10-Q 1 f71164e10vq.htm 10-Q e10vq
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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
 
 
FORM 10-Q
 
 
x   QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.
 
For the quarterly period ended September 30, 2009
 
or
 
o   TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.
 
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
     
Federally chartered corporation   52-0904874
(State or other jurisdiction of
incorporation or organization)
  (I.R.S. Employer
Identification No.)
     
8200 Jones Branch Drive, McLean, Virginia   22102-3110
(Address of principal executive offices)   (Zip Code)
 
(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.
 
Large accelerated filer o Accelerated filer o
 
Non-accelerated filer (Do not check if a smaller reporting company) x 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).  o Yes   x No
 
As of October 30, 2009, there were 648,337,003 shares of the registrant’s common stock outstanding.
 


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     Risk Management
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FINANCIAL STATEMENTS
 
         
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PART I — FINANCIAL INFORMATION
 
This Quarterly Report on Form 10-Q includes forward-looking statements, which may include statements pertaining to the conservatorship and our current expectations and objectives for the MHA Program and other efforts to assist the U.S. residential mortgage markets, as well as our 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. 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 (i) Management’s Discussion and Analysis, or MD&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, 2008, or 2008 Annual Report, and our Quarterly Reports on Form 10-Q for the first and second quarters of 2009 and (ii) the “BUSINESS” section of our 2008 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, including the Financial Statements and MD&A, we use certain acronyms and terms and refer to certain accounting pronouncements which are defined in the Glossary.
 
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 
EXECUTIVE SUMMARY
 
You should read this MD&A in conjunction with our consolidated financial statements and related notes for the three and nine months ended September 30, 2009 and our 2008 Annual Report.
 
Overview
 
Freddie Mac was chartered by Congress in 1970 with a public mission to stabilize the nation’s residential mortgage market 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 also guarantee multifamily mortgage loans that support housing revenue bonds issued by third parties and we guarantee other mortgage loans held by third parties. Securitized mortgage-related assets that back PCs and Structured Securities that are held by third parties are not reflected as assets on our balance sheets. 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 homeownership and rental housing more affordable, reducing the number of foreclosures and helping families keep their homes.
 
We had net loss attributable to Freddie Mac of $5.0 billion for the third quarter of 2009 and total equity of $10.4 billion as of September 30, 2009. Net loss attributable to common stockholders was $6.3 billion for the third quarter of 2009, which includes the payment of $1.3 billion of dividends in cash on the senior preferred stock. Our financial results for the third quarter of 2009, compared to the second quarter of 2009, reflect the unfavorable impact of decreased interest rates on the fair value of our derivatives and our guarantee asset, as well as increased credit-related expenses. These unfavorable impacts were partially offset by gains on trading securities due to tightening OAS and lower interest rates, gains on sales of available-for-sale securities and reduced net impairments on available-for-sale securities recognized in earnings. Total equity increased $2.2 billion during the quarter from $8.2 billion as of June 30, 2009. The increase included $8.3 billion of fair value improvement on available-for-sale securities within AOCI, due primarily to declines in interest rates and tightening of mortgage-to-debt OAS, offset by the third quarter 2009 net loss attributable to Freddie Mac of $5.0 billion and senior preferred stock dividends of $1.3 billion.
 
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We expect a variety of factors will continue to place downward pressure on our financial results in future periods, and could cause us to incur further GAAP net losses and request additional draws from Treasury under the Purchase Agreement. Key factors include the potential for continued deterioration in the housing market and rising unemployment, which could result in additional credit-related expenses and security impairments, adverse changes in interest rates and spreads, which could result in mark-to-market losses, additional impairment of our investments in LIHTC partnerships, and our efforts under the MHA Program and other government initiatives, some of which are expected to have an adverse impact on our financial results. While the housing market has experienced recent modest home price improvements beginning in the second quarter of 2009, we expect home price declines in future periods. Consequently, our provisions for credit losses will likely remain high during the remainder of 2009. Further, our senior preferred stock dividend obligation, combined with potentially substantial quarterly commitment fees payable to Treasury beginning in 2010 (the amounts of which have not yet been determined), and our inability to pay down draws under the Purchase Agreement will have a significant adverse impact on our future net worth. To the extent that these factors result in a negative net worth, we would be required to take additional draws from Treasury under the Purchase Agreement. For a discussion of factors that could result in additional draws, see “LIQUIDITY AND CAPITAL RESOURCES — Capital Adequacy”.
 
Recent Management Changes
 
Several significant management changes occurred recently:
 
  •  On August 10, 2009, Charles E. Haldeman, Jr. began serving as our Chief Executive Officer and as a member of our Board of Directors. Mr. Haldeman succeeded John A. Koskinen, who served as our Interim Chief Executive Officer and performed the functions of principal financial officer and who returned to the position of Non-Executive Chairman of the Board;
 
  •  On September 14, 2009, Bruce M. Witherell began serving as our Chief Operating Officer; and
 
  •  On October 12, 2009, Ross J. Kari began serving as our Chief Financial Officer.
 
Business Objectives
 
We continue to operate under the direction of FHFA as our Conservator. 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.
 
We changed certain business practices and other non-financial objectives to provide support for the mortgage market in a manner that serves public policy, but that may not contribute to 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 with Treasury, may adversely impact our financial results, including our segment results.
 
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 current plans of our Conservator to significantly change our business structure in the near-term. As discussed below in “Legislative and Regulatory Matters — Federal Legislation and Related Matters,” Treasury and HUD, in consultation with other government agencies, are expected to develop legislative recommendations for the future of the GSEs.
 
MHA Program and Other Efforts to Assist the Housing Market
 
We are working with our Conservator to help distressed homeowners through initiatives that support the MHA Program. We 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 for our business.
 
During the third quarter of 2009, we continued to enhance our infrastructure and capacity to support the MHA Program by devoting significant internal resources to support the increased activity under both of its key initiatives: the Home Affordable Refinance Program and the Home Affordable Modification Program.
 
Home Affordable Refinance Program
 
The Home Affordable Refinance Program gives eligible homeowners with loans owned or guaranteed by Freddie Mac or Fannie Mae an opportunity to refinance into loans with more affordable monthly payments. The Freddie Mac Relief Refinance Mortgagesm is our implementation of the Home Affordable Refinance Program for our loans. As of
 
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September 30, 2009, we purchased approximately 98,000 loans totaling approximately $20.0 billion in unpaid principal balance under this program, including approximately 54,000 loans with current LTVs above 80%.
 
We expect to continue to experience strong demand for the Freddie Mac Relief Refinance Mortgage due to low interest rates and recent enhancements to the program. These enhancements were designed to help more borrowers take advantage of the program, and include:
 
  •  increasing the maximum allowable current LTV ratio of a Freddie Mac Relief Refinance Mortgage to 125%;
 
  •  allowing borrowers to refinance a Freddie Mac-owned or guaranteed mortgage with any lender affiliated with Freddie Mac; and
 
  •  increasing the amount of closing costs that can be included in the new refinance mortgage up to $5,000.
 
Home Affordable Modification Program, or HAMP
 
HAMP commits U.S. government, Freddie Mac and Fannie Mae funds to help eligible homeowners avoid foreclosure and keep their homes through mortgage modifications. We have focused our loan modification efforts on HAMP since it was introduced in the second quarter of 2009, and have completed 471 modifications under HAMP as of September 30, 2009. Under HAMP, borrowers must complete a trial period of three or more months before the loan is modified. Our overall loan modification volume declined in the third quarter of 2009 as compared to the second quarter of 2009 because borrowers did not begin entering into trial periods under HAMP in significant numbers until early in the third quarter and, in many cases, trial periods were extended beyond the initial three month period as HAMP guidelines were modified. Based on information reported by our servicers to the MHA program administrator, more than 88,000 loans that we own or guarantee were in the trial period portion of the HAMP process as of September 30, 2009. Trial period loans under HAMP are those where the borrower has made the first payment under the terms of a trial period offer.
 
Through September 30, 2009, our loss mitigation activity under HAMP has been primarily focused with our larger seller/servicers, which service the majority of our loans, and variations in their approaches may cause fluctuations in HAMP processing volumes. There is uncertainty regarding the sustainability of our current volume levels once our larger seller/servicers complete the bulk of their initial efforts. The completion rate for HAMP loans, which is the percentage of loans that successfully exit the trial period due to the borrower fulfilling the requirements for the modification, remains uncertain due to the number of new requirements of this program. We have undertaken several initiatives designed to increase the number of loans modified under HAMP, including:
 
  •  engaging a vendor to help ease backlogs at several servicers by processing requests for HAMP modifications;
 
  •  engaging a vendor to meet with eligible borrowers at their homes and help them complete loan modification requests; and
 
  •  implementing a second-look program designed to ensure that borrowers are being properly considered for HAMP modifications. Borrowers who do not qualify for HAMP are then considered under the company’s other foreclosure prevention programs.
 
We also serve as compliance agent for certain foreclosure prevention activities under HAMP. Among other duties, as the program compliance agent, we will conduct examinations and review servicer compliance with the published requirements for the program. We will report the results of our examination findings to Treasury. Based on the examinations, we may also provide Treasury with advice, guidance and lessons learned to improve operation of the program.
 
The MHA Program is intended to provide borrowers the opportunity to obtain more affordable monthly payments and to reduce the number of delinquent mortgages that proceed to foreclosure and, ultimately, mitigate our total credit losses by reducing or eliminating a portion of the costs related to foreclosed properties and avoiding the credit loss in REO. At present, it is difficult for us to predict the full impact of the MHA Program on us. However, to the extent our borrowers participate in HAMP in large numbers, the costs we incur, including the servicer and borrower incentive fees, could be substantial. Under HAMP, 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, and we will not receive a reimbursement of these costs from Treasury. 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 by the prevention or reduction of potential future costs of loan defaults and foreclosures due to these initiatives.
 
Our Other Recent Efforts to Assist the U.S. Housing Market
 
  •  During the nine months ended September 30, 2009, we purchased or guaranteed $444.2 billion in unpaid principal balance of mortgages and mortgage-related securities for our total mortgage portfolio. This amount
 
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  included $382.0 billion of newly-issued PCs and Structured Securities. Our purchases and guarantees of single-family mortgage loans provided financing for approximately 1.78 million conforming single-family loans, of which approximately 82% consisted of refinancings. We also remain a key source of liquidity for the multifamily market with purchases or guarantees of mortgages that financed approximately 181,000 multifamily units during the nine months ended September 30, 2009;
 
  •  In addition to supporting HAMP, we continued to help borrowers stay in their homes or sell their properties through our other programs. For example, we completed more than 8,000 non-HAMP loan modifications and nearly 18,000 repayment plans, forbearance agreements and pre-foreclosure sales during the third quarter of 2009;
 
  •  We have 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. In October 2009, we announced a pilot program to help our seller/servicers obtain warehouse lines of credit with certain participating warehouse lenders;
 
  •  In October 2009, we announced our participation in the Housing Finance Agency initiative, which is a collaborative effort of Treasury, FHFA, Freddie Mac, and Fannie Mae. Under this initiative, we will give credit and liquidity support to state and local housing finance agencies so that such agencies can continue to meet their mission of providing affordable financing for both single-family and multifamily housing;
 
  •  Despite challenging conditions, in October 2009, we completed our second securitization transaction with multifamily mortgage loans this year, which totaled approximately $1 billion;
 
  •  We expect to participate in more than 300 foreclosure prevention workshops during 2009, reaching borrowers in more than 25 states nationwide. In the first half of 2009, Freddie Mac contributed nearly $5 million to non-profit organizations to help educate borrowers about their options and prevent fraud. We will be providing additional grants to organizations that are working to support the MHA program. These organizations will assist borrowers in completing HAMP requirements.
 
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.
 
We had a positive net worth at September 30, 2009 as our assets exceeded our liabilities by $10.4 billion. Therefore, we did not require additional funding from Treasury under the Purchase Agreement. However, we expect to make additional draws under the Purchase Agreement in future periods due to a variety of factors that could adversely affect our net worth.
 
Significant developments with respect to the support we receive from the government include the following:
 
  •  The aggregate liquidation preference of the senior preferred stock was $51.7 billion as of September 30, 2009. To date, we have paid total dividends of $3.0 billion in cash on the senior preferred stock to Treasury, at the direction of the Conservator.
 
  •  Treasury continues to purchase our mortgage-related securities under a program it announced in September 2008. According to information provided by Treasury, as of September 30, 2009 it held $176.0 billion of mortgage-related securities issued by us and Fannie Mae. Treasury’s purchase authority under this program is scheduled to expire on December 31, 2009.
 
  •  No amounts have been borrowed under the Lending Agreement as of September 30, 2009. However, we have successfully tested our ability to access funds under the Lending Agreement.
 
  •  The Federal Reserve continues to purchase our debt and mortgage-related securities under a program it announced in November 2008. According to information provided by the Federal Reserve, as of October 28, 2009 it had net purchases of $325.6 billion of our mortgage-related securities and held $54.0 billion of our direct obligations. On September 23, 2009, the Federal Reserve announced that it will gradually slow the pace of purchases under the program in order to promote a smooth transition in markets and anticipates that these purchases will be executed by the end of the first quarter of 2010. As discussed below, the slowing of debt purchases by the Federal Reserve and the conclusion of its debt purchase program could adversely affect our ability to access the unsecured debt markets.
 
It is difficult at this time to predict the impact that the completion of the Federal Reserve’s and Treasury’s mortgage-related securities purchase programs will have on our business and the U.S. mortgage market. It is possible
 
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that interest rate spreads on mortgage-related securities could widen, resulting in more favorable investment opportunities for us following the completion of these programs. However, we may be limited in our ability to take full advantage of any potential investment opportunities because, beginning in 2010, we must reduce our mortgage-related investments portfolio, pursuant to the Purchase Agreement, by 10% per year, until it reaches $250 billion.
 
For information on the potential impacts of the completion of the Federal Reserve’s purchase program and the expiration of the Lending Agreement with Treasury on our access to the debt markets and our liquidity backstop plan, see “Liquidity and Capital Resources — Liquidity”.
 
For more information on the terms of the conservatorship, the powers of our Conservator and certain of the initiatives, programs and agreements described above, see “BUSINESS — Conservatorship and Related Developments” in our 2008 Annual Report.
 
Housing and Economic Conditions and Impact on Third Quarter 2009 Results
 
Our financial results for the third quarter of 2009 reflect the continuing adverse economic conditions in the U.S. During 2009, there have been some positive housing market developments, including higher volumes of home sales and modest improvements in home prices in certain regions and states. However, there have been significant increases in unemployment rates which, coupled with declines in household wealth, have contributed to increases in residential mortgage delinquency rates. We believe that much of the increase in home sales reflects distressed home sales, including higher short sales and sales of foreclosed properties in the market. As a result, we continue to experience significant credit-related expenses. Our provision for credit losses was $7.6 billion in the third quarter of 2009, principally due to increased estimates of incurred losses caused by the deteriorating economic conditions, which were evidenced by our increased rates of delinquency, the significant volume of REO acquisitions and an increase in our single-family non-performing assets.
 
Home prices nationwide increased an estimated 0.3% in the third quarter of 2009 (and an estimated 0.9% during the nine months ended September 30, 2009) based on our own internal index. However, many regions and states suffered significant home price declines in the last two years. The percentage decline in home prices in the last two years has been particularly large in the states of California, Florida, Arizona and Nevada, which comprised approximately 25% of the loans in our single-family mortgage portfolio as of September 30, 2009. The second and third quarters of the year are historically strong periods for home sales. Seasonal strength along with the impact of state and federal government actions, including incentives for first time homebuyers and foreclosure suspensions, may have contributed to the increase in home prices during the third quarter of 2009. We expect that when temporary government actions expire and the seasonal peak in home sales has passed, home prices are likely to decline over the near term. Unemployment rates worsened in the third quarter of 2009, and the national unemployment rate increased to 9.8% at September 30, 2009 as compared to 9.5% at June 30, 2009. Certain states experienced much higher unemployment rates, such as California, Florida, Michigan and Nevada, where the unemployment rate reached 12.2%, 11.0%, 15.3% and 13.3%, respectively, at September 30, 2009. Loans originated in these states comprised approximately 26% of the loans in our single-family mortgage portfolio as of September 30, 2009. Many financial institutions continued to remain cautious in their lending activities during the third quarter of 2009. Although there was overall improvement in credit and liquidity conditions during the third quarter, credit spreads for both mortgage and corporate loans remained higher than before the start of the recession.
 
These macroeconomic conditions and other factors, such as our temporary suspensions of foreclosure transfers of occupied homes, contributed to an increase in the number and aging of delinquent loans in our single-family mortgage portfolio during the third quarter of 2009. Beginning in November 2008, we temporarily suspended all foreclosure transfers of occupied homes for certain periods ending March 6, 2009. Beginning March 7, 2009, we began suspension of foreclosure transfers on owner-occupied homes where the borrower may be eligible to receive a loan modification under HAMP. We also observed a continued increase in market-reported delinquency rates for mortgages serviced by financial institutions, not only for subprime and Alt-A loans but also for prime loans, and we experienced significant increases in delinquency rates for all product types during the third quarter of 2009. Additionally, as the slump in the U.S. housing market has lasted over two years, increasing numbers of borrowers that previously had significant equity in their homes are now “underwater,” or owing more on their mortgage loans than their homes are currently worth.
 
The continued weakness in housing market conditions during the third quarter of 2009 also led to a further decline in the performance of the non-agency mortgage-related securities in our mortgage-related investments portfolio. Mortgage-related securities backed by subprime, option ARM, Alt-A and other loans have significantly greater concentrations in the states that are undergoing the greatest stress, including California, Florida, Arizona and Nevada.
 
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As a result of these and other factors, we recognized impairments of available-for-sale securities in earnings during the third quarter of 2009.
 
Multifamily housing fundamentals deteriorated during the third quarter of 2009, reflecting an increasing unemployment rate and reduced access to credit for individual and institutional borrowers. Partially as a result of home ownership becoming more affordable over the past several years, multifamily properties experienced declining rent levels and vacancy rates rose to multi-year highs. This trend negatively impacted multifamily property cash flows in the third quarter of 2009. Our multifamily delinquency rate was unchanged at September 30, 2009 from 11 basis points as of June 30, 2009, though we expect it to increase during the remainder of 2009. During 2009, we have also seen significant deterioration in the financial strength of certain multifamily borrowers in measures such as the debt coverage ratio and estimated current LTV ratios for the properties.
 
Consolidated Results of Operations — Third Quarter 2009
 
Net income (loss) was $(5.0) billion and $(25.3) billion for the third quarters of 2009 and 2008, respectively. Net loss decreased in the third quarter of 2009 compared to the third quarter of 2008, principally due to lower impairment-related losses on mortgage-related securities, higher net interest income, and fair value gains on our guarantee asset and other investment activities, compared to losses on these items during the third quarter of 2008. These income and gains for the third quarter of 2009 were partially offset by increased provision for credit losses, losses on debt recorded at fair value and losses on loans purchased, compared to the third quarter of 2008.
 
Net interest income was $4.5 billion for the third quarter of 2009, compared to $1.8 billion for the third quarter of 2008. As compared to the third quarter of 2008, we held higher amounts of fixed-rate mortgage loans and agency mortgage-related securities in our mortgage-related investments portfolio and had lower funding costs, due to significantly lower interest rates on our short- and long-term borrowings during the three months ended September 30, 2009. Net interest income during the three months ended September 30, 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 as dividends paid on senior preferred stock.
 
Non-interest income (loss) was $(1.1) billion for the three months ended September 30, 2009, compared to $(11.4) billion for the three months ended September 30, 2008. The decrease in non-interest loss in the third quarter of 2009 was primarily due to improvements in investment activity, which was a gain of $1.4 billion in the third quarter of 2009 as compared to a loss of $9.8 billion in the third quarter of 2008, and our guarantee asset, which was a gain of $0.6 billion in the third quarter of 2009 as compared to a loss of $1.7 billion in the third quarter of 2008. These improvements were partially offset by a $2.3 billion increase in derivatives losses, net of foreign-currency related effects. The decrease in losses on investment activity during the third quarter of 2009 was due principally to lower impairment-related losses primarily recognized on available-for-sale non-agency mortgage-related securities backed by subprime, option ARM, Alt-A and other loans during the quarter, which decreased to $1.2 billion in the third quarter of 2009, compared to $9.1 billion in the third quarter of 2008.
 
Non-interest expenses increased to $8.5 billion in the third quarter of 2009 from $7.8 billion in the third quarter of 2008 due primarily to higher provision for credit losses. Our results for the third quarter of 2008 included a non-recurring securities administrator loss on investment activity of $1.1 billion related to the September 2008 bankruptcy of Lehman Brothers Holdings, Inc. Credit-related expenses totaled $7.5 billion and $6.0 billion for the third quarters of 2009 and 2008, respectively, and included our provision for credit losses of $7.6 billion and $5.7 billion, respectively. The increase in provision for credit losses was primarily due to the continued credit deterioration in our single-family mortgage portfolio, reflected in further increases in delinquency rates. Losses on loans purchased increased to $531 million for the third quarter of 2009, compared to $252 million for the third quarter of 2008, due to lower market valuations for delinquent and modified loans in the third quarter of 2009, as compared to the third quarter of 2008. We expect to incur losses on loans purchased in the fourth quarter of 2009. Administrative expenses totaled $433 million for the third quarter of 2009, up from $308 million for the third quarter of 2008, primarily due to a partial reversal of short-term compensation expenses recorded in the third quarter of 2008.
 
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.
 
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Table 1 presents Segment Earnings by segment and the All Other category and includes a reconciliation of Segment Earnings to net income (loss) prepared in accordance with GAAP.
 
