UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

 

FORM 10-Q

 

 

 

For the quarterly period ended June 30, 2010

 

or

 

 

For the transition period from                to

 

Commission File Number: 000-53330

 

 

Federal Home Loan Mortgage Corporation

(Exact name of registrant as specified in its charter)

 

Freddie Mac

 

(703) 903-2000

 

(Registrant’s telephone number, including area code)

 

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.     x Yes  o No

 

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 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.

 

 

 

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

 

As of July 23, 2010, there were 649,150,132 shares of the registrant’s common stock outstanding.

 

 

TABLE OF CONTENTS

 

 

FINANCIAL STATEMENTS

 

 

 

This Quarterly Report on Form 10-Q includes forward-looking statements, which may include statements pertaining to the conservatorship, our current expectations and objectives for our efforts under the MHA Program and other programs to assist the U.S. residential mortgage market, our future business plans, liquidity, capital management, economic and market conditions and trends, market share, the effect of 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. You should not rely unduly on our forward-looking statements. Actual results might differ significantly from those described in or implied by such forward-looking statements due to various factors and uncertainties, including those described in: (a) “MD&A — FORWARD-LOOKING STATEMENTS,” and “RISK FACTORS” in this Form 10-Q and in the comparably captioned sections of our Annual Report on Form 10-K for the year ended December 31, 2009, or 2009 Annual Report, and our Quarterly Report on Form 10-Q for the first quarter of 2010; and (b) the “BUSINESS” section of our 2009 Annual Report. These forward-looking statements are made as of the date of this Form 10-Q and we undertake no obligation to update any forward-looking statement to reflect events or circumstances after the date of this Form 10-Q, or to reflect the occurrence of unanticipated events.

 

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

 

You should read this MD&A in conjunction with our consolidated financial statements and related notes for the three and six months ended June 30, 2010 and our 2009 Annual Report.

 

Overview

 

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.

 

We had a net loss attributable to Freddie Mac of $4.7 billion for the three months ended June 30, 2010, reflecting the ongoing adverse conditions in the U.S. mortgage markets. Total equity (deficit) was $(1.7) billion at June 30, 2010. The $1.7 billion deficit was primarily driven by our net loss of $4.7 billion and the $1.3 billion dividend payment to Treasury on the senior preferred stock during the second quarter of 2010. These items were partially offset by a $4.1 billion decrease in unrealized losses related to available-for-sale securities recorded in AOCI during the second quarter of 2010. To address the deficit in our net worth, FHFA, as Conservator, will submit a draw request, on our behalf, to Treasury for $1.8 billion in funding under our Purchase Agreement with Treasury. Following receipt of the draw, the aggregate liquidation preference on the senior preferred stock owned by Treasury will be $64.1 billion.

 

Our financial results for the six months ended June 30, 2010 were significantly affected by changes in accounting principles, which resulted in a net decrease to total equity (deficit) as of January 1, 2010 of $11.7 billion.

 

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. Conservatorship benefits us by, for example, providing us improved access to the debt markets as a result of the support we received from the Federal Reserve and continue to receive from Treasury. We continue to provide access to funding for mortgage originators and, indirectly, for mortgage borrowers. In addition, through our role in the Obama Administration’s initiatives, including the MHA Program, we continue to work to meet the needs of the mortgage market by making homeownership and rental housing more affordable, reducing the number of foreclosures and helping families keep their homes, where possible.

 

While the conservatorship has benefited us, we are subject to certain constraints on our business activities by Treasury due to the terms of, and Treasury’s rights under, the Purchase Agreement and by FHFA, as our Conservator. There is also 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 conservatorship, including whether we will continue to exist. While we are not aware of any current plans of our Conservator to significantly change our business structure in the near-term, Treasury and HUD, in consultation with other government agencies, are expected to develop legislative recommendations in the near term for the future of the GSEs. We have no ability to predict the outcome of these deliberations.

 

In a letter to the Chairmen and Ranking Members of the Senate Banking and House 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 permitting us to offer new products is inconsistent with the goals of the conservatorship. The Acting Director also 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. These restrictions could adversely affect our business over time. We are also subject to limits on the amount of assets we can sell from our mortgage-related investments portfolio in any calendar month without review and approval by FHFA and, if FHFA determines, Treasury.

 

Government Support for our Business

 

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.

 

Significant recent developments with respect to the support we receive from the government include the following:

 

 

To address our deficit in net worth of $1.7 billion as of June 30, 2010, FHFA, as Conservator, will submit a draw request, on our behalf, to Treasury under the Purchase Agreement in the amount of $1.8 billion. We expect to receive these funds by September 30, 2010. Upon funding of the draw request:

 

 

We expect to make additional draws under the Purchase Agreement in future periods. We expect our net worth to be negatively impacted by continued large credit-related expenses as we move through this credit cycle. Our net worth will also be negatively impacted by dividend payments on our senior preferred stock. To date, we have paid $6.9 billion in cash dividends on the senior preferred stock. The payment of dividends on our senior preferred stock in cash reduces our net worth. Future payments 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 continue to have an adverse impact on our future financial condition and net worth.

 

For more information on the terms of the conservatorship, the powers of our Conservator and the terms of the Purchase Agreement, see “BUSINESS — Conservatorship and Related Developments” in our 2009 Annual Report.

 

Delisting of Common Stock and Preferred Stock from NYSE

 

On June 16, 2010, we announced that we notified the NYSE of our intent to delist our common stock and our 20 listed classes of preferred stock pursuant to a directive by FHFA, our Conservator, requiring us to delist our common and preferred securities from the NYSE. According to a press release by FHFA, the Acting Director of FHFA issued similar directives to both us and Fannie Mae.

 

On June 28, 2010 and in accordance with SEC rules and regulations, we filed a Form 25 (Notification of Removal from Listing under Section 12(b) of the Securities Exchange Act of 1934) and the delisting of our common and preferred stock from the NYSE was effective on July 8, 2010.

 

After the delisting of our equity securities from the NYSE, our common stock and the classes of preferred stock that were previously listed on the NYSE are traded exclusively in the OTC market. Shares of our common stock now trade under the ticker symbol FMCC. We expect that our common stock and the previously listed classes of preferred stock will continue to trade in the OTC market so long as market makers demonstrate an interest in trading the common and preferred stock. See “RISK FACTORS — There may not be an active, liquid trading market for our equity securities” for additional information.

