable, or in extrapolating third-party values to certain of our assets and liabilities. We also use models to measure and monitor our exposure 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 less reliable results for a number of reasons, including the use of faulty assumptions, the need for frequent adjustments to respond to rapid changes in economic conditions, the application of models to events or products outside the model’s intended use, and errors, such as incorrect coding or the use of incorrect data. The complexity of our models creates additional risk regarding the reliability of model output.

 

We use market-based information as inputs to our models. However, there is generally a lag between the availability of this market information and the preparation of our financial statements. When market conditions change quickly and in unforeseen ways, there is an increased risk that the inputs reflected in our models are not representative of current market conditions.

 

Management may need to exercise judgment to interpret or adjust modeled results to take into account new information or changes in conditions. The dramatic changes in the housing and credit capital markets have required frequent adjustments to our models and the application of greater management judgment in the interpretation and adjustment of the results produced by our models. We may also need to adjust our models and apply greater management judgment to account for the impact of actions we may take to assist the mortgage market, such as the MHA Program. This further increases the risk that the process may produce less reliable information, particularly since many of these events and actions are unprecedented.

 

The valuations, risk metrics, amortization results, loan loss reserve estimations and security impairment charges produced by our internal models may be different from actual results, which could adversely affect our business results, cash flows, fair value of net assets, business prospects and future financial results. 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 different. The different results could cause a revision of previously reported financial 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 difficulties in comparisons of the financial condition or results of operations of prior or future periods.

 

Due to increased uncertainty about model results, we also face increased risk that we could make poor business decisions in areas where model results are an important factor, including loan purchases, management and guarantee fee pricing and asset and liability management. Furthermore, any strategies we employ to attempt to manage the risks associated with our use of models may not be effective. See “MD&A — CRITICAL ACCOUNTING POLICIES AND ESTIMATES — Valuation of a Significant Portion of Assets and Liabilities” and “QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK — 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 affect how we report our financial condition or results of operations.

 

Our accounting policies are fundamental to understanding our financial condition and results of operations. Certain of our accounting policies and estimates are “critical” as they are both important to the presentation of our financial condition and results of operations and they require management to make particularly subjective or complex judgments about matters that are inherently uncertain and for which materially different amounts could be recorded using different assumptions or estimates. For a description of our critical accounting policies, see “MD&A — CRITICAL ACCOUNTING POLICIES AND ESTIMATES.”

 

From time to time, the FASB and the SEC change the financial accounting and reporting standards that govern the preparation of our financial statements. These changes are beyond our control, can be difficult to predict and could materially impact how we report our financial 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 financial statements by material amounts. The implementation of new or revised accounting standards could result in material adverse effects to our stockholders’ equity (deficit) and result in or contribute to the need for additional draws under the Purchase Agreement.

 

See “NOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES” to our consolidated financial statements for more information.

 

We face additional risks related to our adoption of changes in accounting standards related to securitization entities.

 

Historically, our PCs, Structured Securities and other securitization entities were generally considered off-balance sheet arrangements. However, effective January 1, 2010, because of changes to the accounting standards for transfers of financial assets and consolidation of VIEs, we consolidated our single-family PC trusts and certain of our Structured Transactions on our consolidated balance sheets. The cumulative effect of these changes in accounting principles as of January 1, 2010 is a net decrease of approximately $11.7 billion to total equity (deficit), which includes the changes to the opening balances of AOCI and retained earnings (accumulated deficit). This will increase the likelihood that we will require a draw from Treasury under the Purchase Agreement for the first quarter of 2010.

 

Implementation of these accounting changes has required us to make significant process and systems changes. Given the magnitude of these changes, the risk that new control weaknesses may be identified has increased. We have devoted significant resources and management attention to complete these changes. This has had, and may continue to have, an adverse affect on our ability to devote resources to other systems, controls and business related initiatives. For example, we may be required to delay the implementation of, or divert resources from, other initiatives, including efforts to remedy previously identified control weaknesses.

 

For additional information, see “MD&A — EXECUTIVE SUMMARY” and “NOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES — Recently Issued Accounting Standards, Not Yet Adopted Within These Consolidated Financial Statements — Accounting for Transfers of Financial Assets and Consolidation of VIEs” to our consolidated financial statements.

 

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, financial loss, disruption of our business, liability to customers, further 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 are complex and are subject to various legal, accounting and regulatory standards. Our financial,

 

accounting, data processing or other operating systems and facilities may fail to operate properly or become disabled, adversely affecting 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, clearinghouses or other financial intermediaries we use to facilitate our securities and derivatives transactions. Any such failure or termination could adversely affect our ability to effect transactions, service our customers and manage our exposure to risk.

 

Most of our key business activities are conducted in our principal offices 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 offices or communicate with or travel to other locations, our ability to service and interact with our customers or counterparties may suffer 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 significant business disruption and an inability to process transactions through normal business processes. Any measures we take to mitigate this risk may not be sufficient to respond to the full range of catastrophic events that may occur.

 

Our operations rely on the secure processing, storage and transmission of confidential and other information in our computer systems and networks. 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 confidential 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 significant losses or reputational damage. We may be required to expend significant additional resources to modify our protective measures or to investigate and remediate vulnerabilities or other exposures, and we may be subject to litigation and financial losses that are not fully insured.

 

We rely on third parties for certain important functions, including some that are critical to financial reporting, our mortgage-related investment 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 financial instrument valuation; (b) custody and recordkeeping for our mortgage-related investments; (c) processing functions for mortgage loan underwriting; and (d) certain services we provide to Treasury in our role as program compliance agent under HAMP. 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 confidential information or other harm. Financial or operational difficulties of an outside vendor could also hurt our operations if those difficulties interfere with the vendor’s ability to provide services to us.

 

Our risk management and loss mitigation efforts may not effectively mitigate the risks we seek to manage.

 

We could incur substantial losses and our business operations could be disrupted if we are unable to effectively 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 sufficient to mitigate the risks we have identified or to appropriately identify additional risks to which we are subject. See “QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK” and “MD&A — RISK MANAGEMENT” for a discussion of our approach to managing the risks we face.

 

Legal and Regulatory Risks

 

The future status and role of Freddie Mac could be materially adversely affected by legislative and regulatory action that alters the ownership, structure and mission of the company.

 

Future legislation will likely materially affect the role of the company, our business model, our structure and future results of operations. Some or all of our functions could be transferred to other institutions, and we could cease to exist as a stockholder-owned company or at all. If any of these events were to occur, our shares could further diminish in value, or cease to have any value, and there can be no assurance that our stockholders would receive any compensation for such loss in value.

