10-Q 1 f58905e10vq.htm 10-Q e10vq
Table of Contents

 
 
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 June 30, 2008
 
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.     o Yes  x 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 “accelerated filer,” “large 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 July 28, 2008, there were 647,015,161 shares of the registrant’s common stock outstanding.
 


Table of Contents

 
TABLE OF CONTENTS
 
             
    1  
      86  
      1  
   
     Executive Summary
    1  
        15  
        16  
        33  
        49  
        50  
   
     Credit Risks
    53  
        71  
        72  
   
     Our Portfolios
    75  
        79  
        81  
      83  
      85  
       
    133  
      133  
      133  
      135  
      136  
      136  
       
    137  
    138  
 
            i Freddie Mac


Table of Contents

FINANCIAL STATEMENTS
 
         
    Page
 
    87  
    88  
    89  
    90  
    91  
    93  
    97  
    99  
    103  
    106  
    107  
    107  
    108  
    109  
    110  
    112  
    113  
    114  
    122  
    124  
    131  
    131  
 
            ii Freddie Mac


Table of Contents

 
PART I — FINANCIAL INFORMATION
 
This Quarterly Report on Form 10-Q includes forward-looking statements, which may include expectations and objectives related to our operating results, financial condition, business, capital management, remediation of significant deficiencies in internal controls, credit losses, market share and trends and other matters. 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 OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS,” or MD&A, “FORWARD-LOOKING STATEMENTS” and “RISK FACTORS” in this Form 10-Q and in the comparably captioned sections of our Form 10 Registration Statement filed and declared effective by the Securities and Exchange Commission, or SEC, on July 18, 2008, or Registration Statement, and (ii) the “BUSINESS” section of our Registration Statement. 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.
 
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 
EXECUTIVE SUMMARY
 
Freddie Mac is a stockholder-owned company chartered by Congress in 1970 to stabilize the nation’s residential mortgage markets and expand opportunities for homeownership and affordable rental housing. Our mission is to provide liquidity, stability and affordability to the U.S. housing market. We fulfill our mission by purchasing residential mortgage loans and mortgage-related securities in the secondary mortgage market. We are one of the largest purchasers of mortgage loans in the U.S. We purchase mortgage loans and bundle them into mortgage-related securities that can be sold to investors. We can use the proceeds to purchase additional mortgage loans from primary market mortgage lenders, providing these lenders with a continuous flow of funds. We also purchase mortgage loans and mortgage-related securities for our retained portfolio. We finance our purchases for our retained portfolio and manage associated interest-rate and other market risks primarily by issuing a variety of debt instruments and entering into derivative contracts in the capital markets. See “CONSOLIDATED BALANCE SHEETS ANALYSIS — Retained Portfolio” and “OUR PORTFOLIOS” for a description and composition of our portfolios.
 
Though we are chartered by Congress, our business is funded completely with private capital. We alone are responsible for making payments on our securities. Neither the U.S. government nor any other agency or instrumentality of the U.S. government is obligated to fund our mortgage purchase or financing activities or to guarantee our securities or other obligations. Although the U.S. government’s ability to provide financial support to us has recently increased, this has not changed our responsibility to fund our obligations or resulted in any guarantee of our securities or other obligations. See “Legislative and Regulatory Matters.”
 
Recent Events
 
Since mid-June 2008, there has been a substantial decline in the market price of our common stock. The market conditions that have contributed to this price decline are likely to affect our approach to raising new core capital including the timing, amount, type and mix of securities we may issue. We have committed to the Office of Federal Housing Enterprise Oversight, or OFHEO, to raise $5.5 billion of new capital. We remain committed to raising this capital given appropriate market conditions and will evaluate raising capital beyond this amount depending on our needs and as market conditions mandate.
 
Our financial performance for the second quarter, while reflecting the challenges that face the industry, leaves us capitalized at a level greater than the 20% mandatory target capital surplus established by OFHEO and with a greater surplus above the statutory minimum capital requirement. Given the challenges facing the industry, we expect to take actions to maintain our capital position above the mandatory target capital surplus. Accordingly, subject to approval by our board of directors, we currently expect to reduce the dividend on our common stock in the third quarter of 2008 from $0.25 to $0.05 or less per share and to pay the full dividends at contractual rates on our preferred stock. In addition, we continue to review and consider other alternatives for managing our capital including issuing equity in amounts that could be substantial and materially dilutive to our existing shareholders, reducing or rebalancing risk, slowing purchases into our credit guarantee portfolio and limiting the growth or reducing the size of our retained portfolio by allowing the portfolio to run off and/or by selling securities classified as trading or carried at fair value under Statement of Financial Accounting Standards, or SFAS, No. 159 “The Fair Value Option for Financial Assets and Financial Liabilities, Including an Amendment of FASB Statement No. 115,” or SFAS 159, or available-for-sale securities that are accretive to capital (i.e., fair value exceeds amortized cost). We have retained and are working with financial advisors and we continue to engage in discussions with OFHEO and the U.S. Department of the Treasury, or Treasury, on these matters.
 
            1 Freddie Mac


Table of Contents

Our liquidity position remains strong as a result of: (a) our continued access to the debt markets at attractive spreads, (b) our cash and investments portfolio of approximately $70 billion and (c) an unencumbered agency mortgage-related securities portfolio of approximately $470 billion, which could serve as collateral for additional borrowings. Under stressful market conditions, counterparties willing to provide funding based on our unencumbered portfolio may be unavailable or may offer terms that are not attractive to the company. On July 13, 2008, the Board of Governors of the Federal Reserve System, or the Federal Reserve, granted the Federal Reserve Bank of New York the authority to lend to Freddie Mac if necessary. Any such lending would be at the discount rate charged for primary credit, or the primary credit rate, and collateralized by U.S. government and federal agency securities. This authorization was intended to supplement the Treasury’s existing authority to purchase obligations of Freddie Mac.
 
The Housing and Economic Recovery Act of 2008 was signed into law on July 30, 2008. Division A of this legislation, the Federal Housing Finance Regulatory Reform Act of 2008, or the Regulatory Reform Act, establishes a new regulator for us, the Federal Housing Finance Agency, or FHFA, with enhanced regulatory authorities relating, among other things, to our minimum and risk-based capital levels and our business activities, including portfolio investments, new products, management and operations standards, affordable housing goals, and executive compensation. The Regulatory Reform Act expands the circumstances under which we could be placed into conservatorship and also authorizes the FHFA to place us into receivership under specified circumstances. The Regulatory Reform Act also requires us to allocate or transfer certain amounts to: (a) the Secretary of the U.S. Department of Housing and Urban Development, or HUD, to fund a Housing Trust Fund and (b) a Capital Magnet Fund administered by the Secretary of the Treasury. In addition, the Regulatory Reform Act provides the Secretary of the Treasury with temporary authority, until December 31, 2009, to purchase any obligations and other securities we issue under certain circumstances. See “Legislative and Regulatory Matters” for additional information concerning the provisions of the Regulatory Reform Act and their potential impact on us.
 
Market Overview
 
In the first six months of 2008, the single-family residential mortgage market has continued to experience deterioration that began during 2007. The various factors contributing to this deterioration have adversely affected our financial condition and results of operations. Specifically, our estimates of nationwide home price changes, which measure home values primarily based on repeat home sales indicated home price declines of approximately 1% and 5%, in the three and six months ended June 30, 2008, respectively, with significant variation across regions and metropolitan areas. Home price changes are an important market indicator for us because they represent the general trend in value associated with the single-family mortgage loans underlying our Mortgage Participation Certificates, or PCs, and other mortgage-related securities. As home prices decline, the risk of borrower defaults generally increases and the severity of credit losses also increases. Forecasts of nationwide home prices indicate a continued overall decline in 2008.
 
Other trends in the single-family residential mortgage market also reflect the weakening in the housing market. Since early 2006, the volume of new and existing home sales has declined and increased inventories of unsold homes have undermined property values. Demand for investor properties and second homes has also declined dramatically. Annual total single-family conventional mortgage originations are expected to continue to decline during 2008.
 
Credit concerns and resulting liquidity issues have also affected the financial markets. Since mid-2007, the market for non-agency mortgage-related securities has been characterized by high levels of uncertainty, reduced demand, illiquidity and significantly wider credit spreads. Non-agency mortgage-related securities, particularly those backed by subprime and Alt-A mortgage products, have been subject to rating agency downgrades and significant price declines in the market. The reduced liquidity in U.S. financial markets prompted the Federal Reserve to take several significant actions during the first half of 2008, including a series of reductions in the discount rate totaling 2.50%. In early March 2008, the Federal Reserve expanded its securities lending program to allow primary dealers to borrow U.S. Treasury securities for 28 day terms (rather than only overnight) with a pledge of other securities by the borrower, including AAA-rated, private-issuer, residential mortgage securities. The Federal Reserve has left key lending rates unchanged since May 2008; however, credit and liquidity concerns have continued to affect the market.
 
The rate reductions by the Federal Reserve have had an impact on other key market rates affecting our assets and liabilities, including generally reducing the return on our cash and investments portfolio and lowering our cost of short-term debt financing. In addition, the reduction in rates by the Federal Reserve caused mortgage interest rates to temporarily decline early in 2008 and drove a surge in refinancing activity during the first four months of 2008. However, as residential mortgage rates rose during the remainder of the second quarter, the pace of refinancing activity slowed, and this is expected to also slow the growth of new issuances for our guaranteed PCs and Structured Securities portfolio during the second half of 2008.
 
The credit performance of mortgage products deteriorated during 2007 and 2008, most severely for subprime and Alt-A mortgage products. The decline in credit performance of mortgages during 2008, particularly subprime mortgages, has also impacted the ratings of certain monoline bond insurance providers, or monolines, which has negatively affected the pricing
 
            2 Freddie Mac


Table of Contents

of non-agency mortgage and asset-backed securities in the market. We have direct and indirect exposure to monolines and recognized other-than-temporary impairment losses related to some of these exposures during the second quarter of 2008. See “CONSOLIDATED BALANCE SHEETS ANALYSIS — Retained Portfolio” for additional information regarding our exposure to monolines as well as mortgage-related securities backed by subprime and Alt-A loans. Concerns about the potential for higher delinquency rates and more severe credit losses have resulted in greater increases in mortgage rates in the non-conforming and subprime portions of the market. Many lenders have tightened credit standards or elected to stop originating certain types of mortgages and several mortgage originators have exited the origination business. Decreases in home prices have also eroded the equity of many homeowners seeking to refinance. These factors have adversely affected many borrowers seeking alternative financing to refinance out of non-traditional and adjustable-rate mortgages, or ARMs.
 
The multifamily mortgage market differs from the residential single-family market in several respects. The likelihood that a multifamily borrower will make scheduled payments on its mortgage is a function of the ability of the property to generate income sufficient to make those payments, which is affected by rent levels and the percentage of available units that are occupied. Strength in the multifamily market therefore is affected by the balance between the supply of and demand for rental housing (both multifamily and single-family), which in turn is affected by employment, the number of new units added to the rental housing supply, rates of household formation and the relative cost of owner-occupied housing alternatives. Although multifamily market fundamentals have been strong in much of the nation, liquidity concerns and wider credit spreads have spilled over from the single-family mortgage market into the multifamily segment during 2008. However, we have continued to support the multifamily housing market during 2008 by making investments that we believe have attractive expected returns.
 
Summary of Financial Results for the Three and Six Months Ended June 30, 2008
 
Generally Accepted Accounting Principles, or GAAP, Results
 
Effective January 1, 2008, we adopted SFAS No. 157, “Fair Value Measurements,” or SFAS 157, which defines fair value, establishes a framework for measuring fair value in financial statements and expands required disclosures about fair value measurements. In connection with the adoption of SFAS 157, we changed our method for determining the fair value of our newly-issued guarantee obligations. Under SFAS 157, the initial fair value of our guarantee obligation equals the fair value of compensation received, consisting of management and guarantee fees and other upfront compensation, in the related securitization transaction, which is a practical expedient for determining fair value. As a result, prospectively from January 1, 2008, we no longer record estimates of deferred gains or immediate, “day one” losses on most guarantees. Our adoption of SFAS 157 did not result in an immediate recognition of gain or loss, but the prospective change had a positive impact on our financial results for the three and six months ended June 30, 2008.
 
Also effective January 1, 2008, we adopted SFAS 159 or the fair value option, which permits companies to choose to measure certain eligible financial instruments at fair value that are not currently required to be measured at fair value in order to mitigate volatility in reported earnings caused by measuring assets and liabilities differently. We initially elected the fair value option for certain available-for-sale mortgage-related securities and our foreign-currency denominated debt. Upon adoption of SFAS 159, we recognized a $1.0 billion after-tax increase to our retained earnings at January 1, 2008. We may continue to elect the fair value option for certain securities to mitigate interest-rate aspects of our guarantee asset and certain non-hedge designated pay-fixed swaps.
 
Net income (loss) was $(821) million and $729 million for the three months ended June 30, 2008 and 2007, respectively. Net income (loss) was $(972) million and $596 million for the six months ended June 30, 2008 and 2007, respectively. Net income decreased in the three and six months ended June 30, 2008 compared to the same periods of 2007, principally due to increased losses on investment activity as well as increased credit-related expenses, which consist of the provision for credit losses and real estate owned, or REO, operations expense. These loss and expense items for the three and six months ended June 30, 2008 were partially offset by higher net interest income and income on our guarantee obligation as well as lower losses on certain credit guarantees and lower losses on loans purchased due to our use of the practical expedient for determining fair value under SFAS 157 and changes in our operational practice of purchasing delinquent loans out of PC securitization pools.
 
Net interest income was $1.5 billion for the three months ended June 30, 2008, compared to $793 million for the three months ended June 30, 2007. Net interest income was $2.3 billion for the six months ended June 30, 2008, compared to $1.6 billion for the six months ended June 30, 2007. After the limitation on the growth of our retained portfolio expired, we were able to purchase significant amounts of fixed-rate agency mortgage-related securities at significantly wider spreads relative to our funding costs during the three and six months ended June 30, 2008. This action not only helped to serve our mission, but benefited our customers and the secondary mortgage market. The increase in net interest income and yield is also due to significantly lower short-term interest rates on our short-term borrowings and lower long-term interest rates on our long-term borrowings for the three and six months ended June 30, 2008. In addition, a higher proportion of short-term
 
            3 Freddie Mac


Table of Contents

debt, together with a lower proportion of floating rate securities within our retained portfolio contributed to the improvement in net interest income and net interest yield during the three and six months ended June 30, 2008.
 
Non-interest income was $164 million and $895 million for the three and six months ended June 30, 2008, respectively, compared to non-interest income of $1.5 billion for both the three and six months ended June 30, 2007. The decrease in non-interest income in the second quarter of 2008 was primarily due to higher losses on investment activity, excluding foreign-currency related effects, which was partially offset by gains on our guarantee asset, increased income on our guarantee obligation and higher management and guarantee income. Increased losses on investment activity during the second quarter of 2008 were primarily due to the impact of the increase in interest rates on our investments classified as trading and security impairments recognized on available-for-sale non-agency mortgage-related securities backed by subprime and Alt-A and other loans. Our investments classified as trading securities included those securities for which we elected fair value accounting under SFAS 159. The election of SFAS 159 for these securities provides income statement recognition of the economic hedge they provide against changes in the fair value of our guarantee asset and our derivative portfolio resulting from movements in interest rates. Losses related to trading securities were partially offset by gains on our guarantee asset and our derivative portfolio during the second quarter of 2008. Income on our guarantee obligation was $769 million and $474 million for the three months ended June 30, 2008 and 2007, respectively and $1.9 billion and $904 million for the six months ended June 30, 2008 and 2007, respectively. Our amortization of income on our guarantee obligation has accelerated in the three and six months ended June 30, 2008 as compared to the same 2007 periods in order to match our economic release from risk on the pools of mortgage loans we guarantee. Management and guarantee income increased 28%, to $757 million for the three months ended June 30, 2008 from $591 million for the three months ended June 30, 2007. Management and guarantee income increased to $1.5 billion, for the six months ended June 30, 2008 from $1.2 billion for the six months ended June 30, 2007. This reflects increases in the average balance of our PCs and Structured Securities of 14% and 15% on an annualized basis for the three and six months ended June 30, 2008, respectively. The increase also reflects higher average total management and guarantee fee rates for the three and six months ended June 30, 2008 compared to the same 2007 periods. See “CONSOLIDATED RESULTS OF OPERATIONS — Non-Interest Income” for further discussion of our non-interest income.
 
Our non-interest expenses for the three months ended June 30, 2008 and 2007 totaled $3.5 billion and $1.5 billion, respectively. Our non-interest expenses for the six months ended June 30, 2008 and 2007 totaled $5.6 billion and $2.7 billion, respectively. Credit-related expenses were $2.8 billion and $0.5 billion for the three months ended June 30, 2008 and 2007, respectively. Credit-related expenses were $4.3 billion and $0.7 billion for the six months ended June 30, 2008 and 2007, respectively. For the three and six months ended June 30, 2008, our provision for credit losses increased due to credit deterioration in our single-family credit guarantee portfolio, primarily due to increases in delinquency rates and higher severity of losses on a per-property basis. Credit deterioration has been largely driven by declines in home prices and regional economic conditions as well as the effect of a higher composition of nontraditional products in the mortgage origination market purchased prior to 2008. Nontraditional mortgage products, such as interest-only and Alt-A loans, made up 20% to 30% of our mortgage purchase volume during 2006 and 2007. Due to changes in underwriting practice and reduced originations in the market, these products made up approximately 7% to 10% of our mortgage purchase volume during the six months ended June 30, 2008. REO operations expense increased as a result of an increase in market-based write-downs of REO property due to the decline in home prices, coupled with higher volumes in REO inventory, particularly in the states of California, Florida, Arizona, Virginia and Nevada.
 
Non-interest expense, excluding credit-related expenses, for the three and six months ended June 30, 2008 totaled $743 million and $1.4 billion, compared to $1.1 billion and $2.0 billion for the three and six months ended June 30, 2007, respectively. The decline in non-interest expense, excluding credit-related expenses, was primarily due to the reductions in losses on certain credit guarantees and losses on loans purchased. Losses on certain credit guarantees decreased to $— and $15 million for the three and six months ended June 30, 2008, compared to $150 million and $327 million for the three and six months ended June 30, 2007, due to the change in our method for determining the fair value of our newly-issued guarantee obligation upon adoption of SFAS 157 that we adopted effective January 1, 2008. Losses on loans purchased decreased to $120 million and $171 million for the three and six months ended June 30, 2008, compared to $264 million and $480 million for the three and six months ended June 30, 2007, respectively, due to changes in our operational practice of purchasing delinquent loans out of PC pools. See “CONSOLIDATED RESULTS OF OPERATIONS — Non-Interest Expense — Losses on Certain Credit Guarantees and — Losses on Loans Purchased,” for additional information on the change in our operational practice. Administrative expenses totaled $404 million for the three months ended June 30, 2008, down from $442 million for the three months ended June 30, 2007. As a percentage of our average total mortgage portfolio, administrative expenses declined to 7.4 basis points for the three months ended June 30, 2008, from 9.2 basis points for the three months ended June 30, 2007. Administrative expenses totaled $801 million for the six months ended June 30, 2008, down from $845 million for the six months ended June 30, 2007. As a percentage of our average total mortgage portfolio,
 
            4 Freddie Mac


Table of Contents

administrative expenses declined to 7.5 basis points for the six months ended June 30, 2008, from 8.9 basis points for the six months ended June 30, 2007.
 
For the three months ended June 30, 2008 and 2007, we recognized effective tax rates of 56% and 11%, respectively. For the six months ended June 30, 2008 and 2007, we recognized effective tax rates of 60% and (103)%, respectively. See “NOTE 12: INCOME TAXES” to our consolidated financial statements for additional information about how our effective tax rate is determined.
 
Segments
 
We manage our business through three reportable segments:
 
  •  Investments;
 
  •  Single-family Guarantee; and
 
  •  Multifamily.
 
Certain activities that are not part of a segment are included in the All Other category. We manage and evaluate the performance of the segments and All Other using a Segment Earnings approach. Segment Earnings differs significantly from, and should not be used as a substitute for, net income (loss) as determined in accordance with GAAP. There are important limitations to using Segment Earnings as a measure of our financial performance. Among them, our regulatory capital requirements are based on our GAAP results. Segment Earnings adjusts for the effects of certain gains and losses and mark-to-fair-value items which, depending on market circumstances, can significantly affect, positively or negatively, our GAAP results and which, in recent periods, have caused us to record GAAP net losses. GAAP net losses will adversely impact our regulatory capital, regardless of results reflected in Segment Earnings. For a summary and description of our financial performance on a segment basis, see “CONSOLIDATED RESULTS OF OPERATIONS — Segment Earnings” and “NOTE 16: SEGMENT REPORTING” in the accompanying notes to our consolidated financial statements.
 
In managing our business, we present the operating performance of our segments using Segment Earnings. Segment Earnings present our results on an accrual basis as the cash flows from our segments are earned over time. The objective of Segment Earnings is to present our results in a manner more consistent with our business models. The business model for our investment activity is one where we generally buy and hold our investments in mortgage-related assets for the long term, fund our investments with debt and use derivatives to minimize interest rate risk and generate net interest income in line with our return on equity objectives. We believe it is meaningful to measure the performance of our investment business using long-term returns, not short-term value. The business model for our credit guarantee activity is one where we are a long-term guarantor in the conforming mortgage markets, manage credit risk and generate guarantee and credit fees, net of incurred credit losses. As a result of these business models, we believe that this accrual-based metric is a meaningful way to present our results as actual cash flows are realized, net of credit losses and impairments. We believe Segment Earnings provides us with a view of our financial results that is more consistent with our business objectives, which helps us better evaluate the performance of our business, both from period-to-period and over the longer term.
 