 

The transition to OTC trading does not affect our obligation to file periodic and certain other reports with the SEC under applicable federal securities laws.

 

Changes in Accounting Standards Related to Accounting for Transfers of Financial Assets and Consolidation of VIEs

 

In June 2009, the FASB issued two new accounting standards that amended the guidance applicable to the accounting for transfers of financial assets and the consolidation of VIEs. Effective January 1, 2010, we adopted these new accounting standards prospectively for all existing VIEs. The adoption of these two standards had a significant impact on our consolidated financial statements and other financial disclosures beginning in the first quarter of 2010. As a result of the adoption, our consolidated balance sheets reflect the consolidation of our single-family PC trusts and certain of our Structured Transactions. This consolidation resulted in an increase to our assets and liabilities of $1.5 trillion and a net decrease to total equity (deficit) as of January 1, 2010 of $11.7 billion.

 

Because our results of operations for the three and six months ended June 30, 2010 (on both a GAAP and Segment Earnings basis) include the activities of the consolidated VIEs, they are not directly comparable with the results of operations for the three and six months ended June 30, 2009, which reflect the accounting policies in effect during that time (i.e., when the majority of the securitization entities were accounted for off-balance sheet).

 

See “NOTE 2: CHANGE IN ACCOUNTING PRINCIPLES” for detailed discussions regarding the new accounting standards and the impact to our financial statements.

 

Results for the Second Quarter of 2010

 

Financial Results

 

Net income (loss) attributable to Freddie Mac was $(4.7) billion and $0.3 billion for the second quarters of 2010 and 2009, respectively. Key highlights of our financial results for the second quarter of 2010 include:

 

 

We expect a variety of factors will place downward pressure on our financial results in future periods, and could cause us to incur additional GAAP net losses. For a discussion of factors that could result in additional draws, see “LIQUIDITY AND CAPITAL RESOURCES — Capital Resources.”

 

Out-of-Period Accounting Adjustment

 

During the second quarter of 2010, we identified a backlog related to the processing of certain foreclosure alternatives reported to us by our servicers, principally loan modifications and short sales. This backlog was the result of a significant increase in the volume of foreclosure alternatives executed by servicers beginning in 2009, which placed pressure on our existing loan processing capabilities. This backlog in processing loan modifications and short sales resulted in erroneous loan data within our loan reporting systems, thereby impacting our financial accounting and reporting systems. The resulting error impacts our provision for credit losses, allowance for loan losses, and provision for income taxes and affects our previously reported financial statements for the interim period ended March 31, 2010 and the interim 2009 periods and full year ended December 31, 2009. Based upon our evaluation of all relevant quantitative and qualitative factors related to this error, we concluded that this error is not material to our previously issued consolidated financial statements for any of the periods affected and is not material to our estimated earnings for the full year ending December 31, 2010 or to the trend of earnings. As a result, in accordance with the accounting standard related to accounting changes and correction of errors, we have recorded the cumulative effect of this error as a correction in the second quarter of 2010 as an increase to our provision for credit losses. The cumulative effect, net of taxes, of this error corrected in the second quarter of 2010 was $1.2 billion, of which $0.9 billion related to the year

 

ended December 31, 2009. We are taking corrective actions to improve our processing of and accounting for foreclosure alternatives by: (a) expanding our foreclosure alternative processing capabilities to be more responsive to changes in volumes; and (b) enhancing our controls related to data inputs used in our accounting for credit losses. For additional information, see “CONTROLS AND PROCEDURES — Changes in Internal Control Over Financial Reporting During the Quarter Ended June 30, 2010.”

 

Investment Activity and Limits Under the Purchase Agreement

 

Under the terms of the Purchase Agreement, the UPB of our mortgage-related investments portfolio calculated as discussed below may not exceed $810 billion as of December 31, 2010 and this limit will be reduced by 10% each year until it reaches $250 billion.

 

Our mortgage-related investments portfolio under the Purchase Agreement is determined without giving effect to any change in accounting standards related to the transfer of financial assets and consolidation of VIEs or any similar accounting standard. Accordingly, for purposes of the portfolio limit, when PCs and certain Structured Transactions are purchased into the mortgage-related investments portfolio, this is considered the acquisition of assets rather than the reduction of debt. We disclose our mortgage assets on this basis monthly under the caption “Mortgage-Related Investments Portfolio — Ending Balance” in our Monthly Volume Summary reports, which are available on our website and in current reports on Form 8-K we file with the SEC.

 

Table 1 presents the UPB of our mortgage-related investments portfolio, for purposes of the limit imposed by the Purchase Agreement and FHFA regulation. The UPB of our mortgage-related investments portfolio declined slightly from December 31, 2009 to June 30, 2010, primarily due to liquidations, partially offset by the purchase of $96.8 billion of delinquent loans from PC trusts.

 

Table 1 — Mortgage-Related Investments Portfolio⁽¹⁾

 

 

Liquidity

 

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 through December 31, 2012, although the costs of our debt funding could vary. For information regarding the Purchase Agreement, see “BUSINESS — Conservatorship and Related Developments — Overview of the Purchase Agreement” in our 2009 Annual Report.

 

Under the December 2009 amendment to the Purchase Agreement, the $200 billion maximum amount of the commitment from Treasury will increase as necessary to eliminate any net worth deficits we may have during 2010, 2011 and 2012. After 2012, Treasury’s remaining funding commitment under the Purchase Agreement will be $149.3 billion ($200 billion maximum amount of the commitment from Treasury reduced by cumulative draws of $50.7 billion for net worth deficits through December 31, 2009), minus the lesser of (a) any positive net worth we may have as of December 31, 2012 and (b) any cumulative amount of any draws that we have taken to eliminate net worth deficits during 2010, 2011 and 2012.

 

Total Mortgage Portfolio

 

Our total mortgage portfolio declined 2.5% on an annualized basis in the first half of 2010 and was $2.2 trillion at June 30, 2010. Our total non-performing assets were approximately 5.9% and 5.2% of our total mortgage portfolio, excluding non-Freddie Mac securities, at June 30, 2010 and December 31, 2009, respectively, and our loan loss reserves totaled 34.1% of our non-performing loans, at both dates.

