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Freddie Mac Releases Fourth Quarter 2007 Financial Results

Introduces Accounting Changes and Expanded Disclosures
Company Reports Fourth Quarter Net Loss of $2.5 Billion or $3.97 Per Diluted Share
Returns to Timely Financial Reporting With Release of 2007 Annual Report

For Immediate Release
February 28, 2008
Contact: corprel@freddiemac.com
or (703) 903-3933

Summary

  • Fourth quarter net loss of $2.5 billion, or $3.97 per diluted share, and full-year net loss of $3.1 billion, or $5.37 per diluted share.
  • Estimated regulatory core capital was $37.9 billion at December 31, 2007.
  • Credit guarantee portfolio increased 17.7 percent, and retained portfolio grew 2.4 percent for the year.
  • Company demonstrates leadership in addressing subprime crisis through the purchase of approximately $43 billion in conventional conforming product originations to borrowers who otherwise might have been limited to subprime mortgages; helps nearly 47,000 families avoid foreclosure.
  • Company initiates use of Adjusted operating income, a non-GAAP financial measure, for evaluating financial performance of company and introduces new segment reporting.

McLean, VA – Freddie Mac (NYSE:FRE) today reported a net loss of $3.1 billion, or $5.37 per diluted common share, for the year ended December 31, 2007, compared to net income of $2.3 billion, or $3.00 per diluted common share, for 2006. For the fourth quarter of 2007, the net loss was $2.5 billion, or $3.97 per diluted common share, compared to a net loss of $401 million in the fourth quarter of 2006, or $0.73 per diluted common share.

"Today's economy represents one of the most severe housing downturns in American history, and our results reflect that difficult environment as well as Freddie Mac's steadfast commitment to its important mission of providing liquidity, stability and affordability to the U.S. housing finance system," said Richard F. Syron, Freddie Mac chairman and chief executive officer. "Throughout 2007, Freddie Mac worked tirelessly to protect distressed homeowners by stabilizing the conforming mortgage market and reducing mortgage foreclosures. In addition to leadership on behalf of homeowners, we are keenly focused on managing our business through this difficult cycle towards a stronger future. As a clear sign of our progress, we are gratified that today's release marks Freddie Mac's return to timely financial reporting, an accomplishment that would not have been possible without the terrific efforts of everyone on the Freddie Mac team."

Looking ahead to 2008, Syron commented, "We remain extremely cautious as we enter 2008. If the economy weakens substantially from here – a possibility for which we need to be prepared as a company – it will have a further negative effect on homeowners across the country and drive credit costs higher. However, we have taken the steps to add capital, tighten our management of credit risk and institute pricing policies that are more consistent with the risk we bear. These actions should help us build the business for the future."

"With our large capital raise in the fourth quarter, we boosted our surplus relative to OFHEO's 30 percent mandatory target capital surplus," said Buddy Piszel, chief financial officer. "In 2008, we will continue to prudently manage our capital, particularly given the outlook for continued weakening in the housing market."

"Likewise, today's release of our full-year 2007 financial results and annual report is significant as it marks Freddie Mac's return to timely financial reporting and is further evidence of the progress the company is making," Piszel said. "We have also enhanced our financial reporting to provide greater clarity and comparability through the adoption of new accounting policies and introduction of a supplemental non-GAAP financial metric, which we call Adjusted operating income. Today, we are presenting these enhancements – including detailed segment information on our Investments, Single-family Guarantee and Multifamily businesses – so as to provide investors with an expanded view of Freddie Mac's business performance."

Consistent with the company's efforts to improve the clarity and comparability of its financial reports, Freddie Mac has made two significant changes in its financial presentation – adoption of new accounting policies and an introduction of a supplemental non-GAAP financial metric. For a more detailed discussion, see the Appendix accompanying this release.

While the accounting methods the company applied before the changes are acceptable, Freddie Mac believes that the newly adopted accounting methods are preferable in that they significantly enhance the transparency and understandability of the company's financial results, promote uniformity in the accounting model for the credit risk retained in its primary credit guarantee business and better align revenue recognition to the release from economic risk of loss under its guarantee.