Table 1 presents Segment Earnings (loss) by segment and the All Other category and includes a reconciliation of Segment Earnings (loss) to net income (loss) prepared in accordance with GAAP.
 
Table 1 — Reconciliation of Segment Earnings (Loss) to GAAP Net Income (Loss)
 
                                 
    Three Months Ended
    Six Months Ended
 
    June 30,     June 30,  
    2008     2007     2008     2007  
    (in millions)  
 
Segment Earnings (loss) after taxes:
                               
Investments
  $ 793     $ 571     $ 906     $ 1,085  
Single-family Guarantee
    (1,388 )     129       (1,846 )     353  
Multifamily
    118       84       216       209  
All Other
    144       (43 )     140       (59 )
                                 
Total Segment Earnings (loss), net of taxes
    (333 )     741       (584 )     1,588  
                                 
Reconciliation to GAAP net income (loss):
                               
Derivative- and foreign-currency denominated debt-related adjustments
    527       (471 )     (667 )     (1,553 )
Credit guarantee-related adjustments
    1,818       831       1,644       329  
Investment sales, debt retirements and fair value-related adjustments
    (3,096 )     (379 )     (1,571 )     (310 )
Fully taxable-equivalent adjustments
    (105 )     (97 )     (215 )     (190 )
                                 
Total pre-tax adjustments
    (856 )     (116 )     (809 )     (1,724 )
Tax-related adjustments
    368       104       421       732  
                                 
Total reconciling items, net of taxes
    (488 )     (12 )     (388 )     (992 )
                                 
GAAP net income (loss)
  $ (821 )   $ 729     $ (972 )   $ 596  
                                 
 
            5 Freddie Mac


Table of Contents

Investments Segment
 
Our Investments segment is responsible for our 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 mortgage loans through our mortgage-related investment portfolio.
 
We seek to generate attractive returns on our portfolio of mortgage-related investments while maintaining a disciplined approach to interest-rate risk and capital management. We seek to accomplish this objective through opportunistic purchases, sales and restructurings of mortgage assets and repurchases of liabilities. Although we are primarily a buy-and-hold investor in mortgage assets, we may sell assets to reduce risk, to respond to capital constraints, to provide liquidity or to structure certain transactions in order to improve our returns. We estimate our expected investment returns using an option-adjusted spread, or OAS, approach. Our Investments segment activities may also include the purchase of mortgages and mortgage-related securities with less attractive investment returns and with incremental risk in order to achieve our affordable housing goals and subgoals. Additionally, we maintain a cash and non-mortgage-related securities investment portfolio in this segment to help manage our liquidity needs.
 
Investments segment performance highlights for the three and six months ended June 30, 2008:
 
  •  Segment Earnings increased 39% to $793 million in the second quarter of 2008 versus $571 million in the second quarter of 2007. For the six months ended June 30, 2008, Segment Earnings decreased 17% to $906 million from $1.1 billion during the six months ended June 30, 2007.
 
  •  Segment Earnings net interest yield increased 23 basis points in the second quarter of 2008, as compared to the second quarter of 2007, due to the purchase of fixed-rate assets at significantly wider spreads relative to our funding costs and the amortization of gains on certain futures positions that matured in March 2008. Segment Earnings net interest yield decreased 3 basis points in the six months ended June 30, 2008 compared to the six months ended June 30, 2007 due to spread compression between our floating rate assets and liabilities during the first three months of 2008, which was mostly offset by wider spreads in the second quarter of 2008.
 
  •  During the second quarter of 2008, we recognized security impairments in Segment Earnings of $142 million associated with anticipated future principal credit losses on our non-agency mortgage-related securities.
 
  •  Capital constraints and OAS levels that were not compelling early in the first quarter of 2008 became less restrictive in the latter part of the first quarter and through the second quarter. Starting in March and continuing through the second quarter of 2008, our net mortgage purchase commitments for the mortgage-related investment portfolio were substantially higher than earlier in 2008 in response to substantially wider OAS. The unpaid principal balance of our mortgage-related investment portfolio increased 9.8% to $728 billion at June 30, 2008 compared to $663 billion at December 31, 2007. Agency securities comprised approximately 67% of the unpaid principal balance of the mortgage-related investment portfolio at June 30, 2008 versus 61% at December 31, 2007.
 
  •  In addition during March 2008, OFHEO reduced our mandatory target capital surplus to 20% allowing us to take advantage of favorable investment opportunities. The ability to take advantage of favorable investment opportunities not only helped to serve our mission, but also benefited our customers and the secondary mortgage market during the second quarter of 2008. Also, effective March 1, 2008, we were no longer subject to the voluntary growth limit of 2% annually on our retained portfolio.
 
  •  We continued to be able to issue debt securities at attractive levels during the second quarter of 2008.
 
Single-family Guarantee Segment
 
In our Single-family Guarantee segment, we securitize substantially all of the newly or recently originated single-family mortgages we have purchased and issue mortgage-related securities called PCs that can be sold to investors or held by us in our Investments segment. We guarantee the payment of principal and interest on our single-family PCs, including those held in our retained portfolio, in exchange for management and guarantee fees, which are paid on a monthly basis as a percentage of the underlying unpaid principal balance of the loans, and initial upfront cash payments referred to as credit or delivery fees. Earnings for this segment consist of management and guarantee fee revenues, including amortization of upfront payments, and trust management fees, less the related credit costs (i.e., provision for credit losses) and operating expenses. Also included is the interest earned on assets held in the Investments segment related to single-family guarantee activities, net of allocated funding costs.
 
Single-family Guarantee segment performance highlights for the three and six months ended June 30, 2008 and 2007:
 
  •  Segment Earnings (loss) decreased to $(1.4) billion for the three months ended June 30, 2008 compared to earnings of $129 million for the three months ended June 30, 2007. Segment Earnings (loss) decreased to $(1.8) billion for the six months ended June 30, 2008 compared to earnings of $353 million for the six months ended June 30, 2007.
 
  •  Segment Earnings provision for credit losses for the Single-family Guarantee segment increased to $2.6 billion for the three months ended June 30, 2008 from $469 million for the three months ended June 30, 2007. Segment Earnings
 
            6 Freddie Mac


Table of Contents

  provision for credit losses for the Single-family Guarantee segment increased to $4.0 billion for the six months ended June 30, 2008 from $758 million for the six months ended June 30, 2007.
 
  •  Realized single-family credit losses for the three months ended June 30, 2008 were 18.1 basis points of the average single-family credit guarantee portfolio, compared to 2.0 basis points for the three months ended June 30, 2007. Realized single-family credit losses for the six months ended June 30, 2008 were 15.1 basis points compared to 1.8 basis points for the six months ended June 30, 2007.
 
  •  We implemented several delivery fee increases that were effective at varying dates between March and June 2008, or as our customers’ contracts permitted. These increases include an additional 25 basis point fee assessed on all loans issued through flow-business channels, as well as higher or new delivery fees for certain mortgage products and for mortgages deemed to be higher-risk based primarily on property type, loan purpose, loan-to-value, or LTV ratio and/or borrower credit scores. We also implemented several changes in our underwriting and eligibility criteria in early 2008 to reduce our credit risk, including requiring our seller/servicers to deliver loans with larger down payments and higher credit scores, and limiting our acquisition of certain higher-risk loan products, such as Alt-A loans.
 
  •  The single-family credit guarantee portfolio increased by 9% and 15% on an annualized basis for the three months ended June 30, 2008 and 2007, respectively.
 
  •  Average rates of Segment Earnings management and guarantee fee income for the Single-family Guarantee segment increased to 18.7 basis points for the three months ended June 30, 2008 compared to 17.9 basis points for the three months ended June 30, 2007. Average rates of Segment Earnings management and guarantee fee income for the Single-family Guarantee segment increased to 19.6 basis points for the six months ended June 30, 2008 compared to 17.9 basis points for the six months ended June 30, 2007.
 
Multifamily Segment
 
Our Multifamily segment activities include purchases of multifamily mortgages for our retained portfolio and guarantees of payments of principal and interest on multifamily mortgage-related securities and mortgages underlying multifamily housing revenue bonds. The assets of the Multifamily segment include mortgages that finance multifamily rental apartments. Our Multifamily segment also includes certain equity investments in various limited partnerships that sponsor low- and moderate-income multifamily rental apartments, which benefit from low-income housing tax credits, or LIHTC. These activities support our mission to supply financing for affordable rental housing. Also included is the interest earned on assets held in our Investments segment related to multifamily guarantee activities, net of allocated funding costs.
 
Multifamily segment performance highlights for the three and six months ended June 30, 2008 and 2007:
 
  •  Segment Earnings increased 40% to $118 million for the three months ended June 30, 2008 versus $84 million for the three months ended June 30, 2007. Segment Earnings increased 3% to $216 million for the six months ended June 30, 2008 versus $209 million for the six months ended June 30, 2007.
 
  •  Segment Earnings net interest income was $98 million for the three months ended June 30, 2008, an increase of $4 million versus the three months ended June 30, 2007 as a result of an increase in interest income on mortgage loans due to higher average balances, partially offset by a decrease in prepayment, or yield maintenance, fee income. Segment Earnings net interest income was $173 million for the six months ended June 30, 2008, a decline of $44 million versus the six months ended June 30, 2007.
 
  •  Mortgage purchases into our multifamily loan portfolio increased approximately 74% for the three months ended June 30, 2008 to $4.2 billion from $2.4 billion for the three months ended June 30, 2007. Mortgage purchases into our multifamily loan portfolio increased approximately 49% for the six months ended June 30, 2008 to $8.3 billion from $5.5 billion for the six months ended June 30, 2007.
 
  •  Unpaid principal balance of our multifamily mortgage loan portfolio increased to $63.8 billion at June 30, 2008 from $57.6 billion at December 31, 2007 as market fundamentals continued to provide opportunities to purchase loans to be held in our portfolio.
 
  •  Segment Earnings provision for credit losses for the Multifamily segment totaled $7 million and $16 million for the three and six months ended June 30, 2008, respectively. Segment Earnings provision for credit losses for the Multifamily segment totaled $1 million and $4 million for the three and six months ended June 30, 2007, respectively.
 
Capital Management
 
Our primary objective in managing capital is preserving our safety and soundness and having sufficient capital to support our business and mission. We make investment decisions while considering our capital levels. OFHEO monitors our capital adequacy using several capital standards. Beginning in January 2004, OFHEO directed us to maintain a 30% mandatory target capital surplus above our statutory minimum capital requirement. On March 19, 2008, OFHEO reduced our mandatory target capital surplus to 20% above our statutory minimum capital requirement, and in return we announced that
 
            7 Freddie Mac


Table of Contents

we would begin the process to raise capital and maintain overall capital levels well in excess of requirements while the mortgage markets recover. At June 30, 2008, our estimated regulatory core capital was $37.1 billion, which is an estimated $8.4 billion in excess of our statutory minimum capital requirement and $2.7 billion in excess of the 20% mandatory target capital surplus.
 
On May 14, 2008, we announced our commitment to raise $5.5 billion of new core capital through one or more offerings, which will likely include both common or common equivalent and preferred securities. The timing, amount and mix of securities to be offered will depend on a variety of factors, including prevailing market conditions and approval by our board of directors. OFHEO has informed us that, upon completion of these offerings, our mandatory target capital surplus will be reduced from 20% to 15%. OFHEO has also informed us that it intends a further reduction of our mandatory target capital surplus from 15% to 10% upon the combination of completion of our SEC registration process, which was completed on July 18, 2008, our completion of the remaining Consent Order requirement (i.e., the separation of the positions of Chairman and Chief Executive Officer), our continued commitment to maintain capital well above OFHEO’s regulatory requirement and no material adverse changes to ongoing regulatory compliance.
 
The sharp decline in the housing market and volatility in financial markets continue to adversely affect our capital, including our ability to manage to our regulatory capital requirements and the 20% mandatory target capital surplus. Factors that could adversely affect the adequacy of our capital in future periods include our ability to execute capital raising transactions; GAAP net losses; continued declines in home prices; increases in our credit and interest-rate risk profiles; adverse changes in interest-rates, the yield curve or implied volatility; adverse OAS changes; impairments of non-agency mortgage-related securities; downgrades of non-agency mortgage-related securities (with respect to regulatory risk-based capital); counterparty downgrades; legislative or regulatory actions that increase capital requirements or changes in accounting practices or standards.
 
Under current OFHEO regulations, the regulatory risk based capital standard in particular is highly sensitive to underlying drivers, including house price changes (based on OFHEO’s all transaction index); downgrades of non-agency mortgage-related securities; counterparty downgrades; retained portfolio growth; the duration, term and optionality of our funding and hedging instruments; and other factors. While we have historically met the risk-based capital standard, there is a significant possibility that continued adverse developments in relation to one or more of these underlying drivers could cause us to fail to meet this standard. If we were not to meet the risk-based capital standard, we would be classified as “undercapitalized” by OFHEO. See “ITEM 1. BUSINESS — REGULATION AND SUPERVISION — Office of Federal Housing Enterprise Oversight — Capital Standards and Dividend Restrictions” and “ITEM 13. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA — AUDITED CONSOLIDATED FINANCIAL STATEMENTS AND ACCOMPANYING NOTES — NOTE 9: REGULATORY CAPITAL — Classification” in our Registration Statement for information regarding potential actions OFHEO may seek to take in that event. Under the Regulatory Reform Act, FHFA is charged with developing risk-based capital requirements by regulation. The nature of the requirements FHFA may eventually adopt pursuant to this authority is currently uncertain.
 
Also affecting our capital position was our adoption of SFAS 159 on January 1, 2008. Our election of the fair value option allows us to better reflect, in the financial statements, the economic offsets that exist related to items that were not previously recognized at fair value with changes in fair value reflected in our consolidated statements of income. We expect our adoption of the fair value option will reduce the impact of interest-rate changes on our net income (loss) and capital levels. However, since changes in OAS affect the gains (losses) on both our mortgage-related trading portfolio and guarantee asset, our adoption of SFAS 159 will increase the impact of OAS changes on net income (loss) and capital. For a further discussion of our adoption of SFAS 159 see “NOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES — Change in Accounting Principles” to our consolidated financial statements. Beginning in the first quarter of 2008, we initiated our use of cash flow hedge accounting relationships to include hedging the changes in cash flows associated with our forecasted issuances of debt. We expect this accounting strategy will reduce the effect of interest-rate changes on our capital. We also employed this accounting strategy while maintaining our disciplined approach to interest-rate risk management. See “NOTE 10: DERIVATIVES” to our consolidated financial statements for additional information about our derivatives designated as cash flow hedges.
 
We expect to take actions to maintain our capital position above the OFHEO-directed mandatory target surplus. Accordingly, subject to approval by our Board of Directors, we currently expect to reduce the dividend on our common stock in the third quarter of 2008 from $0.25 to $0.05 or less per share and to pay the full dividends at contractual rates on our preferred stock. In addition, we continue to review and consider other alternatives for managing our capital including issuing equity in amounts that could be substantial and materially dilutive to our existing shareholders, reducing or rebalancing risk, slowing purchases into our credit guarantee portfolio and limiting the growth or reducing the size of our retained portfolio by allowing the portfolio to run off and/or by selling securities classified as trading or carried at fair value under SFAS 159 or available-for-sale securities that are accretive to capital (i.e., fair value exceeds amortized cost). We have retained and are working with financial advisors and we continue to engage in discussions with OFHEO and the Treasury on these matters.
 
            8 Freddie Mac


Table of Contents

Our ability to execute any of these actions or their effectiveness may be limited and we might not be able to manage to our regulatory capital requirements and the mandatory target capital surplus. If we are not able to manage to the mandatory target capital surplus, OFHEO may, among other things, seek to require us to (a) submit a plan for remediation or (b) take other remedial steps. In addition, OFHEO has discretion to reduce our capital classification by one level if OFHEO determines that we are engaging in conduct that could result in a rapid depletion of core capital or determines that the value of property subject to mortgage loans we hold or guarantee has decreased significantly. See “PART II — ITEM 1A. RISK FACTORS” in this Form 10-Q and “ITEM 1. BUSINESS — REGULATION AND SUPERVISION — Office of Federal Housing Enterprise Oversight — Capital Standards and Dividend Restrictions” and “ITEM 13. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA — AUDITED CONSOLIDATED FINANCIAL STATEMENTS AND ACCOMPANYING NOTES — NOTE 9: REGULATORY CAPITAL — Classification” in our Registration Statement for information regarding additional potential actions OFHEO may seek to take against us. See “Legislative and Regulatory Matters — Government Sponsored Enterprise, or GSE, Oversight Legislation” in this Form 10-Q for information regarding the enhanced regulatory authorities FHFA now possesses.
 
Fair Value Results
 
Our consolidated fair value measurements are a component of our risk management processes, as we use daily estimates of the changes in fair value to calculate our Portfolio Market Value Sensitivity, or PMVS, and duration gap measures.
 
During the three months ended June 30, 2008, the fair value of net assets, before capital transactions, remained unchanged compared to a $0.7 billion increase during the three months ended June 30, 2007.
 
Our attribution of changes in the fair value of net assets relies on models, assumptions and other measurement techniques that evolve over time. The following attribution of changes in fair value reflects our current estimate of the items presented (on a pre-tax basis) and excludes the effect of returns on capital and administrative expenses.
 
During the three months ended June 30, 2008, our investment activities increased fair value by approximately $6.7 billion, resulting from a higher core spread income and an increase in fair value of approximately $1.9 billion attributable to net mortgage-to-debt OAS tightening. Core spread income on our retained portfolio is a fair value estimate of the net current period accrual of income from the spread between mortgage-related investments and debt, calculated on an option-adjusted basis.
 
During the three months ended June 30, 2007, our investment activities decreased fair value by approximately $0.8 billion. This estimate includes declines in fair value of approximately $1.4 billion attributable to the net widening of mortgage-to-debt OAS.
 
The impact of mortgage-to-debt OAS tightening during the three months ended June 30, 2008 increased the current fair value of our investment activities. Due to the still relatively wide OAS levels for purchases during the period, there is a likelihood that, in future periods, we will be able to recognize core spread income from our investment activities at a higher spread level than historically. We estimate that for the three months ended June 30, 2008, we will recognize core spread income at a net mortgage-to-debt OAS level of approximately 140 to 160 basis points in the long run, as compared to approximately 25 to 35 basis points estimated for the three months ended June 30, 2007. As market conditions change, our estimate of expected fair value gains from OAS may also change, leading to significantly different fair value results.
 
During the three months ended June 30, 2008, our credit guarantee activities, including our single-family whole loan credit exposure, decreased fair value by an estimated $6.2 billion. This estimate includes an increase in the single-family guarantee obligation of approximately $7.2 billion, primarily attributable to a declining credit environment.
 
Our credit guarantee activities increased fair value by an estimated $1.8 billion during the three months ended June 30, 2007. This increase includes the receipt of cash primarily related to management, guarantee and other up-front fees. This increase also includes a fair value increase related to our single-family guarantee asset of approximately $1.8 billion, primarily attributable to an increase in interest rates during the three months ended June 30, 2007. These increases were partially offset by an increase in the fair value of our single-family guarantee obligation of approximately $0.6 billion.
 
See “CONSOLIDATED FAIR VALUE BALANCE SHEETS ANALYSIS” for additional information regarding attribution of changes in the fair value of net assets for the six months ended June 30, 2008.
 
Legislative and Regulatory Matters
 
Government Sponsored Enterprise, or GSE, Oversight Legislation
 
The Regulatory Reform Act was signed into law on July 30, 2008. This Act consolidates regulation of Freddie Mac and Federal National Mortgage Association, or Fannie Mae, or the enterprises, and the Federal Home Loan Banks, or FHLBs, into a single new regulator, FHFA. FHFA is an independent agency of the federal government responsible for oversight of the operations of the enterprises and the FHLBs. OFHEO will remain in existence for a transition period of up to one year.
 
            9 Freddie Mac


Table of Contents

FHFA has a Director appointed by the President and confirmed by the Senate for a five-year term, removable only for cause. The Regulatory Reform Act authorizes the Director of OFHEO on the date of enactment to act for all purposes and with the full powers of the Director of FHFA until such Director is appointed and confirmed.
 
The Regulatory Reform Act also establishes the Federal Housing Finance Oversight Board, or the Oversight Board which is responsible for advising the Director of FHFA with respect to overall strategies and policies. The Oversight Board consists of the Director of FHFA as Chairperson, the Secretary of the Treasury, the Chairman of the SEC and the Secretary of HUD.
 
The Regulatory Reform Act gives our regulator substantial authority to assess our safety and soundness and to regulate our portfolio investments, including requiring reductions in those investments, consistent with our mission and safe and sound operations. The Act also includes provisions that increase the regulator’s authority to change our minimum and risk-based capital levels and to regulate our business activities. In addition, the Act requires us to make certain contributions to affordable housing funds administered by the Secretary of HUD and the Secretary of the Treasury.
 
Given the recent enactment of this Act and the fact that FHFA has considerable discretion in implementing its provisions, including through rulemaking proceedings and the issuance of orders, we cannot predict the impacts that the Act and FHFA’s exercise of its authority under the Act will have on our business, financial position or results of operations. However, to the extent the Act or regulations or orders issued by FHFA pursuant to the Act may, for example, increase our capital requirements, limit our portfolio and new product activities, increase our affordable housing goals, or limit our ability to attract and retain senior executives, we anticipate that the impact could be materially adverse. Certain of the more significant provisions of the Act are summarized below.
 