 

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.

 

Beginning January 1, 2010, we revised our method for presenting Segment Earnings to reflect changes in how management measures and assesses the financial performance of each segment and the company as a whole. Table 2 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 for the three and six months ended June 30, 2009. We restated Segment Earnings for the three and six months ended June 30, 2009 to reflect the revisions to our method of evaluating the performance of our reportable segments. We did not include in Segment Earnings adjustments related to our adoption of the amendments to the accounting standards for transfers of financial assets and consolidation of VIEs. We applied this change prospectively, consistent with our GAAP financial results. As a result, our Segment Earnings results for the three and six months ended June 30, 2010 are not directly comparable to the results for the three and six months ended June 30, 2009.

 

Table 2 — Summary of Segment Earnings⁽¹⁾

 

 

For more information on Segment Earnings, including the revised method we use to present Segment Earnings, see “CONSOLIDATED RESULTS OF OPERATIONS — Segment Earnings” and “NOTE 16: SEGMENT REPORTING.”

 

Mortgage Credit Risk

 

Mortgage and credit market conditions remained challenging in the second quarter of 2010. 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 future government actions in these markets. We estimate that home prices increased 2.6% nationwide during the first half of 2010, which includes a 3.4% increase in the second quarter of 2010, based on our own index of our single-family credit guarantee portfolio. We believe home prices in the first half of 2010 were positively impacted by seasonal factors as well as availability of the federal homebuyer tax credit. Our expectation for home prices, based on our own index, is that national average home prices will decline over the near term before any sustained turnaround in housing begins, due to, among other factors:

 

 

Even if home prices do not decline in the near term as we expect, our credit losses will likely remain significantly above historical levels for the foreseeable future due to the substantial number of borrowers in our single-family credit

 

guarantee portfolio that owe more on their mortgage than their home is currently worth as well as the substantial backlog of delinquent loans discussed above.

 

Single-Family Credit Guarantee Portfolio

 

The following table provides certain credit statistics for our single-family credit guarantee portfolio, which consists of unsecuritized single-family mortgage loans held-for-investment and those underlying our issued single-family PCs and Structured Securities and other mortgage-related guarantees. The UPB of our single-family credit guarantee portfolio decreased 2%, from approximately $1.90 trillion at December 31, 2009 to $1.87 trillion at June 30, 2010.

 

Table 3 — Credit Statistics, Single-Family Credit Guarantee Portfolio

 

 

As shown in the table above, although the number of delinquent loan additions (those borrowers who became three monthly payments or more past due or in foreclosure) declined in the second quarter of 2010, our single-family credit guarantee portfolio continued to experience a high level of delinquencies. The credit losses of our single-family credit guarantee portfolio continued to increase in the second quarter of 2010 due to several factors, including the following:

 

 

We believe the credit quality of the single-family loans we acquired in the first half of 2010 (excluding those refinance mortgages in the Home Affordable Refinance Program) is strong as compared to loans acquired from 2005 through 2008, as measured by original LTV ratios, FICO scores, and income documentation standards.

 

Multifamily Mortgage Portfolio

 

The following table provides certain credit statistics for our multifamily mortgage portfolio, which consists of loans held by us on our consolidated balance sheets as well as those underlying non-consolidated PCs, Structured Securities and other mortgage-related financial guarantees, but excluding those underlying Structured Transactions and

 

our guarantees of HFA bonds. The UPB of our multifamily mortgage portfolio decreased approximately 2%, from $98.2 billion at December 31, 2009 to $96.5 billion at June 30, 2010.

 

Table 4 — Credit Statistics, Multifamily Mortgage Portfolio

 

 

National multifamily market indicators such as unemployment, effective rents, and vacancies have shown signs of modest improvement in 2010. However, certain markets continue to exhibit weak fundamentals, particularly in the Southeast and West regions, which could adversely affect delinquency rates and credit losses in future periods. Multifamily loans are generally repaid from the cash flows generated by the underlying property. Prolonged periods of high apartment vacancies and negative or flat effective rent growth will adversely impact a multifamily property’s net operating income and related cash flows, which can strain the borrower’s ability to make timely required loan payments and thereby potentially increase our delinquencies and credit losses. Delinquency rates have historically been a lagging indicator and, as a result, we may continue to experience increased delinquencies and credit losses as markets stabilize, reflecting the impact of an extended period of lower property cash flows.

 

The delinquency rates for loans in our multifamily mortgage portfolio are positively impacted to the extent we are successful in working with borrowers to modify their loans prior to their becoming delinquent or providing temporary relief through short term loan extensions. In the first half of 2010, we extended, modified or restructured twenty-five loans totaling $303 million in UPB, compared to nine loans with $36 million in UPB in the first half of 2009.

 

In certain cases, we receive credit enhancement on the multifamily loans we purchase or guarantee, in the form of supplemental collateral or allocation of first losses to holders of subordinate interests, which reduces our risk of credit loss. As of June 30, 2010, approximately two-thirds of the multifamily loans, measured both in terms of number of loans and on a UPB basis, that were two monthly payments or more past due had credit enhancements that we believe will mitigate our expected losses on those loans.

 

Loss Mitigation

 

We continue to devote significant resources to assist our single-family seller/servicers complete loan modifications and support other outreach programs with the objectives of keeping more borrowers in their homes and reducing losses where possible. Our loss mitigation activities included the following:

 

 

Some of our loss mitigation activities create fluctuations in our single-family credit statistics. For example, loans that we report as delinquent before they enter the HAMP trial period remain as delinquent for purposes of our

 

delinquency reporting until the modifications become effective and the loans are removed from delinquent status. However, under many of our non-HAMP modifications, the borrower would return to a current payment status sooner, because many of these modifications do not have trial periods. Thus, the volume and timing of effective modifications impacts our reported single-family delinquency rate. We do not have sufficient empirical information to estimate whether, or the extent to which, costs incurred in the near term from HAMP or other MHA Program efforts may be offset, if at all, by the prevention or reduction of potential future costs of loan defaults and foreclosures due to these initiatives. However, we believe our overall loss mitigation programs could reduce our ultimate credit losses over the long term.