Effect of GAAP Accounting Policy Changes Related to the Guarantee Obligation

Effective December 31, 2007, the company changed its methods of accounting for its guarantee obligation and has retrospectively changed its prior years' financial results to reflect the new methods. See the Appendix for more detail. Except where indicated, the GAAP and Adjusted operating income financial information in this release is presented after giving effect to these changes. The table below shows the effects of such changes on the company's previously reported results for the three and nine months ended September 30, 2007.

 
Three Months Ended
September 30, 2007
Nine Months Ended
September 30, 2007
($ in millions) 
As Previously Reported
As Adjusted (1)
As Previously Reported
As Adjusted (1)
Net interest income
$987
$761
$2,938
$2,325
Management and guarantee income
520
718
1,454
1,937
Other non-interest income (loss)
(2,185)
(601)
(2,391)
(348)
Total revenues
(678)
878
2,001
3,914
Administrative expenses
(428)
(428)
(1,273)
(1,273)
Credit-related expenses
(1,248)
(1,423)
(1,777)
(2,148)
Other non-interest expense
(1,055)
(1,219)
(2,133)
(2,392)
Total expenses
(2,731)
(3,070)
(5,183)
(5,813)
Income (loss) before taxes
(3,409)
(2,192)
(3,182)
(1,899)
Income tax benefit
1,380
954
1,706
1,257
Net income (loss)
$ (2,029)
$ (1,238)
$ (1,476)
$ (642)
Estimated regulatory core capital(2)    
$ 34,643
$ 34,672

(1) Adjusted to give effect to the change in accounting methods for the guarantee obligation.
(2) At period end. Includes the net cumulative effect of accounting policy changes.

GAAP Results

 
Three Months Ended
($ in millions)  December 31, 2007 September 30, 2007(1)  December 31, 2006(1) 
Net interest income
$ 774
$ 761
$ 761
Management and guarantee income
698
718
635
Other non-interest income (loss)
(2,093)
(601)
(811)
Total revenues
(621)
878
585
Administrative expenses
(401)
(428)
(445)
Credit-related expenses
(912)
(1,423)
(182)
Other non-interest expense
(2,144)
(1,219)
(380)
Total expenses
(3,457)
(3,070)
(1,007)
Income (loss) before taxes
(4,078)
(2,192)
(422)
Income tax (expense) benefit
1,626
954
21
Net income (loss)
$ (2,452)
$ (1,238)
$ (401)
Estimated regulatory core capital (at period end)
$ 37,867
$ 34,672
$ 35,365

(1) Adjusted to give effect to the change in accounting methods for the guarantee obligation.

Net loss was $2.5 billion for the fourth quarter of 2007, compared to a loss of $1.2 billion for the third quarter of 2007. The majority of this increase in loss resulted from significant mark-to-market losses detailed below in the discussions of other non-interest loss and other non-interest expense. Without giving effect to the accounting changes for the company's guarantee obligation discussed above, the fourth quarter 2007 net loss would have been $3.7 billion.

The key components affecting the company's net loss for the fourth quarter of 2007 as compared to the third quarter of 2007 were:

Net interest income was $774 million for the fourth quarter, a slight increase from $761 million for the third quarter, primarily due to lower amortization expense, partially offset by lower average balances as the company managed the retained portfolio to the 30 percent mandatory target capital surplus.

Management and guarantee income on PCs and Structured Securities was $698 million for the fourth quarter, a slight decrease from $718 million for the third quarter, mainly driven by decreased amortization income.

Other non-interest loss increased to $2.1 billion in the fourth quarter, compared to a loss of $601 million for the third quarter. Included in the fourth quarter non-interest loss were mark-to-market losses of approximately $0.8 billion on the value of the company's credit guarantee asset and approximately $2.3 billion on the value of the company's derivatives portfolio, both due to the impact of declining long-term interest rates. The company expects to experience reduced volatility from mark-to-market effects on its guarantee asset and derivatives portfolio as a result of the adoption of SFAS No. 159, "The Fair Value Option for Financial Assets and Financial Liabilities, Including an amendment of FASB Statement No. 115" (SFAS 159) (see "Core Capital" below) and, to a lesser extent, the company's planned implementation of hedge accounting. See the Appendix for more detail on the adoption of SFAS 159.

Administrative expenses totaled $401 million for the fourth quarter, down from $428 million in the third quarter, primarily due to the reversal of previously accrued compensation expenses.