Capital
 
FHFA may increase minimum capital levels from the existing statutory percentages either by regulation or on a temporary basis by order. FHFA may also, by regulation or order, establish capital or reserve requirements with respect to any product or activity of an enterprise, as FHFA considers appropriate. In addition, FHFA must, by regulation, establish risk-based capital requirements to ensure the enterprises operate in a safe and sound manner, maintaining sufficient capital and reserves to support the risks that arise in their operations and management. The Act provides FHFA with greater authority to take additional remedial actions as an enterprise’s capital levels decline.
 
Portfolio Activities
 
The Regulatory Reform Act requires FHFA to establish, by regulation, criteria governing retained portfolio holdings to ensure the holdings are backed by sufficient capital and consistent with the enterprises’ mission and safe and sound operations. In establishing these criteria, FHFA must consider the ability of the enterprises to provide a liquid secondary market through securitization activities, the portfolio holdings in relation to the mortgage market and the enterprises’ compliance with the prudential management and operations standards prescribed by FHFA.
 
FHFA may make temporary adjustments to the established portfolio standards by issuing an order to a particular enterprise, such as during times of economic distress or market disruption. In addition, FHFA must monitor the portfolio of each enterprise and may, by order, require an enterprise on such terms and conditions as FHFA determines appropriate to dispose of, or to acquire, any asset if FHFA determines such action is consistent with certain statutory purposes and the enterprises’ authorizing statutes.
 
New Products
 
The Regulatory Reform Act requires the enterprises to obtain the approval of FHFA before initially offering any new product. Excluded from the product review process are automated loan underwriting systems of the enterprises in existence on July 30, 2008, including upgrades; any modification to mortgage terms and conditions or underwriting criteria relating to mortgages purchased or guaranteed, as long as the modifications do not change the underlying transaction to include services or financing other than residential mortgage financing; and any other activities that are substantially similar to the activities described above or that have previously been approved by FHFA. The Act provides for a public comment process on requests for approval of new products. FHFA may temporarily approve a product without soliciting public comment if delay would be contrary to the public interest. FHFA may condition approval of a product on specific terms, conditions and limitations. The standards for FHFA’s approval of a new product are that the product is authorized by the enterprise’s charter, is in the public interest and is consistent with the safety and soundness of the enterprise or the mortgage finance system.
 
Prudential Management and Operations Standards
 
The Regulatory Reform Act requires FHFA to establish prudential standards, by regulation or by guideline, for a broad range of operations of the enterprises. These standards must address internal controls, information systems, independence and adequacy of internal audit systems, management of interest rate risk, management of market risk, liquidity and reserves, management of asset and investment portfolio growth, overall risk management processes, investments and asset acquisitions,
 
            10 Freddie Mac


Table of Contents

management of credit and counterparty risk, and recordkeeping. FHFA may also establish any additional operational and management standards the Director of FHFA determines appropriate.
 
If an enterprise or a FHLB fails to comply with the standards, FHFA could require submission of a plan to correct the deficiency. If the enterprise fails to submit an acceptable plan, or fails in any material respect to carry out an accepted plan, FHFA must order correction of the deficiency and may impose certain growth restrictions, require an increase in the ratio of core capital to assets and require other actions. FHFA must take one or more of these actions if FHFA determines that an enterprise has failed to meet a standard, the deficiency has not been corrected, and the enterprise underwent extraordinary growth, as defined by the Director of FHFA, during the 18-month period before the date of failure to meet a standard.
 
Affordable Housing Goals
 
Under the Regulatory Reform Act, the annual affordable housing goals previously established by HUD and in place for 2008 remain in effect for 2009, except that within 270 days from July 30, 2008, FHFA must review the 2009 housing goals to determine the feasibility of such goals in light of current market conditions and, after seeking public comment for up to 30 days, FHFA may make appropriate adjustments to the 2009 goals consistent with market conditions.
 
Effective beginning calendar year 2010, the Regulatory Reform Act replaces the existing annual affordable housing goals with the requirement that FHFA establish the following annual affordable housing goals by regulation:
 
  Single-family Housing Goals
 
  •  FHFA must establish goals for the purchase of conventional, conforming, single-family, owner-occupied, purchase money mortgages financing housing for each of the following: (i) low-income families, (ii) families that reside in low-income areas and (iii) very low-income families. The goals must be established as a percentage of total single-family dwelling units financed by single-family purchase money mortgages.
 
  •  FHFA must also establish a goal for the purchase of conventional, conforming, single-family, owner-occupied refinance mortgages given to pay off or prepay an existing mortgage on the same property for low-income families. The goals must be established as a percentage of total single-family dwelling units refinanced by mortgage purchases.
 
  •  In addition to the above goals, FHFA has discretion to establish additional requirements for mortgages on single-family, owner-occupied rental housing units.
 
  Multifamily Special Affordable Housing Goal
 
  •  FHFA must establish a goal, by either unit or dollar volume, for the purchase of mortgages that finance dwelling units affordable to low-income families, and also requirements for mortgages that finance dwelling units affordable to very low-income families. FHFA has discretion to establish additional requirements for mortgages on smaller multifamily properties.
 
The Regulatory Reform Act allows an enterprise to petition FHFA for a reduction in any goal or subgoal at any time, and authorizes FHFA to reduce the level of the goal or subgoal only if market and economic conditions or the financial condition of the enterprise require such a reduction, or if efforts to meet the goal would result in the constraint of liquidity, over-investment in certain market segments or other consequences contrary to the intent of the goals or the public purposes of the enterprises.
 
The Regulatory Reform Act requires FHFA to establish annual goals targets, by regulation, for each goal described above. In establishing the single-family targets, FHFA must take into consideration national housing needs; economic, housing and demographic conditions, including expected market developments; the performance and effort of the enterprises toward achieving the housing goals in previous years; the size of the purchase money conventional or refinance conventional mortgage market, as applicable; the ability of the enterprise to lead the industry in making mortgage credit available; the need to maintain the sound financial condition of the enterprises; and the prior three years of information under the Home Mortgage Disclosure Act of 1975 for conventional, conforming, single-family, owner-occupied purchase money and refinance mortgages, as applicable.
 
In establishing the multifamily target, FHFA must take into consideration national multifamily credit needs and the ability of the enterprises to provide additional liquidity and stability for the multifamily market, the performance and effort of the enterprises towards achieving the housing goals in previous years, the size of the multifamily market, the ability of the enterprises to lead the industry in making multifamily mortgage credit available, the availability of public subsidies, and the need to maintain the sound financial condition of the enterprises.
 
FHFA may change annual targets, by regulation, to reflect market conditions and subsequent available data. The targets cannot consider segments of the market that are inconsistent with safety and soundness, unauthorized for purchase by the enterprises pursuant to regulation or, for single-family targets, contrary to good lending practices.
 
In addition, the Regulatory Reform Act creates a duty to serve underserved markets requiring the enterprises to provide leadership to the market in developing loan products and flexible underwriting guidelines to facilitate a secondary market for
 
            11 Freddie Mac


Table of Contents

mortgages on manufactured homes, for affordable housing preservation, and for housing in rural areas. FHFA must establish, by regulation effective beginning 2010, a manner for evaluating compliance with the duty to serve underserved markets and for rating the extent of compliance, and include the evaluation and rating in FHFA’s annual report to Congress.
 
Affordable Housing Allocations
 
The Regulatory Reform Act requires each enterprise to set aside, in each fiscal year, an amount equal to 4.2 basis points of the unpaid principal balance of total new business purchases, and to allocate or transfer (1) 65% of such amounts to the Secretary of HUD to fund the Housing Trust Fund program to be established and managed by the Secretary of HUD, and (2) 35% of such amounts to the Capital Magnet Fund to be established and managed by the Secretary of the Treasury. FHFA must suspend the allocation of an enterprise upon finding that the payment is contributing, or would contribute, to the financial instability of the enterprise; is causing, or would cause, the enterprise’s capital to be classified as undercapitalized; or is preventing, or would prevent, the enterprise from successfully completing a capital restoration plan. FHFA must promulgate regulations prohibiting the enterprises from passing on the cost of contributions through increased charges or fees or decreased premiums, or in any other manner, to the originators of mortgages purchased or securitized by the enterprise.
 
Loan Limits
 
The Regulatory Reform Act allows increases in single-family conforming loan limits based on changes in the new housing price index established by FHFA, beginning January 1, 2009. Consistent with existing OFHEO Examination Guidance, “Conforming Loan Limit Calculations,” decreases would be accumulated and would offset any future increases in the housing price index so that loan limits do not decrease from year-to-year. In high-cost areas — where 115% of the median home price exceeds the otherwise applicable conforming loan limit — the Regulatory Reform Act increases the loan limits to the lesser of (i) 115% of the median house price or (ii) 150% of the conforming loan limit, currently $625,500. The high-cost provisions on loan limits become effective January 1, 2009 when the temporary authority for purchases of high-cost loans granted by the Economic Stimulus Act of 2008 expires.
 
Executive Compensation
 
The Regulatory Reform Act provides FHFA with executive compensation authority that extends beyond the authority OFHEO possessed.
 
In determining whether executive compensation for an enterprise executive officer is prohibited under the “reasonable and comparable” standard contained in existing law, FHFA is authorized to take into account any factors it considers relevant, including any wrongdoing on the part of the executive officer, such as any fraudulent act or omission, breach of trust or fiduciary duty, any violation of law, rule, regulation, order, or written agreement, and insider abuse with respect to the enterprise. A determination by FHFA that termination compensation is prohibited would override any contrary contractual provisions, even if such provisions had been previously approved.
 
FHFA is also authorized to require an enterprise to withhold, or place in escrow, a payment, transfer or disbursement of compensation pending review of the reasonableness and comparability of such compensation. The Regulatory Reform Act amends the enterprises’ charters expressly to prohibit the transfer, disbursement or payment of compensation to any executive officer or entry into an agreement with an executive officer for matters being reviewed by FHFA under its authority to prohibit compensation that is not reasonable and comparable.
 
In addition, FHFA is authorized to prohibit or limit, by regulation or order, certain golden parachute and indemnification payments to an affiliated party of the enterprises. The Director is to prescribe, by regulation, the factors to be considered in limiting golden parachute and indemnification payments.
 
FHFA Enforcement Authority
 
The Regulatory Reform Act expands the grounds for issuing both permanent and temporary cease-and-desist orders against the enterprises and affiliated parties to include grounds such as unsafe or unsound practices. The amounts of civil money penalties FHFA may impose are increased substantially. In addition, FHFA has new authority to remove certain affiliated parties of the enterprises and to prohibit them from further participation in the industry. The Regulatory Reform Act also provides expanded authority to enforce the affordable housing goals.
 
Conservatorship and Receivership
 
The Regulatory Reform Act replaces the conservatorship provisions previously applicable to the enterprise with conservatorship and receivership provisions based generally on federal banking law. The Regulatory Reform Act expands the grounds for which an enterprise may be placed into conservatorship, establishes the grounds for which an enterprise may be placed into receivership, and provides for appointment of FHFA as conservator or receiver. FHFA has broad powers when acting as conservator or receiver of an enterprise. As conservator, FHFA may take such actions as may be necessary for restoring the enterprise to a sound and solvent condition, and appropriate to carry on the business of the enterprise and to conserve the assets and property of the enterprise. As receiver, FHFA must liquidate and proceed to realize upon the assets of
 
            12 Freddie Mac


Table of Contents

an enterprise in such manner as FHFA deems appropriate, including through the sale of assets, through the transfer of assets to a limited-life regulated entity which succeeds to the charter of the enterprise and operates in accordance with the charter and other applicable laws, or through the exercise of other rights and privileges granted FHFA.
 
As either conservator or receiver, FHFA has the power to take over the assets of an enterprise and operate with all the powers of the shareholders, directors and officers of the enterprise. In addition, among other powers as conservator or receiver, FHFA may replace management, transfer or sell any asset or liability of an enterprise in default without any approval, assignment or consent with respect to such transfer or sale, and repudiate contracts entered into prior to appointment if, in the sole discretion of FHFA, FHFA determines such contracts to be burdensome and determines repudiation will promote the orderly administration of affairs. The Regulatory Reform Act contains special provisions applicable to service contracts, leases, contracts for the purchase of real property and qualified financial contracts such as forward contracts, repurchase agreements and swap agreements.
 
Temporary Treasury Authority to Purchase GSE Obligations and Securities
 
The Regulatory Reform Act grants the Secretary of the Treasury authority to purchase any obligations and securities issued by the enterprises until December 31, 2009 on such terms and conditions and in such amounts as the Secretary may determine, provided that the Secretary determines the purchases are necessary to provide stability to the financial markets, prevent disruptions in the availability of mortgage finance, and protect taxpayers. The Secretary may not engage in open market purchases of the common stock of an enterprise in the absence of an agreement with the enterprise, and the enterprises are not required to issue obligations or securities to the Secretary without mutual agreement.
 
In connection with exercising this temporary purchase authority, the Secretary of the Treasury must consider the need for preferences regarding payments to the government; limits on maturity or disposal of the enterprise obligations and securities purchased; the enterprise’s plan for orderly resumption of private market funding or capital market access; the probability of the enterprise fulfilling the terms of the obligations and securities, including repayment; the need to maintain the status of the enterprise as a private shareholder-owned company; and restrictions on the use of enterprise resources, including limits on dividend payments and executive compensation. The Regulatory Reform Act also grants FHFA temporary authority to approve, disapprove or modify executive compensation for top executive officers for which compensation must be disclosed publicly pursuant to the SEC’s Regulation S-K. These authorities of both FHFA and Treasury expire on December 31, 2009.
 
Temporary Consultative Requirement Between the Director of FHFA and the Chairman of the Federal Reserve
 
The Regulatory Reform Act requires FHFA to consult with, and consider the views of, the Chairman of the Federal Reserve regarding the risks posed by the enterprises to the financial system prior to issuing any proposed or final regulations, orders, or guidelines with respect to prudential management and operations standards, safe and sound operations, capital requirements and portfolio standards. In addition, the Regulatory Reform Act requires consultation regarding any decision to place an enterprise into conservatorship or receivership. To facilitate the consultative process, the Regulatory Reform Act requires periodic sharing of information between FHFA and the Federal Reserve regarding the capital, assets and liabilities, financial condition and risk management practices of the enterprises and any information related to financial market stability. This consultative requirement expires December 31, 2009.
 
Composition of Board of Directors
 
The Regulatory Reform Act eliminates the five Presidential appointees from the boards of directors of the enterprises, leaving 13 shareholder-elected members, and allows FHFA to determine that a different number of board members is appropriate. The Regulatory Reform Act leaves in place the requirements for having board members from the home building, mortgage lending, and real estate industries and from an organization representing consumer or community interests.
 
Temporary Increase in Conforming Loan Limits
 
On February 13, 2008, the President signed into law the Economic Stimulus Act of 2008, which includes a temporary increase in conventional conforming loan limits that apply to the GSEs as well as the Federal Housing Administration, or FHA. The law raises the conforming loan limits 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. We began accepting these “conforming-jumbo” mortgages for securitization as PCs and purchases into our retained portfolio in April 2008. Our purchases of these loans into our total mortgage portfolio for the three months ended June 30, 2008 totaled $471 million in unpaid principal balance. We have experienced increased competition in the mortgage finance market during the first half of 2008 with respect to this product. Given market conditions and competition especially from FHA, we do not anticipate purchasing material amounts of conforming jumbo product in 2008.
 
            13 Freddie Mac


Table of Contents

Voluntary, Temporary Growth Limit
 
In response to a request by OFHEO on August 1, 2006, we announced that we would voluntarily and temporarily limit the growth of our retained portfolio to 2% annually. Consistent with OFHEO’s February 27, 2008 announcement of the removal of the growth limit on March 1, 2008, the growth limit has expired.
 
Risk-based Capital
 
On June 10, 2008, OFHEO announced two rule changes for loss severity calculations under OFHEO’s risk-based capital regulation. These changes became effective on June 25, 2008 for our third quarter 2008 risk-based capital submission. According to OFHEO, these rule changes correct certain deficiencies in the formulas used to calculate risk-based capital. The first change was implemented because certain loss severity equations resulted in the GSEs recording profits instead of losses on foreclosed mortgages during the calculation of the risk-based capital requirement. Unaltered, the loss severity equations overestimated GSE recoveries for defaulted government-guaranteed and low LTV ratio mortgages. Those results were not consistent with the risk-based capital regulation and resulted in significant reductions to the risk-based capital requirements of the GSEs. The second change was implemented because the prior treatment of FHA insurance associated with single-family mortgages with an LTV below 78% is inconsistent with current law. According to OFHEO, implementation of these rule changes would have increased our risk-based capital requirement by $5.4 billion at December 31, 2006 had they been in effect at that time.
 
Mission and Affordable Housing Goals
 
In March 2008, we reported to HUD that we did not achieve two home purchase subgoals (the low- and moderate-income subgoal and the special affordable housing subgoal) for 2007. We believe that achievement of these two home purchase subgoals was infeasible in 2007 under the terms of the Federal Housing Enterprises Financial Safety and Soundness Act of 1992, or the GSE Act, and accordingly submitted an infeasibility analysis to HUD. In April 2008, HUD notified us that it had determined that, given the declining affordability of the primary market since 2005, the scope of market turmoil in 2007, and the collapse of the non-agency, or private label, secondary mortgage market, the availability of subgoal-qualifying home purchase loans was reduced significantly and therefore achievement of these subgoals was infeasible. Consequently, we will not submit a housing plan to HUD.
 
In 2008, we expect that the market conditions discussed above and the tightened credit and underwriting environment will continue to make achieving our affordable housing goals and subgoals challenging.
 
            14 Freddie Mac


Table of Contents

 
SELECTED FINANCIAL DATA AND OTHER OPERATING MEASURES(1)
 
                                                         
    At or for the Six
       
    Months Ended June 30,     At or for the Year Ended December 31,  
    2008     2007     2007     2006     2005     2004     2003  
    (dollars in millions, except share-related amounts)  
 
Income Statement Data
                                                       
Net interest income
  $ 2,327     $ 1,564     $ 3,099     $ 3,412     $ 4,627     $ 8,313     $ 8,598  
Non-interest income (loss)
    895       1,472       194       2,086       1,003       (2,723 )     532  
Non-interest expense
    (5,648 )     (2,743 )     (9,270 )     (3,216 )     (3,100 )     (2,378 )     (2,123 )
Net income (loss) before cumulative effect of change in accounting principle
    (972 )     596       (3,094 )     2,327       2,172       2,603       4,809  
Cumulative effect of change in accounting principle, net of taxes
                            (59 )            
Net income (loss)
    (972 )     596       (3,094 )     2,327       2,113       2,603       4,809  
Net income (loss) available to common stockholders
  $ (1,476 )   $ 405     $ (3,503 )   $ 2,051     $ 1,890     $ 2,392     $ 4,593  
Earnings (loss) per common share before cumulative effect of change in accounting principle:
                                                       
Basic
  $ (2.28 )   $ 0.62     $ (5.37 )   $ 3.01     $ 2.82     $ 3.47     $ 6.68  
Diluted
    (2.28 )     0.61       (5.37 )     3.00       2.81       3.46       6.67  
Earnings (loss) per common share after cumulative effect of change in accounting principle:
                                                       
Basic
  $ (2.28 )   $ 0.62     $ (5.37 )   $ 3.01     $ 2.73     $ 3.47     $ 6.68  
Diluted
    (2.28 )     0.61       (5.37 )     3.00       2.73       3.46       6.67  
Dividends per common share
  $ 0.50     $ 1.00     $ 1.75     $ 1.91     $ 1.52     $ 1.20     $ 1.04  
Weighted average common shares outstanding (in thousands):
                                                       
Basic
    646,603       657,103       651,881       680,856       691,582       689,282       687,094  
Diluted
    646,603       659,365       651,881       682,664       693,511       691,521       688,675  
Balance Sheet Data
                                                       
Total assets
  $ 879,043     $ 814,118     $ 794,368     $ 804,910     $ 798,609     $ 779,572     $ 787,962  
Senior debt, due within one year
    326,303       267,919       295,921       285,264       279,764       266,024       279,180  
Senior debt, due after one year
    505,013       478,295       438,147       452,677       454,627       443,772       438,738  
Subordinated debt, due after one year
    4,496       5,227       4,489       6,400       5,633       5,622       5,613  
All other liabilities
    30,152       37,867       28,911       33,139       31,945       32,720       32,094  
Minority interests in consolidated subsidiaries
    131       282       176       516       949       1,509       1,929  
Stockholders’ equity
    12,948       24,528       26,724       26,914       25,691       29,925       30,408  
Portfolio Balances(2)
                                                       
Retained portfolio(3)
  $ 791,798     $ 712,136     $ 720,813     $ 703,959     $ 710,346     $ 653,261     $ 645,767  
Total PCs and Structured Securities issued(4)
    1,823,803       1,592,524       1,738,833       1,477,023       1,335,524       1,208,968       1,162,068  
Total mortgage portfolio
    2,201,694       1,952,949       2,102,676       1,826,720       1,684,546       1,505,531       1,414,700  
Ratios
                                                       
Return on average assets(5)
    (0.2 )%     0.1 %     (0.4 )%     0.3 %     0.3 %     0.3 %     0.6 %
Return on common equity(6)
    (51.5 )     4.2       (21.0 )     9.8       8.1       9.4       17.7  
Return on total equity(7)
    (9.8 )     4.6       (11.5 )     8.8       7.6       8.6       15.8  
Dividend payout ratio on common stock(8)
    N/A       163.7       N/A       63.9       56.9       34.9       15.6  
Equity to assets ratio(9)
    2.4       3.2       3.4       3.3       3.5       3.8       4.0  
Preferred stock to core capital ratio(10)
    38.0       20.0       37.3       17.3       13.2       13.5       14.2  
  (1)  See “ITEM 2. FINANCIAL INFORMATION — SELECTED FINANCIAL DATA AND OTHER OPERATING MEASURES” in our Registration Statement for information regarding accounting changes impacting periods prior to January 1, 2008.
  (2)  Represent the unpaid principal balance and exclude mortgage loans and mortgage-related securities traded, but not yet settled. Effective in December 2007, we established a trust for the administration of cash remittances received related to the underlying assets of our PCs and Structured Securities issued. As a result, for December 2007 and each period in 2008, we report the balance of our mortgage portfolios to reflect the publicly-available security balances of our PCs and Structured Securities. For periods prior to December 2007, we report these balances based on the unpaid principal balance of the underlying mortgage loans. We reflected this change as an increase in the unpaid principal balance of our retained portfolio by $2.8 billion at December 31, 2007.
  (3)  The retained portfolio presented on our consolidated balance sheets differs from the retained portfolio in this table because the consolidated balance sheet caption includes valuation adjustments and deferred balances. See “CONSOLIDATED BALANCE SHEETS ANALYSIS — Table 15 — Characteristics of Mortgage Loans and Mortgage-Related Securities in our Retained Portfolio” for more information.
  (4)  Includes PCs and Structured Securities that are held in our retained portfolio. See “OUR PORTFOLIOS — Table 49 — 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, Real Estate Mortgage Investment Conduits, or 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)  Ratio computed as annualized net income (loss) divided by the simple average of the beginning and ending balances of total assets.
  (6)  Ratio computed as annualized net income (loss) available to common stockholders divided by the simple average of the beginning and ending balances of stockholders’ equity, net of preferred stock (at redemption value).
  (7)  Ratio computed as annualized net income (loss) divided by the simple average of the beginning and ending balances of stockholders’ equity.
  (8)  Ratio computed as common stock dividends declared divided by net income available to common stockholders. Ratio is not computed for periods in which net income (loss) available to common stockholders was a loss.
  (9)  Ratio computed as the simple average of the beginning and ending balances of stockholders’ equity divided by the simple average of the beginning and ending balances of total assets.
(10)  Ratio computed as preferred stock, at redemption value divided by core capital. See “NOTE 9: REGULATORY CAPITAL” to our consolidated financial statements for more information regarding core capital.
 