 

On June 17, 2009, the Obama Administration announced a legislative proposal to overhaul the regulatory structure of the financial services industry. The proposal does not address the regulatory oversight or structure of Freddie Mac. However, the proposal states that Treasury and HUD are expected to consult with other government agencies and develop recommendations for the future of Freddie Mac, Fannie Mae and the Federal Home Loan Bank System. Separately, Treasury Secretary Geithner and House Financial Services Committee Chairman Frank have both expressed support for substantially reforming the structure of the GSE model. Representatives of the Obama Administration have indicated that the Administration will release a statement regarding the future of the GSEs in the near future.

 

In addition to legislative actions, FHFA has expansive regulatory authority over us, and the manner in which FHFA will use its authority in the future is unclear. FHFA could take a number of regulatory actions that could materially adversely affect our company, such as changing our current capital requirements, which are not binding during conservatorship.

 

Legislation or regulation affecting the financial services, mortgage and investment banking industries may adversely affect our business activities and financial results.

 

We expect that the financial services, mortgage and investment banking industries will face increased regulation, whether by legislation or regulatory actions at the federal or state level.

 

Congress and state legislatures are considering several legislative and regulatory actions that would impact our business activities. These actions include among other things, regulatory oversight of systemically important financial institutions and reforms related to asset-backed securitization, consumer financial protection, over-the-counter derivatives and mortgage lending. We could be subject to new and additional regulatory oversight and standards related to our activities, products and capital adequacy and exposed to increased liability or credit losses. We could also be adversely affected by any legislative or regulatory changes to existing bankruptcy laws or proceedings or the foreclosure process, including any changes that would allow bankruptcy judges to unilaterally change the terms of mortgage loans.

 

In addition, legislation or regulatory actions could indirectly affect us to the extent such legislation or actions affect the activities of banks, savings institutions, insurance companies, securities dealers and other regulated entities that constitute a significant part of our customer base or counterparties. Legislative or regulatory provisions that create or remove incentives for these entities to sell mortgage loans to us, purchase our securities or enter into derivatives or other transactions with us could have a material adverse effect on our business results and financial condition.

 

Our financial condition and results of operations and our ability to return to long-term profitability may be affected by the nature, extent and success of the actions taken by the U.S. government to stabilize the economy and the housing and financial markets.

 

Conditions in the overall economy, and the mortgage markets in particular, may be affected in both the short and long-term by the implementation of the Emergency Economic Stabilization Act of 2008, the Recovery Act, the Financial Stability Plan announced by Treasury Secretary Geithner on February 10, 2009 and the MHA Program. The long-term impact that the implementation of these, or any future, laws and programs may have on our business and on the financial markets is uncertain. While the financial markets appear to have stabilized, there can be no assurance that this will continue. Any worsening of current financial market conditions could materially and adversely affect our business, financial condition, results of operations, or access to the debt markets.

 

The government could implement new laws or programs to support the economy and the housing and financial markets that could have an adverse effect on our business, including by increasing our credit losses.

 

We may make certain changes to our business in an attempt to meet the housing goals and subgoals set for us by FHFA that may increase our losses.

 

We may make adjustments to our mortgage sourcing and purchase strategies in an effort 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 offer lower expected returns on our investment and increase our exposure to credit losses. Doing so could cause us to forgo other purchase opportunities that we would expect to be more profitable. If our current efforts to meet the goals and subgoals prove to be insufficient, we may need to take additional steps that could further increase our losses.

 

We are involved in legal proceedings, governmental investigations and IRS examinations that could result in the payment of substantial damages or otherwise harm our business.

 

We are a party to various legal actions, and are subject to investigations by the SEC and the U.S. Attorney’s Office for the Eastern District of Virginia. In addition, certain of our current and former directors, officers 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, proceedings or examinations. Any legal proceeding, governmental investigation or examination issue, even if resolved in our favor, could result in negative publicity or cause us to incur significant legal and other expenses. Furthermore, developments in, outcomes of, impacts of, and costs, expenses, settlements and judgments related to these legal proceedings and governmental investigations and examinations may differ 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 and “NOTE 15: INCOME TAXES” to our consolidated financial statements for information about IRS examinations.

 

 

None.

 

 

As of February 11, 2010, our principal offices consist of five office buildings in McLean, Virginia. We own a 75% interest in a limited partnership that owns four of the office buildings, comprising approximately 1.3 million square feet. We occupy these buildings under a long-term lease from the partnership. We occupy the fifth building, comprising approximately 200,000 square feet, under a lease from a third party.

 

 

We are involved as a party to a variety of legal proceedings arising from time to time in the ordinary course of business. See “NOTE 14: LEGAL CONTINGENCIES” to our consolidated financial statements for more information regarding our involvement as a party to various legal proceedings.

 

 

None.

 

 

Throughout PART II of this Form 10-K, including the Financial Statements and MD&A, we use certain acronyms and terms which are defined in the Glossary.

 

Market Information

 

Our common stock, par value $0.00 per share, is listed on the NYSE under the symbol “FRE.” As of February 11, 2010, there were 648,377,977 shares of our common stock outstanding.

 

Table 4 sets forth the high and low sale prices of our common stock for the periods indicated.

 

Table 4 — Quarterly Common Stock Information

 

 

Holders

 

As of February 11, 2010, we had 2,062 common stockholders of record.

 

Dividends

 

Table 5 sets forth the cash dividends per common share that we have declared for the periods indicated.

 

Table 5 — Dividends Per Common Share

 

 

Dividend Restrictions

 

Our payment of dividends is subject to the following restrictions:

 

Restrictions Relating to Conservatorship

 

As Conservator, FHFA announced on September 7, 2008 that we would not pay any dividends on Freddie Mac’s common stock or on any series of Freddie Mac’s preferred stock (other than the senior preferred stock). FHFA has instructed our Board of Directors that it should consult with and obtain the approval of FHFA before taking actions involving dividends. See also “— Restrictions on Dividends from REIT Subsidiaries.”

 

Restrictions Under Purchase Agreement

 

The Purchase Agreement prohibits us and any of our subsidiaries from declaring or paying any dividends on Freddie Mac equity securities (other than the senior preferred stock) without the prior written consent of Treasury. See also “— Restrictions on Dividends from REIT Subsidiaries.”