Table 1 — Reconciliation of Segment Earnings to GAAP Net Income (Loss)(1)
 
                                 
    Three Months Ended
    Nine Months Ended
 
    September 30,     September 30,  
    2009     2008     2009     2008  
    (in millions)  
 
Segment Earnings, net of taxes:
                               
Investments
  $ (4 )   $ (1,177 )   $ (1,523 )   $ (389 )
Single-family Guarantee
    (4,292 )     (3,501 )     (13,329 )     (5,347 )
Multifamily
    99       193       394       527  
All Other
    (18 )     (6 )     (26 )     134  
Reconciliation to GAAP net income (loss):
                               
Derivative- and debt-related adjustments
    (1,443 )     (1,292 )     2,915       (1,959 )
Credit guarantee-related adjustments
    734       (1,076 )     1,690       568  
Investment sales, debt retirements and fair value-related adjustments
    2,351       (7,717 )     3,279       (9,288 )
Fully taxable-equivalent adjustments
    (96 )     (103 )     (294 )     (318 )
                                 
Total pre-tax adjustments
    1,546       (10,188 )     7,590       (10,997 )
Tax-related adjustments(2)
    (2,343 )     (10,616 )     (7,201 )     (10,195 )
                                 
Total reconciling items, net of taxes
    (797 )     (20,804 )     389       (21,192 )
                                 
Net income (loss) attributable to Freddie Mac
  $ (5,012 )   $ (25,295 )   $ (14,095 )   $ (26,267 )
                                 
(1)  In the third quarter of 2009, we reclassified our investments in commercial mortgage-backed securities and all related income and expenses from the Investments segment to the Multifamily segment. Prior periods have been reclassified to conform to the current presentation.
(2)  Includes a non-cash charge, related to the establishment of a partial valuation allowance against our deferred tax assets, net that is not included in Segment Earnings of approximately $1.9 billion and $4.7 billion for the three and nine months ended September 30, 2009, respectively, as well as $14.3 billion for both the three and nine months ended September 30, 2008.
 
Segment Earnings is calculated for the segments by adjusting GAAP net income (loss) 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) 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 16: SEGMENT REPORTING” to our consolidated financial statements.
 
Consolidated Balance Sheets Analysis
 
During the nine months ended September 30, 2009, total assets increased by $15.6 billion to $866.6 billion while total liabilities decreased by $25.4 billion to $856.2 billion. Total equity (deficit) was $10.4 billion at September 30, 2009 compared to $(30.6) billion at December 31, 2008.
 
Our cash and other investments portfolio increased by $19.4 billion during the nine months ended September 30, 2009 to $83.7 billion, primarily due to a $10.3 billion increase in cash and cash equivalents and a $9.7 billion increase in non-mortgage-related securities. 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 June 30, 2009, we did not receive any additional funding from Treasury during the three months ended September 30, 2009.
 
The unpaid principal balance of our mortgage-related investments portfolio decreased 2.6%, or $20.6 billion, during the nine months ended September 30, 2009 to $784.2 billion. The decrease in our mortgage-related investments portfolio 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 are driven by the Federal Reserve’s and Treasury’s agency mortgage-related securities purchase programs. We expect investment opportunities for agency mortgage-related securities will remain limited while these purchase programs remain in effect. Once these programs are completed, it is possible that spreads could widen again, which might create favorable investment opportunities. We may be limited in our ability to take full advantage of any such opportunities in future periods because, beginning in 2010, we must reduce our mortgage-related investments portfolio pursuant to the Purchase Agreement by 10% per year, until it reaches $250 billion. We may be required to sell mortgage-related assets in 2010 to meet the required 10% reduction, 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. In addition, further widening of spreads could result in additional unrealized losses on our available-for-sale securities.
 
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Short-term debt decreased by $69.7 billion during the nine months ended September 30, 2009 to $365.4 billion, and long-term debt increased by $30.5 billion to $438.4 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 45% at September 30, 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, primarily as a result of the Federal Reserve’s purchases in the secondary market of our long-term debt under its purchase program. In July 2009 we made a tender offer to purchase $4.4 billion of our outstanding Freddie SUBS® securities. We accepted $3.9 billion of the tendered securities. This tender offer was consistent with our effort to reduce our funding costs by retiring higher cost debt. Our reserve for guarantee losses on PCs increased by $13.7 billion to $28.6 billion during the nine months ended September 30, 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 increasing unemployment.
 
Total equity (deficit) increased from $(30.6) billion at December 31, 2008 to $10.4 billion at September 30, 2009, reflecting increases due to (i) $36.9 billion we received from Treasury under the Purchase Agreement during the first nine months of 2009, (ii) a $15.3 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 (FASB ASC 320-10-65-1). These increases in total equity (deficit) were partially offset by (i) a $14.1 billion net loss and (ii) $2.8 billion of senior preferred stock dividends for the nine months ended September 30, 2009. The $15.3 billion decrease in the unrealized losses in AOCI, net of taxes, on our available-for-sale securities during the nine months ended September 30, 2009 was largely due to (i) fair value improvement on our available-for-sale mortgage-related securities, particularly during the third quarter of 2009, primarily as a result of tighter mortgage-to-debt OAS and lower interest rates, and (ii) the recognition in earnings of other-than-temporary impairments on our non-agency mortgage-related securities.
 
Consolidated Fair Value Results
 
During the three months ended September 30, 2009, the fair value of net assets, before capital transactions, increased by $4.1 billion compared to a decrease of $36.7 billion during the three months ended September 30, 2008. The fair value of net assets as of September 30, 2009 was $(67.7) billion, compared to $(70.5) billion as of June 30, 2009. Included in our fair value results for the three months ended September 30, 2009 are the $1.3 billion of dividends paid in cash to Treasury on our senior preferred stock. The increase in the fair value of our net assets, before capital transactions, during the three months ended September 30, 2009 principally relates to an increase in the fair value of our mortgage-related investments portfolio, 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 has improved since the height of the credit crisis in the fall of 2008. The support of Treasury and the Federal Reserve in recent periods has contributed to this improvement. During the third quarter of 2009, the Federal Reserve continued to be an active purchaser in the secondary market of our long-term debt under its purchase program and, as a result, spreads on our debt remained favorable. 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. During the third quarter of 2009, we were able to continue to reduce our use of short-term debt by issuing long-term and callable debt. See “MD&A — LIQUIDITY AND CAPITAL RESOURCES — Liquidity” in our 2008 Annual Report for more information on our debt funding activities and risks posed by current market challenges and “RISK FACTORS” in our 2008 Annual Report for a discussion of the risks to our business posed by our reliance on the issuance of debt to fund our operations.
 
Treasury and the Federal Reserve have taken a number of actions affecting our access to debt financing, including the following:
 
  •  Treasury entered into the Lending Agreement with us on September 18, 2008, under which we may request funds until its scheduled expiration on December 31, 2009. As of September 30, 2009, we had not borrowed under the Lending Agreement. However, we have successfully tested our ability to access funds under the Lending Agreement.
 
  •  The Federal Reserve has implemented a program to purchase, in the secondary market, up to $200 billion in direct obligations of Freddie Mac, Fannie Mae, and the FHLBs. On September 23, 2009, the Federal Reserve announced that it will gradually slow the pace of purchases under the program in order to promote a smooth transition in markets and anticipates that the purchases will be executed by the end of the first quarter of 2010.
 
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The scheduled expiration of the Lending Agreement and completion of the Federal Reserve’s debt purchase program could adversely affect our ability to access the unsecured debt markets, making it more difficult or costly to fund our business. The completion of these programs could negatively affect the spreads on our debt and limit our ability to issue long-term and callable debt. This may also adversely affect our ability to replace our short-term funding with longer-term debt.
 
Upon expiration of the Lending Agreement, we will not have a liquidity backstop (other than 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 then be available to us, 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 the assets in our mortgage-related investments portfolio as a significant source of funding. If we were unable to obtain funding from issuances of debt or other conventional sources at suitable terms or in sufficient amounts, it is likely that the funds potentially available from Treasury would not be adequate to operate our business.
 
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 $3.0 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 2010 (the amounts of which must be determined by December 31, 2009), will have an adverse impact on our future financial condition and net worth. Further draws from Treasury under the Purchase Agreement would increase the liquidation preference of and the dividends we owe on, the senior preferred stock and, therefore, payment of our dividend obligations in cash could contribute to the need for additional draws from Treasury.
 
Capital Adequacy
 
On October 9, 2008, FHFA announced that it was suspending 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 September 30, 2009, our assets exceeded our liabilities by $10.4 billion. Because we had a positive net worth as of September 30, 2009, FHFA has not submitted a draw request on our behalf to Treasury for any additional funding under the Purchase Agreement. We also did not require additional funding under the Purchase Agreement based on our positive net worth at the end of the second quarter of 2009. The aggregate liquidation preference of the senior preferred stock is $51.7 billion and the amount remaining under the Treasury’s funding agreement is $149.3 billion as of September 30, 2009.
 
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 making additional draws, see “RISK FACTORS” in our 2008 Annual Report. 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 Adequacy” and “NOTE 9: REGULATORY CAPITAL” to our consolidated financial statements.
 
Risk Management
 
Credit Risks
 
Overview
 
During the current economic crisis, the mortgage markets have relied on Freddie Mac to provide a reliable source of liquidity, stability and affordability through our investment and credit guarantee activities. However, our business activities, including the additional activities we have undertaken during the current economic crisis, expose us to credit risk, primarily 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.
 
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Mortgage and credit market conditions remain challenging in 2009 due to a number of factors, including the following:
 
  •  the effect of changes in other financial institutions’ underwriting standards in past years, which allowed for the origination of significant amounts of new higher-risk mortgage products in 2006 and 2007 and the early months of 2008. These mortgages have performed particularly poorly during the current housing and economic downturn, and have defaulted at historically high rates. However, even with the tightening of underwriting standards, economic conditions will continue to negatively impact recent originations;
 
  •  increases in unemployment;
 
  •  declines in home prices nationally and regionally during much of the last two years;
 
  •  higher incidence of institutional insolvencies;
 
  •  higher levels of mortgage foreclosures and delinquencies;
 
  •  higher incidence of fraud by borrowers, mortgage brokers and other parties involved in real estate transactions;
 
  •  significant volatility in interest rates;
 
  •  significantly lower levels of liquidity in institutional credit markets;
 
  •  wider credit spreads;
 
  •  rating agency downgrades of mortgage-related securities and financial institutions; and
 
  •  declines in market rents and increased vacancy rates that cause declines in multifamily property values.
 
The deterioration in the mortgage and credit markets increased our exposure to both mortgage and institutional credit risks. A number of factors make it difficult to predict when the mortgage and credit markets will recover, including, among others, uncertainty concerning the effect of current or any future government actions in these markets. While 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, there continues to be divergence among economists about the future economic outlook and when a sustained recovery in home prices may occur.
 
Single-Family Mortgage Portfolio
 
The following statistics illustrate the credit deterioration of loans in our single-family mortgage portfolio, which consists of single-family mortgage loans in our mortgage-related investments portfolio and those backing our PCs, Structured Securities and other mortgage-related guarantees.
 
Table 2 — Credit Statistics, Single-Family Mortgage Portfolio(1)
 
                                         
    As of
    09/30/09   06/30/09   03/31/2009   12/31/2008   09/30/2008
 
Delinquency rate(2)
    3.33 %     2.78 %     2.29 %     1.72 %     1.22 %
Non-performing assets, on balance sheet (in millions)
  $ 17,334     $ 14,981     $ 13,445     $ 11,241     $ 9,840  
Non-performing assets, off-balance sheet (in millions)(3)
  $ 74,313     $ 61,936     $ 49,881     $ 36,718     $ 25,657  
Single-family loan loss reserve (in millions)
  $ 29,174     $ 24,867     $ 22,403     $ 15,341     $ 10,133  
REO inventory (in units)
    41,133       34,699       29,145       29,340       28,089  
                                         
                                         
    For the Three Months Ended
    09/30/09   06/30/09   03/31/2009   12/31/2008   09/30/2008
        (in units, unless noted)    
 
Loan modifications(4)
    9,013       15,603       24,623       17,695       8,456  
REO acquisitions
    24,373       21,997       13,988       12,296       15,880  
REO disposition severity ratio(5)
    39.2 %     39.8 %     36.7 %     32.8 %     29.3 %
Single-family credit losses (in millions)(6)
  $ 2,138     $ 1,906     $ 1,318     $ 1,151     $ 1,270  
(1)  See “OUR PORTFOLIOS” and “GLOSSARY” for information about our portfolios.
(2)  Single-family delinquency rate information is based on the number of loans that are 90 days or more past due and those in the process of foreclosure, excluding Structured Transactions. Mortgage loans whose contractual terms have been modified under agreement with the borrower are not included if the borrower is less than 90 days delinquent under the modified terms. Delinquency rates for our single-family mortgage portfolio including Structured Transactions were 3.43% and 1.83% at September 30, 2009 and December 31, 2008, respectively.
(3)  Consists of delinquent loans in our single-family mortgage portfolio which underlie our issued PCs and Structured Securities, based on unpaid principal balances that are past due for 90 days or more.
(4)  The number of executed modifications under agreement with the borrower during the period. Excludes forbearance agreements, which are made in certain circumstances and under which reduced or no payments are required during a defined period, as well as repayment plans, which are separate agreements with the borrower to repay past due amounts and return to compliance with the original terms. Based on information reported by our servicers to the MHA program administrator, excludes 88,668 loans that were in the trial period for the modification process under HAMP as of September 30, 2009.
(5)  Calculated as the aggregate amount of our losses recorded on disposition of REO properties during the respective quarterly period divided by the aggregate unpaid principal balances of the related loans with the borrowers. The amount of losses recognized on disposition of the properties is equal to the amount by which the unpaid principal balance of loans exceeds the amount of net sales proceeds from disposition of the properties. Excludes other related credit losses, such as property maintenance and costs, as well as related recoveries from credit enhancements, such as mortgage insurance.
(6)  See footnote (3) of “Table 52 — Credit Loss Performance” for information on the composition of credit losses.
 
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As the table above illustrates, we have experienced continued deterioration in the performance of our single-family mortgage portfolio due to several factors, including the following:
 
  •  The expansion of the housing and economic downturn has reached a broader group of single-family borrowers. The unemployment rate in the U.S. rose from 7.2% at December 31, 2008 to 9.8% as of September 30, 2009. During 2009, the delinquency rate of 30-year fixed-rate amortizing loans, which is a more traditional mortgage product, increased to 3.37% at September 30, 2009 as compared to 2.76% at June 30, 2009 and 1.69% at December 31, 2008.
 
  •  Certain loan groups within the single-family mortgage portfolio, such as Alt-A and interest-only loans, as well as 2006 and 2007 vintage loans, continue to be larger contributors to our worsening credit statistics than other, more traditional loan groups. These loans have been more affected by macroeconomic factors, such as declines in home prices, which resulted in erosion in the borrower’s equity. These loans are also concentrated in the West region. The West region comprised 27% of the unpaid principal balances of our single-family mortgage portfolio as of September 30, 2009, but accounted for 46% of our REO acquisitions, based on the related loan amount prior to our acquisition, and 37% of delinquencies in the nine months ended September 30, 2009. In addition, states in the West region (especially California, Arizona and Nevada) and Florida tend to have higher average loan balances than the rest of the U.S. and were most affected by the steep home price declines during the last two years. California and Florida were the states with the highest credit losses in the nine months ended September 30, 2009, comprising 46% of our single-family credit losses on a combined basis.
 
Loss Mitigation
 
We are focused on initiatives that support the MHA Program. We have taken several steps designed to support homeowners and mitigate the growth of our non-performing assets. We continue to expand our efforts to increase our use of foreclosure alternatives, and have expanded our staff and engaged certain vendors to assist our seller/servicers in completing loan modifications and other outreach programs with the objective of keeping more borrowers in their homes.
 
Our more recent loss mitigation activities create fluctuations in our credit statistics. For example, our temporary suspensions of foreclosure transfers of occupied homes temporarily slowed the rate of growth of our REO inventory and of charge-offs, a component of our credit losses, in certain periods since November 2008, but caused our reserve for guarantee losses to rise. This also has created an increase in the number of delinquent loans that remain in our single-family mortgage portfolio, which results in higher reported delinquency rates than without the suspension of foreclosure transfers. In addition, the implementation of HAMP in the second quarter of 2009 contributed to a temporary decrease in the number of completed loan modifications in both the second and third quarters of 2009 since there is a trial period before these modifications become effective. Trial periods are required to last for at least three months. Borrowers did not begin entering into trial periods under HAMP in significant numbers until early in the third quarter and, in many cases, trial periods were extended beyond the initial three month period as HAMP guidelines were modified.
 
Our servicers have a key role in the success of our loss mitigation activities. The significant increases in delinquent loan volume and the deteriorating conditions of the mortgage market during 2008 and 2009 placed a strain on the loss mitigation resources of many of our mortgage servicers. To the extent servicers do not complete loan modifications with eligible borrowers our credit losses could increase.
 
Investments in Non-Agency Mortgage-Related Securities
 
Our investments in non-agency mortgage-related securities also were affected by the deteriorating credit conditions in 2008 and continuing into 2009. The table below illustrates the increases in delinquency rates for loans that back our subprime first lien, option ARM and Alt-A securities and associated gross unrealized losses, pre-tax. We believe that unrealized losses on non-agency mortgage-related securities at September 30, 2009 were attributable to poor underlying collateral performance, decreased liquidity and larger risk premiums in the non-agency mortgage market. These securities comprise $100.7 billion of the $180.8 billion of non-agency mortgage-related securities in our mortgage-related investments portfolio as of September 30, 2009. Given our forecast that national home prices are likely to decline over the near term, the performance of the loans backing these securities could continue to deteriorate.
 
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Table 3 — Credit Statistics, Non-Agency Mortgage-Related Securities Backed by Subprime, Option ARM and Alt-A Loans
 
                                         
    As of  
    09/30/2009     06/30/2009     03/31/2009     12/31/2008     09/30/2008  
    (dollars in millions)  
 
Delinquency rates:(1)
                                       
Non-agency mortgage-related securities backed by:
                                       
Subprime first lien
    46 %     44 %     42 %     38 %     35 %
Option ARM
    42       40       36       30       24  
Alt-A(2)
    24       22       20       17       14  
Cumulative collateral loss:(3)
                                       
Non-agency mortgage-related securities backed by:
                                       
Subprime first lien
    12 %     10 %     7 %     6 %     4 %
Option ARM
    6       4       2       1       1  
Alt-A(2)
    3       3       2       1       1  
Gross unrealized losses, pre-tax(4)(5)
  $ 38,039     $ 41,157     $ 27,475     $ 30,671     $ 22,411  
                                         
Total other-than-temporary impairment of available-for-sale securities(5)
  $ 3,235     $ 10,380     $ 6,956     $ 6,794     $ 8,856  
Portion of other-than-temporary impairment recognized in AOCI(5)
    2,105       8,223                    
                                         
Net impairment of available-for-sale securities recognized in earnings for the three months ended(5)
  $ 1,130     $ 2,157     $ 6,956     $ 6,794     $ 8,856  
                                         
(1)  Based on the number of loans that are 60 days or more past due. Mortgage loans whose contractual terms have been modified under agreement with the borrower are not included if the borrower is less than 60 days delinquent under the modified terms.
(2)  Excludes non-agency mortgage-related securities backed by other loans, which are primarily comprised of securities backed by home equity lines of credit.
(3)  Based on the actual losses incurred on the collateral underlying these securities. Actual losses incurred on the securities that we hold are less than the losses on the underlying collateral as presented in this table, as a majority of the securities we hold include significant credit enhancements, particularly through subordination.
(4)  Gross unrealized losses, pre-tax, represent the aggregate of the amount by which amortized cost exceeds fair value measured at the individual lot level.
(5)  Upon the adoption of an amendment to the accounting standards for investments in debt and equity securities (FASB ASC 320-10-35) on April 1, 2009, the amount of credit losses and other-than-temporary impairment related to securities where we have the intent to sell or where it is more likely than not that we will be required to sell is recognized in our consolidated statements of operations within the line captioned net impairment on available-for-sale securities recognized in earnings. The amount of other-than-temporary impairment related to all other factors is recognized in AOCI. See “NOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES — Change in Accounting Principles — Change in the Impairment Model for Debt Securities” to our consolidated financial statements.
 
We held unpaid principal balances of $104.9 billion of non-agency mortgage-related securities backed by subprime, option ARM, Alt-A and other loans in our mortgage-related investments portfolio as of September 30, 2009, compared to $119.5 billion as of December 31, 2008. This decrease is due to the receipt of monthly remittances of principal repayments from both the recoveries of liquidated loans and, to a lesser extent, voluntary prepayments on the underlying collateral of $4.6 billion and $14.6 billion during the three and nine months ended September 30, 2009, respectively, representing a partial return of our investment in these securities. We recorded net impairment of available-for-sale securities recognized in earnings on non-agency mortgage-related securities backed by subprime, option ARM, Alt-A and other loans of approximately $1.1 billion and $10.2 billion for the three and nine months ended September 30, 2009, respectively. See “NOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES — Change in Accounting Principles — Change in the Impairment Model for Debt Securities” to our consolidated financial statements for information on how other-than-temporary impairments are recorded on our financial statements commencing in the second quarter of 2009. Pre-tax unrealized losses on securities backed by subprime, option ARM, Alt-A and other loans reflected in AOCI were $38.0 billion at September 30, 2009. These unrealized losses include $15.3 billion, pre-tax ($9.9 billion, net of tax), of other-than-temporary impairment losses reclassified from retained earnings to AOCI as a result of the second quarter 2009 adoption of an amendment to the accounting standards for investments in debt and equity securities and increases in fair value during the first nine months of 2009 of $7.9 billion primarily due to (i) tighter mortgage-to-debt OAS and (ii) the recognition in earnings of other-than-temporary impairments related to these securities.
 
Interest Rate and Other Market Risks
 
Our mortgage-related investments portfolio is a source of liquidity and stability for the home mortgage finance system, but also exposes us to interest rate risk and other market risks. Prepayment risk arises from the uncertainty as to when borrowers will pay the outstanding principal balance of mortgage loans that we hold or that represent underlying collateral for securities in our mortgage-related investments portfolio. Unexpected mortgage prepayments result in a potential mismatch in the timing of our receipt of cash flows related to such assets versus the timing of payment of cash flows related to our liabilities. As interest rates fluctuate, we use derivatives to adjust the interest rate characteristics of our debt funding in order to more closely match those of our assets.
 
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The recent market environment has remained volatile. Throughout 2008 and into 2009, we adjusted our interest rate risk models to reflect rapidly changing market conditions. In particular, these models were adjusted during 2009 to reflect changes in prepayment expectations resulting from the MHA Programs, including mortgage refinancing expectations.
 