            15 Freddie Mac


Table of Contents

 
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 2 — Summary Consolidated Statements of Income — GAAP Results
 
                                 
    Three Months Ended
    Six Months Ended
 
    June 30,     June 30,  
    2008     2007     2008     2007  
    (in millions)  
 
Net interest income
  $ 1,529     $ 793     $ 2,327     $ 1,564  
Non-interest income:
                               
Management and guarantee income
    757       591       1,546       1,219  
Gains (losses) on guarantee asset
    1,114       820       (280 )     297  
Income on guarantee obligation
    769       474       1,938       904  
Derivative gains (losses)(1)
    115       318       (130 )     (206 )
Gains (losses) on investment activity
    (3,327 )     (540 )     (2,108 )     (522 )
Unrealized gains (losses) on foreign-currency denominated debt recorded at fair value
    569             (816 )      
Gains (losses) on debt retirement
    (29 )     89       276       96  
Recoveries on loans impaired upon purchase
    121       72       347       107  
Foreign-currency gains (losses), net
          (333 )           (530 )
Other income
    75       58       122       107  
                                 
Non-interest income
    164       1,549       895       1,472  
                                 
Non-interest expense
    (3,545 )     (1,519 )     (5,648 )     (2,743 )
                                 
Income (loss) before income tax (expense) benefit
    (1,852 )     823       (2,426 )     293  
Income tax (expense) benefit
    1,031       (94 )     1,454       303  
                                 
Net income (loss)
  $ (821 )   $ 729     $ (972 )   $ 596  
                                 
(1)  Includes derivative gains (losses) on foreign-currency swaps of $(48) million and $332 million for the three months ended June 30, 2008 and 2007, respectively, and $1,189 million and $530 million for the six months ended June 30, 2008 and 2007, respectively. Also includes derivative gains (losses) of $(490) million and $(297) million on foreign-currency denominated receive-fixed swaps for the three and six months ended June 30, 2008, respectively.
 
Net Interest Income
 
Table 3 presents an analysis of net interest income, including average balances and related yields earned on assets and incurred on liabilities.
 
Table 3 — Net Interest Income/Yield and Average Balance Analysis
 
                                                 
    Three Months Ended June 30,  
    2008     2007  
          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)
  $ 89,813     $ 1,320       5.88 %   $ 67,994     $ 1,075       6.32 %
Mortgage-related securities
    664,727       8,380       5.04       648,023       8,784       5.42  
                                                 
Total retained portfolio
    754,540       9,700       5.14       716,017       9,859       5.51  
Investments(4)
    54,061       400       2.92       49,106       634       5.11  
Securities purchased under agreements to resell and federal funds sold
    20,660       120       2.32       24,887       332       5.33  
                                                 
Total interest-earning assets
    829,261       10,220       4.93       790,010       10,825       5.47  
                                                 
Interest-bearing liabilities:
                                               
Short-term debt
    240,119       (1,637 )     (2.70 )     172,592       (2,249 )     (5.16 )
Long-term debt(5)
    569,443       (6,711 )     (4.71 )     581,482       (7,331 )     (5.04 )
                                                 
Total debt securities
    809,562       (8,348 )     (4.11 )     754,074       (9,580 )     (5.07 )
Due to PC investors
                      9,061       (121 )     (5.32 )
                                                 
Total interest-bearing liabilities
    809,562       (8,348 )     (4.11 )     763,135       (9,701 )     (5.07 )
Expense related to derivatives
          (343 )     (0.17 )           (331 )     (0.17 )
Impact of net non-interest-bearing funding
    19,699             0.10       26,875             0.18  
                                                 
Total funding of interest-earning assets
  $ 829,261       (8,691 )     (4.18 )   $ 790,010       (10,032 )     (5.06 )
                                                 
Net interest income/yield
            1,529       0.75               793       0.41  
Fully taxable-equivalent adjustments(6)
            105       0.05               99       0.05  
                                                 
Net interest income/yield (fully taxable-equivalent basis)
          $ 1,634       0.80             $ 892       0.46  
                                                 
 
 
            16 Freddie Mac


Table of Contents

                                                 
    Six Months Ended June 30,  
    2008     2007  
          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)
  $ 87,052     $ 2,563       5.89 %   $ 67,288     $ 2,141       6.36 %
Mortgage-related securities
    646,724       16,513       5.11       645,938       17,335       5.37  
                                                 
Total retained portfolio
    733,776       19,076       5.20       713,226       19,476       5.46  
Investments(4)
    46,758       799       3.38       48,924       1,257       5.11  
Securities purchased under agreements to resell and federal funds sold
    17,548       241       2.74       25,684       681       5.30  
                                                 
Total interest-earning assets
    798,082       20,116       5.04       787,834       21,414       5.43  
                                                 
Interest-bearing liabilities:
                                               
Short-term debt
    222,385       (3,681 )     (3.27 )     171,921       (4,457 )     (5.16 )
Long-term debt(5)
    553,869       (13,436 )     (4.85 )     580,814       (14,507 )     (4.99 )
                                                 
Total debt securities
    776,254       (17,117 )     (4.40 )     752,735       (18,964 )     (5.03 )
Due to PC investors
                      8,364       (224 )     (5.35 )
                                                 
Total interest-bearing liabilities
    776,254       (17,117 )     (4.40 )     761,099       (19,188 )     (5.03 )
Expense related to derivatives
          (672 )     (0.17 )           (662 )     (0.17 )
Impact of net non-interest-bearing funding
    21,828             0.12       26,735             0.17  
                                                 
Total funding of interest-earning assets
  $ 798,082       (17,789 )     (4.45 )   $ 787,834       (19,850 )     (5.03 )
                                                 
Net interest income/yield
            2,327       0.59               1,564       0.40  
Fully taxable-equivalent adjustments(6)
            212       0.06               194       0.05  
                                                 
Net interest income/yield (fully taxable-equivalent basis)
          $ 2,539       0.65             $ 1,758       0.45  
                                                 
(1)  Excludes mortgage loans and mortgage-related securities traded, but not yet settled.
(2)  For securities in our retained portfolio and cash and investment portfolios, we calculated average balances based on their unpaid principal balance plus their associated deferred fees and costs (e.g., premiums and discounts), but excluded the effect of mark-to-fair-value changes.
(3)  Non-performing loans, where interest income is recognized when collected, are included in average balances.
(4)  Consist of cash and cash equivalents and non-mortgage-related securities.
(5)  Includes current portion of long-term debt.
(6)  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%.
 
Net interest income and net interest yield on a fully taxable-equivalent basis increased during the three and six months ended June 30, 2008 compared to the three and six months ended June 30, 2007. During the latter half of the first quarter of 2008 and continuing into the second quarter of 2008, liquidity concerns in the market resulted in more favorable investment opportunities for agency mortgage-related securities at wider spreads. In response, we increased our purchase activities resulting in an increase in the average balance of our interest-earning assets. The increases in net interest income and net interest yield on a fully taxable-equivalent basis are primarily attributable to purchases of fixed-rate assets at significantly wider spreads relative to our funding costs. Net interest income and net interest yield for the three and six months ended June 30, 2008 also benefited from funding fixed-rate assets with a higher proportion of short-term debt in a steep yield curve environment as well as replacing higher cost long-term debt with lower cost issuances. Altering the mix of our debt funding between longer- and shorter-term debt is consistent with our overall investment management framework. As market conditions change, we can change the mix of debt we use to fund our retained portfolio, both floating- and fixed-rate assets. During the first and second quarters of 2008, our short-term funding balances increased significantly. We seek to manage interest rate risk by attempting to substantially match the duration characteristics of our assets and liabilities. To accomplish this, we use an integrated strategy that involves asset and liability portfolio management, including the use of derivatives for purposes of rebalancing the portfolio and maintaining low PMVS and duration gap. The increases in net interest income and net interest yield on a fully tax-equivalent basis during the six months ended June 30, 2008 were partially offset by the impact of declining interest rates because our floating rate assets reset faster than our short-term debt during the first quarter of 2008. As a result of the creation of the securitization trusts in December of 2007, due to PC investors interest expense is now recorded in trust management fees within other income on our consolidated statements of income. See “Non-Interest Income — Other Income” for additional information about due to PC investors interest expense.
 
Non-Interest Income
 
Management and Guarantee Income
 
Table 4 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 certain pre-2003 deferred credit and buy-down fees received by us that were recorded as deferred income as a component of other liabilities. Post-2002 credit and buy-down fees are reflected as increased income on guarantee obligation as the guarantee obligation is amortized.
 
            17 Freddie Mac


Table of Contents

Table 4 — Management and Guarantee Income(1)
 
                                                                 
    Three Months Ended June 30,     Six Months Ended June 30,  
    2008     2007     2008     2007  
    Amount     Rate     Amount     Rate     Amount     Rate     Amount     Rate  
    (dollars in millions, rates in basis points)  
 
Contractual management and guarantee fees
  $ 778       17.5     $ 629       16.1     $ 1,535       17.5     $ 1,227       16.0  
Amortization of credit and buy-down fees included in other liabilities
    (21 )     (0.5 )     (38 )     (1.0 )     11       0.1       (8 )     (0.1 )
                                                                 
Total management and guarantee income
  $ 757       17.0     $ 591       15.1     $ 1,546       17.6     $ 1,219       15.9  
                                                                 
Unamortized balance of credit and buy-down fees included in other liabilities, at period end
  $ 403             $ 451             $ 403             $ 451          
(1)  Consists of management and guarantee fees related to all issued and outstanding guarantees, including those issued prior to adoption of Financial Interpretation No. 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including indirect Guarantees of Indebtedness of Others, an interpretation of FASB Statements No. 5, 57 and 107 and rescission of FASB Interpretation No. 34,” or FIN 45, in January 2003, which did not require the establishment of a guarantee asset.
 
The primary drivers affecting management and guarantee income are the average balance of our PCs and Structured Securities and changes in management and guarantee fee rates. Contractual management and guarantee fees include adjustments to the contractual rates for buy-ups and buy-downs, whereby the contractual management and guarantee fee rate is adjusted for up-front cash payments we make (buy-up) or receive (buy-down) at guarantee issuance. Our average rates of management and guarantee income are also affected by the mix of products we issue, competition in market pricing and customer preference for buy-up and buy-down fees. The majority of our guarantees are issued under customer “flow” channel contracts, which have fixed pricing schedules for our management and guarantee fees for periods of up to one year. The remainder of our purchase and guarantee securitization of mortgage loans occurs through “bulk” purchasing with management and guarantee fees negotiated on an individual transaction basis. Given the volatility in the credit market during the three and six months ended June 30, 2008, we will continue to closely monitor the pricing of our management and guarantee fees as well as our delivery fee rates and make adjustments when appropriate.
 
Management and guarantee income increased for the three and six months ended June 30, 2008 compared to the three and six months ended June 30, 2007, primarily reflecting an increase in the average PCs and Structured Securities balances of 14% and 15%, respectively, on an annualized basis. The average contractual management and guarantee fee rate for the three and six months ended June 30, 2008 was higher than the three and six months ended June 30, 2007, primarily due to an increase in buy-up activity as well as the impact of higher management and guarantee fees on purchases of mortgage loans, including interest-only loans, guaranteed in the last half of 2007 that remain in the portfolio. Our management and guarantee fee rates are generally higher on nontraditional loans, such as interest-only mortgages, than our fee rates for fixed-rate mortgages. We experienced a significant decrease in purchase volume through bulk channels as well as declines in the composition of non-traditional loans underlying our newly-issued guarantees during the six months ended June 30, 2008.
 
Gains (Losses) on Guarantee Asset
 
Upon issuance of a guarantee of securitized assets, we record a guarantee asset on our consolidated balance sheets representing the fair value of the management and guarantee fees we expect to receive over the life of our PCs or Structured Securities. Guarantee assets are recognized in connection with transfers of PCs and Structured Securities that are accounted for as sales under SFAS No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishment of Liabilities, a replacement of Financial Accounting Standards Board, or FASB, Statement No. 125.” Additionally, we recognize guarantee assets for PCs issued through our guarantor swap program and for certain Structured Transactions that we issue to third parties in exchange for non-agency mortgage-related 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.
 
The change in fair value of our guarantee asset reflects:
 
  •  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 related PC or Structured Security.
 
The fair value of future management and guarantee fees is driven primarily by expected changes in interest rates that affect the estimated life of mortgages underlying our PCs and Structured Securities and related discount rates used to determine the net present value of the cash flows. For example, an increase in interest rates generally slows the rate of prepayments and extends the life of our guarantee asset and increases the fair value of future management and guarantee fees. Our valuation methodology for our guarantee asset uses market-based information, including market values of interest-only securities, to determine the fair value of future cash flows associated with our guarantee asset.
 
            18 Freddie Mac


Table of Contents

Table 5 — Attribution of Change — Gains (Losses) on Guarantee Asset
 
                                 
    Three Months Ended
    Six Months Ended
 
    June 30,     June 30,  
    2008     2007     2008     2007  
    (in millions)  
 
Contractual management and guarantee fees
  $ (720 )   $ (553 )   $ (1,409 )   $ (1,076 )
Portion related to imputed interest income
    243       130       458       257  
                                 
Return of investment on guarantee asset
    (477 )     (423 )     (951 )     (819 )
Change in fair value of management and guarantee fees
    1,591       1,243       671       1,116  
                                 
Gains (losses) on guarantee asset
  $ 1,114     $ 820     $ (280 )   $ 297  
                                 
 
Contractual management and guarantee fees represent cash received in the current period related to our PCs and Structured Securities with an established guarantee asset. A portion of these cash receipts is attributed to imputed interest income on our guarantee asset. Contractual management and guarantee fees increased for the three and six months ended June 30, 2008 compared to the three and six months ended June 30, 2007, respectively, primarily due to increases in the average balance of our PCs and Structured Securities issued.
 
The increases in the fair values of management and guarantee fees for the three and six months ended June 30, 2008 and 2007 were primarily driven by higher market valuations for interest-only mortgage securities, used to value our guarantee asset resulting from increases in interest rates during these periods. The fair value change during the second quarter of 2008, as compared to the second quarter of 2007, was higher due to a larger increase in interest rates combined with higher average balances during the second quarter of 2008. The increases in the fair values of management and guarantee fees were less significant during the six months ended June 30, 2008, compared to the six months ended June 30, 2007 due to a larger increase in interest rates during the 2007 period than during the 2008 period.
 
Income on Guarantee Obligation
 
Upon issuance of our guarantee, we record a guarantee obligation on our consolidated balance sheets representing the fair value of our obligation to perform under the terms of the guarantee. Our guarantee obligation primarily represents our performance and other related costs, which consist of estimated credit costs, including estimated unrecoverable principal and interest that will be incurred over the expected life of the underlying mortgages backing PCs, estimated foreclosure-related costs, and estimated administrative and other costs related to our 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. The static effective yield is periodically evaluated and adjusted when significant changes in economic events cause a shift in the pattern of our economic release from risk. For example, certain market environments may lead to sharp and sustained changes in home prices or prepayment rates of mortgages, leading to the need for an adjustment in the static effective yield for specific mortgage pools underlying the guarantee. When a change is required, a cumulative catch-up adjustment, which could be significant in a given period, will be recognized and a new static effective yield will be used to determine our guarantee obligation amortization.
 
Effective January 1, 2008, we began estimating the fair value of our newly-issued guarantee obligations at their inception using the practical expedient provided by FIN 45, as amended by SFAS 157. Using this approach, the initial guarantee obligation is recorded at an amount equal to the fair value of the compensation received in the related guarantee transactions, including upfront delivery and other fees. As a result, we no longer record estimates of deferred gains or immediate “day one” losses on most guarantees. All unamortized amounts recorded prior to January 1, 2008 will continue to be deferred and amortized using existing amortization methods. This change had a significant positive impact on our financial results for the three and six months ended June 30, 2008.
 
Table 6 provides information about the components of income on guarantee obligation.
 
Table 6 — Income on Guarantee Obligation
 
                                 
    Three Months Ended
    Six Months Ended
 
    June 30,     June 30,  
    2008     2007     2008     2007  
          (in millions)        
 
Amortization income related to:
                               
Static effective yield
  $ 681     $ 414     $ 1,261     $ 791  
Cumulative catch-up
    88       60       677       113  
                                 
Total income on guarantee obligation
  $ 769     $ 474     $ 1,938     $ 904  
                                 
 
Amortization income increased for the three and six months ended June 30, 2008, compared to the three and six months ended June 30, 2007. This increase is due to (1) higher guarantee obligation balances recognized in 2007 as a result of significant market risk premiums, including those that resulted in significant day one losses (i.e., where the fair value of the guarantee obligation at issuance exceeded the fair value of the guarantee and credit enhancement-related assets), (2) higher cumulative catch-up adjustments for the three and six months ended June 30, 2008 and (3) higher average balances of our
 
            19 Freddie Mac


Table of Contents

PCs and Structured Securities. The cumulative catch-up adjustments recognized during the six months ended June 30, 2008 were principally due to significant declines in home prices and, to a lesser extent, increases in mortgage prepayment speeds related to pools of mortgage loans issued during 2006 and 2007. These cumulative catch-up adjustments are recorded to provide a pattern of revenue recognition that is consistent with our economic release from risk and better aligns with the timing of the recognition of losses on the pools of mortgage loans we guarantee.
 
Derivative Overview
 
Table 7 presents the effect of derivatives on our consolidated financial statements, including notional or contractual amounts of our derivatives and our hedge accounting classifications.
 
Table 7 — Summary of the Effect of Derivatives on Selected Consolidated Financial Statement Captions
 
                                                 
    Consolidated Balance Sheets  
    June 30, 2008     December 31, 2007  
    Notional
    Fair Value
    AOCI
    Notional
    Fair Value
    AOCI
 
Description
  Amount(1)     (Pre-Tax)(2)     (Net of Taxes)(3)     Amount(1)     (Pre-Tax)(2)     (Net of Taxes)(3)  
    (in millions)  
 
Cash flow hedges — open
  $ 15,200     $ 345     $ 221     $     $     $  
No hedge designation
    1,289,827       6,340             1,322,881       4,790        
                                                 
Subtotal
    1,305,027       6,685       221       1,322,881       4,790        
Balance related to closed cash flow hedges
                (3,639 )                 (4,059 )
                                                 
Subtotal
    1,305,027       6,685       (3,418 )     1,322,881       4,790       (4,059 )
Derivative interest receivable (payable), net
            998                       1,659          
Trade/settle receivable (payable), net
            (85 )                              
Derivative collateral (held) posted, net
            (8,067 )                     (6,204 )        
                                                 
Total
  $ 1,305,027     $ (469 )   $ (3,418 )   $ 1,322,881     $ 245     $ (4,059 )
                                                 
 
                                                                 
    Consolidated Statements of Income  
    Three Months Ended June 30,     Six Months Ended June 30,  
    2008     2007     2008     2007  
    Derivative
    Hedge
    Derivative
    Hedge
    Derivative
    Hedge
    Derivative
    Hedge
 
    Gains
    Accounting
    Gains
    Accounting
    Gains
    Accounting
    Gains
    Accounting
 
Description
  (Losses)     Gains (Losses)(4)     (Losses)     Gains (Losses)(4)     (Losses)     Gains (Losses)(4)     (Losses)     Gains (Losses)(4)  
    (in millions)  
 
Cash flow hedges — open(5)
  $     $ 7     $     $     $     $ 4     $     $  
No hedge designation
    115             318             (130 )           (206 )      
                                                                 
Total
  $ 115     $ 7     $ 318     $     $ (130 )   $ 4     $ (206 )   $  
                                                                 
(1)  Notional or contractual amounts are used to calculate the periodic settlement amounts to be received or paid and generally do not represent actual amounts to be exchanged. Notional or contractual amounts are not recorded as assets or liabilities on our consolidated balance sheets.
(2)  The value of derivatives on our consolidated balance sheets is reported as derivative assets, net and derivative liability, net, and includes derivative interest receivable or (payable), net, trade/settle receivable or (payable), net and derivative cash collateral (held) or posted, net.
(3)  Derivatives that meet specific criteria may be accounted for as cash flow hedges. Changes in the fair value of the effective portion of open qualifying cash flow hedges are recorded in AOCI, or accumulated other comprehensive income, net of taxes. Net deferred gains and losses on closed cash flow hedges (i.e., where the derivative is either terminated or redesignated) are also included in AOCI, net of taxes, until the related forecasted transaction affects earnings or is determined to be probable of not occurring.
(4)  Hedge accounting gains (losses) arise when the fair value change of a derivative does not exactly offset the fair value change of the hedged item attributable to the hedged risk, and is a component of other income in our consolidated statements of income. For further information, see “NOTE 10: DERIVATIVES” to our consolidated financial statements.
(5)  For all derivatives in qualifying hedge accounting relationships, the accrual of periodic cash settlements is recorded in net interest income on our consolidated statements of income and those amounts are not included in the table. For derivatives not in qualifying hedge accounting relationships, the accrual of periodic cash settlements is recorded in derivative gains (losses) on our consolidated statements of income.
 