 

Restrictions Under Reform Act

 

Under the Reform Act, FHFA has authority to prohibit capital distributions, including payment of dividends, if we fail to meet applicable capital requirements. Under the Reform Act, we are not permitted to make a capital distribution if, after making the distribution, we would be undercapitalized, except the Director of FHFA may permit us to repurchase shares if the repurchase is made in connection with the issuance of additional shares or obligations in at least an equivalent amount and will reduce our financial obligations or otherwise improve our financial condition. If FHFA classifies us as

 

undercapitalized, we are not permitted to make a capital distribution that would result in our being reclassified as significantly undercapitalized or critically undercapitalized. If FHFA classifies us as significantly undercapitalized, approval of the Director of FHFA is required for any dividend payment; the Director may approve a capital distribution only if the Director determines that the distribution will enhance the ability of the company to meet required capital levels promptly, will contribute to the long-term financial safety-and-soundness of the company or is otherwise in the public interest. Our capital requirements have been suspended during conservatorship.

 

Restrictions Relating to Charter

 

Without regard to our capital classification, we must obtain prior written approval of FHFA to make any capital distribution that would decrease total capital to an amount less than the risk-based capital level or that would decrease core capital to an amount less than the minimum capital level. As noted above, our capital requirements have been suspended during conservatorship.

 

Restrictions Relating to Subordinated Debt

 

During any period in which we defer payment of interest on qualifying subordinated debt, we may not declare or pay dividends on, or redeem, purchase or acquire, our common stock or preferred stock. Our qualifying subordinated debt provides for the deferral of the payment of interest for up to five years if either: (i) our core capital is below 125% of our critical capital requirement; or (ii) our core capital is below our statutory minimum capital requirement, and the Secretary of the Treasury, acting on our request, exercises his or her discretionary authority pursuant to Section 306(c) of our charter to purchase our debt obligations. FHFA has directed us to make interest and principal payments on our subordinated debt, even if we fail to maintain required capital levels. As a result, the terms of any of our subordinated debt that provide for us to defer payments of interest under certain circumstances, including our failure to maintain specified capital levels, are no longer applicable. As noted above, our capital requirements have been suspended during conservatorship.

 

Restrictions Relating to Preferred Stock

 

Payment of dividends on our common stock is also subject to the prior payment of dividends on our 24 series of preferred stock and one series of senior preferred stock, representing an aggregate of 464,170,000 shares and 1,000,000 shares, respectively, outstanding as of December 31, 2009. Payment of dividends on all outstanding preferred stock, other than the senior preferred stock, is also subject to the prior payment of dividends on the senior preferred stock. On December 31, 2009, we paid dividends of $1.3 billion in cash on the senior preferred stock at the direction of the Conservator. We did not declare or pay dividends on any other series of preferred stock outstanding in 2009.

 

Restrictions on Dividends from REIT Subsidiaries

 

On September 19, 2008, FHFA, as Conservator, advised us of FHFA’s determination that no further common or preferred stock dividends should be paid by our REIT subsidiaries, Home Ownership Funding Corporation and Home Ownership Funding Corporation II, until directed otherwise. Since we are the majority owner of both the common and preferred shares of these two REITs, this action eliminated our access through such dividend payments to the cash flows of the REITs. However, at our request and with Treasury’s consent, FHFA directed us and the boards of directors of our REIT subsidiaries to (i) declare and pay dividends for one quarter on the preferred shares of our REIT subsidiaries during the fourth quarter of 2009 which the REITs paid for the quarter ended September 30, 2008 and (ii) take all steps necessary to effect the elimination of the REITs by merger in a timely and expeditious manner. As a result of this dividend payment, the terms of the REIT preferred stock that permit the preferred stockholders to elect a majority of the members of each REIT’s board of directors were not triggered. No other common or preferred dividends were declared by our REIT subsidiaries during 2009. For more information, see “Defaults Upon Senior Securities.”

 

Stock Performance Graph

 

The following graph compares the five-year cumulative total stockholder return on our common stock with that of the 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, 2004. Total return calculations assume annual dividend reinvestment. The graph does not forecast performance of our common stock.

 

Comparative Cumulative Total Stockholder Return
(in dollars)

 

 

 

Recent Sales of Unregistered Securities

 

The securities we issue are “exempted securities” under the Securities Act of 1933, as amended. As a result, we do not file registration statements with the SEC with respect to offerings of our securities.

 

Following our entry into conservatorship, the operation of our ESPP was suspended and we are no longer making grants under our 2004 Stock Compensation Plan, or 2004 Employee Plan, or our 1995 Directors’ Stock Compensation Plan, as amended and restated, or Directors’ Plan. Under the Purchase Agreement, we cannot issue any new options, rights to purchase, participations or other equity interests without Treasury’s prior approval. However, grants outstanding as of the date of the Purchase Agreement remain in effect in accordance with their terms. Prior to conservatorship, we regularly provided stock compensation to our employees and members of our Board of Directors under the ESPP, the 2004 Employee Plan and the 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, 2009, no stock options were granted or exercised under our Employee Plans or Directors’ Plan. Under our ESPP, no options to purchase shares of common stock were exercised and no options to purchase shares of common stock were granted during the three months ended December 31, 2009. Further, for the three months ended December 31, 2009, under the Employee Plans and Directors’ Plan, no restricted stock units were granted and restrictions lapsed on 58,446 restricted stock units.

 

See “NOTE 12: STOCK-BASED COMPENSATION” to our consolidated financial statements for more information.

 

Issuer Purchases of Equity Securities

 

We did not repurchase any of our common or preferred stock during the three months ended December 31, 2009. Additionally, we do not currently have any outstanding authorizations to repurchase common or preferred stock. Under the Purchase Agreement, we cannot repurchase our common or preferred stock without Treasury’s prior consent, and we may only purchase or redeem the senior preferred stock in certain limited circumstances set forth in the Certificate of Creation, Designation, Powers, Preferences, Rights, Privileges, Qualifications, Limitations, Restrictions, Terms and Conditions of Variable Liquidation Preference Senior Preferred Stock.

 

Defaults Upon Senior Securities

 

As discussed above in “Restrictions on Dividends from REIT Subsidiaries,” our REIT subsidiaries are in arrears in the payment of dividends with respect to their preferred stock. As of the date of the filing of this report, the total remaining arrearage with respect to such preferred stock held by third parties was $8 million. For more information, see “NOTE 20: NONCONTROLLING INTERESTS” to our consolidated financial statements.

 

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/investors

 

 

The selected financial data presented below should be reviewed in conjunction with MD&A and our consolidated financial statements and related notes for the year ended December 31, 2009.

 

 

 

 

You should read this MD&A in conjunction with our consolidated financial statements and related notes for the year ended December 31, 2009.