Operational Risks
 
Operational risks are inherent in all of our business activities and can become apparent in various ways, including accounting or operational errors, business interruptions, fraud and failures of the technology used to support our business activities. Our risk of operational failure may be increased by vacancies in officer and key business unit positions and failed or inadequate internal controls. These operational risks may expose us to financial loss, interfere with our ability to sustain timely financial reporting, or result in other adverse consequences.
 
As a result of management’s evaluation of our disclosure controls and procedures, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were not effective as of September 30, 2009, at a reasonable level of assurance. We continue to work to improve our financial reporting governance process and remediate material weaknesses and other deficiencies in our internal controls. While we are making progress on our remediation plans, our material weaknesses have not been fully remediated at this time. After consideration of our mitigating activities, including our remediation efforts through September 30, 2009, we believe that our interim consolidated financial statements for the quarter ended September 30, 2009, have been prepared in conformity with GAAP.
 
Adoption of SFAS 166 and SFAS 167
 
Effective January 1, 2010, we will adopt: (i) the amendment to the accounting standards for transfers of financial assets (SFAS 166), which changes the accounting standards on transfer and servicing of financial assets (FASB ASC 860); and (ii) the amendment to the accounting standards on consolidations (SFAS 167), which changes the consolidation guidance related to variable interest entities. We expect that the adoption of these two amendments will have a significant impact on our consolidated financial statements.
 
Upon adoption of these standards, we will be required to consolidate our single-family PC trusts and some of our Structured Transactions in our financial statements, which could have a significant negative impact on our net worth and could result in additional draws under the Purchase Agreement.
 
The adoption of these two amendments would significantly increase our required level of capital under existing regulatory capital rules, which are not binding during conservatorship as our Conservator has suspended regulatory capital classification of us.
 
Implementation of these changes will require significant operational and systems changes. It may be difficult for us to make all such changes in a controlled manner by the effective date.
 
Off-Balance Sheet Arrangements
 
We enter into certain business arrangements that are not recorded on our consolidated balance sheets or may be recorded in amounts that differ from the full contract or notional amount of the transaction. Most of these arrangements relate to our financial guarantee and securitization activity for which we record guarantee assets and obligations, but the related securitized assets are owned by third parties. These off-balance sheet arrangements may expose us to potential losses in excess of the amounts recorded on our consolidated balance sheets.
 
Our maximum potential off-balance sheet exposure to credit losses relating to our PCs, Structured Securities and other mortgage-related guarantees is primarily represented by the unpaid principal balance of the related loans and securities held by third parties, which was $1,459 billion and $1,403 billion at September 30, 2009 and December 31, 2008, respectively. Based on our historical credit losses, which in the third quarter of 2009 averaged approximately 44.3 basis points of the aggregate unpaid principal balance of our single-family mortgage portfolio, we do not believe that the maximum exposure is representative of our actual exposure on these guarantees.
 
Legislative and Regulatory Matters
 
The following section discusses certain significant recent developments with respect to legislative and regulatory matters.
 
Federal Legislation and Related Matters
 
On June 17, 2009, the Obama Administration announced a legislative proposal to overhaul the regulatory structure of the financial services industry. The proposal includes draft bills addressing resolution authority for systemically significant institutions, consumer financial protection, securitization and derivatives, among other subjects. If enacted, this proposal would result in significant changes in the regulation of the financial services industry, and would affect
 
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the business and operations of Freddie Mac. However, we cannot predict the impact of the proposal on our business and operations, because Congress has not yet fully considered the legislation.
 
The Obama Administration’s proposal does not address the regulatory oversight or structure of Freddie Mac. Under the proposal, 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. According to the proposal, Treasury and HUD will report their recommendations to Congress and the general public at the time of the President’s 2011 budget release, which is currently planned for February 2010.
 
Congress may consider separate legislation that could affect Freddie Mac’s business and operations, such as legislation allowing bankruptcy judges to modify the terms of mortgages on principal residences for borrowers who file for bankruptcy under Chapter 13 of the bankruptcy code.
 
Congress is considering legislative proposals regarding the oversight of the derivatives market. These proposals would generally extend Commodity Futures Trading Commission or SEC regulatory oversight to certain financial derivatives, including derivatives used by Freddie Mac to manage risk exposures. The proposals would also impose new clearing and reporting requirements, as well as new capital requirements for derivatives dealers and counterparties. The Obama Administration has proposed similar derivatives oversight legislation as part of its proposed overhaul of the financial services regulatory structure. If enacted, such legislation could significantly impact Freddie Mac.
 
On June 26, 2009, the House of Representatives passed a comprehensive energy bill that would, among other things, require FHFA to provide Freddie Mac and Fannie Mae with additional affordable housing goals credit for qualifying purchases of certain energy-efficient and location-efficient mortgages. The bill would also create a new duty to serve underserved markets for energy-efficient and location-efficient mortgages. In addition, the bill would create a new federal energy loan guarantee program that would help homeowners finance energy-efficient home improvements. The latter provision could adversely impact Freddie Mac by potentially subordinating our security interest in properties of borrowers who obtain such loans. It is currently unclear when, or if, the Senate will consider comparable legislation.
 
On July 16, 2009, the House of Representatives passed the Financial Services and General Government appropriations bill for fiscal year 2010. The House Committee on Appropriations report accompanying the bill directs Treasury to report to the Committee on its plans to ensure that taxpayers receive repayment of their investment in Freddie Mac and Fannie Mae, as well as companies that received funds from the Troubled Asset Relief Program and other investments of taxpayer funds aimed at ensuring economic and financial stability.
 
As part of the Economic Stimulus Act of 2008, the conforming loan limits were temporarily 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, set at $417,000 for a mortgage secured by a one-unit single-family residence, or 125% of the median house price for a geographic area, not to exceed $729,750 for a one-unit, single-family residence.
 
The American Recovery and Reinvestment Act of 2009, or Recovery Act, ensures that the loan limits for mortgages originated in 2009 in the high-cost areas determined under the Economic Stimulus Act do not fall below their 2008 levels. On October 30, 2009, President Obama signed a Continuing Resolution extending funding for federal agencies through December 18, 2009. The Continuing Resolution also includes language extending the temporary high-cost conforming limits set by the Recovery Act through December 2010.
 
On July 31, 2009, the House of Representatives passed a bill that would require public companies to hold non-binding shareholder votes on executive compensation and to take steps to ensure that members of their compensation committees are independent. The bill would also require specified financial institutions, including Freddie Mac, to disclose incentive-based compensation arrangements to regulators; and would permit federal regulators to prohibit specified financial institutions, including Freddie Mac, from using certain types of compensation structures that the regulators determine encourage inappropriate risks. It is currently unclear when, or if, the Senate will consider comparable legislation.
 
On October 22, 2009, the House Financial Services Committee approved the Consumer Financial Protection Act which would create a new Consumer Financial Protection Agency responsible for regulating covered institutions, including Freddie Mac. The agency would have regulatory, examination and enforcement authority over financial products and offerings that in many instances would overlap with FHFA’s authority. The bill could impact the regulation of our business and impose additional costs. On October 29, 2009, the House Energy and Commerce Committee also marked up and voted to approve the bill.
 
Congress is also considering systemic risk and resolution authority legislation. The proposal would address the regulation and resolution authority for certain systemically significant institutions. The bill could significantly change the regulation of Freddie Mac.
 
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State Legislation
 
Approximately fourteen 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 generally treat the new energy assessments like property tax assessments and allow for the creation of a new lien to secure the assessment that is senior to any existing Freddie Mac mortgage lien. The Obama Administration has expressed support for these laws. If numerous localities adopt such programs and borrowers obtain this type of financing, these laws could have a negative impact on Freddie Mac’s credit losses.
 
Various states, cities, and counties implemented mediation programs that could delay or otherwise change their foreclosure processes. The processes, requirements, and duration of mediation programs may vary for each state but are designed to bring servicers and borrowers together to negotiate foreclosure alternatives. These actions could increase our expenses, including by potentially delaying the final resolution of delinquent mortgage loans and the disposition of non-performing assets.
 
Proposed and Interim Final Regulations
 
On June 17, 2009, FHFA published a proposed rule that would require Freddie Mac, Fannie Mae and the FHLBs to report to FHFA any fraud or possible fraud relating to any loans or other financial instruments that the entity has purchased or sold. The proposed rule would implement the Reform Act’s fraud reporting provisions and would replace OFHEO’s mortgage fraud regulation.
 
On July 2, 2009, FHFA published an interim final rule on prior approval of new products, implementing the new product provisions for Freddie Mac 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. Under the rule, if the Director determines that a new activity of Freddie Mac is a “new product,” a description of the new product must be published for public comment, after which the Director will approve the new product if the Director determines that the new product is: (a) authorized by our charter; (b) in the public interest; and (c) consistent with the safety and soundness of Freddie Mac and the mortgage finance and financial system. On August 31, 2009, Freddie Mac and Fannie Mae filed joint public comments on the interim final rule with FHFA. We cannot currently predict what changes, if any, FHFA may make to the interim final rule in response to our comments and consequently we are not able to predict the impact of the interim final rule on our business or operations. Depending on the manner in which the interim final rule is implemented, this rule could have an adverse impact on our ability to develop and introduce new products and activities to the marketplace.
 
Affordable Housing Goals
 
On July 30, 2009, FHFA issued a final rule that adjusts our affordable housing goals and home purchase subgoals for 2009 to the levels set forth in Table 4 below. Except for the multifamily special affordable volume target, FHFA decreased all of the goals and subgoals, as compared to those in effect for 2008.
 
Table 4 — Housing Goals and Home Purchase Subgoals for 2008 and 2009(1)
 
                 
    Housing Goals
    2009   2008
 
Low- and moderate-income goal
    43 %     56 %
Underserved areas goal
    32       39  
Special affordable goal
    18       27  
Multifamily special affordable volume target (in billions)
  $ 4.60     $ 3.92  
                 
                 
    Home Purchase Subgoals
    2009   2008
 
Low- and moderate-income subgoal
    40 %     47 %
Underserved areas subgoal
    30       34  
Special affordable subgoal
    14       18  
(1)  An individual mortgage may qualify for more than one of the goals or subgoals. Each of the goal and subgoal percentages will be determined independently and cannot be aggregated to determine a percentage of total purchases that qualifies for these goals or subgoals.
 
The final rule 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 from the 2009 housing goals loans with original principal balances that exceed the base conforming loan limits in certain high-cost areas as allowed by the Recovery Act.
 
We expect that market conditions and the tightened credit and underwriting environment will make achieving our affordable housing goals and subgoals for 2009 challenging.
 
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Effective beginning calendar year 2010, the Reform Act requires that FHFA establish, by regulation, four single-family housing goals and one multifamily special affordable housing goal. 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. On August 4, 2009, FHFA released an advance notice of proposed rulemaking regarding the duty of Freddie Mac and Fannie Mae to serve the underserved markets. We provided comments on the proposed rulemaking to FHFA, but we cannot predict the contents of any proposed final rule that FHFA may release, or the impact that the final rulemaking will have on our business or operations.
 
New York Stock Exchange Matters
 
On November 17, 2008, we received a notice from the NYSE 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. On December 2, 2008, we advised the NYSE of our intent to cure this deficiency, and that we might undertake a reverse stock split in order to do so. We did not undertake a reverse stock split or any other action to cure this deficiency.
 
On September 3, 2009, the NYSE notified us that we had returned to compliance with the NYSE’s minimum share price listing requirement, based on a review as of August 31, 2009 showing that our average share price over the preceding 30 trading days and our closing share price on that date were both more than $1.
 
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SELECTED FINANCIAL DATA(1)
 
                                 
    Three Months Ended
  Nine Months Ended
    September 30,   September 30,
    2009   2008   2009   2008
    (dollars in millions, except
    share related amounts)
 
Statement of Operations Data
                               
Net interest income
  $ 4,462     $ 1,844     $ 12,576     $ 4,171  
Non-interest income (loss)
    (1,082 )     (11,403 )     (955 )     (10,733 )
Non-interest expense
    (8,542 )     (7,766 )     (26,988 )     (13,183 )
Net loss attributable to Freddie Mac
    (5,012 )     (25,295 )     (14,095 )     (26,267 )
Net loss attributable to common stockholders
    (6,305 )     (25,301 )     (16,908 )     (26,777 )
Loss per common share:
                               
Basic
  $ (1.94 )   $ (19.44 )   $ (5.20 )   $ (30.90 )
Diluted
  $ (1.94 )   $ (19.44 )   $ (5.20 )   $ (30.90 )
Weighted average common shares outstanding (in thousands):(2)
                               
Basic
    3,253,172       1,301,430       3,254,261       866,472  
Diluted
    3,253,172       1,301,430       3,254,261       866,472  
Dividends per common share
  $     $     $     $ 0.50  
                                 
                                 
            September 30,
  December 31,
            2009   2008
            (dollars in millions)
 
Balance Sheet Data
                               
Total assets
                  $ 866,601     $ 850,963  
Short-term debt
                    365,414       435,114  
Long-term senior debt
                    437,673       403,402  
Long-term subordinated debt
                    694       4,505  
All other liabilities
                    52,414       38,576  
Total equity (deficit)
                    10,406       (30,634 )
Portfolio Balances
                               
Mortgage-related investments portfolio(3)
                    784,171       804,762  
Total PCs and Structured Securities issued(4)
                    1,862,021       1,827,238  
Total mortgage portfolio
                    2,242,702       2,207,476  
Non-performing assets
                    92,225       48,342  
                                 
                                 
    Three Months Ended
  Nine Months Ended
    September 30,   September 30,
    2009   2008   2009   2008
 
Ratios(5)
                               
Return on average assets(6)
    (2.3 )%     (12.0 )%     (2.2 )%     (4.4 )%
Non-performing assets ratio(7)
    4.6       1.9       4.6       1.9  
Equity to assets ratio(8)
    1.0       (0.1 )     (1.2 )     0.8  
Preferred stock to core capital ratio(9)
    N/A       130.2       N/A       130.2  
(1)  See “NOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES — Change in Accounting Principles” to our consolidated financial statements for information regarding accounting changes impacting the current period. See “NOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES — Recently Adopted Accounting Standards” in our 2008 Annual Report for information regarding accounting changes impacting previously reported results.
(2)  For the three and nine months ended September 30, 2009 and 2008, includes the weighted average number of shares that are associated with the warrant for our common stock issued to Treasury as part of the Purchase Agreement. This warrant is included in basic loss per share for both the third quarter of 2009 and the third quarter of 2008, because it is unconditionally exercisable by the holder at a cost of $.00001 per share.
(3)  The mortgage-related investments portfolio presented on our consolidated balance sheets differs from the mortgage-related investments portfolio in this table because the consolidated balance sheet amounts include valuation adjustments, discounts, premiums and other deferred balances. See “CONSOLIDATED BALANCE SHEETS ANALYSIS — Table 19 — Characteristics of Mortgage Loans and Mortgage-Related Securities in our Mortgage-Related Investments Portfolio” for more information.
(4)  Includes PCs and Structured Securities that are held in our mortgage-related investments portfolio. See “OUR PORTFOLIOS — Table 57 — Freddie Mac’s Total Mortgage Portfolio and Segment Portfolio Composition” for the composition of our total mortgage portfolio. Excludes Structured Securities for which we have resecuritized our PCs and Structured Securities. These resecuritized securities do not increase our credit-related exposure and consist of single-class Structured Securities backed by PCs, REMICs, and principal-only strips. The notional balances of interest-only strips are excluded because this line item is based on unpaid principal balance. Includes other guarantees issued that are not in the form of a PC, such as long-term standby commitments and credit enhancements for multifamily housing revenue bonds.
(5)  The return on common equity ratio is not presented because the simple average of the beginning and ending balances of Total Freddie Mac stockholders’ equity (deficit), net of preferred stock (at redemption value), is less than zero for all periods presented. The dividend payout ratio on common stock is not presented because we are reporting a net loss attributable to common stockholders for all periods presented.
(6)  Ratio computed as annualized net income (loss) attributable to Freddie Mac divided by the simple average of the beginning and ending balances of total assets.
(7)  Ratio computed as non-performing assets divided by the ending unpaid principal balances of our total mortgage portfolio, excluding non-Freddie Mac securities.
(8)  Ratio computed as the simple average of the beginning and ending balances of Total Freddie Mac stockholders’ equity (deficit) divided by the simple average of the beginning and ending balances of total assets.
(9)  Ratio computed as preferred stock (excluding senior preferred stock), at redemption value divided by core capital. Senior preferred stock does not meet the statutory definition of core capital. Ratio is not computed for periods in which core capital is less than zero. See “NOTE 9: REGULATORY CAPITAL” to our consolidated financial statements for more information regarding core capital.
 
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CONSOLIDATED RESULTS OF 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 financial position and results of operations.
 
Table 5 — Summary Consolidated Statements of Operations — GAAP Results
 
                                 
    Three Months Ended
    Nine Months Ended
 
    September 30,     September 30,  
    2009     2008     2009     2008  
    (in millions)  
 
Net interest income
  $ 4,462     $ 1,844     $ 12,576     $ 4,171  
Non-interest income (loss):
                               
Management and guarantee income
    800       832       2,290       2,378  
Gains (losses) on guarantee asset
    580       (1,722 )     2,241       (2,002 )
Income on guarantee obligation
    814       783       2,685       2,721  
Derivative gains (losses)
    (3,775 )     (3,080 )     (1,233 )     (3,210 )
Gains (losses) on investments:
                               
Impairment-related(1):
                               
Total other-than-temporary impairment of available-for-sale securities
    (4,199 )     (9,106 )     (21,802 )     (10,217 )
Portion of other-than-temporary impairment recognized in AOCI
    3,012             11,272        
                                 
Net impairment of available-for-sale securities recognized in earnings
    (1,187 )     (9,106 )     (10,530 )     (10,217 )
Other gains (losses) on investments
    2,605       (641 )     5,588       (1,638 )
                                 
Total gains (losses) on investments
    1,418       (9,747 )     (4,942 )     (11,855 )
                                 
Gains (losses) on debt recorded at fair value
    (238 )     1,500       (568 )     684  
Gains (losses) on debt retirement
    (215 )     36       (475 )     312  
Recoveries on loans impaired upon purchase
    109       91       229       438  
Low-income housing tax credit partnerships
    (479 )     (121 )     (752 )     (346 )
Trust management income (expense)
    (155 )     4       (600 )     (12 )
Other income
    59       21       170       159  
                                 
Non-interest income (loss)
    (1,082 )     (11,403 )     (955 )     (10,733 )
                                 
Non-interest expense:
                               
Administrative expenses
    (433 )     (308 )     (1,188 )     (1,109 )
Provision for credit losses
    (7,577 )     (5,702 )     (21,567 )     (9,479 )
REO operations income (expense)
    96       (333 )     (219 )     (806 )
Losses on loans purchased
    (531 )     (252 )     (3,742 )     (423 )
Securities administrator loss on investment activity
          (1,082 )           (1,082 )
Other
    (97 )     (89 )     (272 )     (284 )
                                 
Non-interest expense
    (8,542 )     (7,766 )     (26,988 )     (13,183 )
                                 
Loss before income tax benefit (expense)
    (5,162 )     (17,325 )     (15,367 )     (19,745 )
Income tax benefit (expense)
    149       (7,970 )     1,270       (6,518 )
                                 
Net loss
  $ (5,013 )   $ (25,295 )   $ (14,097 )   $ (26,263 )
Less: Net (income) loss attributable to noncontrolling interest
    1             2       (4 )
                                 
Net loss attributable to Freddie Mac
  $ (5,012 )   $ (25,295 )   $ (14,095 )   $ (26,267 )
                                 
(1)  We adopted an amendment to the accounting standards for investments in debt and equity securities effective April 1, 2009. See “NOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES — Change in Accounting Principles” to our consolidated financial statements for further information.
 
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Net Interest Income
 
Table 6 presents an analysis of net interest income, including average balances and related yields earned on assets and incurred on liabilities.
 