 

Investments in Non-Agency Mortgage-Related Securities

 

Our investments in non-agency mortgage-related securities continue to be adversely affected by the ongoing weak housing and credit conditions, as reflected in poor underlying collateral performance, limited liquidity and large risk premiums in the non-agency mortgage market.

 

Our estimate of the present value of expected credit losses on our non-agency mortgage-related securities portfolio decreased from $10.9 billion to $9.9 billion during the three months ended June 30, 2010, due mainly to improved home prices and lower forward interest rates. However, as impairment is determined on an individual security basis, we recorded net impairment of available-for-sale securities recognized in earnings of approximately $428 million on non-agency mortgage-related securities during the three months ended June 30, 2010, as our estimate of the present value of expected credit losses on certain of these individual securities increased during the period.

 

The table below presents the gross unrealized losses, present value of expected credit losses, net impairment of available-for-sale securities recognized in earnings, and principal cash shortfalls for our non-agency mortgage-related securities. Additionally, the table shows delinquency rates and cumulative collateral loss for the loans backing our subprime first lien, option ARM, and Alt-A securities.

 

Table 5 — Non-Agency Mortgage-Related Securities and Certain Related Credit Statistics

 

 

We held UPB of $94.1 billion of non-agency mortgage-related securities backed by subprime, option ARM, and Alt-A and other loans as of June 30, 2010, compared to $100.7 billion as of December 31, 2009. This decrease is mainly due to the receipt of monthly remittances of principal repayments from both the recoveries of liquidated loans and, to a lesser extent, voluntary repayments of the underlying collateral representing a partial return of our investment in these securities.

 

Pre-tax unrealized losses on securities backed by subprime, option ARM, and Alt-A and other loans reflected in AOCI decreased to $28.0 billion at June 30, 2010. These unrealized losses declined $1.6 billion during the second quarter of 2010 reflecting fair value gains as these securities moved closer to maturity and a decline in market interest rates, partially offset by slightly widening credit spreads on non-agency mortgage-related securities, which we believe is due largely to increased investor concern resulting from the continued European economic crisis.

 

We continue to try to mitigate our losses as an investor in non-agency mortgage-related securities. However, the documents governing the securities trusts in which we have invested do not provide us with an active role in individual loan loss mitigation activities.

 

On July 12, 2010, FHFA, as Conservator of Freddie Mac and Fannie Mae, announced that it had issued subpoenas to various entities seeking loan files and other transaction documents related to non-agency mortgage-related securities in which the two enterprises invested. FHFA stated that the documents will enable it to determine whether issuers of these securities and others are liable to Freddie Mac and Fannie Mae for certain losses they have suffered on the securities. In its announcement, FHFA noted that, before and during conservatorship, Freddie Mac and Fannie Mae sought to assess and enforce their rights as investors in non-agency mortgage-related securities, in an effort to recoup losses suffered in connection with their portfolios. However, difficulty in obtaining the loan documents has presented a challenge to the companies’ efforts.

 

There is no assurance how the various entities will respond to the subpoenas, or to what extent the information sought will result in loss recoveries. As a result, the effectiveness of our loss mitigation efforts for these securities is uncertain and any potential recoveries may take significant time to realize.

 

Legislative and Regulatory Matters

 

On March 23, 2010, the Secretary of the Treasury stated in congressional testimony that, after reform, the GSEs will not exist in the same form. On April 22, 2010, Treasury and HUD published seven questions soliciting public comment on the future of the housing finance system, including Freddie Mac and Fannie Mae, and the overall role of the federal government in housing policy. The Chairman of the House Financial Services Committee has stated that he intends to begin work on GSE reform legislation in the fall of 2010.

 

Dodd-Frank Wall Street Reform and Consumer Protection Act

 

On July 21, 2010, President Obama signed the Dodd-Frank Wall Street Reform and Consumer Protection Act, or the Dodd-Frank Act, into law. The Dodd-Frank Act will significantly change the regulation of the financial services industry, including by creating new standards related to regulatory oversight of systemically important financial companies, derivatives, capital requirements, asset-backed securitization, mortgage underwriting, and consumer financial protection. The Act will directly affect the business and operations of Freddie Mac by subjecting us to new and additional regulatory oversight and standards, including with respect to our activities and products. We may also be affected by provisions of the Act and implementing regulations that affect the activities of banks, savings institutions, insurance companies, securities dealers, and other regulated entities that are our customers and counterparties.

 

At this time, it is difficult to assess fully the impact of the Dodd-Frank Act on Freddie Mac and the financial services industry. Implementation of the Act will be accomplished through numerous rulemakings. Therefore, it will take some time for the final effects of the legislation to emerge and be understood. The Dodd-Frank Act also mandates the preparation of studies of a wide range of issues, which could lead to additional legislation or regulatory changes.

 

The new Financial Stability Oversight Council, created by the Dodd-Frank Act to identify and address emerging risk throughout the financial system, will have the power to designate certain nonbank financial companies to be subject to supervision and regulation by the Federal Reserve. If Freddie Mac is designated by the Council to be a nonbank financial company subject to supervision by the Federal Reserve, the Federal Reserve will have authority to examine Freddie Mac and the company may be required to meet more stringent standards than those applicable to nonbank financial companies that do not present similar risks to U.S. financial stability. These standards may include risk-based capital requirements and leverage limits, liquidity requirements, overall risk management requirements, stress tests, resolution plan and credit exposure reporting requirements, concentration limits and additional capital requirements and quantitative limits related to proprietary trading activities.

 

The Dodd-Frank Act will have a significant impact on the derivatives market, including by subjecting swap dealers and certain other substantial users of swaps known as “major swap participants,” or MSPs, to extensive new oversight and regulations, including new capital, margin and business conduct standards, and position limits. If Freddie Mac is deemed to be an MSP, FHFA, in consultation with the SEC and the U.S. Commodity Futures Trading Commission, or CFTC, will be required to establish new rules with respect to our activities as an MSP regarding capital requirements and margin requirements for certain derivatives transactions. Even if we are not deemed an MSP, we could become subject to new CFTC rules related to clearing, trading, and reporting requirements for derivatives transactions.