 

For 2009, net loss attributed to Freddie Mac was $21.6 billion, as compared to $50.1 billion for 2008. Our financial results for the year ended December 31, 2009 were affected by the adverse conditions in the U.S. mortgage markets, which deteriorated dramatically during the second half of 2008 and remained weak throughout 2009. Weak housing market conditions, including lack of home price appreciation in most states, higher mortgage delinquency rates and higher loss severities, contributed to large credit-related expenses during 2009. Except for the first quarter of 2009, we maintained positive net worth for the year. We received cash proceeds from two draws under Treasury’s funding commitment during 2009, including $6.1 billion relating to our net worth deficit for the first quarter of 2009, which resulted in an aggregate liquidation preference of $51.7 billion on Treasury’s senior preferred stock at December 31, 2009. This and previous draws resulted in a large dividend obligation on our senior preferred stock. We expect to make additional draws on Treasury’s funding commitment in the future. The size of such draws will be determined by a variety of factors, including whether conditions in the housing market continue to remain weak or deteriorate further, and the implementation of changes in accounting standards.

 

Due to the implementation of changes to the accounting standards for transfers of financial assets and consolidation of VIEs, we recognized a significant decline in our total equity (deficit) on January 1, 2010, which will increase the likelihood that we will require a draw from Treasury under the Purchase Agreement for the first quarter of 2010. The cumulative effect of these changes in accounting principles as of January 1, 2010 is a net decrease of approximately $11.7 billion to total equity (deficit), which includes the changes to the opening balances of AOCI and retained earnings (accumulated deficit). For more information, see “2010 Significant Changes in Accounting Standards — Accounting for Transfers of Financial Assets and Consolidation of VIEs.”

 

Under the Purchase Agreement, our ability to repay the liquidation preference of the senior preferred stock is limited and we may not be able to do so for the foreseeable future, if at all. The amounts we are obligated to pay in dividends on the senior preferred stock are substantial and will have an adverse impact on our financial position and net worth and could substantially delay our return to long-term profitability or make long-term profitability unlikely.

 

Business Objectives

 

We continue to operate under the conservatorship that commenced on September 6, 2008, conducting our business under the direction of FHFA as our Conservator. While the conservatorship has benefited us through, for example, improved access to the debt markets because of the support we receive from Treasury and the Federal Reserve, we are also subject to certain constraints on our business activities by Treasury due to the terms of, and Treasury’s rights under, the Purchase Agreement. During the conservatorship, the Conservator delegated certain authority to the Board of Directors to oversee, and to management to conduct, day-to-day operations so that the company can continue to operate in the ordinary course of business.

 

Our business objectives and strategies have in some cases been altered since we entered into conservatorship, and may continue to change. Based on our charter, public statements from Treasury and FHFA officials and guidance from our Conservator, we have a variety of different, and potentially competing, objectives, including:

 

 

These objectives create conflicts in strategic and day-to-day decision making that will likely lead to suboptimal outcomes for one or more, or possibly all, of these objectives. We regularly receive direction from our Conservator on how to pursue our objectives under conservatorship, including direction to focus our efforts on assisting homeowners in the housing and mortgage markets.

 

Certain changes to our business objectives and strategies are designed to provide support for the mortgage market in a manner that serves our public mission and other non-financial objectives, but may not contribute to profitability. Our efforts to help struggling homeowners and the mortgage market, in line with our mission, may help to mitigate credit losses, but in some cases may increase our expenses or require us to forego revenue opportunities in the near term. As a result, in some

 

cases the objectives of reducing the need to draw funds from Treasury and returning to long-term profitability will be subordinated as we provide this assistance. There is significant uncertainty as to the ultimate impact that our efforts to aid the housing and mortgage markets will have on our future capital or liquidity needs and we cannot estimate whether, and the extent to which, costs we incur in the near term as a result of these efforts, which for the most part we are not reimbursed for, will be offset by the prevention or reduction of potential future costs.

 

In a letter to the Chairmen and Ranking Members of the Congressional Banking and Financial Services Committees dated February 2, 2010, the Acting Director of FHFA stated that minimizing our credit losses is our central goal and that we will be limited to continuing our existing core business activities and taking actions necessary to advance the goals of the conservatorship. The Acting Director stated that FHFA does not expect we will be a substantial buyer or seller of mortgages for our mortgage-related investments portfolio, except for purchases of delinquent mortgages out of PC pools. The Acting Director also stated that permitting us to engage in new products is inconsistent with the goals of the conservatorship. These restrictions could limit our ability to return to profitability in future periods. See “BUSINESS — Conservatorship and Related Developments” for information on the purpose and goals of the conservatorship.

 

In addition to supporting the MHA Program as discussed below, we continue to pursue other initiatives to assist the mortgage market and homeowners. For example, in 2009 we entered into standby commitments to purchase single-family and multifamily mortgages from a financial institution that provides short-term loans, known as warehouse lines of credit, to mortgage originators. See “Our Other Efforts to Assist the U.S. Housing Market” for additional information regarding these and other initiatives. Some of these actions could have a negative impact on our business, operating results or financial condition.

 

Given the important role the Obama Administration and our Conservator have placed on Freddie Mac in addressing housing and mortgage market conditions, we may be required to take additional actions that could have a negative impact on our business, operating results or financial condition. The Conservator and Treasury also did not authorize us to engage in certain business activities and transactions, including the sale of certain assets, some of which we believe may have had a beneficial impact on our results of operations or financial condition, if executed. Our inability to execute such transactions may adversely affect our profitability, and thus contribute to our need to draw additional funds from Treasury. However, we believe that the increased support provided by Treasury pursuant to the December 2009 amendment to the Purchase Agreement is sufficient to ensure that we maintain our access to the debt markets and maintain positive net worth and liquidity to continue to conduct our normal business activities over the next three years.

 

On February 18, 2010, we received a letter from the Acting Director of FHFA stating that FHFA has determined that any sale of the LIHTC investments by Freddie Mac would require Treasury’s consent under the terms of the Purchase Agreement. The letter further stated that FHFA had presented other options for Treasury to consider, including allowing Freddie Mac to pay senior preferred stock dividends by waiving the right to claim future tax benefits of the LIHTC investments. However, after further consultation with Treasury and consistent with the terms of the Purchase Agreement, the Acting Director informed us we may not sell or transfer the assets and that he sees no other disposition options. As a result, we wrote down the carrying value of our LIHTC investments to zero as of December 31, 2009, resulting in a loss of $3.4 billion. This write-down reduces our net worth at December 31, 2009 and, as such, increases the likelihood that we will require additional draws from Treasury under the Purchase Agreement and, as a consequence, increases the likelihood that our dividend obligation on the senior preferred stock will increase. See “NOTE 5: VARIABLE INTEREST ENTITIES” to our consolidated financial statements for additional information.