Table 6 — Net Interest Income/Yield and Average Balance Analysis
 
                                                 
    Three Months Ended September 30,  
    2009     2008  
          Interest
                Interest
       
    Average
    Income
    Average
    Average
    Income
    Average
 
    Balance(1)(2)     (Expense)(1)     Rate     Balance(1)(2)     (Expense)(1)     Rate  
    (dollars in millions)  
 
Interest-earning assets:
                                               
Mortgage loans(3)
  $ 129,721     $ 1,740       5.37 %   $ 95,174     $ 1,361       5.72 %
Mortgage-related securities(4)
    663,744       7,936       4.78       676,197       8,590       5.08  
                                                 
Total mortgage-related investments portfolio
    793,465       9,676       4.88       771,371       9,951       5.16  
Non-mortgage-related securities(4)
    19,282       144       2.99       11,658       128       4.40  
Cash and cash equivalents
    48,403       34       0.28       35,735       229       2.51  
Federal funds sold and securities purchased under agreements to resell
    29,256       11       0.15       29,379       161       2.18  
                                                 
Total interest-earning assets
    890,406       9,865       4.43       848,143       10,469       4.93  
                                                 
Interest-bearing liabilities:
                                               
Short-term debt
    256,324       (333 )     (0.51 )     241,150       (1,468 )     (2.38 )
Long-term debt(5)
    570,863       (4,792 )     (3.35 )     589,377       (6,795 )     (4.60 )
                                                 
Total interest-bearing liabilities
    827,187       (5,125 )     (2.48 )     830,527       (8,263 )     (3.96 )
Expense related to derivatives(6)
          (278 )     (0.13 )           (362 )     (0.18 )
Impact of net non-interest-bearing funding
    63,219             0.19       17,616             0.09  
                                                 
Total funding of interest-earning assets
  $ 890,406       (5,403 )     (2.42 )   $ 848,143       (8,625 )     (4.05 )
                                                 
Net interest income/yield
            4,462       2.01               1,844       0.88  
Fully taxable-equivalent adjustments(7)
            95       0.04               98       0.05  
                                                 
Net interest income/yield (fully taxable-equivalent basis)
          $ 4,557       2.05             $ 1,942       0.93  
                                                 
                                                 
                                                 
    Nine Months Ended September 30,  
    2009     2008  
          Interest
                Interest
       
    Average
    Income
    Average
    Average
    Income
    Average
 
    Balance(1)(2)     (Expense)(1)     Rate     Balance(1)(2)     (Expense)(1)     Rate  
    (dollars in millions)  
 
Interest-earning assets:
                                               
Mortgage loans(3)
  $ 125,379     $ 5,041       5.36 %   $ 89,760     $ 3,924       5.83 %
Mortgage-related securities(4)
    688,301       24,931       4.83       656,548       25,103       5.10  
                                                 
Total mortgage-related investments portfolio
    813,680       29,972       4.91       746,308       29,027       5.19  
Non-mortgage-related securities(4)
    15,691       643       5.47       23,053       664       3.84  
Cash and cash equivalents
    51,912       172       0.44       23,917       495       2.72  
Federal funds sold and securities purchased under agreements to resell
    30,801       42       0.18       21,491       399       2.47  
                                                 
Total interest-earning assets
    912,084       30,829       4.51       814,769       30,585       5.00  
                                                 
Interest-bearing liabilities:
                                               
Short-term debt
    304,122       (2,026 )     (0.88 )     228,640       (5,149 )     (2.96 )
Long-term debt(5)
    558,337       (15,367 )     (3.67 )     565,705       (20,231 )     (4.76 )
                                                 
Total interest-bearing liabilities
    862,459       (17,393 )     (2.68 )     794,345       (25,380 )     (4.24 )
Expense related to derivatives(6)
          (860 )     (0.13 )           (1,034 )     (0.17 )
Impact of net non-interest-bearing funding
    49,625             0.15       20,424             0.11  
                                                 
Total funding of interest-earning assets
  $ 912,084       (18,253 )     (2.66 )   $ 814,769       (26,414 )     (4.30 )
                                                 
Net interest income/yield
            12,576       1.85               4,171       0.70  
Fully taxable-equivalent adjustments(7)
            296       0.04               310       0.05  
                                                 
Net interest income/yield (fully taxable-equivalent basis)
          $ 12,872       1.89             $ 4,481       0.75  
                                                 
(1)  Excludes mortgage loans and mortgage-related securities traded, but not yet settled.
(2)  For securities, we calculated average balances based on their unpaid principal balance plus their associated deferred fees and costs (e.g., premiums and discounts), but excluded the effect of mark-to-fair-value changes.
(3)  Non-performing loans, where interest income is recognized when collected, are included in average balances.
(4)  Interest income (expense) includes the portion of impairment charges recognized in earnings expected to be recovered.
(5)  Includes current portion of long-term debt.
(6)  Represents changes in fair value of derivatives in cash flow hedge relationships that were previously deferred in AOCI and have been reclassified to earnings as the associated hedged forecasted issuance of debt and mortgage purchase transactions affect earnings. 2008 also includes the accrual of periodic cash settlements of all derivatives in qualifying hedge accounting relationships.
(7)  The determination of net interest income/yield (fully taxable-equivalent basis), which reflects fully taxable-equivalent adjustments to interest income, involves the conversion of tax-exempt sources of interest income to the equivalent amounts of interest income that would be necessary to derive the same net return if the investments had been subject to income taxes using our federal statutory tax rate of 35%.
 
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Net interest income and net interest yield on a fully taxable-equivalent basis increased significantly during the three and nine months ended September 30, 2009 compared to the three and nine months ended September 30, 2008 primarily due to: (a) a decrease in funding costs as a result of the replacement of higher cost short- and long-term debt with new lower cost debt; (b) a significant increase in the average size of our mortgage-related investments portfolio, including an increase in our holdings of fixed-rate assets; and (c) accretion of other-than-temporary impairments of investments in available-for-sale securities; partially offset by (d) the impact of declining short-term interest rates on floating rate assets held in our mortgage-related investments portfolio and cash and other investments portfolio. Net interest income and net interest yield during the three and nine months ended September 30, 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 as dividends paid on senior preferred stock.
 
During the nine months ended September 30, 2009, spreads on our debt improved and our access to the debt markets increased, primarily due to the Federal Reserve’s purchases in the secondary market of our long-term debt under its purchase program. As a result, we were able to replace some higher cost short- and long-term debt with new lower cost floating-rate long-term debt and short-term debt, resulting in a decrease in our funding costs. Consequently, our concentrations of floating rate debt returned to more historical levels as of September 30, 2009. Due to our limited ability to issue long-term and callable debt during the second half of 2008 and the first few months of 2009, we increased our use of the strategy of combining derivatives and floating-rate long-term debt or short-term debt to synthetically create the substantive economic equivalent of various longer-term fixed rate debt funding structures. See “Non-Interest Income (Loss) — Derivative Overview” for additional information.
 
The increase in the average balance of our mortgage-related investments portfolio during the 2009 periods resulted from our acquiring and holding increased amounts of mortgage loans and mortgage-related securities to provide additional liquidity to the mortgage market. Also, primarily during the first quarter of 2009, continued liquidity concerns in the market caused spreads to widen resulting in more favorable investment opportunities for agency mortgage-related securities. In response, our purchase activities increased, resulting in an increase in the average balance of our interest-earning assets. However, during the third quarter of 2009, the unpaid principal balance of our mortgage-related investments portfolio declined due to tightened spreads which we believe resulted from the Federal Reserve and Treasury actively purchasing agency mortgage-related securities in the secondary market which made investment opportunities less favorable. For information on the potential impact of (i) the termination of these purchase programs and (ii) the requirement to reduce the mortgage-related investments portfolio by 10% annually, beginning in 2010, see “CONSOLIDATED BALANCE SHEETS ANALYSIS — Mortgage-Related Investments Portfolio” and “LIQUIDITY AND CAPITAL RESOURCES — Liquidity.”
 
Net interest income also included $1.1 billion of income during the nine months ended September 30, 2009, primarily recognized in the first quarter of 2009, compared to $81 million of income during the nine months ended September 30, 2008, recognized in the third quarter of 2008, related to the accretion of other-than-temporary impairments of investments in available-for-sale securities. Upon our adoption of an amendment to the accounting standards for investments in debt and equity securities (FASB ASC 320-10-65-1) on April 1, 2009, previously recognized non-credit-related other-than-temporary impairments were reclassified from retained earnings to AOCI and these amounts are no longer accreted into net interest income. See “NOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES” to our consolidated financial statements for a discussion of the impact of these accounting changes.
 
The increases in net interest income and net interest yield on a fully taxable-equivalent basis during the three and nine months ended September 30, 2009 were partially offset by the impact of declining short-term interest rates on floating rate assets held in our mortgage-related investments portfolio. We also increased our cash and other investments portfolio during the three and nine months ended September 30, 2009 compared to the three and nine months ended September 30, 2008, as we replaced higher-yielding, longer-term non-mortgage-related securities with lower-yielding, shorter-term cash and cash equivalents, Treasury bills and securities purchased under agreements to resell. This shift, in combination with lower short-term rates, also partially offset the increase in net interest income and net interest yield.
 
We expect net interest income may be negatively impacted in future periods by: (a) the required decreases in our mortgage-related investments portfolio balance, through successive annual 10% reductions commencing in 2010 until it reaches $250 billion, which will cause a reduction in our interest-earning assets; and (b) the termination of the Federal Reserve’s program to purchase our debt securities, which may increase our funding costs.
 
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Non-Interest Income (Loss)
 
Management and Guarantee Income
 
Table 7 provides summary information about management and guarantee income. Management and guarantee income consists of contractual amounts due to us (reflecting buy-ups and buy-downs to base management and guarantee fees) as well as amortization of pre-2003 delivery and buy-down fees received by us that were recorded as deferred income as a component of other liabilities. Beginning in 2003, delivery and buy-down fees are reflected within income on guarantee obligation as the guarantee obligation is amortized.
 
Table 7 — Management and Guarantee Income
 
                                                                 
    Three Months Ended September 30,     Nine Months Ended September 30,  
    2009     2008     2009     2008  
    Amount     Rate     Amount     Rate     Amount     Rate     Amount     Rate  
    (dollars in millions, rates in basis points)  
 
Contractual management and guarantee fees(1)
  $ 765       16.8     $ 796       17.6     $ 2,323       17.2     $ 2,331       17.5  
Amortization of deferred fees included in other liabilities
    35       0.8       36       0.8       (33 )     (0.3 )     47       0.4  
                                                                 
Total management and guarantee income
  $ 800       17.6     $ 832       18.4     $ 2,290       16.9     $ 2,378       17.9  
                                                                 
Unamortized balance of deferred fees included in other liabilities, at period end
  $ 218             $ 371             $ 218             $ 371          
                                                                 
(1)  Consists of management and guarantee fees related to all issued and outstanding guarantees, including those issued prior to adoption of the accounting standard for guarantees (FASB ASC 460-10) in January 2003, which did not require the establishment of a guarantee asset.
 
Management and guarantee income decreased slightly for the three and nine months ended September 30, 2009 compared to the three and nine months ended September 30, 2008. For the nine months ended September 30, 2009, the decrease in management and guarantee income compared to the nine months ended September 30, 2008 is primarily due to the reversal of amortization of pre-2003 deferred fees in the first and second quarter of 2009. Amortization of deferred fees declined due to our expectations of increasing interest rates and slowing prepayments in the future, which resulted in our recognizing a catch-up, or reversal, of previous amortization in the nine months ended September 30, 2009. The unpaid principal balance of our issued PCs and Structured Securities was $1.86 trillion at September 30, 2009 compared to $1.83 trillion at September 30, 2008, an increase of 2%. Although there were higher average balances of our issued guarantees during the three and nine months ended September 30, 2009, compared to the same periods in 2008, the effect of this increase was offset by declines in the average rate of contractual management and guarantee fees. Our average management and guarantee fee rates declined in the three and nine months ended September 30, 2009, compared to the same periods in 2008, due primarily to portfolio turnover in these periods, since newly issued PCs generally had lower average contractual guarantee fee rates than the previously outstanding PCs that were liquidated. This rate decline was also caused by the impact of market-adjusted pricing on new business purchases and an increase in the composition of 30-year fixed-rate amortizing mortgages within our new PC issuances during 2009 (for which we receive a lower fee).
 
We implemented additional delivery fee increases effective September 1, 2009 and October 1, 2009, for mortgages with certain combinations of LTV ratios and other higher-risk loan characteristics. Although we increased delivery fees during 2009, we have been experiencing competitive pressure on our contractual management and guarantee rates, which limited our ability to increase our rates as customers renew their contracts. Due to these competitive pressures, we do not have the ability to raise our contractual guarantee and management rates to offset the increased provision for credit losses on existing business.
 
Gains (Losses) on Guarantee Asset
 
Upon issuance of a financial guarantee, we record a guarantee asset on our consolidated balance sheets representing the fair value of the management and guarantee fees we expect to receive over the life of our PCs and Structured Securities. Subsequent changes in the fair value of the future cash flows of our guarantee asset are reported in the current period income as gains (losses) on guarantee asset.
 
Gains (losses) on guarantee asset reflect:
 
  •  reductions related to the management and guarantee fees received that are considered a return of our recorded investment in our guarantee asset; and
 
  •  changes in the fair value of management and guarantee fees we expect to receive over the life of the financial guarantee.
 
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Contractual management and guarantee fees shown in Table 8 represent cash received in each period for those financial guarantees with an established guarantee asset. A portion of these contractual management and guarantee fees is attributed to imputed interest income on the guarantee asset.
 
Table 8 — Attribution of Change — Gains (Losses) on Guarantee Asset
 
                                 
    Three Months Ended
    Nine Months Ended
 
    September 30,     September 30,  
    2009     2008     2009     2008  
    (in millions)  
 
Contractual management and guarantee fees
  $ (729 )   $ (730 )   $ (2,193 )   $ (2,139 )
Portion attributable to imputed interest income
    235       299       735       757  
                                 
Return of investment on guarantee asset
    (494 )     (431 )     (1,458 )     (1,382 )
Change in fair value of future management and guarantee fees
    1,074       (1,291 )     3,699       (620 )
                                 
Gains (losses) on guarantee asset
  $ 580     $ (1,722 )   $ 2,241     $ (2,002 )
                                 
 
Contractual management and guarantee fees increased slightly in the nine months ended September 30, 2009 as compared to the nine months ended September 30, 2008, primarily due to increases in the average balance of our PCs and Structured Securities issued.
 
As shown in the table above, the change in fair value of future management and guarantee fees was $1.1 billion in the third quarter of 2009 compared to $(1.3) billion in the third quarter of 2008 and was $3.7 billion and $(0.6) billion for the nine months ended September 30, 2009 and 2008, respectively. The increases in the fair value gain on our guarantee asset in the 2009 periods were principally attributed to a greater increase in the valuations of excess-servicing, interest-only mortgage securities (which we use to estimate the value of our guarantee asset) during these periods, as compared to the decrease in the valuations during the corresponding periods of 2008.
 
Income on Guarantee Obligation
 
Upon issuance of our guarantee, we record a guarantee obligation on our consolidated balance sheets representing the estimated fair value of our obligation to perform under the terms of the guarantee. Our guarantee obligation is amortized into income using a static effective yield determined at inception of the guarantee based on forecasted repayments of the principal balances on loans underlying the guarantee. See “CRITICAL ACCOUNTING POLICIES AND ESTIMATES — Application of the Static Effective Yield Method to Amortize the Guarantee Obligation” in our 2008 Annual Report for additional information on application of the static effective yield method. The static effective yield is periodically evaluated and amortization is adjusted when significant changes in economic events cause a shift in the pattern of our economic release from risk. When this type of change is required, a cumulative catch-up adjustment, which could be significant in a given period, will be recognized. In the first quarter of 2009, we enhanced our methodology for evaluating significant changes in economic events to be more in line with the current economic environment and to monitor the rate of amortization on our guarantee obligation so that it remains reflective of our expected duration of losses.
 
Table 9 provides information about the components of income on guarantee obligation.
 
Table 9 — Income on Guarantee Obligation
 
                                 
    Three Months Ended
    Nine Months Ended
 
    September 30,     September 30,  
    2009     2008     2009     2008  
    (in millions)  
 
Static effective yield amortization:
                               
Basic
  $ 692     $ 679     $ 2,208     $ 1,940  
Cumulative catch-up
    122       104       477       781  
                                 
Total income on guarantee obligation
  $ 814     $ 783     $ 2,685     $ 2,721  
                                 
 
Basic amortization under the static effective yield method increased in both the three and nine months ended September 30, 2009, compared to the same periods in 2008, due to growth in the balance of our issued PCs and Structured Securities. Higher prepayment rates on the related loans, which was attributed to higher refinance activity during the 2009 periods, also resulted in increased basic amortization in the 2009 periods, compared to the 2008 periods.
 
Cumulative catch-up amortization was higher for the third quarter of 2009 than in the third quarter of 2008 principally due to higher prepayment rates experienced in the third quarter of 2009, resulting from higher refinance activity. We recognized higher cumulative catch-up adjustments in the nine months ended September 30, 2008 than in the nine months ended September 30, 2009 due to the significant declines in home prices that occurred during the nine months ended September 30, 2008. We estimate that home prices increased by approximately 0.9% during the nine
 
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months ended September 30, 2009, based on our own index of our single-family mortgage portfolio, compared to an estimated decrease of 5.5% during the nine months ended September 30, 2008.
 
Derivative Overview
 
Table 10 presents the gains and losses related to derivatives that were not accounted for in hedge accounting relationships. Derivative gains (losses) represents the change in fair value of derivatives not accounted for in hedge accounting relationships because the derivatives did not qualify for, or we did not elect to pursue, hedge accounting, resulting in fair value changes being recorded to earnings. At September 30, 2009, we did not have any derivatives in hedge accounting relationships. Derivative gains (losses) also includes the accrual of periodic settlements for derivatives that are not in hedge accounting relationships. Although derivatives are an important aspect of our management of interest rate risk, they generally increase the volatility of reported net income (loss), particularly when they are not accounted for in hedge accounting relationships. Our use of derivatives also exposes us to counterparty credit risk. For a discussion of the impact of derivatives on our consolidated financial statements and our discontinuation in 2008 of hedge accounting for derivatives previously designated as cash flow hedges, see “NOTE 10: DERIVATIVES” to our consolidated financial statements.
 
Table 10 — Derivative Gains (Losses)
 
                                 
    Derivative Gains (Losses)(1)  
    Three Months Ended
    Nine Months Ended
 
Derivatives not designated as hedging instruments under the
  September 30,     September 30,  
accounting standards for derivatives and hedging (FASB ASC 815-20-25)(2)
  2009     2008     2009     2008  
    (in millions)  
 
Interest-rate swaps:
                               
Receive-fixed
                               
Foreign-currency denominated
  $ (2 )   $ 228     $ 122     $ (69 )
U.S. dollar denominated
    4,539       2,101       (7,451 )     4,400  
                                 
Total receive-fixed swaps
    4,537       2,329       (7,329 )     4,331  
Pay-fixed
    (8,223 )     (5,296 )     17,006       (9,170 )
Basis (floating to floating)
    (59 )     (54 )     (174 )     (75 )
                                 
Total interest-rate swaps
    (3,745 )     (3,021 )     9,503       (4,914 )
Option-based:
                               
Call swaptions
                               
Purchased
    2,285       1,824       (7,012 )     2,522  
Written
    (59 )     (7 )     152       14  
Put swaptions
                               
Purchased
    (1,087 )     22       (40 )     (31 )
Written
    107       154       (250 )     64  
Other option-based derivatives(3)
    13       95       (202 )     31  
                                 
Total option-based
    1,259       2,088       (7,352 )     2,600  
Futures
    (11 )     (534 )     (235 )     (41 )
Foreign-currency swaps(4)
    238       (1,578 )     248       (389 )
Forward purchase and sale commitments
    (385 )     280       (657 )     548  
Credit derivatives
          (2 )     (5 )     12  
Swap guarantee derivatives
          (4 )     (22 )     (5 )
Other(5)
          (27 )           (27 )
                                 
Subtotal
    (2,644 )     (2,798 )     1,480       (2,216 )
Accrual of periodic settlements:
                               
Receive-fixed interest rate swaps(6)
    1,684       753       4,152       1,474  
Pay-fixed interest rate swaps
    (2,847 )     (1,128 )     (7,058 )     (2,723 )
Foreign-currency swaps
    10       105       81       263  
Other
    22       (12 )     112       (8 )
                                 
Total accrual of periodic settlements
    (1,131 )     (282 )     (2,713 )     (994 )
                                 
Total
  $ (3,775 )   $ (3,080 )   $ (1,233 )   $ (3,210 )
                                 
(1)  Gains (losses) are reported as derivative gains (losses) on our consolidated statements of operations.
(2)  See “NOTE 10: DERIVATIVES” to our consolidated financial statements for additional information about the purpose of entering into derivatives not designated as hedging instruments and our overall risk management strategies.
(3)  Primarily represents purchased interest rate caps and floors, purchased put options on agency mortgage-related securities, as well as certain written options, including guarantees of stated final maturity of issued Structured Securities and written call options on agency mortgage-related securities.
(4)  Foreign-currency swaps are defined as swaps in which the net settlement is based on one leg calculated in a foreign-currency and the other leg calculated in U.S. dollars.
(5)  Related to the bankruptcy of Lehman Brothers Holdings, Inc. for both the three and nine months ended September 30, 2008.
(6)  Includes imputed interest on zero-coupon swaps.
 
Gains (losses) on derivatives not accounted for in hedge accounting relationships are principally driven by changes in (i) swap interest rates and implied volatility and (ii) the mix and volume of derivatives in our derivatives portfolio. We use receive- and pay-fixed interest rate swaps to adjust the interest-rate characteristics of our debt funding in order to more closely match changes in the interest-rate characteristics of our mortgage-related assets. Our mix and volume
 
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of derivatives change period to period as we respond to changing interest rate environments. We also use derivatives to synthetically create the substantive economic equivalent of various debt funding structures. For example, the combination of a series of short-term debt issuances over a defined period and a pay-fixed interest rate swap with the same maturity as the last debt issuance is the substantive economic equivalent of a long-term fixed-rate debt instrument of comparable maturity. However, the use of these derivatives may expose us to additional counterparty credit risk. Due to limits on our ability to issue long-term and callable debt in the second half of 2008 and the first few months of 2009, we pursued this strategy and thus increased our use of pay-fixed interest rate swaps. Additionally, we use swaptions and other option-based derivatives to adjust the characteristics of our debt in response to changes in the expected lives of mortgage-related assets in our mortgage-related investments portfolio. For a discussion regarding our ability to issue debt, see “LIQUIDITY AND CAPITAL RESOURCES — Liquidity — Debt Securities.”
 
During the three months ended September 30, 2009, swap interest rates and implied volatility both declined, resulting in a loss on derivatives of $3.8 billion. During this period, the declining swap interest rates resulted in fair value losses on our pay-fixed interest rate swaps of $8.2 billion, partially offset by gains on our receive-fixed interest rate swaps of $4.5 billion. The decline in swap interest rates more than offset the decrease in implied volatility, resulting in gains of $2.3 billion on our purchased call swaptions.
 
During the three months ended September 30, 2008, longer-term swap interest rates declined and implied volatility increased, resulting in a loss on derivatives of $3.1 billion. During this period, the decrease in longer-term interest rates resulted in fair value losses on our pay-fixed swaps of $5.3 billion, partially offset by gains on our receive-fixed swaps of $2.3 billion. The decrease in longer-term swap interest rates and an increase in implied volatility contributed to gains of $1.8 billion on our purchased call swaptions for this period.
 
During the nine months ended September 30, 2009, the mix and volume of our derivative portfolio were impacted by fluctuations in swap interest rates resulting in a loss on derivatives of $1.2 billion. While swap interest rates declined over the three months ended September 30, 2009, longer-term swap interest rates and implied volatility both increased during the nine months ended September 30, 2009. As a result of these factors, we recorded gains on our pay-fixed swap positions, partially offset by losses on our receive-fixed swaps. We also recorded losses on our purchased call swaptions, as the impact of the increasing swap interest rates more than offset the impact of higher implied volatility.
 