 

The Dodd-Frank Act will create new standards and requirements related to asset-backed securities, including requiring securitizers and potentially originators to retain a portion of the underlying loans’ credit risk. The impact of this provision on the financial services industry, asset-backed securities markets, and Freddie Mac will be difficult to

 

determine until the regulations are promulgated. The regulatory provisions could weaken or remove incentives for financial institutions to sell mortgage loans to us, which could have an adverse effect on our business results and financial condition.

 

Under the Dodd-Frank Act, new minimum mortgage underwriting standards will be required for residential mortgages, including a requirement that lenders make a reasonable and good faith determination based on “verified and documented information” that the consumer has a “reasonable ability to repay” the mortgage. The Act requires regulators to establish a class of qualified loans that will receive certain protections from legal liability, such as the borrower’s right to rescind the loan and seek damages. Mortgage originators and assignees including Freddie Mac will be subject to increased legal risk for loans that do not meet these requirements.

 

Under the Dodd-Frank Act, federal regulators, including FHFA, are directed to promulgate regulations, to be applicable to financial institutions including Freddie Mac, that will prohibit incentive-based compensation structures that the regulators determine encourage inappropriate risks by providing excessive compensation or benefits or that could lead to material financial loss. It is possible that any such regulations will have an adverse effect on our ability to retain and recruit management and other valuable employees, as we may be at a competitive disadvantage as compared to other potential employers not subject to these or similar regulations.

 

The Dodd-Frank Act does not address the future of the GSEs. However, the Act states that it is the sense of Congress that reform efforts related to residential mortgage credit and the practices related to such credit would be incomplete without enactment of meaningful structural reforms of Freddie Mac and Fannie Mae. In addition, the Act requires the Secretary of the Treasury to conduct a study and develop recommendations regarding the options for ending the conservatorship. The Secretary’s report and recommendations are required to be submitted to Congress not later than January 31, 2011.

 

For more information, see “RISK FACTORS — The Dodd-Frank Act and related regulation may adversely affect our business activities and financial results.”

 

Energy Loan Tax Assessment Programs

 

A number of states have enacted laws allowing localities to create energy loan assessment programs for the purpose of financing energy efficient home improvements. These programs are typically denominated as Property Assessed Clean Energy, or PACE, programs. While the specific terms may vary, these laws generally treat the new energy assessments like property tax assessments, which generally creates a new lien to secure the assessment that is senior to any existing first mortgage lien. These laws could have a negative impact on Freddie Mac’s credit losses, to the extent large numbers of borrowers obtain this type of financing.

 

On July 6, 2010, FHFA announced that it had determined that certain of these programs present significant safety and soundness concerns that must be addressed by the GSEs. The FHFA statement indicates that letters sent by Freddie Mac and Fannie Mae on May 5, 2010 alerting their seller-servicers that PACE programs with first liens run contrary to the Fannie Mae-Freddie Mac uniform mortgage document remain in effect. In addition, FHFA announced that it is directing Freddie Mac and Fannie Mae to undertake the following prudential actions:

 

 

The statement issued by FHFA indicates that it does not affect our normal underwriting programs or our dealings with PACE programs that do not have a senior lien priority. Also, this directive does not affect our underwriting related to traditional tax liens. We are unable to estimate the amount of loans that may have a PACE lien prior to July 6, 2010 in our single-family credit guarantee portfolio since these loans are not identified as such and borrowers may have obtained such a loan subsequent to our purchase of the first lien mortgage. Beginning July 6, 2010, our seller/servicers represent that there are no PACE liens at origination on single-family loans sold to us.

 

We are subject to lawsuits relating to PACE programs in California. See “NOTE 20 — LEGAL CONTINGENCIES.” Legislation has been introduced in the Senate and the House of Representatives that would require Freddie Mac and Fannie Mae to adopt standards that support PACE programs.

 

Proposed Rule on Conservatorship and Receivership Operations

 

On July 9, 2010, FHFA published in the Federal Register a proposed rule to codify certain terms of conservatorship and receivership operations for Fannie Mae, Freddie Mac and the FHLBs. FHFA noted that among the key issues addressed in the proposed rule are the status and priority of claims and the relationships among various

 

classes of creditors and equity-holders under conservatorships or receiverships. The Acting Director of FHFA stated that publication of this rule for comment has no impact on the current conservatorship operations and is not a reflection of the condition of Freddie Mac, Fannie Mae or the FHLBs.

 

Affordable Housing Goals

 

In March 2010, we reported to FHFA that we did not meet the 2009 underserved areas housing goal, special affordable housing goal, underserved areas home purchase subgoal and multifamily special affordable target. In June 2010, FHFA notified us that it had determined that we failed to achieve these goals. FHFA determined that achievement of the underserved areas housing goal and multifamily special affordable target was infeasible, but that achievement of the special affordable housing goal and underserved areas home purchase subgoal was feasible. FHFA also notified us of its determination that we will not be required to submit a housing plan with regard to any such goals.

 

Our housing goals and results for 2009 are set forth below:

 

Table 6 — Affordable Housing Goals and Reported Results for 2009⁽¹⁾

 

 

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. On June 7, 2010, FHFA published in the Federal Register a proposed rule regarding the duty of Freddie Mac and Fannie Mae to serve the underserved markets. Comments were due on July 22, 2010. We provided comments on the proposed rule to FHFA, but we cannot predict the contents of any final rule that FHFA may release, or the impact that the final rule will have on our business or operations.

 

 

 

 

The following discussion of our consolidated results of operations should be read in conjunction with our consolidated financial statements including the accompanying notes. Also see “CRITICAL ACCOUNTING POLICIES AND ESTIMATES” for more information concerning our more significant accounting policies and estimates applied in determining our reported results of operations.

 

Change in Accounting Principles

 

As discussed in “EXECUTIVE SUMMARY,” our adoption of two new accounting standards that amended the guidance applicable to the accounting for transfers of financial assets and the consolidation of VIEs had a significant impact on our consolidated financial statements and other financial disclosures beginning in the first quarter of 2010.