 

Management is continuing its efforts to identify and evaluate actions that could be taken to reduce the significant uncertainties surrounding our business, as well as the level of future draws under the Purchase Agreement; however, our ability to pursue such actions may be limited by market conditions and other factors. Any actions we take related to the uncertainties surrounding our business and future draws will likely require approval by FHFA and Treasury before they are implemented. In addition, FHFA, Treasury or Congress may have a different perspective from management and may direct us to focus our efforts on supporting the mortgage markets in ways that make it more difficult for us to implement any such actions.

 

MHA Program

 

Participation in the MHA Program is an integral part of our mission of providing stability to the housing market, including helping families maintain ownership whenever possible and helping maintain the stability of communities. In addition to our long-standing initiatives for foreclosure avoidance, we have also implemented a number of other initiatives to assist the U.S. residential mortgage market and help families keep their homes, some of which were undertaken at the direction of FHFA. If our efforts under the MHA Program and other initiatives to support the U.S. residential mortgage market do not achieve their desired results, or are otherwise perceived to have failed to achieve their objectives, we may experience damage to our reputation, which may impact the extent of future government support to our business and the

 

ultimate resolution of the conservatorship. We discuss this program in further detail in “MHA PROGRAM AND OTHER EFFORTS TO ASSIST THE U.S. HOUSING MARKET.”

 

The MHA Program includes:

 

 

Since most of our HAMP-related costs are incurred over time and we do not know what our results would have been without this program, it is not possible for us to predict the net impact of HAMP participation on our financial results. Without this program, we may have modified many HAMP eligible loans under our own programs without the borrower completing a trial period and without providing borrower incentive fees and non-recurring servicer incentive fees. Consequently, the timing of modifications and foreclosure transfers would have been different in many cases, which, depending on market prices for REO properties and modified loans, would provide differing financial results and these results could have been better or worse than we experienced in 2009. To the extent our borrowers participate in HAMP in large numbers, it is likely that the costs we incur could be substantial. Freddie Mac will bear the full cost of the monthly payment reductions related to modifications of loans we own or guarantee, and all servicer and borrower incentive fees. We will not receive any reimbursement from Treasury associated with costs incurred or losses recognized from our HAMP activities. In addition, we continue to devote significant internal resources to the implementation of the various initiatives under the MHA Program. It is not possible at present to estimate whether, and the extent to which, costs, incurred in the near term, will be offset, if at all, by the prevention or reduction of potential future costs of loan defaults and foreclosures due to these initiatives.

 

Our Other Efforts to Assist the U.S. Housing Market

 

Our other efforts to assist the U.S. housing market include the following:

 

 

 

 

Government Support for our Business

 

We are dependent upon the continued support of Treasury and FHFA in order to continue operating our business. We also receive substantial support from the Federal Reserve. Our ability to access funds from Treasury under the Purchase Agreement is critical to keeping us solvent and avoiding the appointment of a receiver by FHFA under statutory mandatory receivership provisions. Recent developments concerning this support include the following:

 

 

For information on the potential impact of the completion of the Federal Reserve’s mortgage-related securities and debt purchase programs on our business, see “LIQUIDITY AND CAPITAL RESOURCES — Liquidity.” We do not believe we have experienced any adverse effects on our business from the expiration of the Lending Agreement (which occurred after the December 2009 amendment to the Purchase Agreement) or the expiration of Treasury’s mortgage-related securities purchase program.

 

For more information on the programs and agreements described above, see “BUSINESS — Conservatorship and Related Developments.”

 

2010 Significant Changes in Accounting Standards — Accounting for Transfers of Financial Assets and Consolidation of VIEs

 

We use separate securitization trusts in our securities issuance process for the purpose of managing the receipts and payments of cash flow of our PCs and Structured Securities. Prior to January 1, 2010, these trusts met the definition of QSPEs and were therefore not subject to consolidation analysis. Effective January 1, 2010, the concept of a QSPE was removed from GAAP and entities previously considered QSPEs are now required to be evaluated for consolidation. Based on our evaluation, we determined that, under the new consolidation guidance, we are the primary beneficiary of our single-

 

family PC trusts and certain Structured Transactions. Therefore, effective January 1, 2010, we consolidated on our balance sheet the assets and liabilities of these trusts at their unpaid principal balances. As such, we will prospectively recognize on our consolidated balance sheets the mortgage loans underlying our issued single-family PCs and certain Structured Transactions as mortgage loans held-for-investment by consolidated trusts, at amortized cost. Correspondingly, we will also prospectively recognize single-family PCs and certain Structured Transactions held by third parties on our consolidated balance sheets as debt securities of consolidated trusts held by third parties.

 

The cumulative effect of these changes in accounting principles as of January 1, 2010 is a net decrease of approximately $11.7 billion to total equity (deficit), which includes the changes to the opening balances of AOCI and retained earnings (accumulated deficit).

 

See “NOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES — Recently Issued Accounting Standards, Not Yet Adopted Within These Consolidated Financial Statements — Accounting for Transfers of Financial Assets and Consolidation of VIEs” to our consolidated financial statements for additional information regarding these changes and a description of how these changes are expected to impact our results and financial statement presentation.

 

Housing and Economic Conditions and Impact on 2009 Results

 

During 2009, both the U.S. economy and the U.S. residential mortgage market remained weak. The combined effect of increased unemployment rates and declines in home values that began in 2006, contributed to increases in residential mortgage delinquency rates. Adverse market developments have been the principal drivers of our large credit losses in 2009 and we expect the residential mortgage market will continue to remain weak in 2010.

 

We estimate that home prices decreased nationwide by approximately 0.8% during 2009, based on our own index of our single-family mortgage portfolio, compared to an estimated decrease of 11.7% during 2008. We attribute the relative stability of home prices in 2009 to:

 

 

We estimate that there was a national decline in home prices from June 2006 through December 2009 of approximately 18%, based on our own index. Other indices of home price changes may have different results, as they are determined using different pools of mortgage loans and calculated under different conventions than our own. The cumulative decline and volatility in home prices that began in 2006 was particularly large in California, Florida, Arizona and Nevada, which comprised approximately 25% of the loans in our single-family mortgage portfolio as of December 31 2009. We estimate that home prices, as measured by our index, increased (declined) by 4.6%, (5.1)%, (8.1)% and (13.2)% in California, Florida, Arizona and Nevada, respectively, during 2009 and declined by approximately 26%, 26%, 26% and 32% during 2008.

 

Unemployment rates worsened significantly during 2009, reaching 10.0% at the national level as of December 31, 2009. The U.S. Bureau of Labor Statistics reported unemployment rates in California, Florida, Arizona and Nevada of 12.4%, 11.8%, 9.1% and 13.0% as of December 31, 2009, respectively.