During the nine months ended September 30, 2008, swap interest rates declined, while implied volatility increased, resulting in a loss on derivatives of $3.2 billion. During the period, these changes resulted in a loss on our pay-fixed swap positions, partially offset by gains on our receive-fixed swaps and a gain on our purchased call swaptions.
 
As a result of our election of the fair value option for our foreign-currency denominated debt, foreign-currency translation gains and losses and fair value adjustments related to our foreign-currency denominated debt are recognized on our consolidated statements of operations as gains (losses) on debt recorded at fair value. Due to this election, we can better reflect in earnings the economic offset that exists between certain derivative instruments and our foreign-currency denominated debt. We use a combination of foreign-currency swaps and foreign-currency denominated receive-fixed interest rate swaps to manage the risks of changes in fair value of our foreign-currency denominated debt related to fluctuations in exchange rates and interest rates, respectively. As illustrated below:
 
  •  fair value gains (losses) related to translation, which is a component of gains (losses) on debt recorded at fair value, is partially offset by derivative gains (losses) on foreign-currency swaps; and
 
  •  gains (losses) relating to interest rate and instrument-specific credit risk adjustments, which is also a component of gains (losses) on debt recorded at fair value, is partially offset by derivative gains (losses) on foreign-currency denominated receive-fixed interest rate swaps.
 
For the three and nine months ended September 30, 2009, we recognized fair value gains (losses) of $(239) million and $(569) million, respectively, on our foreign-currency denominated debt. These amounts included:
 
  •  fair value gains (losses) related to translation of $(240) million and $(316) million, respectively, which were partially offset by derivative gains (losses) on foreign-currency swaps of $238 million and $248 million, respectively; and
 
  •  fair value gains (losses) relating to interest rate and instrument-specific credit risk adjustments of $1 million and $(253) million, respectively, which were partially offset by derivative gains (losses) on foreign-currency denominated receive-fixed interest rate swaps of $(2) million and $122 million, respectively.
 
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For the three and nine months ended September 30, 2008, we recognized fair value gains (losses) of $1.5 billion and $684 million, respectively, on our foreign-currency denominated debt. These amounts included:
 
  •  fair value gains (losses) related to translation of $1.7 billion and $539 million, respectively, which were partially offset by derivative gains (losses) on foreign-currency swaps of $(1.6) billion and $(389) million, respectively; and
 
  •  fair value gains (losses) relating to interest rate and instrument-specific credit risk adjustments of $(165) million and $145 million, respectively, which were partially offset by derivative gains (losses) on foreign-currency denominated receive-fixed interest rate swaps of $228 million and $(69) million, respectively.
 
For a discussion of the instrument-specific credit risk and our election to adopt the fair value option on our foreign-currency denominated debt see “NOTE 17: FAIR VALUE DISCLOSURES — Fair Value Election — Foreign-Currency Denominated Debt with the Fair Value Option Elected” in our 2008 Annual Report.
 
Gains (Losses) on Investments
 
Gains (losses) on investments include gains and losses on certain assets where changes in fair value are recognized through earnings, gains and losses related to sales, impairments and other valuation adjustments. Table 11 summarizes the components of gains (losses) on investments.
 
Table 11 — Gains (Losses) on Investments
 
                                 
    Three Months Ended
    Nine Months Ended
 
    September 30,     September 30,  
    2009     2008     2009     2008  
    (in millions)  
 
Impairment-related(1):
                               
Total other-than-temporary impairment of available-for-sale securities
  $ (4,199 )   $ (9,106 )   $ (21,802 )   $ (10,217 )
Portion of other-than-temporary impairment recognized in AOCI
    3,012             11,272        
                                 
Net impairment of available-for-sale securities recognized in earnings
    (1,187 )     (9,106 )     (10,530 )     (10,217 )
Other:
                               
Gains (losses) on trading securities(2)
    2,211       (932 )     4,964       (2,240 )
Gains (losses) on sale of mortgage loans(3)
    282       31       576       97  
Gains (losses) on sale of available-for-sale securities
    473       287       729       540  
Lower-of-cost-or-fair-value adjustments
    (360 )     (20 )     (591 )     (28 )
Gains (losses) on mortgage loans elected at fair value
    (1 )     (7 )     (90 )     (7 )
                                 
Total gains (losses) on investments
  $ 1,418     $ (9,747 )   $ (4,942 )   $ (11,855 )
                                 
(1)  We adopted an amendment to the accounting standards for investments in debt and equity securities effective April 1, 2009. See “NOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES — Change in Accounting Principles” to our consolidated financial statements for further information.
(2)  Includes mark-to-fair value adjustments on securities classified as trading recorded in accordance with accounting guidance for investments in beneficial interests for securitized assets (FASB ASC 325-40).
(3)  Represents gains (losses) on mortgage loans sold in connection with securitization transactions.
 
Impairments on Available-For-Sale Securities
 
During the third quarter of 2009, we recorded total other-than-temporary impairment related to our available-for-sale securities of $4.2 billion, of which $1.2 billion was recognized in earnings and $3.0 billion was recognized in AOCI. We adopted an amendment to the accounting standards for investments in debt and equity securities on April 1, 2009, which provides guidance designed to create greater clarity and consistency in accounting for and presenting impairment losses on debt securities. Under this guidance, the non-credit-related portion of the other-than-temporary impairment (that portion which relates to securities not intended to be sold or which it is not more likely than not we will be required to sell) is recorded in AOCI and not recognized in earnings. Credit-related portions of other-than-temporary impairments are recognized in earnings. See “NOTE 4: INVESTMENTS IN SECURITIES” to our consolidated financial statements for additional information regarding these accounting principles and other-than-temporary impairments recorded during the three and nine months ended September 30, 2009 and 2008. See “NOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES — Change in Accounting Principles — Change in the Impairment Model for Debt Securities” to our consolidated financial statements for information on how other-than-temporary impairments are recorded on our financial statements commencing in the second quarter of 2009.
 
See “CONSOLIDATED BALANCE SHEETS ANALYSIS — Mortgage-Related Investments Portfolio — Other-Than-Temporary Impairments on Available-for-Sale Mortgage-Related Securities” for additional information.
 
Gains (Losses) on Trading Securities
 
We recognized net gains on trading securities of $2.2 billion and $5.0 billion for the three and nine months ended September 30, 2009, respectively, as compared to net losses of $(0.9) billion and $(2.2) billion for the three and nine months ended September 30, 2008, respectively. The unpaid principal balance of our securities classified as trading
 
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increased to $222 billion at September 30, 2009 compared to $116 billion at September 30, 2008, primarily due to our increased purchases of agency mortgage-related securities. The increased balance in our trading portfolio, combined with lower interest rates and, to a lesser degree, tightening OAS levels, contributed $2.0 billion and $3.5 billion to the gains on these trading securities for the three and nine months ended September 30, 2009, respectively. In addition, during the three and nine months ended September 30, 2009, we sold agency securities classified as trading with unpaid principal balances of approximately $48 billion and $135 billion, respectively, which generated realized gains of $213 million and $1.5 billion, respectively.
 
We recognized net losses on trading securities for the three months ended September 30, 2008, due to sales of agency securities classified as trading with unpaid principal balances of $58 billion, which generated a realized loss of $547 million. Wider spreads also contributed to the net losses on trading securities for the three and nine months ended September 30, 2008.
 
Gains (Losses) on Sale of Available-For-Sale Securities
 
We recorded net gains on the sale of available-for-sale securities of $473 million for the third quarter of 2009 compared to $287 million for the third quarter of 2008. During the third quarter of 2009, we sold agency mortgage-related securities with unpaid principal balances of approximately $8.2 billion, which generated a net gain of $391 million. The remainder of the gains during the third quarter, $83 million, was due to the sale of asset-backed securities from our cash and other investments portfolio with unpaid principal balances of $1.0 billion. During the third quarter of 2008, primarily prior to conservatorship, we sold securities with unpaid principal balances of $14.8 billion, primarily consisting of agency mortgage-related securities, which generated a net gain of $287 million.
 
We recorded net gains on the sale of available-for-sale securities of $729 million and $540 million for the nine months ended September 30, 2009 and 2008, respectively. During 2009, we sold agency mortgage-related securities with unpaid principal balances of approximately $14.1 billion, which generated a net gain of $582 million. In addition, during the nine months ended September 30, 2009, we recorded gains of $152 million due to the sale of asset-backed securities from our cash and other investments portfolio with unpaid principal balances of $2.1 billion. During the nine months ended September 30, 2008, we sold securities with unpaid principal balances of $35 billion, primarily consisting of agency mortgage-related securities, which generated a net gain of $538 million. These sales occurred principally during the earlier months of the first quarter and prior to conservatorship during the third quarter of 2008 when market conditions were favorable and were driven in part by our need to maintain our then-effective mandatory target capital surplus requirement. We were not required to sell these securities in either nine month period.
 
Lower of Cost or Fair Value Adjustments
 
We recognized lower of cost or fair value adjustments of $360 million and $591 million for the three and nine months ended September 30, 2009, respectively, as compared to $20 million and $28 million during the three and nine months ended September 30, 2008, respectively. We record single-family mortgage loans classified as held-for-sale at the lower of amortized cost or fair value, which is evaluated each period by aggregating loans based on the mortgage product type. During the three and nine months ended September 30, 2009, we transferred, $9.7 billion of single-family mortgage loans from held-for-sale to held-for-investment. The majority of these loans were originally purchased with the expectation of subsequent sale in a PC auction, but we now expect to hold these in our mortgage-related investments portfolio. Upon transfer, we evaluate the lower of cost or fair value for each individual loan. We recognized approximately $400 million of losses associated with these transfers during the third quarter of 2009, representing the unrealized losses of certain loans on the dates of transfer; however, we are not permitted to similarly recognize any unrealized gains on individual loans at the time of transfer. Losses associated with transfer during the third quarter of 2009 were partially offset by recoveries of previous fair value adjustments. We did not transfer any mortgage loans between these categories during the nine months ended September 30, 2008.
 
Gains (Losses) on Debt Recorded at Fair Value
 
We elected the fair value option for our foreign-currency denominated debt effective January 1, 2008. Accordingly, foreign-currency translation exposure is a component of gains (losses) on debt recorded at fair value. We manage the exposure associated with our foreign-currency denominated debt related to fluctuations in exchange rates and interest rates through the use of derivatives, and changes in the fair value of such derivatives are recorded as derivative gains (losses) in our consolidated statements of operations. For the three and nine months ended September 30, 2009, we recognized fair value gains (losses) on our debt recorded at fair value of $(238) million and $(568) million, respectively, due primarily to the impact on our foreign-currency denominated debt of the U.S. dollar weakening relative to the Euro. For the three and nine months ended September 30, 2008, we recognized fair value gains of $1.5 billion and $684 million on our foreign-currency denominated debt, respectively, primarily due to the
 
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U.S. dollar strengthening relative to the Euro. See “Derivative Overview” for additional information about how we mitigate changes in the fair value of our foreign-currency denominated debt by using derivatives.
 
Gains (Losses) on Debt Retirement
 
Gains (losses) on debt retirement were $(215) million and $(475) million during the three and nine months ended September 30, 2009, respectively, compared to $36 million and $312 million for the three and nine months ended September 30, 2008, respectively. The losses for the 2009 periods were due in part to losses related to debt repurchases pursuant to tender offers we conducted in 2009, including a loss of $184 million for the three months ended September 30, 2009 related to our July 2009 tender offer for our subordinated debt securities. For more information, see “LIQUIDITY AND CAPITAL RESOURCES — Liquidity — Debt Securities — Debt Retirement Activities.” Also contributing to the increased losses was a decreased level of call activity involving our debt with coupon levels that increase at pre-determined intervals. During the nine months ended September 30, 2008, we recognized gains due to the increased level of call activity, primarily involving our debt with coupon levels that increase at pre-determined intervals, which led to gains upon retirement and write-offs of previously recorded interest expense.
 
Recoveries on Loans Impaired Upon Purchase
 
Recoveries on loans impaired upon purchase represent the recapture into income of previously recognized losses on loans purchased and provision for credit losses associated with purchases of delinquent loans under our financial guarantee. Recoveries occur when a non-performing loan is repaid in full or when at the time of foreclosure the estimated fair value of the acquired property, less costs to sell, exceeds the carrying value of the loan. For impaired loans where the borrower has made required payments that return the loan to less than 90 days delinquent, the recovery amounts are instead accreted into interest income over time as periodic payments are received.
 
During the three months ended September 30, 2009 and 2008, we recognized recoveries on loans impaired upon purchase of $109 million and $91 million, respectively. For the nine months ended September 30, 2009 and 2008, our recoveries were $229 million and $438 million, respectively. Our recoveries on impaired loans decreased in the nine months ended September 30, 2009 due to a lower rate of loan payoffs and a higher proportion of modified loans among those loans purchased, as compared to the same periods in 2008. In general, home prices in states having the greatest concentration of our impaired loans have remained weak during 2009, which limited our recoveries on foreclosure transfers.
 
Low-Income Housing Tax Credit Partnerships
 
We record the combination of our share of partnership losses and any impairment of our net investment in LIHTC partnerships as LIHTC expense on our consolidated statements of operations. LIHTC partnership expenses totaled $479 million and $121 million during the third quarters of 2009 and 2008, respectively, and totaled $752 million and $346 million in the nine months ended September 30, 2009 and 2008, respectively. The increase of LIHTC partnership expenses in both 2009 periods, as compared to 2008 periods, is due to the recognition of impairment on a portion of our investment in certain LIHTC partnerships during the third quarter of 2009, reflecting a decline in value as a result of the economic recession. We recognized $370 million and $379 million of other-than-temporary impairment on LIHTC partnership investments during the three and nine months ended September 30, 2009, respectively, related to 143 partnerships in which we have investments. We recognized $10 million of other-than-temporary impairment on these assets in the nine months ended September 30, 2008. We have not sold any of our LIHTC partnership investments during the nine months ended September 30, 2009. As of the third quarter of 2009, we have concluded that it is now probable that our ability to realize the carrying value in our LIHTC investments is limited to our ability to execute sales or other transactions related to our partnership interests. This determination is based upon a number of factors including our inability to date to finalize an alternative transaction that would allow us to monetize our LIHTC investments and continued uncertainty in our future business structure and our ability to generate sufficient taxable income to utilize the tax credits. As a result, we have determined that individual partnerships whose carrying value exceeds fair value are other than temporarily impaired and should be written down to their fair value. Fair value is determined based on reference to market transactions, however, there can be no assurance that we will be able to access these markets. If we are not able to execute sales or other transactions in order to realize the benefits of these investments or do not receive regulatory approval for such transactions, we may record significant other-than-temporary impairment of our LIHTC partnership investments in the future. Our total investments in LIHTC partnerships totaled $3.4 billion as of September 30, 2009.
 
Trust Management Income (Expense)
 
Trust management income (expense) represents the amounts we earn as administrator, issuer and trustee, net of related expenses, related to the management of remittances of principal and interest on loans underlying our PCs and
 
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Structured Securities. Trust management income (expense) was $(155) million and $4 million for the three months ended September 30, 2009 and 2008, respectively, and $(600) million and $(12) million for the nine months ended September 30, 2009 and 2008, respectively. During the three and nine months ended September 30, 2009, we experienced trust management expenses associated with shortfalls in interest payments on PCs, known as compensating interest, which significantly exceeded our trust management income. The increase in expense for these shortfalls was attributable to significantly higher refinance activity and lower interest income on trust assets, which we receive as fee income, in the 2009 periods, as compared to the same periods in 2008. See “MD&A — CONSOLIDATED RESULTS OF OPERATIONS — Segment Earnings — Results — Single-Family Guarantee” in our 2008 Annual Report for further information on compensating interest.
 
Non-Interest Expense
 
Table 12 summarizes the components of non-interest expense.
 
Table 12 — Non-Interest Expense
 
                                 
    Three Months Ended
    Nine Months Ended
 
    September 30,     September 30,  
    2009     2008     2009     2008  
    (in millions)  
 
Administrative expenses:
                               
Salaries and employee benefits
  $ 230     $ 133     $ 658     $ 605  
Professional services
    91       61       215       188  
Occupancy expense
    16       16       49       49  
Other administrative expenses
    96       98       266       267  
                                 
Total administrative expenses
    433       308       1,188       1,109  
Provision for credit losses
    7,577       5,702       21,567       9,479  
REO operations (income) expense
    (96 )     333       219       806  
Losses on loans purchased
    531       252       3,742       423  
Securities administrator loss on investment activity
          1,082             1,082  
Other expenses
    97       89       272       284  
                                 
Total non-interest expense
  $ 8,542     $ 7,766     $ 26,988     $ 13,183  
                                 
 
Administrative Expenses
 
Administrative expenses increased slightly for the nine months ended September 30, 2009, compared to the nine months ended September 30, 2008, in part due to higher professional services costs to support corporate initiatives. The increase in salaries and benefits expense for the three months ended September 30, 2009, compared to the third quarter of 2008, reflected a partial reversal of short-term performance compensation that we recognized in the third quarter of 2008 that related to the first half of 2008.
 
Provision for Credit Losses
 
Our reserves for mortgage loan and guarantee losses reflect our best projection of defaults we believe are likely as a result of loss events that have occurred through September 30, 2009. The substantial weakness in the national housing market, the uncertainty in other macroeconomic factors, such as trends in unemployment rates and home prices, and the uncertainty of the effect of current or any future government actions to address the economic and housing crisis makes forecasting of default rates imprecise. Our reserves also include the impact of our projections of the results of strategic loss mitigation initiatives, including our temporary suspensions of certain foreclosure transfers, a higher volume of loan modifications, and projections of recoveries through repurchases by seller/servicers of defaulted loans due to failure to follow contractual underwriting requirements at the time of the loan origination. An inability to realize the benefits of our loss mitigation plans, a lower realized rate of seller/servicer repurchases or default rates that exceed our current projections would cause our losses to be significantly higher than those currently estimated.
 
The provision for credit losses was $7.6 billion and $21.6 billion in the three and nine months ended September 30, 2009, respectively, compared to $5.7 billion and $9.5 billion in the three and nine months ended September 30, 2008, respectively, as continued weakness in the housing market and a rise in unemployment affected our single-family mortgage portfolio. The provision for credit losses for the nine months ended September 30, 2009 was also affected by observed changes in economic drivers impacting borrower behavior and delinquency trends for certain loans during the third quarter and a change in our methodology for estimating loan loss reserves in the second quarter of 2009. For more information on how we derive our estimate for the provision for credit losses and these changes, see “NOTE 5: MORTGAGE LOANS AND LOAN LOSS RESERVES” to our consolidated financial statements. See “EXECUTIVE SUMMARY — Table 2 — Credit Statistics, Single-Family Mortgage Portfolio” for quarterly trends in our other credit-related statistics.
 
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In the three and nine months ended September 30, 2009, we recorded a $4.4 billion and $14.0 billion increase, respectively, in our loan loss reserve, which is a combined reserve for credit losses on loans within our mortgage-related investments portfolio and mortgages underlying our PCs, Structured Securities and other mortgage-related guarantees. This resulted in a total loan loss reserve balance of $29.6 billion at September 30, 2009.
 
The primary drivers of these increases are outlined below:
 
  •  increased estimates of incurred losses on single-family mortgage loans that are expected to experience higher default rates. In particular, our estimates of incurred losses are higher for single-family loans we purchased or guaranteed during 2006, 2007 and to a lesser extent 2005 and 2008. We expect such loans to continue experiencing higher default rates than loans originated in earlier years. We purchased a greater percentage of higher-risk loans in 2005 through 2008, such as Alt-A, interest-only and other such products, and these mortgages have performed particularly poorly during the current housing and economic downturn;
 
  •  a significant increase in the size of the non-performing single-family loan portfolio for which we maintain loan loss reserves. This increase is primarily due to deteriorating market conditions and initiatives to prevent or avoid foreclosures. Our single-family non-performing assets increased to $91.6 billion at September 30, 2009, compared to $48.0 billion and $35.5 billion at December 31, 2008 and September 30, 2008, respectively;
 
  •  an observed trend of increasing delinquency rates and foreclosure timeframes. We experienced more significant increases in delinquency rates concentrated in certain regions and states within the U.S. that have been most affected by home price declines, as well as loans with second lien, third-party financing. For example, as of September 30, 2009, at least 14% of loans in our single-family mortgage portfolio had second lien, third-party financing at the time of origination and we estimate that these loans comprise 22% of our delinquent loans, based on unpaid principal balances;
 
  •  with respect to the nine months ended September 30, 2009, increases in the estimated average loss per loan, or severity of losses, net of expected recoveries from credit enhancements, driven in part by declines in home sales and home prices in the last two years. The states with the largest declines in home prices in the last two years and highest severity of losses include California, Florida, Nevada and Arizona; and
 
  •  increased amounts of delinquent interest associated with past due loans, including those where the borrower is completing the trial period under HAMP. A portion of our provision relates to interest income due to PC investors each month that a loan remains delinquent and remains in the PC pool.
 
Recent modest home price improvements in certain regions and states, which we believe were positively affected by the impact of state and federal government actions, including incentives to first time homebuyers and foreclosure suspensions, led to a slight improvement in loss severity used to estimate our loan loss reserves in the third quarter of 2009, as compared to the second quarter of 2009. However, we expect home prices are likely to decline in the near term, which may result in increasing single-family mortgage defaults and loss severity, which would likely require us to increase our loan loss reserves. Consequently, we expect our provisions for credit losses will likely remain high during the remainder of 2009. The level of our provision for credit losses in 2010 will depend on a number of factors, including the impact of the MHA Program on our 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.
 
REO Operations (Income) Expense
 
REO operations (income) expense was $(96) million during the three months ended September 30, 2009, as compared to $333 million during the three months ended September 30, 2008, and was $219 million and $806 million during the nine months ended September 30, 2009 and 2008, respectively. Our REO operations results improved in the three and nine months ended September 30, 2009 primarily as a result of lower disposition losses and recoveries of property writedowns. We recognize a writedown (when REO property values decrease) or recovery, up to the original carrying value of an REO property (when REO property values increase), for estimated changes in REO fair value during the period properties are held, which is included in REO operations expense. During the three months ended September 30, 2009, our carrying values and disposition values were more closely aligned due to more stable national home prices, reducing the size of our disposition losses.
 