Credit-related expenses, consisting of provision for credit losses and real estate owned (REO) operations expense, were $912 million for the fourth quarter, compared to $1.4 billion for the third quarter. The provision for credit losses in the third and fourth quarter included amounts related to increased estimates of incurred losses on mortgage loans associated with higher default rates, an observed increase in delinquency rates and increases in severity of losses on a per-property basis, driven in part by the declines in home sales and home prices. The company expects credit-related expenses to remain high relative to recent periods and to vary from period to period as the U.S. housing market remains under pressure.

Total credit losses, consisting of net charge-offs plus REO operations expense, were $236 million for the fourth quarter, $126 million for the third quarter and $499 million for the full-year 2007. Realized credit losses were an annualized 5.4 basis points, 3.0 basis points and 3.0 basis points of the average total mortgage portfolio for the fourth quarter, the third quarter and full-year 2007, respectively. The company expects total credit losses to increase in 2008.

In addition, as a result of the continuing deterioration in the U.S. housing market, the company has revised its estimate of total credit losses for 2008 and 2009 to $2.2 billion and $2.9 billion, respectively.

Other non-interest expense for the fourth quarter was $2.1 billion, compared to $1.2 billion for the third quarter. Fourth quarter non-interest expense included losses on certain credit guarantees of $1.3 billion, compared to $392 million for the third quarter, primarily related to higher expected future credit costs reflected in the market-based valuations of the guarantee obligation associated with newly-issued PCs. The company expects that price increases, including the delivery fee increase effective in March 2008, may mitigate a portion of the losses on certain credit guarantees.

Also included in other non-interest expense for the fourth quarter were losses of $736 million on loans purchased out of PC pools, compared to losses of $649 million in the third quarter, largely due to a decline in the estimated fair value and an increase in the average unpaid principal balance per loan of non-performing loans purchased out of PC pools. The company announced in December 2007 certain operational changes for purchasing delinquent loans from PC pools. This action is expected to reduce the losses on loans purchased out of PC pools and result in a higher provision for credit losses associated with our PCs and Structured Securities.

During the fourth quarter, the company recognized $273 million in other non-interest income associated with the recapture of previously recognized market value losses on purchased loans due to either borrower payoffs or property fair values upon foreclosure that exceeded the carrying basis of the loan.

For a full discussion of year-over-year results, see “MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS – EXECUTIVE SUMMARY” of the company’s Information Statement and Annual Report dated February 28, 2008.

Core Capital

Estimated regulatory core capital was $37.9 billion at December 31, 2007, which represented an estimated $11.4 billion in excess of the company's regulatory minimum capital requirement, and an estimated $3.5 billion in excess of the 30 percent mandatory target capital surplus directed by the Office of Federal Housing Enterprise Oversight (OFHEO).

In order to manage to the 30 percent mandatory target capital surplus and improve business flexibility, during the fourth quarter of 2007, the company issued $6.0 billion of non-cumulative, perpetual preferred stock, reduced its common dividend by 50 percent and reduced the size of its cash and investments portfolio.

As a result of adopting SFAS 159, the company recognized a $1.0 billion after-tax increase to its beginning retained earnings, and estimated regulatory core capital, at January 1, 2008, above the estimated regulatory core capital it reported at December 31, 2007. See the Appendix for more detail on the adoption of SFAS 159.

Adjusted Operating Income Results

Freddie Mac has initiated a new method of managing and evaluating the financial performance of its business, resulting in three reportable segments, the results of which are reported using an Adjusted operating income approach, as discussed below. Prior to December 1, 2007, the company prepared its results as a single segment using GAAP-basis income. Adjusted operating income is a non-GAAP financial measure and should not be used as a substitute for GAAP. With the introduction of a segment-based Adjusted operating income metric, the company has added another measure in addition to its GAAP and fair value results that investors can use to evaluate the performance of the company. See the Appendix for a reconciliation of Adjusted operating income to net income (loss) in accordance with GAAP and other information about how the company uses Adjusted operating income and its limitations as a measure of financial performance for the company.

The company's reportable segments are set forth below. Certain activities that are not part of a segment are included in the All Other category.