Beginning in the first quarter of 2008, we began designating certain derivative positions as cash flow hedges of changes in cash flows associated with our forecasted issuances of debt consistent with our risk management goals. In the periods presented prior to 2008, we only elected cash flow hedge accounting relationships for certain commitments to sell mortgage-related securities. We expect this expanded hedge accounting strategy will reduce volatility in our consolidated statements of income going forward. For a derivative accounted for as a cash flow hedge, changes in fair value are reported in AOCI, net of taxes, on our consolidated balance sheets to the extent the hedge is effective. The ineffective portion of changes in fair value is reported as other income on our consolidated statements of income. We record changes in the fair value, including periodic settlements, of derivatives not in hedge accounting relationships as derivative gains (losses) on our consolidated statements of income. See “NOTE 10: DERIVATIVES” to our consolidated financial statements for additional information about our derivatives designated as cash flow hedges.
 
Derivative Gains (Losses)
 
Table 8 provides a summary of the notional or contractual amounts and 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. Derivative gains (losses) also
 
            20 Freddie Mac


Table of Contents

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 will generally increase the volatility of reported net income (loss), particularly when they are not accounted for in hedge accounting relationships.
 
Table 8 — Derivatives Not in Hedge Accounting Relationships
 
                                                 
    Notional or
                         
    Contractual Amount     Derivative Gains (Losses)  
    June 30,     Three Months Ended June 30,     Six Months Ended June 30,  
    2008     2007     2008     2007     2008     2007  
                (in millions)              
 
Call swaptions:
                                               
Purchased
  $ 213,897     $ 236,752     $ (2,542 )   $ (1,168 )   $ 698     $ (1,721 )
Written
    1,500       3,400       27       48       21       50  
Put swaptions:
                                               
Purchased
    21,175       19,325       72       244       (53 )     236  
Written
    38,150       2,600       (93 )     (144 )     (90 )     (146 )
Receive-fixed swaps
                                               
Foreign-currency denominated
    14,993       21,050       (490 )     (394 )     (297 )     (500 )
U.S. dollar denominated
    230,061       193,607       (7,204 )     (3,106 )     2,299       (2,741 )
                                                 
Total receive-fixed swaps
    245,054       214,657       (7,694 )     (3,500 )     2,002       (3,241 )
Pay-fixed swaps
    395,874       284,927       11,259       4,531       (3,874 )     4,053  
Futures
    147,291       113,000       (154 )     (70 )     493       (51 )
Foreign-currency swaps(1)
    15,353       22,709       (48 )     332       1,189       530  
Forward purchase and sale commitments
    63,512       54,783       (243 )     (66 )     268       (71 )
Other(2)
    148,021       35,719       (102 )     17       (72 )     22  
                                                 
Subtotal
    1,289,827       987,872       482       224       582       (339 )
Accrual of periodic settlements:
                                               
Receive-fixed swaps(3)
                    648       (37 )     721       (95 )
Pay-fixed swaps
                    (1,118 )     155       (1,595 )     303  
Foreign-currency swaps
                    101       (25 )     158       (77 )
Other
                    2       1       4       2  
                                                 
Total accrual of periodic settlements
                    (367 )     94       (712 )     133  
                                                 
Total
  $ 1,289,827     $ 987,872     $ 115     $ 318     $ (130 )   $ (206 )
                                                 
(1)  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.
(2)  Consists of basis swaps, certain option-based contracts (including written options), interest-rate caps, swap guarantee derivatives and credit derivatives.
(3)  Includes imputed interest on zero-coupon swaps.
 
We use receive- and pay-fixed 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. During the second quarter of 2008, fair value gains on our pay-fixed swaps of $11.3 billion contributed to an overall gain recorded for derivatives. The gains were partially offset by losses on our receive-fixed swaps of $7.7 billion as swap interest rates increased. 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 retained portfolio. The losses on our purchased call swaptions, which increased during the second quarter of 2008, compared to the second quarter of 2007, were primarily attributable to increasing swap interest rates, partially offset by an increase in implied volatility during the second quarter of 2008.
 
During the six months ended June 30, 2008, we recognized a smaller derivative loss as compared to the six months ended June 30, 2007. On a year-to-date basis for 2008, the shorter term swap interest rates declined resulting in a loss on our pay-fixed swap positions, partially offset by gains on our receive-fixed swaps. The decrease in shorter term swap interest rates on a year-to-date basis for 2008, combined with an increase in volatility resulted in a gain related to our purchased call swaptions for the six months ended June 30, 2008.
 
Effective January 1, 2008, we elected the fair value option for our foreign-currency denominated debt. As a result of this election, foreign-currency translation gains and losses and fair value adjustments related to our foreign-currency denominated debt are recognized on our consolidated statements of income as unrealized gains (losses) on foreign-currency denominated debt recorded at fair value. Prior to January 1, 2008, translation gains and losses on our foreign-currency denominated debt were recorded in foreign-currency gains (losses), net and changes in value related to market movements were not recognized. We use a combination of foreign-currency swaps and foreign-currency denominated receive-fixed swaps to hedge the changes in fair value of our foreign-currency denominated debt related to fluctuations in exchange rates and interest rates, respectively. Derivative gains (losses) on foreign-currency swaps were $(48) million and $1.2 billion for the three and six months ended June 30, 2008, respectively, compared to $332 million and $530 million for the three and six months ended June 30, 2007, respectively. These amounts were offset by fair value gains (losses) related to translation of $88 million and $(1.1) billion for the three and six months ended June 30, 2008, respectively, and $(333) million and $(530) million for the three and six months ended June 30, 2007, respectively, on our foreign-currency denominated debt. In addition, the interest-rate component of the derivative losses of $490 million and $297 million for the three and six months
 
            21 Freddie Mac


Table of Contents

ended June 30, 2008, respectively, on foreign-currency denominated receive-fixed swaps largely offset market value adjustments gains included in unrealized gains (losses) on foreign-currency denominated debt recorded at fair value of $481 million and $310 million for the three and six months ended June 30, 2008, respectively. See “Unrealized Gains (Losses) on Foreign-Currency Denominated Debt Recorded at Fair Value” and NOTE 1: “SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES” to our consolidated financial statements for additional information about our election to adopt the fair value option for foreign-currency denominated debt. See “ITEM 13. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA — AUDITED CONSOLIDATED FINANCIAL STATEMENTS AND ACCOMPANYING NOTES — NOTE 11: DERIVATIVES” in our Registration Statement for additional information about our derivatives.
 
Gains (Losses) on Investment Activity
 
Gains (losses) on investment activity includes 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 9 summarizes the components of gains (losses) on investment activity.
 
Table 9 — Gains (Losses) on Investment Activity
 
                                 
    Three Months Ended
    Six Months Ended
 
    June 30,     June 30,  
    2008     2007     2008     2007  
          (in millions)        
 
Gains (losses) on trading securities(1)
  $ (2,279 )   $ 20     $ (1,308 )   $ 45  
Gains (losses) on sale of mortgage loans(2)
    (5 )     3       66       20  
Gains (losses) on sale of available-for-sale securities
    38       (249 )     253       (215 )
Security impairments on available-for-sale securities
    (1,040 )     (294 )     (1,111 )     (350 )
Lower-of-cost-or-fair-value adjustments
    (41 )     (20 )     (8 )     (22 )
                                 
Total gains (losses) on investment activity
  $ (3,327 )   $ (540 )   $ (2,108 )   $ (522 )
                                 
(1)  Includes mark-to-fair value adjustments recorded in accordance with Emerging Issues Task Force, or EITF, 99-20, “Recognition of Interest Income and Impairment on Purchased Beneficial Interests and Beneficial Interests That Continue to Be Held by a Transferor in Securitized Financial Assets” on securities classified as trading of $(7) million and $(2) million for the three months ended June 30, 2008 and 2007, respectively and $(327) million and $(3) million for the six months ended June 30, 2008 and 2007, respectively. Prior period amounts have been revised to conform to the current period presentation.
 
(2)  Represent gains (losses) on mortgage loans sold in connection with securitization transactions.
 
Gains (Losses) on Trading Securities
 
We recognized net losses on trading securities for the three and six months ended June 30, 2008, as compared to net gains for the three and six months ended June 30, 2007. On January 1, 2008, we implemented fair value option accounting and transferred approximately $90 billion in securities, primarily ARMs and fixed-rate PCs, from available-for-sale securities to trading securities significantly increasing our securities classified as trading. The unpaid principal balance of our securities classified as trading was approximately $157 billion at June 30, 2008 compared to approximately $12 billion at December 31, 2007. The increased balance in our trading portfolio together with an increase in interest rates contributed to losses on trading securities of $2.3 billion and $1.3 billion for the three and six months ended June 30, 2008, respectively. These losses were partially offset by gains on our interest-only securities.
 
Gains (Losses) on Sale of Available-For-Sale Securities
 
We recognized net gains on the sale of available-for-sale securities for the second quarter of 2008, as compared to net losses during the second quarter of 2007. During the second quarter of 2008, we sold $1.2 billion of seasoned securities, primarily consisting of obligations of states and political subdivisions, which generated a net gain of $47 million. During the second quarter of 2007, we entered into structuring transactions and sales of seasoned securities with unpaid principal balances of $21.4 billion generating net losses recognized in gains (losses) on investment activity because the securities sold had lower coupon rates than those available in the market at the time of sale.
 
We recognized net gains on the sale of available-for-sale securities for the six months ended June 30, 2008, as compared to net losses for the six months ended June 30, 2007. During the six months ended June 30, 2008, we entered into structuring transactions and sales of seasoned securities with unpaid principal balances of $20 billion, primarily consisting of PCs and Structured Securities, which generated a net gain of $201 million. These sales occurred principally during the earlier months of the first quarter of 2008 when market conditions were favorable and were driven in part by our need to maintain our mandatory target capital surplus. We were not required to sell these securities. However, in an effort to improve our capital position in light of the unanticipated extraordinary market conditions that began in the latter half of 2007, we strategically selected blocks of securities to sell, the majority of which were in a gain position. These sales reduced the assets on our balance sheet against which we are required to hold capital. In addition, the net gains on these sales increased our retained earnings, further improving our capital position. During the six months ended June 30, 2007, we sold $31.1 billion of PCs and Structured Securities, which generated a net loss of $132 million.
 
            22 Freddie Mac


Table of Contents

Security Impairments on Available-For-Sale Securities
 
During the second quarter of 2008 and 2007, we recorded other-than-temporary impairments related to investments in available-for-sale securities of $1.0 billion and $294 million, respectively. Of the impairments recognized during the second quarter of 2008, $826 million related to non-agency securities backed by subprime or Alt-A and other loans, primarily due to recent deterioration in the performance of the collateral underlying these securities. The primary contributors to the deteriorating performance were negative delinquency trends that continued, and in several cases accelerated. Our securities backed by second lien subprime loans suffered a pronounced decline in credit enhancement levels. Also contributing to these impairments were credit enhancements related to monoline bond insurance provided by one monoline on individual securities in an unrealized loss position where we have determined that it is both probable a principal and interest shortfall will occur on the insured securities and that in such a case there is substantial uncertainty surrounding the insurer’s ability to pay all future claims. In making this determination we considered additional qualitative factors, such as the monoline’s availability of capital, ability to generate new business, pending regulatory actions, ratings agency actions, security prices, credit default swap levels traded on the insurer and our own cash flow analysis. We also recognized impairment charges of $214 million related to our short-term available-for-sale non-mortgage-related securities with $8.9 billion of unpaid principal balance, as management could no longer assert the positive intent to hold these securities to recovery. The decision to impair these securities is consistent with our consideration of sales of securities from the cash and investments portfolio as a contingent source of liquidity. During the three months ended June 30, 2007, security impairments on available-for-sale securities included $291 million in mortgage-related securities impairments attributed to agency mortgage-related securities in an unrealized loss position that we did not have the intent to hold to a forecasted recovery. Of these $291 million of impairments, $279 million related to securities where the duration of the unrealized loss prior to impairment was greater than 12 months.
 
During the six months ended June 30, 2008 and 2007, we recorded impairments related to investments in available-for-sale securities of $1.1 billion and $350 million, respectively. Of the impairments recognized during the six months ended June 30, 2008, $826 million related to non-agency securities backed by subprime or Alt-A and other loans as discussed above. Of the remaining $285 million, the majority, $214 million, related to impairments of our available-for-sale non-mortgage-related securities during the three months ended June 30, 2008 where we did not have the intent to hold to a forecasted recovery. During the six months ended June 30, 2007, security impairments on available-for-sale securities included $347 million in impairments attributed to agency mortgage-related securities in an unrealized loss position that we did not have the intent to hold to a forecasted recovery.
 
Unrealized Gains (Losses) on Foreign-Currency Denominated Debt Recorded at Fair Value
 
We elected the fair value option for our foreign-currency denominated debt effective January 1, 2008. Accordingly, foreign-currency exposure is now a component of unrealized gains (losses) on foreign-currency denominated debt recorded at fair value. Prior to that date, translation gains and losses on our foreign-currency denominated debt were reported in foreign-currency gains (losses), net in our consolidated statements of income. We manage the foreign-currency exposure associated with our foreign-currency denominated debt through the use of derivatives. For the three months ended June 30, 2008, we recognized fair value gains of $569 million on our foreign-currency denominated debt primarily due to an increase in interest rates and the U.S. dollar strengthening relative to the Euro. However, the U.S. dollar weakened relative to the Euro during the six months ended June 30, 2008, contributing to our recognition of fair value losses of $816 million on our foreign-currency denominated debt. See “Derivative Gains (Losses)” for additional information about how we mitigate changes in the fair value of our foreign-currency denominated debt by using derivatives. See “Foreign-Currency Gains (Losses), Net” and “NOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES” to our consolidated financial statements for additional information about our adoption of SFAS 159.
 
Gains (Losses) on Debt Retirements
 
Gains (losses) on debt retirement were $(29) million and $276 million during the three and six months ended June 30, 2008, respectively, compared to gains of $89 million and $96 million during the three and six months ended June 30, 2007, respectively. During the six months ended June 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 during the first quarter of 2008.
 
Recoveries on Loans Impaired upon Purchase
 
Recoveries on loans impaired upon purchase represent the recapture into income of previously recognized losses on loans purchased and provision for credit losses associated with purchases of delinquent loans from our PCs and Structured Securities in conjunction with our guarantee activities. Recoveries occur when a non-performing loan is repaid in full or when at the time of foreclosure the estimated fair value of the acquired property, less costs to sell, exceeds the carrying value of the loan. 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.
 
            23 Freddie Mac


Table of Contents

During the three months ended June 30, 2008 and 2007, we recognized recoveries on loans impaired upon purchase of $121 million and $72 million, respectively. During the six months ended June 30, 2008 and 2007, we recognized recoveries on loans impaired upon purchase of $347 million and $107 million, respectively. The volume and magnitude of recoveries were greater during the three and six months ended June 30, 2008 than during the three and six months ended June 30, 2007, since the initial losses on impaired loans purchased during 2007 were principally based on market valuations that were more severe in the last half of 2007 due to liquidity and mortgage credit concerns. In addition, our purchases of impaired loans were greater during 2007 than in 2008 due to our change in practice in December 2007 to delay our optional repurchase of delinquent loans underlying our PCs.
 
Foreign-Currency Gains (Losses), Net
 
We manage the foreign-currency exposure associated with our foreign-currency denominated debt through the use of derivatives. We elected the fair value option for foreign-currency denominated debt effective January 1, 2008. Prior to this election, gains and losses associated with the foreign-currency exposure of our foreign-currency denominated debt were recorded as foreign-currency gains (losses), net in our consolidated statements of income. With the adoption of SFAS 159, foreign-currency exposure is now a component of unrealized gains (losses) on foreign-currency denominated debt recorded at fair value. Because the fair value option is prospective, prior period amounts have not been reclassified. See “Derivative Gains (Losses)” and “Unrealized Gains (Losses) on Foreign-Currency Denominated Debt Recorded at Fair Value” and “NOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES” to our consolidated financial statements for additional information.
 
For the three and six months ended June 30, 2007, we recognized net foreign-currency translation losses primarily related to our foreign-currency denominated debt of $333 million and $530 million, respectively, as the U.S. dollar weakened relative to the Euro during the period. During the same period, these losses were offset by an increase of $332 million and $530 million, respectively, in the fair value of foreign-currency-related derivatives recorded in derivative gains (losses).
 
Other Income
 
Other income primarily consists of resecuritization fees, trust management income, fees associated with servicing and technology-related products, including Loan Prospector®, fees related to multifamily loans (including application and other fees) and various other fees received from mortgage originators and servicers. Resecuritization fees are revenues we earn primarily in connection with the issuance of Structured Securities for which we make a REMIC election, where the underlying collateral is provided by third parties. These fees are also generated in connection with the creation of interest-only and principal-only strips as well as other Structured Securities. Trust management fees represent the fees we earn as administrator, issuer and trustee, net of related expenses, which prior to December 2007, was reported as due to PC investors, a component of net interest income.
 
Non-Interest Expense
 
Table 10 summarizes the components of non-interest expense.
 
Table 10 — Non-Interest Expense
 
                                 
    Three Months Ended
    Six Months Ended
 
    June 30,     June 30,  
    2008     2007     2008     2007  
          (in millions)        
 
Administrative expenses:
                               
Salaries and employee benefits
  $ 241     $ 227     $ 472     $ 440  
Professional services
    55       104       127       193  
Occupancy expense
    18       16       33       30  
Other administrative expenses
    90       95       169       182  
                                 
Total administrative expenses
    404       442       801       845  
Provision for credit losses
    2,537       447       3,777       695  
REO operations expense
    265       16       473       30  
Losses on certain credit guarantees
          150       15       327  
Losses on loans purchased
    120       264       171       480  
LIHTC partnerships
    108       135       225       243  
Minority interests in earnings of consolidated subsidiaries
    5       9       8       18  
Other expenses
    106       56       178       105  
                                 
Total non-interest expense
  $ 3,545     $ 1,519     $ 5,648     $ 2,743  
                                 
 
Administrative Expenses
 
Administrative expenses decreased slightly for the three and six months ended June 30, 2008, compared to the three and six months ended June 30, 2007, primarily due to a reduction in our use of consultants. As a percentage of the average total mortgage portfolio, administrative expenses declined to 7.4 basis points and 7.5 basis points for the three and six months ended June 30, 2008, respectively, from 9.2 basis points and 8.9 basis points for the three and six months ended June 30, 2007, respectively.
 
            24 Freddie Mac


Table of Contents

Provision for Credit Losses
 
Our credit loss reserves reflect our best estimates of incurred losses. Our reserve estimate includes projections related to strategic loss mitigation initiatives, including a higher rate of loan modifications for troubled borrowers, and projections of recoveries through repurchases by seller/servicers of defaulted loans due to failure to follow contractual underwriting requirements at the time of the loan origination. Our reserve estimate also reflects our best projection of defaults. However, the unprecedented deterioration in the national housing market and the uncertainty in other macroeconomic factors makes forecasting of default rates increasingly imprecise. These estimates require significant judgments and other parties could arrive at different conclusions as to the likelihood of various defaults and severity outcomes. The inability to realize the anticipated benefits of our loss mitigation plans, a lower realized rate of seller/servicer repurchases or default rates and severity that exceed our current projections would cause our losses to be significantly higher than those currently estimated. Although significant flooding occurred in certain states in the midwestern U.S. during the second quarter of 2008, we do not believe this had a significant impact on our mortgage portfolio and it did not have a meaningful impact on our estimates of incurred loss as of June 30, 2008.
 