Single-family REO disposition losses, excluding our holding period allowance, totaled $125 million and $191 million for the three months ended September 30, 2009 and 2008, respectively, and were $735 million and $483 million during the nine months ended September 30, 2009 and 2008, respectively. We also record recoveries of charge-offs related to insurance reimbursement and other third-party credit enhancements associated with foreclosed properties as a reduction to REO operations expense. During the three months ended September 30, 2009, the
 
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combination of mortgage insurance and REO property value recoveries was greater than the amount of our REO disposition losses and other REO expenses and resulted in REO operations income in the period.
 
Losses on Loans Purchased
 
Losses on delinquent and modified loans purchased from the mortgage pools underlying PCs and Structured Securities occur when the acquisition basis of the purchased loan exceeds the estimated fair value of the loan on the date of purchase. As a result of increases in delinquency rates of loans underlying our PCs and Structured Securities and our increasing efforts to reduce foreclosures, the number of loan modifications increased significantly during the nine months ended September 30, 2009, as compared to the nine months ended September 30, 2008. When a loan underlying our PCs and Structured Securities is modified, we exercise our repurchase option and hold the modified loan in our mortgage-related investments portfolio. See “Recoveries on Loans Impaired upon Purchase” and “CONSOLIDATED BALANCE SHEETS ANALYSIS — Mortgage-Related Investments Portfolio — Table 21 — Changes in Loans Purchased Under Financial Guarantees” for additional information about the impacts of these loans on our financial results.
 
During the three and nine months ended September 30, 2009, the market-based valuation of non-performing loans continued to be adversely affected by the expectation of higher default costs and reduced liquidity in the single-family mortgage market. Our losses on loans purchased were $531 million and $252 million for the three months ended September 30, 2009 and 2008, respectively, and totaled $3.7 billion and $423 million for the nine months ended September 30, 2009 and 2008, respectively. The increase in losses on loans purchased for the nine months ended September 30, 2009 is attributed both to the increase in volume of our optional repurchases of delinquent and modified loans underlying our guarantees as well as a decline in market valuations for these loans as compared to 2008. The growth in volume of our purchases of delinquent and modified loans from our PC pools temporarily slowed in the second and third quarters of 2009 primarily due to our implementation of the loan modification process under HAMP. Loans that we would have otherwise purchased remained in the PC pools while the borrowers requested and began the trial period payment plan under HAMP. The increase in losses on loans purchased for the three months ended September 30, 2009 is attributed to a decline in market valuations for these loans compared to the three months ended September 30, 2008.
 
We could experience an increase in losses on loans purchased in the fourth quarter of 2009, primarily due to the more than 88,000 loans in the trial period of HAMP as of September 30, 2009, although the completion rate remains uncertain. We also expect additional loans in our PC pools may be purchased into our mortgage-related investments portfolio as they reach 24 months of delinquency in the fourth quarter of 2009 and in 2010. We purchased approximately 7,400 and 43,700 loans from PC pools during the three and nine months ended September 30, 2009, respectively. This compares to approximately 7,100 and 14,400 loans purchased from PC pools during the three and nine months ended September 30, 2008, respectively.
 
Securities Administrator Loss on Investment Activity
 
In August 2008, acting as the security administrator for a trust that holds mortgage loan pools backing our PCs, we invested in $1.2 billion of short-term, unsecured loans which we made to Lehman on the trust’s behalf. We refer to these loans as the Lehman short-term transactions. These transactions were due to mature on September 15, 2008; however, Lehman failed to repay these loans and the accrued interest. On September 15, 2008, Lehman filed a chapter 11 bankruptcy petition in the Bankruptcy Court for the Southern District of New York. To the extent there is a loss related to an eligible investment for the trust, we, as the administrator, are responsible for making up that shortfall. During the third quarter of 2008, we recorded a non-recurring $1.1 billion loss to reduce the carrying amount of this asset to our estimate of the net realizable amount on these loans. On September 22, 2009, we filed proofs of claim in the Lehman bankruptcies.
 
Income Tax Benefit (Expense)
 
For the three months ended September 30, 2009 and 2008, we reported an income tax benefit (expense) of $149 million and $(8.0) billion, respectively. For the nine months ended September 30, 2009 and 2008 we reported an income tax benefit (expense) of $1.3 billion and $(6.5) billion, respectively. See “NOTE 12: INCOME TAXES” to our consolidated financial statements for additional information.
 
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; this category consists of certain unallocated corporate items, such as costs associated with remediating our internal controls and near-term restructuring costs, costs related to the resolution of
 
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certain legal matters and certain income tax items. 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. 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 with Treasury, may negatively impact our Segment Earnings and the performance of individual segments.
 
Segment Earnings is calculated for the segments by adjusting GAAP net income (loss) for certain investment-related activities and credit guarantee-related activities. Segment Earnings also 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. We continue to assess the methodologies used for segment reporting and refinements may be made in future periods. Segment Earnings does not include the effect of the establishment of the valuation allowance against our deferred tax assets, net. See “NOTE 16: SEGMENT REPORTING” to our consolidated financial statements for further information regarding our segments and the adjustments and reclassifications used to calculate Segment Earnings, as well as the allocation process used to generate our segment results.
 
In the third quarter of 2009, we reclassified our investments in commercial mortgage-backed securities and all related income and expenses from the Investments segment to the Multifamily segment. This reclassification better aligns the financial results related to these securities with management responsibility. Prior periods have been reclassified to conform to the current presentation.
 
Segment Earnings — Results
 
Investments Segment
 
Our Investments segment is responsible for investment activity in 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.
 
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Table 13 presents the Segment Earnings of our Investments segment.
 
Table 13 — Segment Earnings and Key Metrics — Investments
 
                                 
    Three Months Ended
    Nine Months Ended
 
    September 30,     September 30,  
    2009     2008     2009     2008  
    (dollars in millions)  
 
Segment Earnings:
                               
Net interest income
  $ 1,282     $ 1,253     $ 5,589     $ 2,852  
Non-interest income (loss)
    (1,149 )     (1,871 )     (7,539 )     (1,981 )
Non-interest expense:
                               
Administrative expenses
    (130 )     (104 )     (369 )     (365 )
Other non-interest expense
    (9 )     (1,089 )     (24 )     (1,105 )
                                 
Total non-interest expense
    (139 )     (1,193 )     (393 )     (1,470 )
                                 
Segment Earnings (loss) before income tax (expense) benefit
    (6 )     (1,811 )     (2,343 )     (599 )
Income tax (expense) benefit
    2       634       820       210  
                                 
Segment Earnings (loss), net of taxes
    (4 )     (1,177 )     (1,523 )     (389 )
                                 
Reconciliation to GAAP net income (loss):
                               
Derivative- and debt-related adjustments
    (1,443 )     (1,282 )     2,947       (1,933 )
Investment sales, debt retirements and fair value-related adjustments
    2,709       (7,708 )     3,659       (9,267 )
Fully taxable-equivalent adjustment
    (96 )     (103 )     (294 )     (318 )
Tax-related adjustments(1)
    (134 )     (3,278 )     616       (2,292 )
                                 
Total reconciling items, net of taxes
    1,036       (12,371 )     6,928       (13,810 )
                                 
GAAP net income (loss)
  $ 1,032     $ (13,548 )   $ 5,405     $ (14,199 )
                                 
Key metrics — Investments:
                               
Growth:
                               
Purchases of securities — Mortgage-related investments portfolio:(2)(3)
                               
Guaranteed PCs and Structured Securities
  $ 43,725     $ 21,938     $ 174,504     $ 134,536  
Non-Freddie Mac mortgage-related securities:
                               
Agency mortgage-related securities
    375       12,173       42,465       46,244  
Non-agency mortgage-related securities
    84       22       179       699  
                                 
Total purchases of securities — Mortgage-related investments portfolio
  $ 44,184     $ 34,133     $ 217,148     $ 181,479  
                                 
Growth rate of mortgage-related investments portfolio (annualized)
    (27.96 )%     (35.57 )%     (5.43 )%     1.34 %
Return:
                               
Net interest yield — Segment Earnings basis
    0.71 %     0.73 %     0.98 %     0.58 %
(1)  Includes an allocation of the non-cash charge related to the establishment of the partial valuation allowance against our deferred tax assets, net that is not included in Segment Earnings. 2008 amounts have been revised to reflect this allocation.
(2)  Based on unpaid principal balance and excludes mortgage-related securities traded, but not yet settled.
(3)  Excludes single-family mortgage loans.
 
Segment Earnings for our Investments segment increased $1.2 billion for the three months ended September 30, 2009 compared to the three months ended September 30, 2008, primarily due to (a) a decrease in net impairment of available-for-sale non-agency mortgage-related securities recognized in Segment Earnings and (b) a non-recurring securities administrator loss on investment activity of $1.1 billion related to the September 2008 bankruptcy of Lehman Brothers Holdings, Inc. recorded for the three months ended September 30, 2008.
 
Segment Earnings for our Investments segment decreased $1.1 billion for the nine months ended September 30, 2009 compared to the nine months ended September 30, 2008, primarily due to an increase in net impairment of available-for-sale non-agency mortgage-related securities recognized in Segment Earnings, partially offset by an increase in Segment Earnings net interest income. The results for the nine months ended September 30, 2008 included a non-recurring securities administrator loss on investment activity of $1.1 billion related to the September 2008 bankruptcy of Lehman Brothers Holdings, Inc.
 
Net impairment of available-for-sale securities recognized in earnings decreased to $1.1 billion during the three months ended September 30, 2009 due to a decrease in expected credit-related losses on our non-agency mortgage-related securities, compared to $1.9 billion of net impairment of available-for-sale securities recognized in earnings during the three months ended September 30, 2008. Net impairment of available-for-sale securities recognized in earnings increased to $7.7 billion during the nine months ended September 30, 2009 compared to $2.0 billion during the nine months ended September 30, 2008 due to an increase in expected credit-related losses on our non-agency mortgage-related securities primarily recognized during the first half of 2009. Security impairments that reflect expected or realized credit-related losses are realized in earnings immediately in both our GAAP results and in Segment Earnings. Impairments on securities we intend to sell or more likely than not will be required to sell prior to anticipated recovery are recognized in our GAAP results immediately but are excluded from Segment Earnings.
 
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Segment Earnings net interest income increased $29 million while Segment Earnings net interest yield decreased 2 basis points to 71 basis points for the three months ended September 30, 2009 compared to the three months ended September 30, 2008. Segment Earnings net interest income increased $2.7 billion and Segment Earnings net interest yield increased 40 basis points to 98 basis points for the nine months ended September 30, 2009 compared to the nine months ended September 30, 2008. The primary drivers underlying the increases in Segment Earnings net interest income for the 2009 periods were (a) a decrease in funding costs as a result of the replacement of higher cost short- and long-term debt with lower cost debt and (b) an increase in the average size of our mortgage-related investments portfolio including an increase in our holdings of fixed-rate assets. Net interest income and net interest yield during the three and nine months ended September 30, 2009 also benefited from the receipt of funds 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 as dividends paid on senior preferred stock.
 
The increase in Investments segment net interest income for the 2009 periods was partially offset by increases in (i) derivative cash amortization expense primarily associated with purchased swaptions, and (ii) derivative interest carry expense on net pay-fixed interest rate swaps. Both of these items are recognized within net interest income in Segment Earnings. The prepayment option risk, or negative convexity, of our mortgage assets increased significantly largely due to the low interest rate environment of the first half of 2009 as well as refinancing expectations as a result of our implementation of the MHA Program. In order to mitigate this increased risk, we increased our swaption purchase activity during the second and third quarters of 2009. The payments of up-front premiums associated with these purchased swaptions are amortized prospectively on a straight-line basis into net interest income in Segment Earnings over the option period to reflect the periodic cost associated with the protection provided by the option contract.
 
During the nine months ended September 30, 2009, the mortgage-related investments portfolio of our Investments segment declined at an annualized rate of 5.4%, compared to a 1.3% increase for the nine months ended September 30, 2008. The unpaid principal balance of the mortgage-related investments portfolio of our Investments segment increased from $603 billion at September 30, 2008 to $667 billion at December 31, 2008, and then decreased to $640 billion at September 30, 2009. The portfolio decreased in 2009 due to a relative lack of favorable investment opportunities caused by tighter spreads on agency mortgage-related securities as a result of the Federal Reserve’s and Treasury’s purchases of agency mortgage-related securities in the market. For information on the potential impact of (i) the termination of these purchase programs and (ii) the requirement to reduce the mortgage-related investments portfolio by 10% annually, beginning in 2010, see “CONSOLIDATED BALANCE SHEETS ANALYSIS — Mortgage-Related Investments Portfolio” and “LIQUIDITY AND CAPITAL RESOURCES — Liquidity.”
 
We held $67.5 billion of non-Freddie Mac agency mortgage-related securities and $118.3 billion of non-agency mortgage-related securities as of September 30, 2009 compared to $70.2 billion of non-Freddie Mac agency mortgage-related securities and $133.7 billion of non-agency mortgage-related securities as of December 31, 2008. The decline in the unpaid principal balance of non-agency mortgage-related securities is due primarily to the receipt of monthly remittances of principal repayments from both the recoveries of liquidated loans and, to a lesser extent, voluntary prepayments on the underlying collateral of these securities. Agency securities comprised approximately 74% of the unpaid principal balance of the Investments Segment mortgage-related investments portfolio at both September 30, 2009 and December 31, 2008. See “CONSOLIDATED BALANCE SHEETS ANALYSIS — Mortgage-Related Investments Portfolio” for additional information regarding our mortgage-related securities.
 
The objectives set forth for us under our charter and conservatorship and restrictions set forth in the Purchase Agreement may negatively impact our Investments segment results over the long term. For example, the required reduction pursuant to the Purchase Agreement in our mortgage-related investments portfolio balance to $250 billion, through successive annual 10% declines commencing in 2010, will cause a corresponding reduction in our net interest income from these assets. We expect this will negatively affect our Investments segment results.
 
Single-Family Guarantee Segment
 
In our Single-family Guarantee segment, we guarantee the payment of principal and interest on single-family mortgage-related securities, including those held in our mortgage-related investments portfolio, in exchange for monthly management and guarantee fees and other up-front compensation. Earnings for this segment consist primarily of management and guarantee fee revenues less the related credit costs (i.e., provision for credit losses) 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 expected net float benefits.
 
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Table 14 presents the Segment Earnings of our Single-family Guarantee segment.
 
Table 14 — Segment Earnings and Key Metrics — Single-Family Guarantee
 
                                 
    Three Months Ended
    Nine Months Ended
 
    September 30,     September 30,  
    2009     2008     2009     2008  
    (in millions)  
 
Segment Earnings:
                               
Net interest income
  $ 35     $ 52     $ 88     $ 187  
Non-interest income:
                               
Management and guarantee income
    898       883       2,762       2,618  
Other non-interest income
    87       94       258       301  
                                 
Total non-interest income
    985       977       3,020       2,919  
Non-interest expense:
                               
Administrative expenses
    (222 )     (164 )     (628 )     (580 )
Provision for credit losses
    (7,469 )     (5,899 )     (22,695 )     (9,878 )
REO operations income (expense)
    98       (333 )     (209 )     (806 )
Other non-interest expense
    (31 )     (20 )     (83 )     (68 )
                                 
Total non-interest expense
    (7,624 )     (6,416 )     (23,615 )     (11,332 )
                                 
Segment Earnings (loss) before income tax expense
    (6,604 )     (5,387 )     (20,507 )     (8,226 )
Income tax (expense) benefit
    2,312       1,886       7,178       2,879  
                                 
Segment Earnings (loss), net of taxes
    (4,292 )     (3,501 )     (13,329 )     (5,347 )
                                 
Reconciliation to GAAP net income (loss):
                               
Credit guarantee-related adjustments
    725       (1,074 )     1,678       574  
Tax-related adjustments(1)
    (1,759 )     (6,626 )     (6,075 )     (7,203 )
                                 
Total reconciling items, net of taxes(1)
    (1,034 )     (7,700 )     (4,397 )     (6,629 )
                                 
GAAP net income (loss)
  $ (5,326 )   $ (11,201 )   $ (17,726 )   $ (11,976 )
                                 
Key metrics — Single-family Guarantee:
                               
Balances and Growth (in billions, except rate):
                               
Average securitized balance of single-family credit guarantee portfolio(2)
  $ 1,809     $ 1,792     $ 1,792     $ 1,761  
Issuance — Single-family credit guarantees(2)
  $ 122     $ 64     $ 381     $ 309  
Fixed-rate products — Percentage of issuances(3)
    99.1 %     88.5 %     98.3 %     88.3 %
Liquidation Rate — Single-family credit guarantees (annualized rate)(4)
    24.2 %     12.1 %     25.5 %     16.8 %
Credit:
                               
Delinquency rate(5)
    3.33 %     1.22 %     3.33 %     1.22 %
Delinquency transition rate(6)
    20.0 %     25.4 %     20.0 %     25.4 %
REO inventory (number of units)
    41,133       28,089       41,133       28,089  
Single-family credit losses, in basis points (annualized)
    46.2       27.9       39.0       19.4  
Market:
                               
Single-family mortgage debt outstanding (total U.S. market, in billions)(7)
  $ 10,402     $ 11,254     $ 10,402     $ 11,254  
30-year fixed mortgage rate(8)
    5.2 %     6.3 %     5.1 %     6.1 %
(1)  Includes an allocation of the non-cash charge related to the partial valuation allowance recorded against our deferred tax assets, net that is not included in Segment Earnings. 2008 amounts have been revised to reflect this allocation.
(2)  Based on unpaid principal balance.
(3)  Excludes Structured Transactions, but includes interest-only mortgages with fixed interest rates.
(4)  Includes the effect of terminations of long-term standby commitments.
(5)  Represents the percentage of loans in our single-family credit guarantee portfolio, based on loan count, which are 90 days or more past due at period end and excluding loans underlying Structured Transactions. See “RISK MANAGEMENT — Credit Risks — Credit Performance — Delinquencies” for additional information.
(6)  Represents the percentage of loans that have been reported as 90 days or more delinquent or in foreclosure in the same quarter of the preceding year that have transitioned to REO. The rate excludes other dispositions that can result in a loss, such as short-sales and deed-in-lieu transactions.
(7)  Source: Federal Reserve Flow of Funds Accounts of the United States of America dated September 17, 2009.
(8)  Based on Freddie Mac’s PMMS rate. Represents the national average mortgage commitment rate to a qualified borrower exclusive of the fees and points required by the lender. This commitment rate applies only to conventional financing on conforming mortgages with LTV ratios of 80% or less.
 
Segment Earnings (loss) for our Single-family Guarantee segment increased to a loss of $(4.3) billion for the third quarter of 2009, compared to a loss of $(3.5) billion for the third quarter of 2008. This increase primarily reflects higher credit-related expenses of $1.1 billion due to continued credit deterioration in the single-family portfolio as evidenced by higher rates of delinquency. Segment Earnings management and guarantee income increased slightly for the three and nine months ended September 30, 2009, compared to the same periods in 2008, primarily due to higher balances of our issued guarantees as well as increased credit fee amortization. Amortization of fees was accelerated as a result of increased liquidation, or prepayment, rates on the related loans, which is attributed to higher refinance activity in the 2009 periods. Higher credit fee amortization in the 2009 periods was partially offset by lower average contractual management and guarantee rates as compared to the three and nine months ended September 30, 2008.
 
We implemented additional delivery fee increases effective September 1, 2009 and October 1, 2009, for mortgages with certain combinations of LTV ratios and other higher-risk loan characteristics. Although we increased delivery fees during 2009, we have been experiencing competitive pressure on our contractual management and guarantee rates, which limited our ability to increase our rates as customers renew their contracts. Due to these competitive pressures,
 
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we do not have the ability to raise our contractual guarantee and management rates to offset the increased provision for credit losses on existing business. Consequently, we expect to continue to report Segment Earnings (loss), net of taxes for the Single-family Guarantee segment for the foreseeable future.
 
Table 15 below provides summary information about Segment Earnings management and guarantee income for this segment. Segment Earnings management and guarantee income consists of contractual amounts due to us related to our management and guarantee fees as well as amortization of credit fees.
 
Table 15 — Segment Earnings Management and Guarantee Income — Single-Family Guarantee
 
                                                                 
    Three Months Ended September 30,     Nine Months Ended September 30,  
    2009     2008     2009     2008  
          Average
          Average
          Average
          Average
 
    Amount     Rate     Amount     Rate     Amount     Rate     Amount     Rate  
    (dollars in millions, rates in basis points)  
 
Contractual management and guarantee fees
  $ 688       14.8     $ 727       16.0     $ 2,092       15.2     $ 2,142       16.0  
Amortization of credit fees included in other liabilities
    210       4.5       156       3.4       670       4.8       476       3.5  
                                                                 
Total Segment Earnings management and guarantee income
    898       19.3       883       19.4       2,762       20.0       2,618       19.5  
                                                                 
Adjustments to reconcile to consolidated GAAP:
                                                               
Reclassification between net interest income and management and guarantee fee(1)
    57               53               175               147          
Credit guarantee-related activity adjustments(2)
    (177 )             (124 )             (712 )             (441 )        
Multifamily management and guarantee income(3)
    22               20               65               54          
                                                                 
Management and guarantee income, GAAP
  $ 800             $ 832             $ 2,290             $ 2,378          
                                                                 
(1)  Management and guarantee fees earned on mortgage loans held in our mortgage-related investments portfolio are reclassified from net interest income within the Investments segment to management and guarantee fees within the Single-family Guarantee segment. Buy-up and buy-down fees are transferred from the Single-family Guarantee segment to the Investments segment.
(2)  Primarily represent credit fee amortization adjustments.
(3)  Represents management and guarantee income recognized related to our Multifamily segment that is not included in our Single-family Guarantee segment.
 