 

The cumulative effect of these changes in accounting principles was a net decrease of $11.7 billion to total equity (deficit) as of January 1, 2010, which includes changes to the opening balances of retained earnings (accumulated deficit) and AOCI, net of taxes. This net decrease was driven principally by: (a) the elimination of unrealized gains resulting from the extinguishment of PCs held as investment securities upon consolidation of the PC trusts, representing the difference between the UPB of the loans underlying the PC trusts and the fair value of the PCs, including premiums, discounts, and other basis adjustments; (b) the elimination of the guarantee asset and guarantee obligation established for guarantees issued to securitization trusts we consolidated; and (c) the application of our nonaccrual policy to delinquent mortgage loans consolidated as of January 1, 2010.

 

See “NOTE 2: CHANGE IN ACCOUNTING PRINCIPLES,” “NOTE 4: VARIABLE INTEREST ENTITIES” and “NOTE 22: SELECTED FINANCIAL STATEMENT LINE ITEMS” for additional information regarding these changes.

 

As these changes in accounting principles were applied prospectively, our results of operations for the three and six months ended June 30, 2010 (on both a GAAP and Segment Earnings basis), which reflect the consolidation of trusts that issue our single-family PCs and certain Structured Transactions, are not directly comparable with the results of operations for the three and six months ended June 30, 2009, which reflect the accounting policies in effect during that time (i.e., when the majority of the securitization entities were accounted for off-balance sheet).

 

Consolidated Statements of Operations — GAAP Results

 

Table 7 summarizes the GAAP Consolidated Statements of Operations.

 

Table 7 — Summary Consolidated Statements of Operations — GAAP Results⁽¹⁾

 

 

Net Interest Income

 

Table 8 presents an analysis of net interest income, including average balances and related yields earned on assets and incurred on liabilities.

 

Table 8 — Net Interest Income/Yield and Average Balance Analysis

 

 

Our adoption of the change to the accounting standards for consolidation, as discussed above, had the following impact on net interest income and net interest yield for the three and six months ended June 30, 2010, and will have similar effects on those items in future periods:

 

 

See “NOTE 2: CHANGE IN ACCOUNTING PRINCIPLES” for additional information.

 

Net interest income decreased by $119 million during the three months ended June 30, 2010 compared to the three months ended June 30, 2009 due mainly to lower mortgage-related securities balances and larger amounts of non-performing loans, partially offset by lower funding costs and the inclusion of amounts previously classified as management and guarantee income. Net interest income increased by $147 million during the six months ended June 30, 2010 compared to the six months ended June 30, 2009 due mainly to lower funding costs and the inclusion of amounts previously classified as management and guarantee income, partially offset by lower mortgage-related securities balances and larger amounts of non-performing loans. Net interest yield declined substantially during the 2010 periods because the net interest yield of our consolidated single-family trusts was lower than the net interest yield of PCs previously included in net interest income and our balance of non-performing mortgage loans increased.

 

During the three and six months ended June 30, 2010, spreads on our debt and our access to the debt markets remained favorable. For more information, see “LIQUIDITY AND CAPITAL RESOURCES — Liquidity.”

 

Provision for Credit Losses

 

We maintain loan loss reserves at levels we deem adequate to absorb probable incurred losses on mortgage loans held-for-investment and loans underlying our financial guarantees. Increases in our loan loss reserves are reflected in earnings as the provision for credit losses.

 

Our loan loss reserves reflect our best estimate of defaults we believe are likely as a result of loss events that have occurred through June 30, 2010. The ongoing weakness in the national housing market, the uncertainty in other macroeconomic factors, such as trends in unemployment rates, and the uncertainty of the effect of government actions to address the economic and housing crisis, make forecasting default rates and severity of resulting losses inherently imprecise. For more information regarding how we derive our estimate for the provision for credit losses, see “MD&A — CRITICAL ACCOUNTING POLICIES AND ESTIMATES” in our 2009 Annual Report.

 

Our loan loss reserves also reflect: (a) the projected recoveries of losses through credit enhancements; (b) the projected impact of strategic loss mitigation initiatives (such as our efforts under the MHA Program), including an expected higher volume of loan modifications; and (c) the projected recoveries through repurchases by seller/servicers of defaulted loans. An inability to realize the projected benefits of our loss mitigation plans, a lower than projected realized rate of seller/servicer repurchases or default rates that exceed our current projections would cause our losses to be higher than those currently estimated.

 

As discussed in “Net Interest Income,” our provision for credit losses was positively impacted by the changes in accounting standards for transfers of financial assets and consolidation of VIEs effective January 1, 2010 since we no

 

longer account for foregone interest income on non-performing loans within our provision for credit losses. See “NOTE 2: CHANGE IN ACCOUNTING PRINCIPLES” for further information.

 

The provision for credit losses was $5.0 billion and $5.7 billion for the second quarters of 2010 and 2009, respectively, and was $10.4 billion in the first half of 2010 compared to $14.6 billion in the first half of 2009. During the 2010 periods, we experienced slower increases in the rate of growth in the balance of our non-performing loans than in the 2009 periods. Loss severity rates were relatively stable in the first half of 2010 and improved slightly in the second quarter of 2010 while severity rates worsened in both the second quarter and first half of 2009. These factors moderated the increase in our loan loss reserves and consequently, our provision for credit losses during the three and six months ended June 30, 2010 was less than that recognized during the 2009 periods.

 

During the second quarter of 2010, we identified a backlog related to the processing of certain foreclosure alternatives reported to us by our servicers, principally loan modifications and short sales. This backlog was the result of a significant increase in the volume of foreclosure alternatives executed by servicers beginning in 2009, which placed pressure on our existing loan processing capabilities. Our loan accounting processing activities and our loan loss reserving process are dependent on accurate loan data from our loan reporting systems. Our foreclosure alternative operational processes rely on manual reviews and approvals prior to modifying the corresponding loan data within our loan reporting systems. This backlog in processing loan modifications and short sales resulted in erroneous loan data within our loan reporting systems, thereby impacting our financial accounting and reporting systems. Prior to the second quarter of 2010, while we modified our loan loss reserving processes to consider potential processing lags in foreclosure alternatives data, we failed to fully adjust for the impacts of the resulting erroneous loan data on our financial statements. The resulting error impacts our provision for credit losses, allowance for loan losses, and provision for income taxes and affects our previously reported financial statements for the interim period ended March 31, 2010 and the interim 2009 periods and full year ended December 31, 2009. Based upon our evaluation of all relevant quantitative and qualitative factors related to this error, we concluded that this error is not material to our previously issued consolidated financial statements for any of the periods affected and is not material to our estimated earnings for the full year ending December 31, 2010 or to the trend of earnings. As a result, in accordance with the accounting standard related to accounting changes and correction of errors, we have recorded the cumulative effect of this error as a correction in the second quarter of 2010 as an increase to our provision for credit losses. The pre-tax cumulative effect on our provision for credit losses of this error corrected in the second quarter of 2010 was $1.3 billion, of which $1.0 billion related to the year ended December 31, 2009. We are taking corrective actions to improve our processing of and accounting for foreclosure alternatives by: (a) expanding our foreclosure alternative processing capabilities to be more responsive to changes in volumes; and (b) enhancing our controls related to data inputs used in our accounting for credit losses. For additional information, see “CONTROLS AND PROCEDURES — Changes in Internal Control Over Financial Reporting During the Quarter Ended June 30, 2010.”