The provision for credit losses increased for the three and six months ended June 30, 2008, compared to the three and six months ended June 30, 2007, respectively, as continued weakening in the housing market affected our single-family portfolio. For the three and six months ended June 30, 2008, we recorded additional reserves for credit losses on our single-family portfolio as a result of:
 
  •  increased estimates of incurred losses on mortgage loans that are expected to experience higher default rates based on their year of origination, particularly those originated during 2006 and 2007 and also based on product-type, particularly Alt-A and interest-only mortgage products;
 
  •  an observed increase in delinquency rates and the percentage of loans that transition from delinquency to foreclosure; and
 
  •  increases in the estimated severity of losses on a per-property basis, driven in part by declines in home sales and home prices. The states with the largest declines in home prices and highest increases in severity of losses include California, Florida, Nevada, Arizona, Virginia, Maryland and Michigan.
 
We expect our provisions for credit losses to remain high for the remainder of 2008 and the extent and duration of high credit costs in future periods will depend on a number of factors, including changes in property values, regional economic conditions, third-party mortgage insurance coverage and recoveries and the realized rate of seller/servicer repurchases. We may further increase our single-family loan loss reserves in future periods as additional losses are incurred, particularly related to mortgages originated in 2006 and 2007. Loans we purchased during 2006 and 2007 represent 36% of the unpaid principal balance of our single-family credit guarantee portfolio and approximately 16% of the unpaid principal balance of single-family loans that we hold in our retained portfolio. There is a significant lag in time from the implementation of loss mitigation activities and the final resolution of delinquent mortgage loans as well as the disposition of nonperforming assets. As indicated by the significant increase in our loan loss reserve during the second quarter of 2008, we expect our charge-offs will continue to increase in the remainder of 2008.
 
REO Operations Expense
 
The increase in REO operations expense for the three and six months ended June 30, 2008, as compared to the three and six months ended June 30, 2007, was due to increases in the number of single-family property additions to our REO balance of 148% and 132%, respectively, as well as declining single-family REO property values. The decline in home prices, which has been both rapid and dramatic in certain geographical areas, combined with our higher REO inventory balance, resulted in an increase in the market-based writedowns of REO, which totaled $118 million and $232 million for the three and six months ended June 30, 2008, respectively. REO expense also increased due to higher real estate taxes, maintenance costs and net losses on sales experienced during the three and six months ended June 30, 2008 as compared to the three and six months ended June 30, 2007. We expect REO operations expense to continue to increase in the remainder of 2008, as single-family REO volume increases and home prices decline.
 
Losses on Certain Credit Guarantees
 
Losses on certain credit guarantees consist of losses recognized upon the issuance of PCs in guarantor swap transactions. Prior to January 1, 2008, our recognition of losses on certain guarantee contracts occurred due to any one or a combination of several factors, including long-term contract pricing for our flow business, the difference in overall transaction pricing versus pool-level accounting measurements and, less significantly, efforts to support our affordable housing mission. Upon adoption of SFAS 157, our losses on certain credit guarantees will generally relate to our efforts to meet our affordable housing goals. See “CRITICAL ACCOUNTING POLICIES AND ESTIMATES — Fair Value Measurements” for information concerning the change in initial recognition of fair value of our guarantee obligations.
 
            25 Freddie Mac


Table of Contents

Effective January 1, 2008, upon the adoption of SFAS 157, which amended FIN 45, we estimate the fair value of our newly-issued guarantee obligations as an amount equal to the fair value of compensation received, inclusive of all rights related to the transaction, in exchange for our guarantee. As a result, we no longer record estimates of deferred gains or immediate “day one” losses on most guarantees. All unamortized amounts recorded prior to January 1, 2008 will continue to be amortized using existing amortization methods. This change had a significant positive impact on our financial results for the three and six months ended June 30, 2008. For the three and six months ended June 30, 2007, we recognized losses of $150 million and $327 million, respectively, on certain guarantor swap transactions entered into during the period and we deferred gains of $365 million and $650 million, respectively, on newly-issued guarantees entered into during those periods.
 
Losses on Loans Purchased
 
Losses on non-performing 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. Effective December 2007, we made certain operational changes for purchasing delinquent loans from PC pools, which significantly reduced the volume of our delinquent loan purchases in the period and consequently the amount of our losses on loans purchased for the three and six months ended June 30, 2008. We made these operational changes in order to better reflect our expectations of future credit losses and in consideration of our capital requirements. For the three months ended June 30, 2008, 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 as compared to the first quarter of 2008. When a loan is modified, we generally exercise our repurchase option and hold the modified loan in our retained portfolio. The increase in modifications during the second quarter of 2008 resulted in higher losses than during the first quarter of 2008. See “Recoveries on Loans Impaired upon Purchase” and “CREDIT RISKS — Table 42 — Changes in Loans Purchased Under Financial Guarantees” for additional information about the impacts from non-performing loans on our financial results.
 
During the three and six months ended June 30, 2008, 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. However, our losses on loans purchased decreased 55% to $120 million during the three months ended June 30, 2008 compared to $264 million during the three months ended June 30, 2007 due to our reduced volume of impaired loan purchases during 2008. Losses on loans purchased decreased 64% to $171 million during the six months ended June 30, 2008 compared to $480 million during the six months ended June 30, 2007.
 
Income Tax (Expense) Benefit
 
For the three months ended June 30, 2008 and 2007, we reported an income tax (expense) benefit of $1.0 billion and $(94) million, respectively. For the six months ended June 30, 2008 and 2007, we reported an income tax (expense) benefit of $1.5 billion and $303 million, 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. The activities of our business segments are described in “EXECUTIVE SUMMARY — Segments.” Certain activities that are not part of a segment are included in the All Other category; this category consists of certain unallocated corporate items, such as remediation and restructuring costs, costs related to the resolution of certain legal matters and certain income tax items. We manage and evaluate performance of the segments and All Other using a Segment Earnings approach. Segment Earnings is calculated for the segments by adjusting net income (loss) for certain investment-related activities and credit guarantee-related activities. Segment Earnings differs significantly from, and should not be used as a substitute for, net income (loss) before cumulative effect of change in accounting principle or net income (loss) as determined in accordance with GAAP. There are important limitations to using Segment Earnings as a measure of our financial performance. Among them, our regulatory capital requirements are based on our GAAP results. Segment Earnings adjusts for the effects of certain gains and losses and mark-to-fair-value items which, depending on market circumstances, can significantly affect, positively or negatively, our GAAP results and which, in recent periods, have caused us to record GAAP net losses. GAAP net losses will adversely impact our regulatory capital, regardless of results reflected in Segment Earnings. Also, our definition of Segment Earnings may differ from similar measures used by other companies. However, we believe that the presentation of Segment Earnings highlights the results from ongoing operations and the underlying results of the segments in a manner that is useful to the way we manage and evaluate the performance of our business. See “NOTE 16: SEGMENT REPORTING” to our consolidated financial statements for more information regarding our segments and the adjustments used to calculate Segment Earnings.
 
In managing our business, we present the operating performance of our segments using Segment Earnings. Segment Earnings presents our results on an accrual basis as the cash flows from our segments are earned over time. The objective of Segment Earnings is to present our results in a manner more consistent with our business models. The business model for
 
            26 Freddie Mac


Table of Contents

our investment activity is one where we generally buy and hold our investments in mortgage-related assets for the long term, fund our investments with debt and use derivatives to minimize interest rate risk and generate net interest income in line with our return on equity objectives. We believe it is meaningful to measure the performance of our investment business using long-term returns, not short-term value. The business model for our credit guarantee activity is one where we are a long-term guarantor in the conforming mortgage markets, manage credit risk and generate guarantee and credit fees, net of incurred credit losses. As a result of these business models, we believe that this accrual-based metric is a meaningful way to present our results as actual cash flows are realized, net of credit losses and impairments. We believe Segment Earnings provides us with a view of our financial results that is more consistent with our business objectives, which helps us better evaluate the performance of our business, both from period-to-period and over the longer term.
 
Investments Segment
 
Through our Investments segment, we seek to generate attractive returns on our mortgage-related investment portfolio while maintaining a disciplined approach to interest-rate risk and capital management. We seek to accomplish this objective through opportunistic purchases, sales and restructurings of mortgage assets. Although we are primarily a buy-and-hold investor in mortgage assets, we may sell assets that are no longer expected to produce desired returns to reduce risk, respond to capital constraints, provide liquidity or structure certain transactions that improve our returns. We estimate our expected investment returns using an OAS approach.
 
Table 11 presents the Segment Earnings of our Investments segment.
 
Table 11 — Segment Earnings and Key Metrics — Investments
 
                                 
    Three Months Ended
    Six Months Ended
 
    June 30,     June 30,  
    2008     2007     2008     2007  
    (dollars in millions)  
 
Segment Earnings:
                               
Net interest income
  $ 1,481     $ 990     $ 1,780     $ 1,892  
Non-interest income (loss)
    (125 )     30       (110 )     54  
Non-interest expense:
                               
Administrative expenses
    (130 )     (133 )     (261 )     (261 )
Other non-interest expense
    (7 )     (8 )     (16 )     (15 )
                                 
Total non-interest expense
    (137 )     (141 )     (277 )     (276 )
                                 
Segment Earnings before income tax expense
    1,219       879       1,393       1,670  
Income tax expense
    (426 )     (308 )     (487 )     (585 )
                                 
Segment Earnings, net of taxes
    793       571       906       1,085  
Reconciliation to GAAP net income (loss):
                               
Derivative- and foreign-currency denominated debt-related adjustments
    530       (464 )     (653 )     (1,545 )
Credit guarantee-related adjustments
                      1  
Investment sales, debt retirements and fair value-related adjustments
    (3,096 )     (379 )     (1,571 )     (310 )
Fully taxable-equivalent adjustment
    (105 )     (97 )     (215 )     (190 )
Tax-related adjustments
    1,004       394       992       842  
                                 
Total reconciling items, net of taxes
    (1,667 )     (546 )     (1,447 )     (1,202 )
                                 
GAAP net income (loss)
  $ (874 )   $ 25     $ (541 )   $ (117 )
                                 
Key metrics — Investments:
                               
Growth:
                               
Purchases of securities — Mortgage-related investment portfolio:(1)(2)
                               
Guaranteed PCs and Structured Securities
  $ 91,054     $ 29,238     $ 112,598     $ 56,313  
Non-Freddie Mac mortgage-related securities:
                               
Agency mortgage-related securities
    24,688       3,520       34,071       4,832  
Non-agency mortgage-related securities
    1,024       24,825       1,884       52,553  
                                 
Total purchases of securities — Mortgage-related investment portfolio
  $ 116,766     $ 57,583     $ 148,553     $ 113,698  
                                 
Growth rate of mortgage-related investment portfolio (annualized)
    46.9 %     (2.0 )%     19.5 %     1.8 %
Return:
                               
Net interest yield — Segment Earnings basis
    0.80 %     0.57 %     0.50 %     0.53 %
(1)  Based on unpaid principal balance and excludes mortgage-related securities traded, but not yet settled.
(2)  Exclude Single-family mortgage loans.
 
Segment Earnings for our Investments segment increased $222 million in the second quarter of 2008 compared to the second quarter of 2007. For the Investments segment, Segment Earnings net interest income increased $491 million and our Segment Earnings net interest yield increased 23 basis points for the second quarter of 2008 compared to the second quarter of 2007. The increases in Segment Earnings net interest income and net interest yield were primarily driven by fixed-rate assets purchased at significantly wider spreads relative to our funding costs, as well as the amortization of gains on certain futures positions that matured in March 2008. Partially offsetting the increase in Segment Earnings for our Investments segment was the recognition of security impairments during the second quarter of 2008 of $142 million associated with anticipated future principal losses on our non-agency mortgage-related securities compared to security impairments of $1 million in the second quarter of 2007. Security impairments that reflect expected or realized credit principal losses are
 
            27 Freddie Mac


Table of Contents

realized immediately pursuant to GAAP and in Segment Earnings. In contrast, non-credit related security impairments are not included in Segment Earnings. These non-credit related security impairments are deferred and amortized prospectively into Segment Earnings on a straight-line basis over five years for securities in the retained portfolio and over three years for securities in the cash and investments portfolio.
 
Segment Earnings for our Investments segment decreased $179 million in the six months ended June 30, 2008 compared to the six months ended June 30, 2007. Additionally, Segment Earnings net interest income decreased $112 million and our Segment Earnings net interest yield decreased 3 basis points for the six months ended June 30, 2008 compared to the six months ended June 30, 2007. These decreases were primarily due to spread compression between our floating rate assets and liabilities during the first quarter of 2008. As rates declined in the first quarter of 2008, our floating rate assets reset faster than our floating rate debt. Declining rates also contributed to an increase in net interest expense on our pay-fixed swaps that was only partially offset by floating rate debt that reset. The decreases in Segment Earnings net interest income and net interest yield were mostly offset by purchases of fixed rate assets at significantly wider spreads relative to our funding costs as well as the amortization of gains on certain futures positions that matured in March 2008. Also contributing to the decrease in Segment Earnings for our Investment segment was the recognition of security impairments during the six months ended June 30, 2008, of $144 million associated with anticipated future principal losses on our non-agency mortgage-related securities compared to $1 million of security impairments recognized during the six months ended June 30, 2007.
 
In the three and the six months ended June 30, 2008, the annualized growth rates of our mortgage-related investment portfolio were 46.9% and 19.5%, respectively, compared to (2.0)% and 1.8% for the three and six months ended June 30, 2007. The unpaid principal balance of our mortgage-related investment portfolio increased from $663.2 billion at December 31, 2007 to $728.0 billion at June 30, 2008. The overall increase in the unpaid principal balance of our mortgage-related investment portfolio was primarily due to more favorable investment opportunities for agency securities, due to liquidity concerns in the market, during the latter half of the first quarter and continuing into the second quarter. In response, our net purchase commitment activity increased considerably as we deployed capital at favorable OAS levels. In addition, as of March 1, 2008, the voluntary growth limit on our retained portfolio is no longer in effect and during March, OFHEO reduced our mandatory target capital surplus from 30% to 20%, allowing us to take advantage of these favorable investment opportunities.
 
We held $74.1 billion of non-Freddie Mac agency mortgage-related securities and $212.7 billion of non-agency mortgage-related securities as of June 30, 2008 compared to $47.8 billion of non-Freddie Mac agency mortgage-related securities and $233.8 billion of non-agency mortgage-related securities as of December 31, 2007.
 
At June 30, 2008 and December 31, 2007, we held investments of $85.6 billion and $101.3 billion, respectively, of non-agency mortgage-related securities backed by subprime loans. In addition to the contractual interest payments, we receive substantial monthly remittances of principal repayments on these securities, which totaled more than $7 billion and $15 billion during the three and six months ended June 30, 2008, respectively, representing a return on our investment in these securities. These securities include significant credit enhancement, particularly through subordination, and 91% and 100% of these securities were investment grade at June 30, 2008 and December 31, 2007, respectively. The unrealized losses, net of tax, on these securities are included in AOCI and totaled $9.5 billion and $5.6 billion at June 30, 2008 and December 31, 2007, respectively. We believe that the declines in fair values for these securities are mainly attributable to decreased liquidity and larger risk premiums in the mortgage market.
 
We also invested in non-agency mortgage-related securities backed by Alt-A and other loans in our mortgage-related investment portfolio. We have classified these securities as Alt-A if the securities were labeled as Alt-A when sold to us or if we believe the underlying collateral includes a significant amount of Alt-A loans. We have classified $47.6 billion and $51.3 billion of our single-family non-agency mortgage-related securities as Alt-A and other loans at June 30, 2008 and December 31, 2007, respectively. In addition to the contractual interest payments, we receive substantial monthly remittances of principal repayments on these securities, which totaled more than $2 billion and $4 billion during the three and six months ended June 30, 2008, respectively, representing a return on our investment in these securities. We have focused our purchases on credit-enhanced, senior tranches of these securities, which provide additional protection due to subordination. 98% and 100% of these securities were investment grade at June 30, 2008 and December 31, 2007, respectively. The unrealized losses, net of tax, on these securities are included in AOCI and totaled $7.3 billion and $1.7 billion at June 30, 2008 and December 31, 2007, respectively. The declines in fair values for these securities are mainly attributable to decreased liquidity and larger risk premiums in the mortgage market. See “CONSOLIDATED BALANCE SHEETS ANALYSIS— Retained Portfolio” for additional information regarding our mortgage-related securities.
 
Single-Family Guarantee Segment
 
Through our Single-family Guarantee segment, we seek to issue guarantees that we believe offer attractive long-term returns relative to anticipated credit costs while fulfilling our mission to provide liquidity, stability and affordability in the
 
            28 Freddie Mac


Table of Contents

residential mortgage market. In addition, we seek to improve our share of the total residential mortgage securitization market by enhancing customer service and increasing the volume of business with our customers.
 
Table 12 presents the Segment Earnings of our Single-family Guarantee segment.
 
Table 12 — Segment Earnings and Key Metrics — Single-Family Guarantee
 
                                 
    Three Months Ended
    Six Months Ended
 
    June 30,     June 30,  
    2008     2007     2008     2007  
    (in millions)  
 
Segment Earnings:
                               
Net interest income(1)
  $ 58     $ 179     $ 135     $ 347  
Non-interest income:
                               
Management and guarantee income
    840       704       1,735       1,381  
Other non-interest income(1)
    103       28       207       50  
                                 
Total non-interest income
    943       732       1,942       1,431  
Non-interest expense:
                               
Administrative expenses
    (212 )     (209 )     (416 )     (408 )
Provision for credit losses
    (2,630 )     (469 )     (3,979 )     (758 )
REO operations expense
    (265 )     (16 )     (473 )     (30 )
Other non-interest expense
    (29 )     (19 )     (48 )     (40 )
                                 
Total non-interest expense
    (3,136 )     (713 )     (4,916 )     (1,236 )
                                 
Segment Earnings (loss) before income tax expense
    (2,135 )     198       (2,839 )     542  
Income tax (expense) benefit
    747       (69 )     993       (189 )
                                 
Segment Earnings (loss), net of taxes
    (1,388 )     129       (1,846 )     353  
Reconciliation to GAAP net income (loss):
                               
Credit guarantee-related adjustments
    1,822       833       1,648       330  
Tax-related adjustments
    (638 )     (293 )     (577 )     (117 )
                                 
Total reconciling items, net of taxes
    1,184       540       1,071       213  
                                 
GAAP net income (loss)
  $ (204 )   $ 669     $ (775 )   $ 566  
                                 
Key metrics — Single-family Guarantee:
                               
Balances and Growth (in billions, except rate):
                               
Average securitized balance of single-family credit guarantee portfolio(2)
  $ 1,764     $ 1,551     $ 1,746     $ 1,522  
Issuance — Single-family credit guarantees(2)
  $ 132     $ 118     $ 245     $ 232  
Fixed-rate products — Percentage of issuances(3)
    90.0 %     78.6 %     91.3 %     76.8 %
Liquidation rate — Single-family credit guarantees (annualized rate)(4)
    20.8 %     16.2 %     18.9 %     15.8 %
Credit:
                               
Delinquency rate(5)
    0.93 %     0.42 %                
Delinquency transition rate(6)
    22.8 %     13.8 %                
REO inventory increase, net (number of units)
    3,610       610       7,635       1,475  
Single-family credit losses, in basis points (annualized)
    18.1       2.0       15.1       1.8  
Market:
                               
Single-family mortgage debt outstanding (total U.S. market, in billions)(7)
  $ 11,227     $ 10,862     $ 11,227     $ 10,862  
30-year fixed mortgage rate(8)
    6.1 %     6.4 %     6.0 %     6.3 %
(1)  In connection with the use of securitization trusts for the underlying assets of our PCs and Structured Securities in December 2007, we began recording trust management income in non-interest income. Trust management income represents the fees we earn as administrator, issuer and trustee. Previously, the benefit derived from interest earned on principal and interest cash flows between the time they were remitted to us by servicers and the date of distribution to our PCs and Structured Securities holders was recorded to net interest income.
(2)  Based on unpaid principal balance.
(3)  Excludes fixed-rate Structured Securities backed by non-Freddie Mac issued mortgage-related securities.
(4)  Includes termination of long-term standby commitments.
(5)  Represents the percentage of single-family loans in our 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 “CREDIT RISKS — Mortgage Credit Risk” for a description of our Structured Transactions.
(6)  Calculated based on all loans that have been reported as 90 days or more delinquent or in foreclosure in the preceding year, which have subsequently transitioned to REO. The rate does not reflect other loss events, such as short-sales and deed-in-lieu transactions.
(7)  U.S. single-family mortgage debt outstanding as of March 31, 2008 for 2008 and June 30, 2007 for 2007. Source: Federal Reserve Flow of Funds Accounts of the United States of America dated June 5, 2008.
(8)  Based on Freddie Mac’s Primary Mortgage Market Survey, or PMMS. 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 declined to a loss of $(1.4) billion for the three months ended June 30, 2008 compared to Segment Earnings of $129 million for the three months ended June 30, 2007. Segment Earnings (loss) for our Single-family Guarantee segment declined to a loss of $(1.8) billion for the six months ended June 30, 2008 compared to Segment Earnings of $353 million for the six months ended June 30, 2007. These declines reflect an increase in credit-related expenses due to higher delinquency rates, higher volumes of non-performing loans and foreclosures, higher severity of losses on a per-property basis and a decline in home prices and other regional economic conditions. The decline in Segment Earnings for this segment for the three and six months ended June 30, 2008 was partially offset by an increase in Segment Earnings management and guarantee income as compared to the three and six months ended June 30, 2007. The increase in Segment Earnings management and guarantee income for this segment for the three and six months ended June 30, 2008 is primarily due to higher average balances of the single-family credit guarantee portfolio and higher delivery and credit fee amortization. Amortization of upfront fees increased as a result of cumulative
 
            29 Freddie Mac


Table of Contents

catch-up adjustments recognized for the three and six months ended June 30, 2008. These cumulative catch-up adjustments result in a pattern of revenue recognition that is consistent with our economic release from risk and the timing of the recognition of losses on pools of mortgage loans we guarantee.
 