For the nine months ended September 30, 2009 and 2008, the annualized growth rates of our single-family credit guarantee portfolio were 2.5% and 7.1%, respectively. Our mortgage purchase volumes are impacted by several factors, including origination volumes, mortgage product and underwriting trends, competition, customer-specific behavior, contract terms, and governmental initiatives concerning our business activities. Origination volumes are also affected by government programs, such as the Home Affordable Refinance Program. Single-family mortgage purchase volumes from individual customers can fluctuate significantly. Despite these fluctuations, our share of the overall single-family mortgage origination market was higher in the nine months ended September 30, 2009 as compared to the nine months ended September 30, 2008, as mortgage originators have generally tightened their credit standards, causing conforming mortgages to be the predominant product in the market during 2009. We have also tightened our own guidelines for mortgages we purchase and we have seen improvements in the credit quality of mortgages delivered to us in 2009. We experienced an increase in refinance activity in 2009 caused by declines in mortgage interest rates as well as our support of the Home Affordable Refinance Program.
 
Our Segment Earnings provision for credit losses for the Single-family Guarantee segment increased to $7.5 billion for the three months ended September 30, 2009 compared to $5.9 billion for the three months ended September 30, 2008. Segment Earnings provision for credit losses was $22.7 billion and $9.9 billion for the nine months ended September 30, 2009 and 2008, respectively. Mortgages in our single-family credit guarantee portfolio experienced significantly higher delinquency rates, higher transition rates to foreclosure, as well as higher loss severities on a per-property basis in the nine months ended September 30, 2009 than in the nine months ended September 30, 2008. Our provision for credit losses is based on our estimate of incurred losses inherent in both our single-family credit guarantee portfolio and the single-family mortgage loans in our mortgage-related investments portfolio using recent historical performance, such as trends in delinquency rates, recent charge-off experience, recoveries from credit enhancements and other loss mitigation activities.
 
The delinquency rate on our single-family credit guarantee portfolio, excluding Structured Transactions, increased to 3.33% as of September 30, 2009 from 1.72% as of December 31, 2008. Increases in delinquency rates occurred in all product types for the three and nine months ended September 30, 2009. Increases in delinquency rates have been more severe in the states of Nevada, Florida, Arizona and California. The delinquency rates for loans in our single-family mortgage portfolio, excluding Structured Transactions, related to the states of Nevada, Florida, Arizona and California were 9.51%, 8.98%, 6.21% and 5.01%, respectively, as of September 30, 2009. We expect our delinquency rates will continue to rise in the remainder of 2009.
 
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Charge-offs, gross, associated with single-family loans increased to $2.9 billion in the third quarter of 2009 compared to $1.2 billion in the third quarter of 2008, primarily due to an increase in the volume of REO properties we acquired through foreclosure transfers. Declining home prices during much of the last two years resulted in higher charge-offs, on a per property basis, during the third quarter of 2009 compared to the third quarter of 2008. We expect our charge-offs and credit losses to increase in the remainder of 2009. See “RISK MANAGEMENT — Credit Risks — Table 53 — Single-Family Credit Loss Concentration Analysis” for additional delinquency and credit loss information.
 
Single-family Guarantee REO operations income (expense) improved during the three and nine months ended September 30, 2009, compared to the same periods in 2008. REO operations expense decreased in the 2009 periods as a result of lower disposition losses and recovery of previous holding period writedowns. In addition, during the 2009 periods, our existing and newly acquired REO required fewer market-based write-downs due to more stable home prices. We expect REO operations expense to fluctuate in the remainder of 2009, as single-family REO acquisition volume increases and home prices remain under downward pressure.
 
During the nine months ended September 30, 2009, we experienced significant increases in REO activity in all regions of the U.S., particularly in the states of California, Florida, Arizona, Nevada and Michigan. The West region represented approximately 35% and 30% of our REO property acquisitions during the nine months ended September 30, 2009 and 2008, respectively, based on the number of units. The highest concentration in the West region is in the state of California. At September 30, 2009, our REO inventory in California comprised 15% of total REO property inventory, based on units, and approximately 24% of our total REO property inventory, based on loan amount prior to acquisition. California has accounted for a significant amount of our credit losses and losses on our loans in this state comprised approximately 34% of our total credit losses in the third quarter of 2009.
 
We temporarily suspended all foreclosure transfers on occupied homes from November 26, 2008 through January 31, 2009 and from February 14, 2009 through March 6, 2009. Beginning March 7, 2009, we began suspension of foreclosure transfers on owner-occupied homes where the borrower may be eligible to receive a loan modification under the MHA Program. As a result of our suspension of foreclosure transfers, we experienced an increase in single-family delinquency rates and a slow-down in the rate of growth of REO acquisitions and REO inventory during the nine months ended September 30, 2009, as compared to what we would have experienced without these actions. Our suspension or delay of foreclosure transfers and any imposed delay in foreclosures by regulatory or governmental agencies also causes a delay in our recognition of credit losses and our loan loss reserves to increase. See “RISK MANAGEMENT — Credit Risks — Loss Mitigation Activities” for further information on these programs.
 
Approximately 27% of loans in our single-family credit guarantee portfolio had estimated current LTV ratios above 90% at September 30, 2009, compared to 17% at September 30, 2008. In general, higher total LTV ratios indicate that the borrower has less equity in the home and would thus be more likely to default in the event of a financial hardship. There was a slight increase in national home prices during the nine months ended September 30, 2009. The second and third quarters of the year are historically strong periods for home sales. Seasonal strength, along with the impact of state and federal government actions, including incentives for first time home buyers and foreclosure suspensions, may have contributed to the increase in home prices during 2009. We expect that when temporary government actions expire and the seasonal peak in home sales has passed, home prices are likely to decline during the near term. Generally, decreases in home prices will result in increases to current LTV ratios. We expect that declines in home prices combined with the deterioration in rates of unemployment and other factors will result in continued high credit losses for our Single-family Guarantee segment during the remainder of 2009 and in 2010.
 
Multifamily Segment
 
Through our Multifamily segment, we purchase multifamily mortgages and CMBS for investment, and securitize and guarantee the payment of principal and interest on multifamily mortgage-related securities and mortgages underlying multifamily housing revenue bonds. The mortgage loans of the Multifamily segment consist of mortgages that are secured by properties with five or more residential rental units. We typically hold multifamily loans for investment purposes. In 2008, we began holding multifamily mortgages designated held-for-sale as part of our initiative to offer securitization capabilities to the market and our customers.
 
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Table 16 presents the Segment Earnings of our Multifamily segment.
 
Table 16 — Segment Earnings and Key Metrics — Multifamily(1)
 
                                 
    Three Months Ended
    Nine Months Ended
 
    September 30,     September 30,  
    2009     2008     2009     2008  
    (dollars in millions)  
 
Segment Earnings:
                               
Net interest income
  $ 224     $ 210     $ 615     $ 564  
Non-interest income (loss):
                               
Management and guarantee income
    22       20       65       54  
LIHTC partnerships
    (117 )     (121 )     (390 )     (346 )
Other non-interest income
    (52 )     16       (44 )     31  
                                 
Total non-interest income (loss)
    (147 )     (85 )     (369 )     (261 )
Non-interest expense:
                               
Administrative expenses
    (57 )     (37 )     (158 )     (135 )
Provision for credit losses
    (88 )     (14 )     (145 )     (30 )
REO operations expense
    (2 )           (10 )      
Other non-interest expense
    (6 )     (4 )     (18 )     (15 )
                                 
Total non-interest expense
    (153 )     (55 )     (331 )     (180 )
                                 
Segment Earnings (loss) before income tax benefit (expense)
    (76 )     70       (85 )     123  
LIHTC partnerships tax benefit
    148       147       447       445  
Income tax benefit (expense)
    26       (24 )     30       (42 )
Less: Net (income) loss — noncontrolling interest
    1             2       1  
                                 
Segment Earnings, net of taxes
    99       193       394       527  
                                 
Reconciliation to GAAP net income (loss):
                               
Derivative and debt-related adjustments
          (10 )     (32 )     (26 )
Credit guarantee-related adjustments
    9       (2 )     12       (6 )
Investment sales, debt retirements and fair value related adjustments
    (358 )     (9 )     (380 )     (21 )
Tax-related adjustments(1)
    (412 )     (31 )     (1,115 )     (20 )
                                 
Total reconciling items, net of taxes(1)
    (761 )     (52 )     (1,515 )     (73 )
                                 
GAAP net income (loss)
  $ (662 )   $ 141     $ (1,121 )   $ 454  
                                 
Key metrics — Multifamily:
                               
Balances and Growth:
                               
Average balance of Multifamily loan portfolio(2)
  $ 79,748     $ 66,004     $ 77,214     $ 62,507  
Average balance of Multifamily guarantee portfolio(2)
  $ 16,373     $ 14,087     $ 15,901     $ 12,878  
Average balance of Multifamily investment securities portfolio(2)
  $ 63,468     $ 65,605     $ 64,067     $ 65,620  
Purchases — Multifamily loan portfolio(2)
  $ 3,521     $ 5,164     $ 11,472     $ 13,416  
Issuances — Multifamily guarantee portfolio(2)
  $ 107     $ 845     $ 1,412     $ 4,332  
Liquidation Rate — Multifamily loan portfolio (annualized rate)
    2.9 %     4.1 %     3.4 %     6.1 %
Credit:
                               
Delinquency rate(3)
    0.11 %     0.01 %     0.11 %     0.01 %
Allowance for loan losses
  $ 404     $ 87     $ 404     $ 87  
(1)  Includes an allocation of the non-cash charge related to the partial valuation allowance recorded against our deferred tax assets, net that is not included in Segment Earnings. 2008 amounts have been revised to reflect this allocation.
(2)  Based on unpaid principal balance.
(3)  Based on net carrying value of mortgages in the multifamily loan and guarantee portfolios that are 90 days or more delinquent as well as those in the process of foreclosure and excluding Structured Transactions. Excludes loans underlying the multifamily investment securities portfolio.
 
Segment Earnings for our Multifamily segment decreased to $99 million for the third quarter of 2009 compared to $193 million for the third quarter of 2008. Segment Earnings for the Multifamily segment were $394 million and $527 million for the nine months ended September 30, 2009 and 2008, respectively. The declines in Segment Earnings for the three and nine months ended September 30, 2009 as compared to the corresponding periods in 2008 were primarily due to higher non-interest expenses primarily caused by a higher provision for credit losses. The decline in Segment Earnings for the third quarter of 2009 as compared to the third quarter of 2008 was also due to other-than-temporary impairments on CMBS within the multifamily investment securities portfolio.
 
Segment Earnings non-interest income (loss) was $(147) million in the third quarter of 2009 compared to $(85) million in the third quarter of 2008, and the increase in loss is attributed to credit-related impairment losses on CMBS in the third quarter of 2009. Impairment on CMBS for both GAAP and Segment Earnings during the three and nine months ended September 30, 2009 totaled $54 million. This relates to four securities from one issuer that are expected to incur contractual losses. There were no other-than-temporary impairments on CMBS during the three and nine months ended September 30, 2008. At September 30, 2009, a majority of our commercial mortgage backed securities were AAA-rated and we believe the declines in fair value are mainly attributable to the deterioration of liquidity and larger risk premiums in the commercial mortgage-backed securities market consistent with the broader credit markets rather than to the performance of the underlying collateral supporting the securities. We view the performance of the four securities impaired during the third quarter of 2009 as significantly worse than the remainder
 
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of our CMBS, and while delinquencies for the remaining securities have increased, we believe the credit enhancement related to these bonds is currently sufficient to cover expected losses on the underlying loans. Since we generally hold these securities to maturity, we do not intend to sell these securities and it is more likely than not that we will not be required to sell such securities before recovery of the unrealized losses.
 
We invest as a limited partner in LIHTC partnerships formed for the purpose of providing equity funding for affordable multifamily rental properties. We have determined that individual partnerships whose carrying value exceeds fair value are other-than-temporarily impaired and should be written down to their fair value. See “NOTE 3: VARIABLE INTEREST ENTITIES” to our consolidated financial statements for additional information on this determination. Other-than-temporary impairments that reflect expected or realized credit-related losses on investment securities or a change in expected earnings to be generated from our LIHTC investments are realized in earnings immediately in both our GAAP results and Segment Earnings. Any additional impairments are not recognized for Segment Earnings. We recognized $370 million and $379 million of other-than-temporary impairment on LIHTC investments in our GAAP results during the three and nine months ended September 30, 2009, respectively, and recognized $8 million and $17 million, respectively, of LIHTC related impairments in Segment Earnings. The fair value of our LIHTC investments has declined during 2009 as a result of the economic recession and decrease in market demand for these partnership interests. If the fair value of our partnership interests does not improve and we are not able to complete sales or other transactions to recover the benefits of our investment, it could result in additional other-than-temporary impairment on our LIHTC investments in the near term.
 
Segment Earnings non-interest expenses increased for the three and nine months ended September 30, 2009 compared to the same periods in 2008, primarily due to higher provision for credit losses. The delinquency rate for loans in the multifamily loan portfolio and multifamily guarantee portfolio, on a combined basis, was 0.11% and 0.01% as of September 30, 2009 and December 31, 2008, respectively. The increase in the delinquency rate for our multifamily loans during the nine months ended September 30, 2009 is principally from loans on properties located in the states of Georgia and Texas. We expect an increase in our multifamily delinquency rates during the remainder of 2009 as multifamily fundamentals and apartment net operating incomes remain under pressure. Market fundamentals for multifamily properties we monitor have experienced the greatest deterioration during the third quarter of 2009 in the Southeast and West regions, particularly the states of Florida, Nevada, California and Arizona. Refinance risk, which is the risk that a multifamily borrower with a maturing balloon mortgage will not be able to refinance and will instead default, is high given the state of the economy, lack of liquidity, deteriorating property cash flows, and declining property market values. These factors contributed to the increase in our provision for loan losses during the nine months ended September 30, 2009. Our REO property inventory has increased to seven properties as of September 30, 2009. REO operations expenses in the nine months ended September 30, 2009 primarily relate to fair value write-down of the properties in inventory due to market conditions. We had two REO acquisitions and two REO dispositions during the third quarter of 2009 and all activity was related to properties in the Southeast region.
 
We continued to provide stability and liquidity for the financing of rental housing through our purchases and credit guarantees of multifamily mortgage loans. In October 2009, we completed a structured securitization transaction with multifamily mortgage loans of approximately $1 billion. This Structured Transaction was backed by 46 multifamily loans and was the second of such transactions this year. We expect to complete additional transactions in 2010, if market conditions are appropriate.
 
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CONSOLIDATED BALANCE SHEETS ANALYSIS
 
The following discussion of our consolidated balance sheets 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 financial position.
 
Cash and Other Investments Portfolio
 
Table 17 provides detail regarding our cash and other investments portfolio.
 
Table 17 — Cash and Other Investments Portfolio
 
                 
    Fair Value  
    September 30, 2009     December 31, 2008  
    (in millions)  
 
Cash and cash equivalents
  $ 55,620     $ 45,326  
Investments:
               
Non-mortgage-related securities:
               
Available-for-sale securities:
               
Asset-backed securities
    4,538       8,794  
                 
Total available-for-sale non-mortgage-related securities
    4,538       8,794  
                 
Trading:
               
Asset-backed securities
    1,344        
Treasury bills
    12,394        
FDIC-guaranteed corporate medium-term notes
    250        
                 
Total trading non-mortgage-related securities
    13,988        
                 
                 
Total non-mortgage-related available-for-sale and trading securities
    18,526       8,794  
Federal funds sold and securities purchased under agreements to resell:
               
Federal funds sold
    550        
Securities purchased under agreements to resell
    9,000       10,150  
                 
Total federal funds sold and securities purchased under agreements to resell
    9,550       10,150  
                 
Total cash and other investments portfolio
  $ 83,696     $ 64,270  
                 
 
Our cash and other investments portfolio is important to our cash flow and asset and liability management and our ability to provide liquidity and stability to the mortgage market, as discussed in “MD&A — CONSOLIDATED BALANCE SHEETS ANALYSIS — Cash and Other Investments Portfolio” in our 2008 Annual Report. We use this portfolio to manage our liquidity until we have mortgage-related investments or credit guarantee opportunities. Cash and cash equivalents comprised $55.6 billion of the $83.7 billion in this portfolio as of September 30, 2009. At September 30, 2009, the investments in this portfolio also included $5.9 billion of non-mortgage-related asset-backed securities and $12.4 billion of Treasury bills that we could sell to provide us with an additional source of liquidity to fund our business operations.
 
During the nine months ended September 30, 2009, we increased the balance of our cash and other investments portfolio by $19.4 billion, primarily due to a $10.3 billion increase in cash and cash equivalents and a $9.7 billion increase in non-mortgage-related securities, principally comprised of Treasury bills. The portfolio balance increased, in part, due to a relative lack of favorable investment opportunities over the past two quarters for mortgage-related investments.
 
We recorded net impairment of available-for-sale securities recognized in earnings related to our cash and other investments portfolio of $185 million during the nine months ended September 30, 2009 for our non-mortgage-related investments, as we could not assert that we did not intend to, or we will not be required to, sell these securities before a recovery of the unrealized losses. Such net impairments occurred in the first and second quarters of 2009; no such net impairments were recorded for the third quarter of 2009 as no non-mortgage-related securities were in an unrealized loss position at September 30, 2009. The decision to impair these securities is consistent with our consideration of securities from the cash and other investments portfolio as a contingent source of liquidity. We do not expect any contractual cash shortfalls related to these securities. See “NOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES — Change in Accounting Principles — Change in the Impairment Model for Debt Securities” to our consolidated financial statements for information on how other-than-temporary impairments are recorded on our financial statements commencing in the second quarter of 2009.
 
During the three and nine months ended September 30, 2008, we recorded $245 million and $458 million, respectively, of net impairment of available-for-sale securities recognized in earnings related to investments in non-mortgage-related asset-backed securities within our cash and other investments portfolio as we could no longer assert the positive intent to hold these securities to recovery. The non-mortgage-related securities impaired during the third quarter of 2008 had $9.9 billion of unpaid principal balances at September 30, 2008.
 
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Table 18 provides credit ratings of the non-mortgage-related asset-backed securities in our cash and other investments portfolio at September 30, 2009. Table 18 includes securities classified as either available-for-sale or trading on our consolidated balance sheets.
 
Table 18 — Investments in Non-Mortgage-Related Asset-Backed Securities
 
                                         
    September 30, 2009  
                            Current
 
    Amortized
    Fair
    Original%
    Current%
    Investment
 
Collateral Type
  Cost     Value     AAA-rated(1)     AAA-rated(2)     Grade(3)  
    (dollars in millions)                    
 
Non-mortgage-related asset-backed securities:
                                       
Credit cards
  $ 3,311     $ 3,535       100 %     94 %     100 %
Auto credit
    1,344       1,403       100       87       100  
Equipment lease
    280       298       100       78       100  
Student loans
    338       353       100       89       100  
Stranded assets(4)
    154       161       100       100       100  
Insurance premiums
    128       132       100       100       100  
                                         
Total non-mortgage-related asset-backed securities
  $ 5,555     $ 5,882       100       92       100  
                                         
(1)  Reflects the composition of the portfolio that was AAA-rated as of the date of our acquisition of the security, based on unpaid principal balance and the lowest rating available.
(2)  Reflects the AAA-rated composition of the securities as of October 30, 2009, based on unpaid principal balance as of September 30, 2009 and the lowest rating available.
(3)  Reflects the composition of these securities with credit ratings BBB– or above as of October 30, 2009, based on unpaid principal balance as of September 30, 2009 and the lowest rating available.
(4)  Consists of securities backed by liens secured by fixed assets owned by regulated public utilities.
 
Mortgage-Related Investments Portfolio
 
We are primarily a buy-and-hold investor in mortgage assets. We invest principally in mortgage loans and mortgage-related securities, which consist of securities issued by us, Fannie Mae, Ginnie Mae and other financial institutions. We refer to these mortgage loans and mortgage-related securities that are recorded on our consolidated balance sheets as our mortgage-related investments portfolio. Our mortgage-related securities are classified as either available-for-sale or trading on our consolidated balance sheets.
 
Under the Purchase Agreement with Treasury and FHFA regulation, our mortgage-related investments portfolio may not exceed $900 billion as of December 31, 2009 and then must decline by 10% per year thereafter until it reaches $250 billion. The first of the annual 10% portfolio reductions is effective on December 31, 2010 and will be calculated relative to the actual balance of our mortgage-related investments portfolio on December 31, 2009. This could constrain our ability to purchase mortgages and mortgage-related securities in 2010. We may be required to sell mortgage-related assets in 2010 to meet the required 10% reduction, particularly given the potential for significant increases in loan modifications and delinquent loans, which result in the purchase of mortgage loans for our mortgage-related investments portfolio as currently measured under the Purchase Agreement. The amount of assets that we may be required to sell in 2010, if any, will depend on factors including the actual balance of our mortgage-related investments portfolio at year-end 2009 (which will determine the portfolio limit for 2010), level of liquidations and volume of loan modifications.
 
Our mortgage-related investments portfolio decreased during the nine months ended September 30, 2009 due to a relative lack of favorable investments opportunities, as evidenced by tighter spreads on agency mortgage-related securities. We believe these tighter spread levels are driven by the Federal Reserve’s and Treasury’s agency mortgage-related securities purchase programs. Investment opportunities for agency mortgage-related securities could remain limited while these purchase programs remain in effect.
 
Table 19 provides unpaid principal balances of the mortgage loans and mortgage-related securities in our mortgage-related investments portfolio. Table 19 includes securities classified as either available-for-sale or trading on our consolidated balance sheets.
 