  • Investments, which encompasses its investment activity in mortgage-related securities and single-family mortgage loans, and its activities related to the company's cash and non-mortgage-related securities investment portfolio.
  • Single-family Guarantee, which encompasses its credit guarantee activity for single-family mortgages.
  • Multifamily, which encompasses both its investment activity and its credit guarantee activity related to multifamily mortgages and its investments in low-income housing tax credit (LIHTC) partnerships.

Consolidated Results – Adjusted Operating Income

Total Adjusted operating income was $2.1 billion for the year ended December 31, 2007, compared with $3.9 billion for the year ended December 31, 2006. The year-over-year decline was primarily due to the $2.9 billion increase in the company's credit-related expenses.

Segment Results – Adjusted Operating Income

Investments

Adjusted Operating Income - Investments
Year Ended December 31,
($ in millions) 
2007
2006
2005
Net interest income
$3,626
$3,736
$4,117
Non-interest income (loss)
40
38
(74)
Non-interest expense:
 
 
 
Administrative expenses
(515)
(495)
(466)
Other non-interest expense
(31)
(31)
(63)
Income tax (expense)
(1,092)
(1,137)
(1,230)
Total Adjusted operating income 
$2,028
$2,111
$2,284

 

Adjusted operating income for the company's Investments segment declined in 2007 compared to 2006. During 2007, the company experienced higher funding costs for its retained portfolio as long-term debt interest expense increased, reflecting the replacement of maturing debt at higher yields, partially offset by lower amortization expense. Wider net mortgage-to-debt option-adjusted spreads (OAS) due to lower demand for mortgage-related securities, along with heightened market uncertainty, resulted in favorable investment opportunities in 2007. However, to manage to its 30 percent mandatory target capital surplus, the company reduced its average balance of interest earning assets.

Single-family Guarantee

Adjusted Operating Income - Single-family Guarantee
Year Ended December 31,
($ in millions) 
2007
2006
2005
Net interest income
$703
$556
$349
Non-interest income:
 
 
 
Management and guarantee income
2,889
2,541
2,341
Other non-interest income
117
159
78
Non-interest expense:
 
 
 
Administrative expenses
(806)
(815)
(767)
Provision for credit losses
(3,014)
(313)
(447)
REO operations expense
(205)
(61)
(40)
Other non-interest expense
(78)
(84)
(30)
Income tax (expense) benefit
138
(694)
(519)
Total Adjusted operating income (loss) 
$(256)
$1,289
$965


The company's Single-family Guarantee segment recorded an Adjusted operating loss of $256 million for the year ended December 31, 2007, compared to Adjusted operating income of $1.3 billion for the year ended December 31, 2006.

The increase in management and guarantee income in 2007 is primarily due to higher weighted average balances of guaranteed assets. This increase in management and guarantee income was offset by a $2.7 billion year-over-year increase in the segment provision for credit losses, due to continued credit deterioration in the single-family credit guarantee portfolio, primarily related to 2006 and 2007 loan originations. The mortgages in this portfolio that were originated in 2006 and 2007 have a higher number of loans transitioning from delinquency to foreclosure, higher delinquency rates and higher loss severities on a per-property basis.

Multifamily

Adjusted Operating Income - Multifamily
Year Ended December 31,
($ in millions) 
2007
2006
2005
Net interest income
$426
$479
$417
Non-interest income:
 
 
 
Management and guarantee income
59
61
59
Other non-interest income
24
28
19
Non-interest expense:
 
 
 
Administrative expenses
(189)
(182)
(151)
Provision for credit losses
(38)
(4)
(7)
REO operations expense
(1)
1
-
LIHTC partnerships
(469)
(407)
(320)
Other non-interest expense
(21)
(17)
(20)
LIHTC partnership tax benefits
534
461
365
Income tax benefit
73 
14 
1 
Total Adjusted operating income 
$398
$434
$363


Adjusted operating income for the company's Multifamily segment decreased in 2007 compared to 2006, primarily due to lower net interest income, higher provision for credit losses and higher LIHTC losses.

Net interest income for this segment declined slightly in 2007, compared to 2006, as higher funding costs more than offset the increase in the company's loan portfolio balances. The company experienced higher funding costs in 2007 compared to 2006, reflecting the replacement of maturing long-term debt that was issued at lower rates in prior years.