 

We experienced a substantial increase in the number of delinquent loans in our single-family mortgage portfolio during 2009. We also observed a significant increase in market-reported delinquency rates for mortgages serviced by financial institutions during 2009, not only for subprime and Alt-A loans, but also for prime loans. This delinquency data suggests that continuing home price declines and growing unemployment significantly affected behavior over a broader segment of mortgage borrowers, increasing numbers of whom are “underwater,” or owing more on their mortgage loans than their homes are currently worth. Our loan loss severities, or the average amount of recognized losses per loan, increased during 2009, especially in California, Florida, Arizona and Nevada, where we have significant concentrations of mortgage loans with higher average loan balances than in other states. As a result of these and other factors, we experienced substantial single-family credit losses in 2009, and significantly increased our loan loss reserves.

 

Our multifamily mortgage portfolio was negatively impacted by higher rates of unemployment and further deterioration in multifamily market fundamentals such as higher property vacancy rates and declines in the average monthly apartment rental rates, which adversely affected our multifamily borrowers.

 

The market conditions during 2009 led to deterioration in the performance of the non-agency mortgage-related securities we own. Furthermore, the mortgage-related securities backed by subprime, Alt-A and option ARM loans have concentrations in the states that are undergoing the greatest economic stress, including California, Florida, Arizona and Nevada. As a result of these and other factors, we recognized substantial impairments of available-for-sale securities in our earnings during 2009.

 

Consolidated Results of Operations — 2009 versus 2008

 

Net loss attributable to Freddie Mac was $21.6 billion and $50.1 billion for 2009 and 2008, respectively. Net loss decreased during 2009 compared to 2008, principally due to higher net interest income, improved mark-to-fair value results on derivatives, our guarantee asset and trading securities, and lower other-than-temporary impairment losses recognized in earnings. These improvements were partially offset by increases in provision for credit losses, write-downs of our LIHTC partnership investments and losses on loans purchased. Income tax benefit (expense) was $0.8 billion and $(5.6) billion for 2009 and 2008, respectively. In 2008, the income tax expense resulted from our establishment of a partial valuation allowance against our net deferred tax asset. Our net loss attributable to common stockholders of $25.7 billion for 2009, reflected $4.1 billion of dividends on the senior preferred stock.

 

Net interest income was $17.1 billion for 2009, compared to $6.8 billion for 2008. In 2009, we held higher amounts of fixed-rate mortgage loans and investments in agency mortgage-related securities and had lower funding costs, due to significantly lower interest rates on our short- and long-term borrowings, as compared to 2008. These items were partially offset by the impact of declining short-term interest rates on floating-rate mortgage-related and non-mortgage-related securities. Net interest income in 2009 also benefited from the funds we received from Treasury under the Purchase Agreement. These funds generate net interest income because the costs of such funds are not reflected in interest expense, but instead are reflected as dividends paid on senior preferred stock.

 

Non-interest income (loss) was $(2.7) billion for 2009 compared to $(29.2) billion for 2008. The increase in non-interest income for 2009 was primarily due to changes in interest rates resulting in improved mark-to-fair value results related to derivatives (increase of $15.7 billion), our guarantee asset (increase of $10.4 billion) and trading securities (increase of $3.9 billion). Non-interest income (loss) also increased for 2009 due to lower other-than-temporary impairment losses recognized in earnings of $6.5 billion, primarily as a result of our adoption of an amendment to the accounting standards for investments in debt and equity securities effective April 1, 2009. These improvements in non-interest income (loss) were partially offset by a $3.7 billion increase in LIHTC partnerships expense in 2009, which reflects our write down of the carrying value of these assets to zero at December 31, 2009. See “NOTE 5: VARIABLE INTEREST ENTITIES” to our consolidated financial statements for additional information.

 

Non-interest expense increased to $36.7 billion in 2009 from $22.2 billion in 2008 primarily due to a $13.1 billion increase in provision for credit losses, which was due to continued credit deterioration in our single-family mortgage portfolio, and principally resulted from further increases in delinquency rates and higher loss severities on a per-property basis. Multifamily provision for credit losses increased in 2009 as a result of deterioration in the multifamily market as well. Also contributing to the increase in non-interest expense was a $3.1 billion increase in losses on loans purchased, which was primarily due to lower fair values on these loans and a higher volume of purchases of modified loans out of PCs in 2009.

 

Consolidated Results of Operations — 2008 versus 2007

 

Net loss was $50.1 billion and $3.1 billion for 2008 and 2007, respectively. Net loss increased during 2008 compared to 2007, principally due to an increase in credit-related expenses, impairment losses on interest-only mortgage securities and certain non-agency mortgage-related securities, the establishment of a partial valuation allowance against our net deferred tax assets and increased losses on our derivative portfolio and guarantee asset. We refer to the combination of our provision for credit losses and REO operations expense as credit-related expenses when we use this term and specifically exclude other market-based impairment losses. These loss and expense items for 2008 were partially offset by higher net interest income and higher income on our guarantee obligation as well as lower losses on certain credit guarantees and lower losses on loans purchased due to changes in our operational practice of purchasing delinquent loans out of PC securitization pools.

 

Net interest income was $6.8 billion for 2008, compared to $3.1 billion for 2007. We held higher amounts of fixed-rate agency mortgage-related securities at significantly wider spreads relative to our funding costs during 2008 as compared to 2007. Non-interest income (loss) was $(29.2) billion and $(0.3) billion for 2008 and 2007, respectively. The increase in non-interest loss during 2008 was primarily due to higher security impairments, higher derivative losses excluding foreign-currency related effects, and higher losses on our guarantee asset driven by increased uncertainty in the market and declines in long-term interest rates. Non-interest expense for 2008 and 2007 totaled $22.2 billion and $8.8 billion, respectively, and included credit-related expenses of $17.5 billion and $3.1 billion, respectively. Administrative expenses totaled $1.5 billion for 2008, down from $1.7 billion for 2007 as we implemented several cost reduction measures.

 

Two accounting changes had a significant positive impact on our financial results for 2008. Upon adoption of an amendment to the accounting standards for fair value measurements and disclosures on January 1, 2008, we began measuring the fair value of our newly-issued guarantee obligations at their inception using the practical expedient provided by the initial measurement guidance for guarantees. As a result, prospectively from January 1, 2008, we no longer record estimates of deferred gains or immediate, “day one” losses on most guarantees. Also effective January 1, 2008, we adopted an amendment to the accounting standards for the fair value option for financial assets and liabilities, which permits companies

 

to choose to measure certain eligible financial instruments at fair value that are not currently required to be measured at fair value in order to mitigate volatility in reported earnings caused by measuring assets and liabilities differently. We initially elected the fair value option for certain available-for-sale mortgage-related securities and our foreign-currency denominated debt. Upon adoption of the fair value option, we recognized a $1.0 billion after-tax increase to our retained earnings (accumulated deficit) at January 1, 2008. For more information, see “CRITICAL ACCOUNTING POLICIES AND ESTIMATES.”