Table 13 below provides summary information about Segment Earnings management and guarantee income for the Single-family Guarantee 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 13 — Segment Earnings Management and Guarantee Income — Single-Family Guarantee
 
                                                                 
    Three Months Ended June 30,     Six Months Ended June 30,  
    2008     2007     2008     2007  
          Average
          Average
          Average
          Average
 
    Amount     Rate     Amount     Rate     Amount     Rate     Amount     Rate  
    (dollars in millions, rates in basis points)  
 
Contractual management and guarantee fees
  $ 708       15.8     $ 610       15.5     $ 1,415       16.0     $ 1,196       15.5  
Amortization of upfront fees included in other liabilities
    132       2.9       94       2.4       320       3.6       185       2.4  
                                                                 
Total Segment Earnings management and guarantee income
    840       18.7       704       17.9       1,735       19.6       1,381       17.9  
                                                                 
Adjustments to reconcile to consolidated GAAP:
                                                               
Reclassification between net interest income and management and guarantee fee(1)
    54               6               94               7          
Credit guarantee-related adjustments(2)
    (156 )             (135 )             (317 )             (200 )        
Multifamily management and guarantee income(3)
    19               16               34               31          
                                                                 
Management and guarantee income, GAAP
  $ 757             $ 591             $ 1,546             $ 1,219          
                                                                 
(1)  Management and guarantee fees earned on mortgage loans held in our retained 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 three months ended June 30, 2008 and 2007, the annualized growth rates of our single-family credit guarantee portfolio were 8.8% and 14.6%, respectively. For the six months ended June 30, 2008 and 2007, the annualized growth rates of our single-family credit guarantee portfolio were 9.5% and 15.8%, respectively. Our mortgage purchase volumes are impacted by several factors, including origination volumes, mortgage product and underwriting trends, competition, customer-specific behavior and contract terms. Single-family mortgage purchase volumes from individual customers can fluctuate significantly. Despite these fluctuations, we expect our share of the overall single-family mortgage securitization market to remain high in the remainder of 2008 as compared to recent years, as mortgage originators have generally tightened their credit standards, causing conforming mortgages to be the predominant product in the market for the three and six months ended June 30, 2008. We have seen improvements in the credit quality of mortgages delivered to us in 2008.
 
We have recently implemented several increases in delivery fees, which are paid at the time of securitization. These increases include an additional 25 basis point fee assessed on all loans purchased or guaranteed through flow-business channels, as well as higher or new upfront fees for certain mortgages deemed to be higher-risk based on product type, property type, loan purpose, LTV ratio and/or borrower credit scores. Upfront fees are recognized in Segment Earnings contractual management and guarantee fee income. For GAAP presentation fees paid after January 1, 2003 are amortized as part of income on guarantee obligation. We expect these increases in delivery fees, once fully implemented with contract renewals, coupled with increases in market share, to have a positive impact on our operations. Given the volatility in the credit market during the three and six months ended June 30, 2008, we will continue to closely monitor the pricing of our management and guarantee fees as well as our delivery fee rates and make adjustments when appropriate.
 
We have also made changes to our underwriting guidelines for loans delivered to us for purchase or securitization in order to reduce our credit risk exposure for new business. These changes include reducing purchases of mortgages with LTV ratios over 95%, and limiting combinations of higher-risk characteristics in loans we purchase, including those with reduced documentation. As with fee increases, in some cases binding commitments under existing customer contracts may delay the effective dates of underwriting adjustments for a period of months.
 
Our Segment Earnings provision for credit losses for the Single-family Guarantee segment increased to $2.6 billion for the three months ended June 30, 2008, compared to $0.5 billion for the three months ended June 30, 2007. Our Segment Earnings provision for credit losses for the Single-family Guarantee segment increased to $4.0 billion for the six months ended June 30, 2008, compared to $0.8 billion for the six months ended June 30, 2007, due to continued credit deterioration in our single-family credit guarantee portfolio, primarily related to 2006 and 2007 loan purchases. Mortgages in our single-family credit guarantee portfolio purchased by us in 2006 and 2007 have higher delinquency rates, higher transition rates to foreclosure, as well as higher loss severities on a per-property basis than our historical experiences. Our provision for credit losses is based on our estimate of incurred losses inherent in both our retained mortgage loan portfolio and our credit
 
            30 Freddie Mac


Table of Contents

guarantee 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, representing those loans which are 90 days or more past due and excluding loans underlying Structured Transactions, increased to 93 basis points as of June 30, 2008 from 65 basis points as of December 31, 2007. Increases in delinquency rates occurred in all product types for the three months ended June 30, 2008, but were most significant for interest-only, Alt-A and ARM mortgages. Although we believe that our delinquency rates remain low relative to conforming loan delinquency rates of other industry participants, we expect our delinquency rates will continue to rise in 2008.
 
The impact of the weak housing market was first evident during 2007 in areas of the country where unemployment rates have been relatively high, such as the North Central region. However, we have also experienced significant increases in delinquency rates and REO activity in the West, Northeast and Southeast regions during the six months ended June 30, 2008, compared to the six months ended June 30, 2007, particularly in the states of California, Florida, Nevada and Arizona. The West region represents approximately 26% of our REO acquisitions during the six months ended June 30, 2008, based on the number of units. The highest concentration in the West region is in the state of California. At June 30, 2008, our REO inventory in California represented approximately 25% of our total REO inventory. California has accounted for an increasing amount of our credit losses and it comprised approximately 30% of our total credit losses in the three months ended June 30, 2008.
 
During the six months ended June 30, 2008, our single-family credit guarantee portfolio also continued to experience increases in the rate at which loans transitioned from delinquency to foreclosure. The increase in these delinquency transition rates, compared to our historical experience, has been progressively worse for mortgage loans purchased by us during 2006 and 2007. This trend is, in part, due to the increase of non-traditional mortgage loans, such as interest-only and Alt-A mortgages, as well as an increase in estimated current LTV ratios for mortgage loans originated during those years. For the three months ended June 30, 2008, single-family charge-offs, gross, were $722 million compared to $114 million for the three months ended June 30, 2007. Single-family charge-offs, gross, increased $970 million to $1.2 billion for the six months ended June 30, 2008 as compared to $207 million for the six months ended June 30, 2007, primarily due to the increase in the volume of REO acquisitions as well as continued deterioration in the real estate market. In addition, there has also been an increase in the average charge-offs, on a per property basis, during the three and six months ended June 30, 2008 compared to the three and six months ended June 30, 2007.
 
Multifamily Segment
 
Through our Multifamily segment, we seek to generate attractive returns on our investments in multifamily mortgage loans while fulfilling our mission to provide stability and liquidity for the financing of affordable rental housing nationwide. We also seek to issue guarantees that we believe offer attractive long-term returns relative to anticipated credit costs. Prior to 2008, we have not typically securitized multifamily mortgages, because our multifamily loans are typically large, customized, non-homogenous loans, that are not as conducive to securitization as single-family loans and the market for multifamily securitizations is relatively illiquid. Accordingly, we typically hold multifamily loans for investment purposes. Beginning in 2008, we have increased our guarantee securitization of multifamily mortgages and we expect to further increase our multifamily mortgage guarantee activity in the remainder of 2008, as market conditions permit.
 
            31 Freddie Mac


Table of Contents

Table 14 presents the Segment Earnings of our Multifamily segment.
 
Table 14 — Segment Earnings and Key Metrics — Multifamily
 
                                 
    Three Months Ended
    Six Months Ended
 
    June 30,     June 30,  
    2008     2007     2008     2007  
          (dollars in millions)        
 
Segment Earnings:
                               
Net interest income
  $ 98     $ 94     $ 173     $ 217  
Non-interest income:
                               
Management and guarantee income
    17       16       34       30  
Other non-interest income
    7       5       15       9  
                                 
Total non-interest income
    24       21       49       39  
Non-interest expense:
                               
Administrative expenses
    (49 )     (49 )     (98 )     (94 )
Provision for credit losses
    (7 )     (1 )     (16 )     (4 )
REO operations expense
                       
LIHTC partnerships
    (108 )     (135 )     (225 )     (243 )
Other non-interest expense
    (5 )     (8 )     (9 )     (12 )
                                 
Total non-interest expense
    (169 )     (193 )     (348 )     (353 )
                                 
Segment Earnings (loss) before income tax benefit
    (47 )     (78 )     (126 )     (97 )
LIHTC partnerships tax benefit
    149       135       298       273  
Income tax benefit
    16       27       44       33  
                                 
Segment Earnings, net of taxes
    118       84       216       209  
Reconciliation to GAAP net income:
                               
Derivative-related adjustments
    (3 )     (7 )     (14 )     (8 )
Credit guarantee-related adjustments
    (4 )     (2 )     (4 )     (2 )
Tax-related adjustments
    2       3       6       4  
                                 
Total reconciling items, net of taxes
    (5 )     (6 )     (12 )     (6 )
                                 
GAAP net income
  $ 113     $ 78     $ 204     $ 203  
                                 
Key metrics — Multifamily:
                               
Balances and Growth:
                               
Average balance of Multifamily loan portfolio(1)
  $ 62,706     $ 47,016     $ 60,759     $ 46,418  
Average balance of Multifamily guarantee portfolio(1)
    13,209       7,762       12,274       7,908  
Purchases — Multifamily loan portfolio(1)
    4,189       2,409       8,252       5,528  
Purchases — Multifamily guarantee portfolio(1)
    1,105       106       3,487       126  
Liquidation rate — Multifamily loan portfolio (annualized rate)
    7.9 %     12.4 %     6.9 %     13.8 %
Credit:
                               
Delinquency rate(2)
    0.04 %     0.05 %     0.04 %     0.05 %
Allowance for loan losses
  $ 78     $ 31     $ 78     $ 31  
(1)  Based on unpaid principal balance.
(2)  Based on net carrying value of mortgages 90 days or more delinquent or in foreclosure.
 
Segment Earnings for our Multifamily segment increased $34 million, or 40%, for the three months ended June 30, 2008 compared to the three months ended June 30, 2007 primarily due to a decrease in non-interest expense. LIHTC losses decreased $27 million for the three months ended June 30, 2008 compared to the three months ended June 30, 2007. Provision for credit losses for our Multifamily segment increased $6 million for the three months ended June 30, 2008 compared to the three months ended June 30, 2007, primarily due to a slight increase in the amount of impaired loans in the second quarter of 2008. Loan purchases into the Multifamily loan portfolio were $4.2 billion for the three months ended June 30, 2008, a 74% increase compared to the three months ended June 30, 2007, as we continue to provide stability and liquidity for the financing of rental housing nationwide.
 
Segment Earnings for our Multifamily segment increased $7 million, or 3%, for the six months ended June 30, 2008 compared to the six months ended June 30, 2007 primarily due to higher LIHTC partnership tax benefit and income tax benefit, higher non-interest income and lower non-interest expense, partially offset by a decrease in net interest income. LIHTC partnership tax benefit increased $25 million for the six months ended June 30, 2008 compared to the six months ended June 30, 2007 as we began to see the benefit from new fund investments entered into during 2007. There have been no new LIHTC investments in 2008. Provision for credit losses for our Multifamily segment increased $12 million for the six months ended June 30, 2008 compared to the six months ended June 30, 2007. The net interest income of this segment declined $44 million for the six months ended June 30, 2008, compared to the six months ended June 30, 2007 due to significantly lower yield maintenance fee income on declines in loan refinancing activity. Loan purchases into the Multifamily loan portfolio were $8.3 billion for the six months ended June 30, 2008, a 49% increase when compared to the six months ended June 30, 2007.
 
            32 Freddie Mac


Table of Contents

 
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.
 
Retained 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 and the Government National Mortgage Association, or Ginnie Mae, and other financial institutions. We refer to these investments that are recorded on our consolidated balance sheet as our retained portfolio.
 
Table 15 provides detail regarding the mortgage loans and mortgage-related securities in our retained portfolio.
 
Table 15 — Characteristics of Mortgage Loans and Mortgage-Related Securities in our Retained Portfolio
 
                                                 
    June 30, 2008     December 31, 2007  
    Fixed
    Variable
          Fixed
    Variable
       
    Rate     Rate     Total     Rate     Rate     Total  
    (in millions)  
 
Mortgage loans:
                                               
Single-family(1)
                                               
Conventional:(2)
                                               
Amortizing
  $ 23,621     $ 1,128     $ 24,749     $ 20,461     $ 1,266     $ 21,727  
Interest-only
    379       814       1,193       246       1,434       1,680  
                                                 
Total conventional
    24,000       1,942       25,942       20,707       2,700       23,407  
RHS/FHA/VA
    1,253             1,253       1,182             1,182  
                                                 
Total single-family
    25,253       1,942       27,195       21,889       2,700       24,589  
Multifamily(3)
    59,743       4,085       63,828       53,114       4,455       57,569  
                                                 
Total mortgage loans
    84,996       6,027       91,023       75,003       7,155       82,158  
                                                 
PCs and Structured Securities:(1)(4)
                                               
Single-family
    314,483       96,779       411,262       269,896       84,415       354,311  
Multifamily
    267       2,378       2,645       2,522       137       2,659  
                                                 
Total PCs and Structured Securities
    314,750       99,157       413,907       272,418       84,552       356,970  
                                                 
Non-Freddie Mac mortgage-related securities:(1)
                                               
Agency mortgage-related securities:(5)
                                               
Fannie Mae:
                                               
Single-family
    37,273       35,434       72,707       23,140       23,043       46,183  
Multifamily
    661       134       795       759       163       922  
Ginnie Mae:
                                               
Single-family
    429       163       592       468       181       649  
Multifamily
    49             49       82             82  
                                                 
Total agency mortgage-related securities
    38,412       35,731       74,143       24,449       23,387       47,836  
                                                 
Non-agency mortgage-related securities:
                                               
Single-family:
                                               
Subprime(6)
    464       85,160       85,624       498       100,827       101,325  
Alt-A and other(7)
    3,466       44,105       47,571       3,762       47,551       51,313  
Commercial mortgage-backed securities
    25,452       39,386       64,838       25,709       39,095       64,804  
Obligations of states and political subdivisions(8)
    13,251       48       13,299       14,870       65       14,935  
Manufactured housing(9)
    1,192       201       1,393       1,250       222       1,472  
                                                 
Total non-agency mortgage-related securities(10)
    43,825       168,900       212,725       46,089       187,760       233,849  
                                                 
Total unpaid principal balance of retained portfolio
  $ 481,983     $ 309,815       791,798     $ 417,959     $ 302,854       720,813  
                                                 
Premiums, discounts, deferred fees, impairments of unpaid principal balances and other basis adjustments
                    383                       (655 )
Net unrealized losses on mortgage-related securities, pre-tax
                    (30,853 )                     (10,116 )
Allowance for loan losses on mortgage loans held-for-investment
                    (468 )                     (256 )
                                                 
Total retained portfolio per consolidated balance sheets
                  $ 760,860                     $ 709,786  
                                                 
  (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)  Includes $1.6 billion and $2.2 billion as of June 30, 2008 and December 31, 2007, respectively, of mortgage loans categorized as Alt-A due solely to reduced documentation standards at the time of loan origination. Although we do not categorize our single-family loans into prime or subprime, we recognize that certain of the mortgage loans in our retained portfolio exhibit higher risk characteristics. Total single-family loans include $1.3 billion at both June 30, 2008 and December 31, 2007, of loans with higher-risk characteristics, which we define as loans with original LTV ratios greater than 90% and borrower credit scores less than 620 at the time of loan origination. See “CREDIT RISKS — Mortgage Credit Risk — Table 37 — Characteristics of Single-Family Mortgage Portfolio” for more information on LTV ratios and credit scores.
  (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 AAA-rated or equivalent.
 
            33 Freddie Mac


Table of Contents

  (6)  Single-family non-agency mortgage-related securities backed by subprime residential loans include significant credit enhancements, particularly through subordination. For information about how these securities are rated, see “Table 16 — Investments in Available-for-Sale Non-Agency Mortgage-Related Securities backed by Subprime Loans and Alt-A and Other Loans in our Retained Portfolio,” “Table 22 — Ratings of Available-For-Sale Non-Agency Mortgage-Related Securities backed by Subprime Loans at June 30, 2008” and “Table 23 — Ratings of Available-For-Sale Non-Agency Mortgage-Related Securities backed by Subprime Loans at June 30, 2008 and July 28, 2008.”
  (7)  Single-family non-agency mortgage-related securities backed by Alt-A and other mortgage loans include significant credit enhancements, particularly through subordination. For information about how these securities are rated, see “Table 16 — Investments in Available-For-Sale Non-Agency Mortgage-Related Securities backed by Subprime Loans and Alt-A and Other Loans in our Retained Portfolio,” “Table 24 — Ratings of Available-For-Sale Non-Agency Mortgage-Related Securities backed by Alt-A and Other Loans at June 30, 2008” and “Table 25 — Ratings of Available-For-Sale Non-Agency Mortgage-Related Securities backed by Alt-A and Other Loans at June 30, 2008 and July 28, 2008.”
  (8)  Consist of mortgage revenue bonds. Approximately 61% and 67% of these securities held at June 30, 2008 and December 31, 2007, respectively, were AAA-rated as of those dates, based on the lowest rating available.
  (9)  At June 30, 2008 and December 31, 2007, 33% and 34%, respectively, of mortgage-related securities backed by manufactured housing bonds were rated BBB− or above, based on the lowest rating available. For the same dates, 93% of manufactured housing bonds had credit enhancements, including primary monoline insurance that covered 23% of the manufactured housing bonds. At June 30, 2008 and December 31, 2007, we had secondary insurance on 73% and 72% of these bonds that were not covered by the primary monoline insurance, respectively. Approximately 3% and 28% of these mortgage-related securities were backed by manufactured housing bonds AAA-rated at June 30, 2008 and December 31, 2007, respectively, based on the lowest rating available.
(10)  Credit ratings for most non-agency mortgage-related securities are designated by no fewer than two nationally recognized statistical rating organizations. Approximately 75% and 96% of total non-agency mortgage-related securities held at June 30, 2008 and December 31, 2007, respectively, were AAA-rated as of those dates, based on the lowest rating available.
 
The unpaid principal balance of our retained portfolio increased by $71.0 billion to $791.8 billion at June 30, 2008 compared to December 31, 2007. The unpaid principal balance of the mortgage-related securities held in our retained portfolio increased by $62.1 billion during the six months ended June 30, 2008, while the balance of mortgage loans increased by $8.9 billion over the same period. The overall increase in the unpaid principal balance of our retained portfolio was primarily due to more favorable investment opportunities for agency securities given a broad market decline driven by a lack of liquidity in the market during the latter half of the first quarter and continuing into the second quarter. In response, our net purchase activity increased considerably as we deployed capital at favorable OAS levels. As of March 1, 2008 the voluntary growth limit on our retained portfolio is no longer in effect. Additionally, our mandatory target capital surplus was reduced by OFHEO to 20% from 30% above our statutory minimum capital requirement on March 19, 2008.
 
Included in our retained portfolio are mortgage loans with higher risk characteristics and mortgage-related securities backed by subprime loans and Alt-A and other loans. Included in our Alt-A loans are monthly treasury average, or MTA, loans that are indexed to the moving average one-year Constant Maturity Treasury.
 
Single-Family Mortgage Loans Held in Our Retained Portfolio
 
We generally do not classify our investments in single-family mortgage loans within our retained portfolio as either prime or subprime; however, we recognize that there are mortgage loans in our retained portfolio with higher risk characteristics. We estimate that there are $1.3 billion at both June 30, 2008 and December 31, 2007, of loans with higher-risk characteristics, which we define as loans with original LTV ratios greater than 90% and FICO scores less than 620 at the time of loan origination.
 
Non-Agency Mortgage-Related Securities Backed by Subprime Loans
 
Participants in the mortgage market often characterize single-family loans based upon their overall credit quality at the time of origination, generally considering them to be prime or subprime. There is no universally accepted 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.
 
At June 30, 2008 and December 31, 2007, we held investments of $85.6 billion and $101.3 billion, respectively, of non-agency mortgage-related securities backed by subprime loans in our retained portfolio. In addition to the contractual interest payments, we receive substantial monthly remittances of principal repayments on these securities, which totaled more than $7 billion and $15 billion during the three and six months ended June 30, 2008, respectively, representing a return on our investment in these securities. These securities include significant credit enhancement, particularly through subordination, and 91% and 100% of these securities were investment grade at June 30, 2008 and December 31, 2007, respectively. Of the securities rated below investment grade by at least one rating agency, 87% are rated as investment grade by at least one other rating agency. The unrealized losses, net of tax, on these securities are included in AOCI and totaled $9.5 billion and $5.6 billion at June 30, 2008 and December 31, 2007, respectively. We believe that the declines in fair values for these securities are mainly attributable to decreased liquidity and larger risk premiums in the mortgage market.
 