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Table 19 — Characteristics of Mortgage Loans and Mortgage-Related Securities in our Mortgage-Related Investments Portfolio
 
                                                 
    September 30, 2009     December 31, 2008  
    Fixed Rate     Variable Rate     Total     Fixed Rate     Variable Rate     Total  
    (in millions)  
 
Mortgage loans:
                                               
Single-family:(1)
                                               
Conventional:(2)
                                               
Amortizing
  $ 46,016     $ 1,033     $ 47,049     $ 34,630     $ 1,295     $ 35,925  
Interest-only
    383       636       1,019       440       841       1,281  
                                                 
Total conventional
    46,399       1,669       48,068       35,070       2,136       37,206  
USDA Rural Development/FHA/VA
    2,581             2,581       1,549             1,549  
                                                 
Total single-family
    48,980       1,669       50,649       36,619       2,136       38,755  
Multifamily(3)
    70,674       10,556       81,230       65,322       7,399       72,721  
                                                 
Total unpaid principal balance of mortgage loans
    119,654       12,225       131,879       101,941       9,535       111,476  
                                                 
PCs and Structured Securities:(4)
                                               
Single-family(1)
    319,275       82,260       401,535       328,965       93,498       422,463  
Multifamily
    278       1,677       1,955       332       1,729       2,061  
                                                 
Total PCs and Structured Securities
    319,553       83,937       403,490       329,297       95,227       424,524  
                                                 
Non-Freddie Mac mortgage-related securities:
                                               
Agency mortgage-related securities:(5)
                                               
Fannie Mae:
                                               
Single-family(1)
    36,296       30,693       66,989       35,142       34,460       69,602  
Multifamily
    441       90       531       582       92       674  
Ginnie Mae:
                                               
Single-family(1)
    357       138       495       398       152       550  
Multifamily
    35             35       26             26  
                                                 
Total agency mortgage-related securities
    37,129       30,921       68,050       36,148       34,704       70,852  
                                                 
Non-agency mortgage-related securities:
                                               
Single-family:(1)(6)
                                               
Subprime
    407       63,989       64,396       438       74,413       74,851  
Option ARM
          18,213       18,213             19,606       19,606  
Alt-A and other
    2,941       19,311       22,252       3,266       21,801       25,067  
Commercial mortgage-backed securities
    23,868       38,581       62,449       25,060       39,131       64,191  
Obligations of states and political subdivisions(7)
    12,165       45       12,210       12,825       44       12,869  
Manufactured housing(8)
    1,061       171       1,232       1,141       185       1,326  
                                                 
Total non-agency mortgage-related securities(9)
    40,442       140,310       180,752       42,730       155,180       197,910  
                                                 
Total mortgage-related securities
    397,124       255,168       652,292       408,175       285,111       693,286  
                                                 
Total unpaid principal balance of mortgage-related investments portfolio
  $ 516,778     $ 267,393       784,171     $ 510,116     $ 294,646       804,762  
                                                 
Premiums, discounts, deferred fees, impairments of unpaid principal balances and other basis adjustments
                    (13,561 )                     (17,788 )
Net unrealized losses on mortgage-related securities, pre-tax
                    (26,738 )                     (38,228 )
Allowance for loan losses on mortgage loans held-for-investment(10)
                    (974 )                     (690 )
                                                 
Total carrying value of mortgage-related investments portfolio
                  $ 742,898                     $ 748,056  
                                                 
 (1)  Variable-rate single-family mortgage loans and mortgage-related securities include those with a contractual coupon rate that, prior to contractual maturity, is either scheduled to change or is subject to change based on changes in the composition of the underlying collateral. Single-family mortgage loans also include mortgages with balloon/reset provisions.
 (2)  See “RISK MANAGEMENT — Credit Risks — Mortgage Credit Risk” for information on Alt-A and subprime loans, which are a component of our single-family conventional mortgage loans
 (3)  Variable-rate multifamily mortgage loans include only those loans that, as of the reporting date, have a contractual coupon rate that is subject to change.
 (4)  For our PCs and Structured Securities, we are subject to the credit risk associated with the underlying mortgage loan collateral.
 (5)  Agency mortgage-related securities are generally not separately rated by nationally recognized statistical rating organizations, but are viewed as having a level of credit quality at least equivalent to non-agency mortgage-related securities rated AAA or equivalent.
 (6)  Single-family non-agency mortgage-related securities backed by subprime, option ARM, Alt-A and other mortgage loans include significant credit enhancements, particularly through subordination. For information about how these securities are rated, see “Table 24 — Ratings of Available-For-Sale Non-Agency Mortgage-Related Securities backed by Subprime, Option ARM, Alt-A and Other Loans at September 30, 2009 and December 31, 2008” and “Table 25 — Ratings Trend of Available-For-Sale Non-Agency Mortgage-Related Securities backed by Subprime, Option ARM, Alt-A and Other Loans.”
 (7)  Consists of mortgage revenue bonds. Approximately 55% and 58% of these securities held at September 30, 2009 and December 31, 2008, respectively, were AAA-rated as of those dates, based on the lowest rating available.
 (8)  At September 30, 2009 and December 31, 2008, 19% and 32%, respectively, of mortgage-related securities backed by manufactured housing were rated BBB– or above, based on the lowest rating available. For both dates, 91% of mortgage-related securities backed by manufactured housing had credit enhancements, including primary monoline insurance, that covered 23% of the mortgage-related securities backed by manufactured housing based on the unpaid principal balance. At both September 30, 2009 and December 31, 2008, we had secondary insurance on 60% of these securities that were not covered by the primary monoline insurance, based on the unpaid principal balance. Approximately 3% of the mortgage-related securities backed by manufactured housing were AAA-rated at both September 30, 2009 and December 31, 2008 based on the unpaid principal balance and the lowest rating available.
 (9)  Credit ratings for most non-agency mortgage-related securities are designated by no fewer than two nationally recognized statistical rating organizations. Approximately 32% and 55% of total non-agency mortgage-related securities held at September 30, 2009 and December 31, 2008, respectively, were AAA-rated as of those dates, based on the unpaid principal balance and the lowest rating available.
(10)  See “RISK MANAGEMENT — Credit Risks — Mortgage Credit Risk — Credit Performance — Loan Loss Reserves” for information about our allowance for loan losses on mortgage loans held-for-investment.
 
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The unpaid principal balance of our mortgage-related investments portfolio decreased by $20.6 billion to $784.2 billion at September 30, 2009 compared to December 31, 2008 due to the relative lack of favorable investment opportunities for mortgage-related securities. The decrease in agency mortgage-related securities balances was partially offset by an increase in purchases of single and multifamily loans.
 
The unpaid principal balance of multifamily loans in our mortgage-related investments portfolio increased from $72.7 billion at December 31, 2008 to $81.2 billion at September 30, 2009, an increase of 12%, primarily due to limited market participation by non-GSE investors. We expect industry-wide loan demand to remain weak for the rest of 2009. While we expect our multifamily loan portfolio to further increase in the fourth quarter of 2009, the rate of growth has slowed, reflecting the market’s contraction.
 
The unpaid principal balance of single-family loans in our mortgage-related investments portfolio increased from $38.8 billion at December 31, 2008 to $50.6 billion at September 30, 2009, an increase of 30%, primarily due to increased purchases of delinquent and modified loans from the mortgage pools underlying our PCs and Structured Securities and increased cash purchase activity. As mortgage interest rates declined during 2009, single-family refinance mortgage originations increased and the volume of deliveries of single-family mortgage loans to us for cash purchase rather than for guarantor swap transactions also increased.
 
Higher Risk Components of Our Mortgage-Related Investments Portfolio
 
As discussed below, we have exposure to subprime, Alt-A, interest-only and option ARM loans in our mortgage-related investments portfolio as follows:
 
  •  Single-family mortgage loans:  We hold Alt-A and interest-only loans in our mortgage-related investments portfolio, which are primarily those purchased from PCs. We do not hold significant amounts of option ARM loans in our mortgage-related investments portfolio. We generally do not classify the single-family mortgage loans in our mortgage-related investments portfolio as either prime or subprime; however, there are mortgage loans within our mortgage-related investments portfolio with higher risk characteristics than other mortgage loans.
 
  •  Single-family non-agency mortgage-related securities:  We hold non-agency mortgage-related securities backed by subprime, option ARM, and Alt-A and other loans in our mortgage-related investments portfolio.
 
In addition, we hold significant dollar amounts of PCs and Structured Securities in our mortgage-related investments portfolio. A portion of the single-family mortgage loans underlying our PCs and Structured Securities are Alt-A and interest-only loans, and there are subprime and option ARM loans underlying some of our Structured Transactions. For more information on single-family loans underlying our PCs and Structured Securities, see “RISK MANAGEMENT — Credit Risks — Mortgage Credit Risk — Single-Family Mortgage Product Types.”
 
During the nine months ended September 30, 2009, we did not buy or sell any non-agency mortgage-related securities backed by subprime, option ARM or Alt-A loans. As discussed below, we recognized significant impairment and unrealized losses on our holdings of such securities in the nine months ended September 30, 2009. See “Table 23 — Net Impairment on Available-For-Sale Mortgage-Related Securities Recognized in Earnings” for more information. We believe that the declines in fair values for these securities are attributable to poor underlying collateral performance and decreased liquidity and larger risk premiums in the mortgage market.
 
Higher Risk Single-Family Mortgage Loans
 
Participants in the mortgage market often characterize single-family loans based upon their overall credit quality at the time of origination, generally considering them to be prime or subprime. There is no universally accepted definition of subprime. The subprime segment of the mortgage market primarily serves borrowers with poorer credit payment histories and such loans typically have a mix of credit characteristics that indicate a higher likelihood of default and higher loss severities than prime loans. Such characteristics might include a combination of high LTV ratios, low credit scores or originations using lower underwriting standards such as limited or no documentation of a borrower’s income and/or assets. Mortgage loans with higher LTV ratios have a higher risk of default, especially during housing and economic downturns, such as the one the U.S. has experienced for the past few years. Many financial institutions have classified their residential mortgages as subprime if the FICO credit score of the borrower is below 620, without regard to any other loan characteristics. For information on loans we hold where the original FICO score of the borrower is less than 620, see “Table 20 — Higher-Risk Single-Family Loans that we hold in the Mortgage-Related Investments Portfolio.” Second lien mortgages are another type of residential loan product that has higher risk of default; however, we do not purchase or hold significant amounts of these loans in our single-family guarantee business.
 
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Although there is no universally accepted definition of Alt-A, many mortgage market participants classify single-family loans with credit characteristics that range between their prime and subprime categories as Alt-A because these loans have a combination of characteristics of each category, or may be underwritten with lower or alternative income or asset documentation requirements compared to a full documentation mortgage loan. In determining our Alt-A exposure on loans underlying our single-family mortgage portfolio, we have classified mortgage loans as Alt-A if the lender that delivers them to us has classified the loans as Alt-A, or if the loans had reduced documentation requirements, as well as a combination of certain credit attributes and expected performance characteristics at acquisition which, when compared to full documentation loans in our portfolio, indicate that the loan should be classified as Alt-A. There are circumstances where loans with reduced documentation are not classified as Alt-A because we already own the credit risk on the loans or the loans fall within various programs which we believe support not classifying the loans as Alt-A. For our non-agency mortgage-related securities that are backed by Alt-A loans, we classified securities as Alt-A if the securities were labeled as Alt-A when sold to us.
 
Table 20 presents information about single-family mortgage loans that we hold in our mortgage-related investments portfolio that have certain higher risk characteristics. See “RISK MANAGEMENT — Credit Risks — Table 42 — Higher-Risk Loans in the Single-Family Mortgage Portfolio” for information on the higher-risk single-family loans in our single-family mortgage portfolio, which generally consists of (i) single-family loans held in our mortgage-related investments portfolio and (ii) single-family loans underlying our issued PCs and Structured Securities. Higher-risk loans include both loan products where the loan product itself creates higher risk and loans where the borrower characteristics present higher-risk at origination. The following table includes a presentation of each higher-risk characteristic in isolation. So, a single loan may fall within more than one category (for example, an interest-only loan may also have a borrower with an original LTV ratio greater than 90%).
 
Table 20 — Higher-Risk(1) Single-Family Mortgage Loans That we Hold in the Mortgage-Related Investments Portfolio
 
                                 
    As of September 30, 2009
    Unpaid
  Estimated
  Percentage
  Delinquency
    Principal Balance   Current LTV(2)   Modified(3)   Rate(4)
    (dollars in millions)
 
Loans with one or more higher risk characteristics
  $ 17,960       103 %     41 %     26 %
Higher-risk loans with individual characteristics:(1)
                               
Interest-only loans
    1,015       106       1       41  
Alt-A loans
    3,747       120       63       44  
Original LTV greater than 90%(5) loans
    9,602       104       34       21  
Lower original FICO scores (less than 620)
    7,220       96       50       32  
                                 
                                 
    As of December 31, 2008
    Unpaid
  Estimated
  Percentage
  Delinquency
    Principal Balance   Current LTV(2)   Modified(3)   Rate(4)
    (dollars in millions)
 
Loans with one or more higher risk characteristics
  $ 13,492       91 %     29 %     20 %
Higher-risk loans with individual characteristics:(1)
                               
Interest-only loans
    1,280       101       9       38  
Alt-A loans
    2,374       103       41       35  
Original LTV greater than 90%(5) loans
    7,418       95       25       16  
Lower original FICO scores (less than 620)
    5,388       84       37       25  
(1)  Higher risk categories are not additive and a single loan may be included in multiple categories if more than one characteristic is associated with the loan.
(2)  Based on our first lien exposure on the property and excludes secondary financing by third parties, if applicable. For refinancing mortgages, the estimated current LTVs are based on third-party appraisals used in loan origination, whereas new purchase mortgages are based on the property sales price.
(3)  Represents the percentage of loans based on loan counts held on our consolidated balance sheet that have been modified under agreement with the borrower, including those with no changes in terms where past due amounts are added to the outstanding principal balance of the loan.
(4)  Based on the number of mortgages 90 days or more delinquent or in foreclosure. See “CREDIT RISKS — Mortgage Credit Risk — Delinquency” for further information about our delinquency rates.
(5)  See footnote (2) to “Table 41 — Characteristics of the Single-Family Mortgage Portfolio” for information about our calculation of original LTV ratios.
 
Loans with a combination of higher-risk attributes will have an even higher risk of default than those with an individual higher-risk characteristic. For example, we estimate that there were $2.3 billion and $1.7 billion at September 30, 2009 and December 31, 2008, respectively, of loans with both original LTV ratios greater than 90% and FICO credit scores less than 620 at the time of loan origination. See “RISK MANAGEMENT — Credit Risks — Mortgage Credit Risk” for further information on single-family mortgage product types and characteristics, including those loans underlying our guaranteed PCs and Structured Securities.
 
A significant number of the single-family loans with higher risk characteristics have been purchased out of PC pools under our financial guarantees. For loans purchased out of PC pools due to delinquency or modifications with
 
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concessions to the borrower, we may recognize losses at the time of purchase in order to reduce the unpaid principal balance of the loan to its fair value.
 
Loans Purchased Under Financial Guarantees
 
As securities administrator, we are required to purchase a mortgage loan from a PC pool under certain circumstances at the direction of a court of competent jurisdiction or a federal government agency. Additionally, we are required to repurchase all convertible ARMs out of PC pools when the borrower exercises the option to convert the interest rate from an adjustable rate to a fixed rate; and in the case of balloon/reset loans, shortly before the mortgage reaches its scheduled balloon reset date. During the nine months ended September 30, 2009 and 2008, we purchased $963 million and $1.7 billion, respectively, of convertible ARMs and balloon/reset loans out of PC pools.
 
As guarantor, we also have the right to purchase mortgages that back our PCs and Structured Securities (other than Structured Transactions) from the underlying loan pools when they are significantly past due or when we determine that loss of the property is likely or default by the borrower is imminent due to borrower incapacity, death or other extraordinary circumstances that make future payments unlikely or impossible. This right to repurchase mortgages or assets is known as our repurchase option, and we exercise this option when we modify a mortgage. We record loans that we purchase in connection with our performance under our financial guarantees at fair value and record losses on loans purchased on our consolidated statements of operations in order to reduce our net investment in acquired loans to their fair value. The table below presents activities related to optional purchases of loans under financial guarantees for the three and nine months ended September 30, 2009 and 2008.
 
Table 21 — Changes in Loans Purchased Under Financial Guarantees(1)
 
                                                                 
    Three Months Ended September 30, 2009     Three Months Ended September 30, 2008  
    Unpaid
    Purchase
    Loan Loss
    Net
    Unpaid
    Purchase
    Loan Loss
    Net
 
    Principal Balance     Discount     Reserves     Investment     Principal Balance     Discount     Reserves     Investment  
    (in millions)  
 
Beginning balance
  $ 15,381     $ (6,871 )   $ (92 )   $ 8,418     $ 6,099     $ (1,386 )   $ (6 )   $ 4,707  
Purchases of loans
    1,238       (766 )           472       1,248       (385 )           863  
Provision for credit losses
                (2 )     (2 )                 (50 )     (50 )
Principal repayments(2)
    (228 )     127       2       (99 )     (183 )     68       1       (114 )
Troubled debt restructurings
    (55 )     23       1       (31 )     (57 )     17             (40 )
Property acquisitions, transferred to REO
    (258 )     103       5       (150 )     (372 )     116       1       (255 )
                                                                 
Ending balance(3)
  $ 16,078     $ (7,384 )   $ (86 )   $ 8,608     $ 6,735     $ (1,570 )   $ (54 )   $ 5,111  
                                                                 
                                                                 
                                                                 
    Nine Months Ended September 30, 2009     Nine Months Ended September 30, 2008  
    Unpaid
    Purchase
    Loan Loss
    Net
    Unpaid
    Purchase
    Loan Loss
    Net
 
    Principal Balance     Discount     Reserves     Investment     Principal Balance     Discount     Reserves     Investment  
    (in millions)  
 
Beginning balance
  $ 9,522     $ (3,097 )   $ (80 )   $ 6,345     $ 7,001     $ (1,767 )   $ (2 )   $ 5,232  
Purchases of loans
    8,170       (5,070 )           3,100       2,394       (630 )           1,764  
Provision for credit losses
                (33 )     (33 )                 (55 )     (55 )
Principal repayments(2)
    (325 )     273       6       (46 )     (693 )     207       1       (485 )
Troubled debt restructurings
    (635 )     267       5       (363 )     (85 )     24             (61 )
Property acquisitions, transferred to REO
    (654 )     243       16       (395 )     (1,882 )     596       2       (1,284 )
                                                                 
Ending balance(3)
  $ 16,078     $ (7,384 )   $ (86 )   $ 8,608     $ 6,735     $ (1,570 )   $ (54 )   $ 5,111  
                                                                 
(1)  Consist of seriously delinquent or modified loans purchased at our option in performance of our financial guarantees and in accordance with accounting standards for loans and debt securities acquired with deteriorated credit quality (FASB ASC 310-30).
(2)  Includes the capitalization of past due interest on loans subject to repayment or other agreements executed during the period, which resulted in an increase in our net investment in these loans during the three and nine months ended September 30, 2009.
(3)  Includes loans that have subsequently returned to current status under the original loan terms.
 
Our net investment in delinquent and modified loans purchased under financial guarantees increased approximately 36% during the nine months ended September 30, 2009. During that period, we purchased approximately $8.2 billion in unpaid principal balances of these loans with a fair value at acquisition of $3.1 billion. The $5.1 billion purchase discount consists of approximately $1.4 billion previously recognized as loan loss reserve or guarantee obligation and $3.7 billion of losses on loans purchased. We expect to continue to incur losses on the purchase of delinquent or modified loans in the fourth quarter of 2009. The volume and severity of these losses is dependent on many factors, including the rate of completion of loan modifications under HAMP, and changes in fair values of delinquent or modified loans, which are impacted by investor demand as well as regional changes in home prices. See “CONSOLIDATED RESULTS OF OPERATIONS — Losses on Loans Purchased,” for further information.
 
As of September 30, 2009, the cure rate for loans that we purchased out of PC pools during the first, second and third quarters of 2009 was approximately 59%, 74% and 90%, respectively. The cure rate is the percentage of loans
 
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purchased with or without modification under our financial guarantees that have returned to less than 90 days past due or have been paid off, divided by the total number of loans purchased under our financial guarantees. The cure rates for the first and second quarters of 2009 are lower than those for the third quarter of 2009 because a significant number of the modifications in the first half of 2009 were completed as part of a pilot program, offered in mid-2008, to complete modifications of significantly delinquent loans on a broad scale. Many of the delinquent borrowers in that pilot program, including those whose modifications were completed in the first half of 2009, did not meet their new payment obligations and defaulted on their modified loans. Mortgages that remain in the PC pools and reperform or proceed to foreclosure are not included in these cure rate statistics.
 
Supplemental Multifamily Mortgage Loans
 
Since the start of 2009, our multifamily mortgage loans have generally been underwritten using requirements that currently establish a maximum original LTV ratio of 75% and a minimum debt service coverage ratio of 1.25. In certain circumstances, we may purchase certain types of multifamily loans that have an original LTV ratio over 75% or a debt service coverage ratio of less than 1.25. We generally do not consider multifamily products to be higher-risk at origination. We do make investments in certain second and other junior lien loans on multifamily properties on which we own the first lien mortgage, which we refer to as supplemental loans. Beginning in 2009, supplemental loans must have a maximum total LTV ratio of 75% and minimum debt service coverage of 1.30 when combined with the first lien mortgage. Supplemental loans generally allow the existing borrower a lower cost option to obtain additional financing without the added expense of refinancing the first lien mortgage. We had supplemental multifamily loans held-for-investment of $2.7 billion and $2.5 billion in our mortgage-related investments portfolio as of September 30, 2009 and December 31, 2008, respectively, and at both dates these loans had average original LTVs of approximately 65% and none of these loans was 90 days or more delinquent at either date. See “CREDIT RISKS — Mortgage Credit Risk — Multifamily Mortgage Product Types” for further information.
 
Non-Agency Mortgage-Related Securities Backed by Subprime, Option ARM and Alt-A Loans
 
We classify our non-agency mortgage-related securities as subprime, option ARM or Alt-A if the securities were labeled as such, when sold to us. Table 22 presents information about our holdings of these securities.
 
Table 22 — Non-Agency Mortgage-Related Securities Backed by Subprime, Option ARM and Alt-A Loans(1)
 
                                                 
    September 30, 2009   December 31, 2008
    Unpaid
  Collateral
  Average
  Unpaid
  Collateral
  Average
    Principal
  Delinquency
  Credit
  Principal
  Delinquency
  Credit
    Balance   Rate(2)   Enhancement(3)   Balance   Rate(2)   Enhancement(3)
    (dollars in millions)
 
Mortgage loans:
                                               
Single-family:(1)
                                               
Subprime first lien
  $ 63,810       46 %     33 %   $ 74,070       38 %     34 %
Option ARM
    18,213       42       20       19,606       30       22  
Alt-A(4)
    18,683       24       14       21,015       17       14  
 
                         
    Three Months Ended
    September 30, 2009   June 30, 2009   March 31, 2009
    (dollars in millions)
 
Principal repayments:(5)
              &nb