 

Segment Earnings

 

Our operations consist of three reportable segments, which are based on the type of business activities each performs — Investments, Single-family Guarantee and Multifamily. Certain activities that are not part of a segment are included in the All Other category. We manage and evaluate performance of the segments and All Other using a Segment Earnings approach, subject to the conduct of our business under the direction of the Conservator. Segment Earnings differ significantly from, and should not be used as a substitute for, net income (loss) as determined in accordance with GAAP.

 

Table 6 presents Segment Earnings by segment and the All Other category and includes a reconciliation of Segment Earnings to net income (loss) attributable to Freddie Mac prepared in accordance with GAAP.

 

Table 6 — Reconciliation of Segment Earnings to GAAP Net Income (Loss)⁽¹⁾

 

 

Segment Earnings is calculated for the segments by adjusting GAAP net income (loss) attributable to Freddie Mac for certain investment-related activities and credit guarantee-related activities. Segment Earnings includes certain reclassifications 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 our company as a whole. Segment Earnings does not include the effect of the establishment of the valuation allowance against our deferred tax assets, net. For more information on Segment Earnings, including the adjustments made to GAAP net income (loss) attributable to Freddie Mac to calculate Segment Earnings and the limitations of Segment Earnings as a measure of our financial performance, see “CONSOLIDATED RESULTS OF OPERATIONS — Segment Earnings” and “NOTE 17: SEGMENT REPORTING” to our consolidated financial statements.

 

Consolidated Balance Sheets Analysis

 

During 2009, total assets decreased by $9.2 billion to $841.8 billion while total liabilities decreased by $44.2 billion to $837.4 billion. Total equity (deficit) was $4.4 billion at December 31, 2009 compared to $(30.6) billion at December 31, 2008.

 

Our cash and cash equivalents increased by $19.4 billion during 2009 to $64.7 billion. We received $6.1 billion and $30.8 billion in June 2009 and March 2009, respectively, pursuant to draw requests that FHFA submitted to Treasury on our behalf to address the deficits in our net worth as of March 31, 2009 and December 31, 2008, respectively. Based upon our positive net worth at both September 30, 2009 and June 30, 2009, we did not receive any additional funding from Treasury during the last six months of 2009.

 

The unpaid principal balance of our investments in mortgage-related securities decreased 11.1%, or $76.8 billion, during 2009 to $616.5 billion. The decrease in our investments in mortgage-related securities is attributable to a relative lack of favorable investment opportunities, as evidenced by tighter spreads on agency mortgage-related securities. We believe these tighter spread levels were driven by the Federal Reserve’s and Treasury’s agency mortgage-related securities purchase

 

programs. Treasury’s purchase program expired on December 31, 2009 and the Federal Reserve is expected to complete its purchase program by the end of the first quarter of 2010. Once this occurs, it is possible that spreads could widen again, which might create favorable investment opportunities. However, we may be limited in our ability to take advantage of any favorable investment opportunities in future periods because, under the Purchase Agreement and FHFA regulation, the unpaid principal balance of our mortgage-related investments portfolio must decline by 10% per year until it reaches $250 billion. Due to this requirement, the unpaid principal balance of our mortgage-related investments portfolio may not exceed $810 billion as of December 31, 2010. Treasury has stated it does not expect us to be an active buyer to increase the size of our mortgage-related investments portfolio, and also does not expect that active selling will be necessary to meet the required portfolio reduction targets. FHFA has also stated its expectation in the Acting Director’s February 2, 2010 letter that we will not be a substantial buyer or seller of mortgages for our mortgage-related investments portfolio, except for purchases of delinquent mortgages out of PC pools.

 

The unpaid principal balance of our mortgage loans increased 24.5%, or $27.3 billion, during 2009 to $138.8 billion. The increase in mortgage loans was primarily due to increased investment opportunities in multifamily mortgage loans as a result of limited market participation by non-GSE investors during 2009. Our investment in single-family mortgage loans also increased in 2009 due to purchases of modified and delinquent loans out of PC pools.

 

Short-term debt decreased by $91.1 billion during 2009 to $344.0 billion, and long-term debt increased by $28.7 billion to $436.6 billion. As a result, our outstanding short-term debt, including the current portion of long-term debt, decreased as a percentage of our total debt outstanding to 44% at December 31, 2009 from 52% at December 31, 2008. The increase in our long-term debt reflects the improvement during 2009 of spreads on our debt and our continued favorable access to the debt markets. We believe the Federal Reserve’s purchases in the secondary market of our long-term debt under its purchase program have contributed to this improvement. In addition, during 2009, consistent with our efforts to reduce funding costs, we made several tender offers to purchase our more costly debt securities.

 

Our reserve for guarantee losses on PCs increased by $17.5 billion to $32.4 billion during 2009 as a result of an increase in probable incurred losses, primarily attributable to the overall macroeconomic environment, including continued weakness in the housing market and high unemployment.

 

Total equity (deficit) increased from $(30.6) billion at December 31, 2008 to $4.4 billion at December 31, 2009, reflecting increases due to (i) $36.9 billion we received from Treasury under the Purchase Agreement during 2009, (ii) a $17.8 billion decrease in our unrealized losses in AOCI, net of taxes, on our available-for-sale securities and (iii) an increase in retained earnings (accumulated deficit) of $15.0 billion, and a corresponding adjustment of $(9.9) billion net of taxes, to AOCI, as a result of the April 1, 2009 adoption of an amendment to the accounting standards for investments in debt and equity securities. These increases in total equity (deficit) were partially offset by an $21.6 billion net loss for 2009, and $4.1 billion of senior preferred stock dividends for 2009. The $17.8 billion decrease in the unrealized losses in AOCI, net of taxes, on our available-for-sale securities during 2009 was largely due to (i) improvements in the market values of agency and non-agency available-for-sale mortgage-related securities and (ii) the recognition in earnings of other-than-temporary impairments on our non-agency mortgage-related securities.

 

Consolidated Fair Value Results

 

During 2009, the fair value of net assets, before capital transactions, increased by $0.3 billion compared to a $120.9 billion decrease during 2008. The fair value of net assets as of December 31, 2009 was $(62.5) billion, compared to $(95.6) billion as of December 31, 2008. Our fair value results for 2009 reflect the $36.9 billion we received from Treasury and $4.1 billion of dividends paid to Treasury on our senior preferred stock during 2009 under the Purchase Agreement. The increase in the fair value of our net assets, before capital transactions, during 2009 was principally related to an increase in the fair value of our mortgage loans and our investments in mortgage-related securities, resulting from higher core spread income and net tightening of mortgage-to-debt OAS.