 

Our charge-offs, net of recoveries, increased to $3.9 billion in the second quarter of 2010, compared to $1.9 billion in the second quarter of 2009, primarily due to an increase in the volume of foreclosure transfers, short sales, and other foreclosure alternatives associated with single-family loans. Charge-offs, net of recoveries were $6.7 billion in the first half of 2010 compared to $2.9 billion in the first half of 2009. We recognized $1.1 billion and $3.7 billion of provision for credit losses above the level of our charge-offs, net during the three and six months ended June 30, 2010, respectively, primarily as a result of:

 

 

The level of our provision for credit losses in the remainder of 2010 will depend on a number of factors, including the actual level of mortgage defaults, the impact of the MHA Program and our other loss mitigation efforts, changes in property values, regional economic conditions, including unemployment rates, third-party mortgage insurance coverage

 

and recoveries, and the realized rate of seller/servicer repurchases. See “RISK MANAGEMENT — Credit Risks — Institutional Credit Risk” for additional information on seller/servicer repurchase obligations.

 

Certain multifamily markets in the Southeast and West regions exhibited weaker than average fundamentals and operating performance in the first half of 2010, which increases our risk of future losses related to properties in these areas. The amount of multifamily loans identified as impaired, where we estimate a specific reserve, increased in both the three and six months ended June 30, 2010, compared to the 2009 periods. As a result, the amount of our loan loss reserve associated with multifamily loans increased to $935 million as of June 30, 2010 from $831 million as of December 31, 2009.

 

See “Table 3 — Credit Statistics, Single-Family Credit Guarantee Portfolio” and “Table 4 — Credit Statistics, Multifamily Mortgage Portfolio” for quarterly trends in our mortgage loan credit statistics.

 

Non-Interest Income (Loss)

 

Gains (Losses) on Extinguishment of Debt Securities of Consolidated Trusts

 

Subsequent to January 1, 2010, due to the change in accounting for consolidation of VIEs, when we purchase PCs that have been issued by consolidated PC trusts, we extinguish a pro rata portion of the outstanding debt securities of the related consolidated trust. We recognize a gain (loss) on extinguishment of the debt securities to the extent the amount paid to redeem the debt security differs from its carrying value adjusted for any related purchase commitments accounted for as derivatives. For the three and six months ended June 30, 2010, we extinguished debt securities of consolidated trusts with a UPB of $0.9 billion and $5.3 billion, respectively (representing our purchase of single-family PCs with a corresponding UPB amount), and our gains (losses) on extinguishment of these debt securities of consolidated trusts were $4 million and $(94) million, respectively. See “NOTE 2: CHANGE IN ACCOUNTING PRINCIPLES” for additional information.

 

Gains (Losses) on Retirement of Other Debt

 

Gains (losses) on retirement of other debt were $(141) million and $(179) million during the three and six months ended June 30, 2010, respectively, compared to $(156) million and $(260) million during the three and six months ended June 30, 2009, respectively. During the three and six months ended June 30, 2010, we recognized fewer losses on debt retirement compared to the three and six months ended June 30, 2009 due to gains on debt repurchases, declines in write-offs of concession fees, and declines in write-offs of basis adjustments related to previously discontinued hedging relationships.

 

Derivative Gains (Losses)

 

Table 9 presents derivative gains (losses) reported in our consolidated statements of operations. See “NOTE 11: DERIVATIVES — Table 11.2 — Gains and Losses on Derivatives” for information about gains and losses related to specific categories of derivatives. Changes in fair value and interest accruals on derivatives not in hedge accounting relationships are recorded as derivative gains (losses) in our consolidated statements of operations. At June 30, 2010 and December 31, 2009, we did not have any derivatives in hedge accounting relationships; however, there are amounts recorded in AOCI related to discontinued cash flow hedges. The deferred amounts in AOCI related to closed cash flow hedges are reclassified to earnings when the forecasted transactions affect earnings. Although derivatives are an important aspect of our management of interest-rate risk, they generally increase the volatility of reported net income (loss), because not all of the assets and liabilities being hedged are recorded at fair value with changes reported in net income.

 

Table 9 — Derivative Gains (Losses)

 

 

Gains (losses) on derivatives are principally driven by changes in: (a) swap interest rates and implied volatility; and (b) the mix and volume of derivatives in our derivative portfolio.

 

During the three and six months ended June 30, 2010, the yield curve flattened, with declining longer-term swap interest rates, resulting in a loss on derivatives of $3.8 billion and $8.5 billion, respectively. Also contributing to these losses was a decline in implied volatility on our options portfolio during the six months ended June 30, 2010. Specifically, for the three and six months ended June 30, 2010, the decrease in longer-term swap interest rates resulted in fair value losses on our pay-fixed swaps of $18.6 billion and $23.4 billion, respectively, partially offset by fair value gains on our receive-fixed swaps of $10.7 billion and $13.0 billion, respectively. We recognized fair value gains for the three and six months ended June 30, 2010 of $5.9 billion and $5.3 billion, respectively, on our option-based derivatives, resulting from gains on our purchased call swaptions primarily due to the declines in forward interest rates during these periods.