Non-Agency Mortgage-Related Securities Backed by Alt-A and Other Loans
 
Many mortgage market participants classify single-family loans with credit characteristics that range between their prime and subprime categories as Alt-A. Although there is no universally accepted definition of Alt-A, industry participants have used this classification principally to describe loans for which the underwriting process has been streamlined in order to reduce the documentation requirements of the borrower or allow alternative documentation. We have classified these securities as Alt-A if the securities were labeled as Alt-A when sold to us or if we believe the underlying collateral includes
 
            34 Freddie Mac


Table of Contents

a significant amount of Alt-A loans. We have classified $47.6 billion and $51.3 billion of our single-family non-agency mortgage-related securities as Alt-A and other loans at June 30, 2008 and December 31, 2007, respectively. Of these securities $20.5 billion and $21.3 billion are backed by Alt-A MTA loans at June 30, 2008 and December 31, 2007, respectively. In addition to the contractual interest payments, we receive substantial monthly remittances of principal repayments on these Alt-A and other securities, which totaled more than $2 billion and $4 billion during the three and six months ended June 30, 2008, respectively, representing a return on our investment in these securities. We have focused our purchases on credit-enhanced, senior tranches of these securities, which provide additional protection due to subordination. Of these securities, 98% and 100% were investment grade at June 30, 2008 and December 31, 2007, respectively. The unrealized losses, net of tax, on these securities are included in AOCI and totaled $7.3 billion and $1.7 billion at June 30, 2008 and December 31, 2007, respectively. We believe the declines in fair values for these securities are mainly attributable to decreased liquidity and larger risk premiums in the mortgage market.
 
Table 16 provides an analysis of investments in available-for-sale non-agency mortgage-related securities backed by subprime loans and Alt-A and other loans in our retained portfolio at June 30, 2008.
 
Table 16 — Investments in Available-For-Sale Non-Agency Mortgage-Related Securities backed by Subprime Loans and Alt-A and Other Loans in our Retained Portfolio
 
                                                                 
    As of June 30, 2008                                
    Unpaid
          Gross
                            Current
 
    Principal
    Amortized
    Unrealized
    Collateral
    Original
    June 30, 2008
    Current
    Investment
 
Non-agency mortgage-related securities backed by:
  Balance     Cost     Losses     Delinquency(1)     % AAA(2)     % AAA     % AAA(3)     Grade(4)  
    (dollars in millions)                                
 
Subprime loans:
                                                               
First lien
  $ 84,720     $ 84,332     $ (14,290 )     31 %     100 %     55 %     55 %     91 %
Second lien
    892       729       (307 )     9 %     100 %                 58 %
                                                                 
Total non-agency mortgage-related securities, backed by subprime loans
  $ 85,612     $ 85,061     $ (14,597 )     31 %     100 %     55 %     55 %     91 %
                                                                 
Alt-A and other loans:
                                                               
Alt-A
  $ 43,093     $ 42,869     $ (9,879 )     15 %     100 %     98 %     94 %     97 %
Other(5)
    4,478       4,479       (1,382 )             100 %     19 %     19 %     89 %
                                                                 
Total non-agency mortgage-related securities, backed by Alt-A and other loans
  $ 47,571     $ 47,348     $ (11,261 )             100 %     91 %     87 %     97 %
                                                                 
 
(1)  Determined based on loans that are 60 days or more past due that underlie the securities and based on servicing data reported for June 30, 2008.
(2)  Reflects the composition of the portfolio that was AAA-rated as of the date of our acquisition of the security, based on the lowest rating available.
(3)  Reflects the AAA-rated composition of the securities as of July 28, 2008, based on the lowest rating available.
(4)  Reflects the composition of these securities with credit ratings BBB- or above as of July 28, 2008, based on unpaid principal balance and the lowest rating available.
(5)  Includes securities backed by FHA/VA mortgage, home-equity lines of credit and other residential loans.
 
            35 Freddie Mac


Table of Contents

Table 17 summarizes amortized cost, estimated fair values and corresponding gross unrealized gains and gross unrealized losses for available-for-sale securities and estimated fair values for trading securities by major security type held in our retained portfolio.
 
Table 17 — Available-for-Sale Securities and Trading Securities in our Retained Portfolio
 
                                 
          Gross
    Gross
       
          Unrealized
    Unrealized
       
    Amortized Cost     Gains     Losses     Fair Value  
June 30, 2008   (in millions)  
 
Retained portfolio:
                               
Available-for-sale mortgage-related securities:
                               
Freddie Mac
  $ 287,354     $ 1,855     $ (3,731 )   $ 285,478  
Subprime
    85,061             (14,597 )     70,464  
Commercial mortgage-backed securities
    64,874       28       (3,565 )     61,337  
Alt-A and other
    47,348       8       (11,261 )     36,095  
Fannie Mae
    44,647       375       (348 )     44,674  
Obligations of states and political subdivisions
    13,320       43       (776 )     12,587  
Manufactured housing
    1,070       100       (48 )     1,122  
Ginnie Mae
    422       19       (1 )     440  
                                 
Total available-for-sale mortgage-related securities
  $ 544,096     $ 2,428     $ (34,327 )   $ 512,197  
                                 
Trading mortgage-related securities:
                               
Freddie Mac
                          $ 129,844  
Fannie Mae
                            29,490  
Ginnie Mae
                            201  
Other
                            59  
                                 
Total trading mortgage-related securities
                          $ 159,594  
                                 
 
                                 
December 31, 2007                        
 
Retained portfolio:
                               
Available-for-sale mortgage-related securities:
                               
Freddie Mac
  $ 346,569     $ 2,981     $ (2,583 )   $ 346,967  
Subprime
    101,278       12       (8,584 )     92,706  
Commercial mortgage-backed securities
    64,965       515       (681 )     64,799  
Alt-A and other
    51,456       15       (2,543 )     48,928  
Fannie Mae
    45,688       513       (344 )     45,857  
Obligations of states and political subdivisions
    14,783       146       (351 )     14,578  
Manufactured housing
    1,149       131       (12 )     1,268  
Ginnie Mae
    545       19       (2 )     562  
                                 
Total available-for-sale mortgage-related securities
  $ 626,433     $ 4,332     $ (15,100 )   $ 615,665  
                                 
Trading mortgage-related securities:
                               
Freddie Mac
                          $ 12,216  
Fannie Mae
                            1,697  
Ginnie Mae
                            175  
Other
                            1  
                                 
Total trading mortgage-related securities
                          $ 14,089  
                                 
 
                                 
June 30, 2007                        
 
Retained portfolio:
                               
Available-for-sale mortgage-related securities:
                               
Freddie Mac
  $ 342,309     $ 852     $ (7,852 )   $ 335,309  
Subprime
    118,670       66       (57 )     118,679  
Commercial mortgage-backed securities
    56,664       53       (1,903 )     54,814  
Alt-A and other
    55,828       49       (413 )     55,464  
Fannie Mae
    42,894       213       (835 )     42,272  
Obligations of states and political subdivisions
    14,063       145       (234 )     13,974  
Manufactured housing
    1,102       130       (2 )     1,230  
Ginnie Mae
    617       14       (9 )     622  
                                 
Total available-for-sale mortgage-related securities
  $ 632,147     $ 1,522     $ (11,305 )   $ 622,364  
                                 
Trading mortgage-related securities:
                               
Freddie Mac
                          $ 10,401  
Fannie Mae
                            1,476  
Ginnie Mae
                            198  
                                 
Total trading mortgage-related securities
                          $ 12,075  
                                 
 
At June 30, 2008, our gross unrealized losses on available-for-sale mortgage-related securities were $34.3 billion. The main components of these losses are gross unrealized losses of $29.4 billion related to non-agency mortgage-related securities backed by subprime, Alt-A and other loans and commercial mortgage-backed securities. We believe that these unrealized losses on non-agency mortgage-related securities at June 30, 2008, were principally a result of decreased liquidity and larger risk premiums in the non-agency mortgage market. All securities in an unrealized loss position are evaluated to determine if the impairment is other-than-temporary. The evaluation of these securities considers all available information, including cash flow analyses based on default and prepayment assumptions.
 
            36 Freddie Mac


Table of Contents

Other-Than-Temporary Impairments
 
Of our $212.7 billion in non-agency mortgage-related securities in our available-for-sale portfolio at June 30, 2008, we have identified securities backed by subprime and Alt-A and other loans with $2.3 billion of unpaid principal balance that are probable of incurring a contractual principal or interest loss due to significant recent deterioration in the performance of the underlying collateral of these securities and risk related to the performance of credit enhancements related to one monoline insurer where we have determined that it is both probable a principal and interest shortfall will occur on the insured securities and that in such a case, there is substantial uncertainty surrounding the insurer’s ability to pay all future claims. As such, we realized impairment losses on these securities of $826 million, which were determined to be other-than-temporary. The recent deterioration has not impacted our ability and intent to hold these securities. We estimate that the future expected principal and interest shortfall on these securities will be significantly less than the impairment loss required to be recorded under GAAP, as we expect these shortfalls to be less than the recent fair value declines. The portion of the impairment charges associated with these expected recoveries will be accreted back through net interest income in future periods.
 
While it is possible that under certain conditions, defaults and severity of losses on our remaining available-for-sale securities for which we have not recorded an impairment charge could exceed our subordination and credit enhancement levels and a principal or interest loss could occur, we do not believe that those conditions were probable at June 30, 2008. Based on our ability and intent to hold our remaining available-for-sale securities for a sufficient time to recover all unrealized losses and our consideration of all available information, we have concluded that the reduction in fair value of these securities was temporary at June 30, 2008. These assessments require significant judgment and are subject to change as the performance of the individual securities changes, mortgage conditions evolve and our assessments of future performance are updated. Furthermore, different market participants could arrive at materially different conclusions regarding the likelihood of various default and severity outcomes and these differences tend to be magnified for nontraditional products such as Alt-A MTA loans.
 
The above impairment charges and unrealized losses do not have a significant impact on our liquidity and capital resources. See “LIQUIDITY AND CAPITAL RESOURCES” for a discussion of our sources of liquidity.
 
The evaluation of unrealized losses on our available-for-sale portfolio for other-than-temporary impairment contemplates numerous factors. We perform an evaluation on a security-by-security basis considering all available information. Important factors include the length of time and extent to which the fair value of the security has been less than book value; the impact of changes in credit ratings (i.e., rating agency downgrades); our intent and ability to retain the security in order to allow for a recovery in fair value; and an analysis of cash flows based on default and prepayment assumptions of the underlying collateral. Implicit in the cash flow analysis is information relevant to expected cash flows (such as collateral performance and characteristics) that also underlies the other impairment factors mentioned above, and we qualitatively consider all available information when assessing whether an impairment is other-than-temporary. The relative importance of this information varies based on the facts and circumstances surrounding each security, as well as the economic environment at the time of assessment. Based on the results of this evaluation, if it is determined that the impairment is other-than-temporary, the carrying value of the security is written down to fair value, and a loss is recognized through earnings. We consider all available information in determining the recovery period and anticipated holding periods for our available-for-sale securities. Because we are a portfolio investor, we generally hold available-for-sale securities in our retained portfolio to maturity. An important underlying factor we consider in determining the period to recover unrealized losses on our available-for-sale securities is the estimated life of the security. Since our available-for-sale securities are prepayable, the average life is far shorter than the contractual maturity.
 
We have concluded that the unrealized losses included in Table 17 are temporary since we have the ability and intent to hold the securities to recovery. These conclusions are based on the following analysis, which is conducted on a quarterly basis and is subject to change as new information regarding delinquencies, severities, timing of losses, prepayment rates and other factors becomes available.
 
Freddie Mac and Fannie Mae Securities
 
These securities generally fit into one of two categories:
 
Unseasoned Securities — These securities are utilized for resecuritization transactions. We frequently resecuritize agency securities, typically unseasoned pass-through securities. In these resecuritization transactions, we typically retain an interest representing a majority of the cash flows, but consider the resecuritization to be a sale of all of the securities for purposes of assessing if an impairment is other-than-temporary. As these securities have generally been recently acquired, they generally have coupon rates and prices close to par, so any decline in the fair value of these agency securities is relatively small. This means that the decline could be recovered easily, and we expect that the recovery period would be in the near term. Notwithstanding this, we recognize other-than-temporary impairments on any of these securities that are likely to be sold. This population is identified based on our expectations of resecuritization volume and our eligible collateral. If any of the
 
            37 Freddie Mac


Table of Contents

securities identified as likely to be sold are in a loss position, other-than-temporary impairment is recorded because management cannot assert that it has the intent to hold such securities to recovery. Any additional losses realized upon sale result from further declines in fair value subsequent to the balance sheet date. For securities that are not likely to be sold, we expect to recover any unrealized losses by holding them to recovery.
 
Seasoned Securities — These securities are not usually utilized for resecuritization transactions. We hold the seasoned agency securities that are in an unrealized loss position at least to recovery. Typically, we hold all seasoned agency securities to maturity. As the principal and interest on these securities are guaranteed and we have the ability and intent to hold these securities, any unrealized loss will be recovered.
 
The unrealized losses on agency securities are primarily a result of movements in interest rates.
 
Non-Agency Mortgage-Related Securities
 
We believe the unrealized losses on our non-agency mortgage-related securities are primarily a result of decreased liquidity and larger risk premiums. With the exception of the other-than-temporarily impaired securities discussed previously, we have not identified any securities that were probable of incurring a contractual principal or interest loss at June 30, 2008. As such, and based on our ability and intent to hold these securities for a period of time sufficient to recover all unrealized losses, we have concluded that the impairment of these securities was temporary.
 
Our review of the securities backed by subprime and Alt-A and other loans includes cash flow analyses of the individual securities based on underlying collateral performance, including the collectibility of amounts that would be recovered from monoline insurers. In the case of monoline insurers, we also consider certain qualitative factors such as the availability of capital, generation of new business, pending regulatory action, ratings, security prices, credit default swap levels traded on the insurers and our own cash flow analysis. In order to determine whether securities are other-than-temporarily impaired, these analyses use assumptions about the losses likely to result from the underlying collateral that are currently more than 60 days delinquent and then evaluate what percentage of the remaining collateral (that are current or less than 60 days delinquent) would have to default to create a loss. The future default rate, severity and prepayment assumptions required to realize a loss are evaluated for probability of occurring. If these assumptions are probable, considering all other factors, the impairment is judged to be other than temporary.
 
We perform a stress test based on the key assumptions in the above analyses to determine whether we would receive our contractual payments on these securities in adverse credit environments. These tests simulate the distribution of cash flows from the underlying loans to the securities that we hold considering different default rate and severity assumptions. In evaluating each scenario, we use numerous assumptions (in addition to the default rate and severity assumptions), including, but not limited to the timing of losses, prepayment rates, the collectability of excess interest and interest rates that could materially impact the results. These tests are performed on a security-by-security basis for all of our securities backed by subprime and Alt-A and other loans. We have concluded that the assumptions required for us to not receive all of our contractual cash flows on any one security, with the exception of the impaired securities previously discussed, were not probable at June 30, 2008. These assessments require judgment and other parties could arrive at different conclusions as to the probability of losses occurring.
 
In evaluating our non-agency mortgage-related securities backed by subprime and Alt-A and other loans for other-than-temporary impairment, we noted and specifically considered that the percentage of securities that were AAA-rated and the percentage that were investment grade had decreased since acquisition and had decreased between the latest balance sheet date and the release of these financial statements. We expect this trend to continue for the remainder of 2008. Although the ratings have declined, the ratings themselves have not been determinative that a loss is probable. According to Standard & Poor’s, or S&P, a security may withstand up to 115% of S&P’s base case loss assumptions and still receive a BB, or below investment grade, rating. In performing this evaluation, the cash flow analyses indicate that it is not probable that we will not receive all of our contractual cash flows. While we consider credit ratings in our analysis, we believe that our detailed security-by-security cash flow analyses provide a more consistent view of the ultimate collectibility of contractual amounts due to us. As such, we have impaired securities with current ratings ranging from B to AAA. See Tables 22 through 25 for the ratings of our non-agency mortgage-related securities backed by subprime and Alt-A and other loans.
 
Furthermore, we consider significant declines in fair value between June 30, 2008 and July 28, 2008 to assess if they were indicative of potential future cash shortfalls. In this assessment, we put greater emphasis on categorical pricing information rather than security-by-security prices. Based on our review, default levels and actual severity experienced were within the range of outcomes considered during our June 30, 2008 impairment analysis. Based on our cash flow analyses, and given that we have the ability and intent to hold these securities to recovery, we determined that any further declines in fair value did not result in the impairment being other-than-temporary.
 
While the result of these analyses further supports our conclusions that the levels of defaults and severities necessary to create principal and interest shortfalls are not currently probable on substantially all of our holdings, we have identified 23 uninsured securities with $1.3 billion of unpaid principal balance that we have judged probable of incurring a contractual
 
            38 Freddie Mac


Table of Contents

principal or interest loss due to significant recent deterioration in the performance of the underlying collateral of these securities. In addition, we have identified 7 securities with $950 million of unpaid principal balance with credit enhancements that included monoline insurance where we have determined that it is not probable that the monoline insurer will have the ability to pay all future claims should a principal or interest shortfall occur and that absent such coverage a principal loss is likely to occur. As such, we realized impairment losses on these securities of $826 million, which were determined to be other-than-temporary during the second quarter of 2008. Our analysis is conducted on a quarterly basis and is subject to change as new information regarding delinquencies, severities, loss timing, prepayments and other factors becomes available. Our non-agency mortgage-related securities have not yet experienced significant cumulative losses and our credit enhancement levels continue to increase on most of our holdings. While it is possible that under certain conditions, defaults and loss severities on the remaining securities could reach or even exceed the levels used for our stress test scenarios and a principal or interest loss could occur on certain individual securities, we do not believe that those conditions are probable as of June 30, 2008.
 
Hypothetical stress test scenarios on our investments in non-agency mortgage-related securities backed by first lien subprime loans
 
For our non-agency mortgage-related securities backed by first lien subprime loans, we use several default rate and severity stress test scenarios including those disclosed in Table 18 — Investments in Available-For-Sale Non-Agency Mortgage-Related Securities Backed by First Lien Subprime Loans. The stress test analysis included in the table below has been enhanced to run different stress default rates on various subcomponents of the portfolio in response to the deteriorating credit environment and liquidity concerns in the market. We divided the portfolio into delinquency quartiles and ran the most stressful default rates on the quartiles with the highest levels of current delinquencies. The stress default and severity assumptions that would indicate a potential loss are more severe than what we believe are probable based on our judgment related to both current delinquency and severity experience and historical data.
 
While the more stressful scenarios are beyond what we currently believe are probable, this table gives insight into the potential economic losses in very stressful conditions. Our most severe default rate for our worst quartiles and severity assumptions for all quartiles are 70% and 65%, respectively, for these securities. As disclosed on Table 18, even in our most severe stress test scenarios, our potential losses are only 3% of our total non-agency mortgage-related securities, backed by first lien subprime loans. However, current mortgage market conditions are unprecedented and actual default and severity experience could differ from our expectations. Furthermore, different market participants could arrive at different conclusions regarding the likelihood of various default and severity outcomes. Current collateral delinquency rates presented in Table 18 averaged 31% for first lien subprime loans, with asset-backed securities indices, or ABX, average first lien severities approximating 48%. There are several differences in the characteristics of the securities in our portfolio as compared to the ABX. For example, the pass-through securities in our portfolio reflect the entirety of the underlying AAA cash flows while only a portion of the underlying AAA cash flows backs the securities in the ABX.
 
Table 18 provides the summary results of the default rate and severity stress test scenarios for our investments in available-for-sale non-agency mortgage-related securities backed by first lien subprime loans at June 30, 2008. In addition to the stress tests scenarios, Table 18 also displays underlying collateral performance and credit enhancement statistics, by vintage and quartile of credit enhancement level. Within each of these quartiles, there is a distribution of both credit enhancement levels and delinquency performance, and individual security performance will differ from the cohort as a whole. Furthermore, some individual securities with lower subordination could have higher delinquencies. The projected economic losses presented in each stress test scenario represent the cash losses we may experience given the related assumptions. However, these amounts do not represent the other-than-temporary impairment charge that would result under the given scenario. Any other-than-temporary impairment charges would vary depending on the fair value of the security at that point in time.
 
            39 Freddie Mac


Table of Contents

Table 18 — Investments in Available-For-Sale Non-Agency Mortgage-Related Securities Backed by First Lien Subprime Loans
 
                                                                                         
        June 30, 2008  
                    Credit Enhancements Statistics                                      
        Underlying Collateral Performance           Minimum
    Stress Test Scenarios(4)  
    Delinquency
  Unpaid Principal
          Average Credit
    Current
    Default
    Severity     Default
    Severity  
Acquisition Date
  Quartile   Balance     Collateral Delinquency(1)     Enhancement(2)     Subordination(3)     Rate     55     65     Rate     55     65  
        (dollars in millions)  
 
2004 & Prior
    1     $ 338       12 %     52 %     21 %     45 %   $     $       50 %   $     $  
2004 & Prior
    2       333       18       52       22       50                   55              
2004 & Prior
    3       307       21       65       24       50                   60              
2004 & Prior
    4       322       31       63       17       55                   65             1  
                                                                                     
2004 & Prior subtotal
          $ 1,300       20       58       17             $     $             $     $ 1  
                                                                                     
2005
    1     $ 4,053       25       53       34       45     $     $       50     $     $  
2005
    2       3,918       33       58       37       50                   55              
2005
    3       3,957       37       51       29       50                   60             2  
2005
    4       3,802       44       54       21       55             1       65       2       6  
                                                                                     
2005 subtotal
          $ 15,730       34       54       21             $     $ 1             $ 2     $ 8  
                                                                                     
2006
    1     $ 8,019       29       29       20       50     $     $ 5       55     $     $ 62  
2006
    2       8,335       34       31       19       50                   60       2       80  
2006
    3       8,213       38       31       20       55             31       65       55       254  
2006
    4       8,599       45       33       20       65             9       70       33       353  
                                                                                     
2006 subtotal
          $ 33,166       37       31       19             $     $ 45             $ 90     $ 749  
                                                                                     
2007
    1     $ 7,989       13       31       21       50     $     $ 3       55     $     $ 25  
2007
    2       8,149       23       28       20       50             11       60       46       264  
2007
    3     </