 

Liquidity and Capital Resources

 

Liquidity

 

Our access to the debt markets improved since the height of the credit crisis in the fall of 2008, and spreads on our debt remained favorable during 2009. Treasury and the Federal Reserve have taken a number of actions in recent periods that have contributed to this improvement in our access to debt financing, including the following:

 

 

 

 

We believe that the increased support provided by Treasury pursuant to the December 2009 amendment to the Purchase Agreement will be sufficient to enable us to maintain our access to the debt markets and ensure that we have adequate liquidity to conduct our normal business activities over the next three years, although the costs of our debt funding could vary. The completion of the Federal Reserve’s debt purchase program could negatively affect the availability of longer-term debt funding as well as the spreads on our debt, and thus increase our debt funding costs. Debt spreads generally refer to the difference between the yields on our debt securities and the yields on a benchmark index or security, such as LIBOR or Treasury bonds of similar maturity. We do not believe we have experienced any adverse impacts on our access to the debt markets from the expiration of the Lending Agreement, which occurred after the December 2009 amendment to the Purchase Agreement. See “RISK FACTORS” for a discussion of the risks to our business posed by our reliance on the issuance of debt to fund our operations.

 

Due to the expiration of the Lending Agreement, we no longer have a liquidity backstop available to us (other than draws from Treasury under the Purchase Agreement and Treasury’s ability to purchase up to $2.25 billion of our obligations under its permanent statutory authority) if we are unable to obtain funding from issuances of debt or other conventional sources. At present, we are not able to predict the likelihood that a liquidity backstop will be needed, or to identify the alternative sources of liquidity that might be available to us if needed, other than draws from Treasury under the Purchase Agreement or Treasury’s ability to purchase up to $2.25 billion of our obligations under its permanent statutory authority. In addition, market conditions could limit the availability of our investments in mortgage-related assets as a significant source of funding.

 

Based on the current aggregate liquidation preference of the senior preferred stock, Treasury is entitled to annual cash dividends of $5.2 billion, which exceeds our annual historical earnings in most periods. To date, we have paid $4.3 billion in cash dividends on the senior preferred stock. Continued cash payment of senior preferred dividends combined with potentially substantial quarterly commitment fees payable to Treasury beginning in 2011 (the amounts of which must be determined by December 31, 2010), will have an adverse impact on our future financial condition and net worth.

 

The payment of dividends on our senior preferred stock in cash reduces our net worth. For periods in which our earnings and other changes in equity do not result in positive net worth, draws under the Purchase Agreement effectively fund the cash payment of senior preferred dividends to Treasury.

 

Capital Resources

 

FHFA suspended capital classification of us during conservatorship in light of the Purchase Agreement. The Purchase Agreement provides that, if FHFA, as Conservator, determines as of quarter end that our liabilities have exceeded our assets under GAAP, upon FHFA’s request on our behalf, Treasury will contribute funds to us in an amount equal to the difference between such liabilities and assets, up to the maximum aggregate amount that may be funded under the Purchase Agreement. At December 31, 2009, our assets exceeded our liabilities by $4.4 billion. Because we had positive net worth as of December 31, 2009, FHFA has not submitted a draw request on our behalf to Treasury for any additional funding under the Purchase Agreement. The aggregate liquidation preference of the senior preferred stock was $51.7 billion as of December 31, 2009.

 

As previously discussed, due to the implementation of changes to the accounting standards for transfers of financial assets and consolidation of VIEs, we recognized a decrease of approximately $11.7 billion to total equity (deficit) on January 1, 2010, which will increase the likelihood that we will require a draw from Treasury under the Purchase Agreement for the first quarter of 2010.

 

We expect to make additional draws under the Purchase Agreement in future periods, due to a variety of factors that could materially affect the level and volatility of our net worth. For additional information concerning the potential impact of the Purchase Agreement, including the impact of making additional draws, see “RISK FACTORS.” For additional information on our capital management during conservatorship and factors that could affect the level and volatility of our net worth, see “LIQUIDITY AND CAPITAL RESOURCES — Capital Resources” and “NOTE 11: REGULATORY CAPITAL” to our consolidated financial statements.

 

Risk Management

 

Our total mortgage 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 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 mortgage-related guarantee. Institutional credit risk is the risk that a counterparty that has entered into a business contract or arrangement with us will fail to meet its obligations. Our exposure to both mortgage and institutional credit risks remains high due to continued weakness in the mortgage and credit markets.

 

Institutional Credit Risk

 

Our primary institutional credit risk exposure arises from agreements with:

 

 

A significant failure to perform by a major entity in one of these categories could have a material adverse effect on the assets in our total mortgage portfolio or other financial assets on our consolidated balance sheets. The weakened financial condition and liquidity position of some of our counterparties may adversely affect their ability to perform their obligations to us, or the quality of the services that they provide to us. Our exposure to individual counterparties may become more concentrated due to the needs of our business and consolidation in the industry. In addition, any efforts we take to reduce exposure to financially weakened counterparties could result in increased exposure among a smaller number of institutions. The failure of any of our primary counterparties to meet their obligations to us could have additional material adverse effects on our results of operations and financial condition.

 

In addition to obligations to us under certain recourse agreements, our seller/servicers are required to repurchase mortgages sold to us when we determine there are breaches of the representations and warranties made to us. In lieu of repurchase, we may choose to allow a seller/servicer to indemnify us against losses on such mortgages. Some of our seller/servicers failed to perform their repurchase obligations due to lack of financial capacity, while many of our larger, higher credit-quality seller/servicers have not fully performed their repurchase obligations in a timely manner. As of December 31, 2009 and 2008, we had outstanding repurchase requests to our seller/servicers with respect to loans with an unpaid principal balance of approximately $4 billion and $3 billion, respectively. At December 31, 2009, nearly 30% of our outstanding repurchase requests were outstanding for more than 90 days. Our credit losses may increase to the extent our seller/servicers do not fully meet their repurchase obligations. Enforcing repurchase obligations with lender customers who have the financial capacity to perform those obligations could also negatively impact our relationships with such customers and ability to retain market share.

 

Mortgage Credit Risk

 

Mortgage and credit market conditions remained challenging in 2009 due to a number of factors, including the following:

 

 

 

A number of factors make it difficult to predict when a sustained recovery in the mortgage and credit markets will occur, including, among others, uncertainty concerning the effect of current or any future government actions in these markets. Our assumption for home prices, based on our own index, continues to be for a further decline in national home prices over the near term before any sustained turnaround in housing begins, due to, among other factors:

 

 

Single-Family Mortgage Portfolio