 

During the three months ended June 30, 2009, longer-term swap interest rates and implied volatility both increased, resulting in a gain on derivatives of $2.4 billion. During the period, the increasing swap interest rates resulted in fair value gains on our pay-fixed swaps of $18.5 billion, partially offset by losses on our receive-fixed swaps of $10.3 billion. The $5.4 billion decrease in fair value of option-based derivatives resulted from losses on our purchased call swaptions where increases in longer-term swap interest rates more than offset the increase in implied volatility.

 

During the six months ended June 30, 2009, longer-term swap interest rates increased, resulting in a gain on derivatives of $2.5 billion. During the period, the increasing swap interest rates resulted in fair value gains on our pay-fixed swaps, partially offset by losses on our receive-fixed swaps. The $8.6 billion decrease in fair value of option-based derivatives resulted from losses on our purchased call swaptions where increases in longer-term swap interest rates more than offset the increase in implied volatility.

 

Investment Securities-Related Activities

 

Since January 1, 2010, as a result of our adoption of amendments to the accounting standards for transfers of financial assets and consolidation of VIEs, we no longer account for the single-family PCs and certain Structured Transactions we hold as investments in securities. Instead, we now recognize the underlying mortgage loans on our consolidated balance sheets through consolidation of the related trusts. Our adoption of these amendments resulted in a decrease in our investments in securities of $286.5 billion on January 1, 2010. See “NOTE 2: CHANGE IN ACCOUNTING PRINCIPLES” for additional information.

 

Impairments of Available-for-Sale Securities

 

We recorded net impairments of available-for-sale securities recognized in earnings of $428 million and $938 million during the three and six months ended June 30, 2010, respectively. See “CONSOLIDATED BALANCE SHEETS ANALYSIS — Investments in Securities — Mortgage-Related Securities — Other-Than-Temporary Impairments on Available-for-Sale Mortgage-Related Securities” and “NOTE 7: INVESTMENTS IN SECURITIES” for information regarding the accounting principles for investments in debt and equity securities and the other-than-temporary impairments recorded during the three and six months ended June 30, 2010 and 2009. See “NOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES — Recently Adopted Accounting Standards — Change in the Impairment Model for Debt Securities” in our 2009 Annual Report for information on how other-than-temporary impairments are recorded on our financial statements commencing in the second quarter of 2009.

 

Other Gains (Losses) on Investment Securities Recognized in Earnings

 

Other gains (losses) on investment securities recognized in earnings primarily consists of gains (losses) on trading securities. We recognized $(277) million and $(694) million related to gains (losses) on trading securities during the three and six months ended June 30, 2010, respectively, compared to $622 million and $2.8 billion during the three and six months ended June 30, 2009, respectively.

 

The fair value of our securities classified as trading was approximately $66.6 billion at June 30, 2010 compared to approximately $250.7 billion at June 30, 2009. The decline in fair value was primarily due to our adoption of amendments to the accounting standards for transfers of financial assets and consolidation of VIEs on January 1, 2010 together with minimal purchase activity during the first half of 2010 thus changing the mix of our securities classified as trading to a larger percentage of interest-only securities. The net gains on trading securities during the three and six months ended June 30, 2009 related primarily to tightening OAS levels. In addition, during the three and six months ended June 30, 2009, we sold agency securities classified as trading with UPB of approximately $51 billion and $87 billion, respectively, which generated realized gains of $0.2 billion and $1.3 billion, respectively.

 

Other Income

 

Table 10 summarizes the significant components of other income.

 

Table 10 — Other Income

 

 

Other income includes items associated with our guarantee business activities of non-consolidated trusts, including management and guarantee income, gains (losses) on guarantee asset, income on guarantee obligation, and trust management income (expense). Upon consolidation of our single-family PC trusts and certain Structured Transactions, guarantee-related items no longer have a material impact on our results and are therefore included in other income on our consolidated statements of operations. The management and guarantee income recognized during the first half of 2010 was earned from our non-consolidated securitization trusts and other mortgage credit guarantees which had an aggregate UPB of $40.8 billion as of June 30, 2010 compared to $1.9 trillion as of June 30, 2009. For additional information on the impact of consolidation of our single-family PC trusts and certain Structured Transactions, see “NOTE 2: CHANGE IN ACCOUNTING PRINCIPLES” and “NOTE 22: SELECTED FINANCIAL STATEMENT LINE ITEMS.”

 

Lower-of-Cost-or-Fair-Value Adjustments on Held-for-Sale Mortgage Loans

 

During the three months ended June 30, 2010 and 2009, we recognized lower-of-cost-or-fair-value adjustments of $0 million and $(102) million, respectively. During the six months ended June 30, 2010 and 2009, we recognized lower-of-cost-or-fair-value adjustments of $0 million and $(231) million, respectively. Due to the change in consolidation accounting for VIEs, which we adopted on January 1, 2010, all single-family mortgage loans on our balance sheet were reclassified as held-for-investment. Consequently, beginning in 2010, we no longer record lower-of-cost-or-fair-value adjustments on single-family mortgage loans.

 

Recoveries on Loans Impaired Upon Purchase

 

During the three months ended June 30, 2010 and 2009, we recognized recoveries on loans impaired upon purchase of $227 million and $70 million, respectively, and in the first half of 2010 and 2009 our recoveries were $396 million and $120 million, respectively. Our recoveries on loans impaired upon purchase increased in the 2010 periods due to a higher volume of short sales and foreclosure transfers, combined with improvements in home prices in many geographical areas during the first half of 2010, as compared to the first half of 2009. Our recoveries on these loans may be volatile in the short-term due to the effects of changes in home prices, among other factors. We expect

 

our recoveries to remain higher in the remainder of 2010, as compared to 2009, due to higher expected volumes of foreclosures in 2010.

 

Low-Income Housing Tax Credit Partnerships

 

We wrote down the carrying value of our LIHTC investments to zero in the fourth quarter of 2009, as we will not be able to realize any value either through reductions to our taxable income and related tax liabilities or through a sale to a third party. See “CONSOLIDATED RESULTS OF OPERATIONS — Non-Interest Income (Loss) — Low-Income Housing Tax Credit Partnerships” in our 2009 Annual Report for more information.

 

Non-Interest Expense

 

Table 11 summarizes the components of non-interest expense.

 

Table 11 — Non-Interest Expense