Despite market volatility and credit concerns in the single-family market, multifamily market fundamentals generally continued to display positive trends throughout 2007. Effective rents increased in the majority of areas and vacancy rates were stable, although likely to trend upward in 2008.

Mortgage purchases into the company's multifamily loan portfolio, which were at record levels, increased approximately 50 percent in 2007, to $18.2 billion from $12.1 billion in 2006. The unpaid principal balance of the company's multifamily loan portfolio increased to $57.6 billion at December 31, 2007 from $45.2 billion at December 31, 2006.

All Other

All Other includes corporate-level expenses not allocated to any of the company's reportable segments, such as costs associated with remediating its internal controls and near-term restructuring costs, and costs related to the resolution of certain legal matters and certain income tax items. All Other was a loss of $103 million for 2007.

Fair Value of Net Assets

The company's attribution of changes in fair value relies on models, assumptions, and other measurement techniques that evolve over time.

At December 31, 2007, the fair value of net assets was $12.6 billion, reflecting a net after-tax reduction of $19.2 billion from the December 31, 2006 level of $31.8 billion. This change in fair value of net assets reflects the impact of net cash flows received from guarantee activities; core spread income received from investment activities; the payment of preferred and common stock dividends; other capital transactions, including the issuance of $6 billion in preferred stock during the fourth quarter of 2007; and changes in fair value of assets and liabilities managed in the company's underlying businesses.

The company estimates that wider net mortgage-to-debt OAS resulted in a pre-tax reduction in fair value of $23.8 billion for the year ended December 31, 2007. In addition, the company estimates that a change in fair value of the net single-family guarantee asset and obligation resulted in a pre-tax reduction of $20.1 billion for the year ended December 31, 2007. See the Appendix for more detail on the company's fair value results.

Interest-Rate Risk Management

During 2007, Freddie Mac's interest-rate risk remained low with portfolio market value sensitivity (PMVS-L) averaging $261 million and duration gap averaging zero months, compared to $229 million and zero months, respectively, for full-year 2006.

Internal Controls

Remediation of the known material weaknesses and significant deficiencies in Freddie Mac's financial reporting process was a top corporate priority during 2007 and continues into 2008. The company believes the measures it has implemented during 2007 to remediate the material weaknesses in internal control over financial reporting have had a positive impact on its internal control over financial reporting. From January 1, 2007 to date, the company has:

  • Designed and implemented the controls it believes are necessary to remediate all known material weaknesses;
  • Remediated, through demonstration of the operating effectiveness of the controls implemented by the company, material weaknesses around adequacy of staffing; IT general controls over access to data, security administration and change management, but identified certain new significant deficiencies in IT general controls in connection with testing the controls implemented by the company;
  • Implemented new financial accounting applications for guarantee asset valuation in the fourth quarter of 2007 and for the company's entire mortgage-related securities portfolio and credit guarantees as of January 1, 2008;
  • Made several changes in its accounting policies that simplified its accounting processes (see “NOTE 20: CHANGES IN ACCOUNTING PRINCIPLES” to the company’s consolidated financial statements of its Information Statement and Annual Report dated February 28, 2008 for additional information on the company’s accounting changes); and
  • Substantially completed the business process design review through which the company assessed significant risks to the business processes that are important to its financial reporting process, identified the controls to mitigate those risks, and identified for remediation any deficiencies in the design of those controls.

Mission Activities

In 2007, Freddie Mac financed homes for approximately 3.6 million families. In addition to providing much needed liquidity, stability and affordability to the market, Freddie Mac has taken a leadership role in addressing some of the excesses of subprime lending, including taking early steps to enhance the level of underwriting standards in the market. The company exceeded its commitment to support consumer-friendly mortgages that provide better choices for borrowers by purchasing approximately $43 billion of conventional conforming mortgages that financed borrowers whose credit profiles might have otherwise relegated them to subprime financing. The company has consistently been at the forefront of efforts to help borrowers avoid foreclosure. Freddie Mac and its servicers helped nearly 47,000 borrowers avoid foreclosure and keep their homes in 2007. From time to time, Freddie Mac enters into mission related transactions with lower, or negative, expected economic returns as compared to typical transactions.

Additional Information

For more information, see the Appendix accompanying this release, the company’s Information Statement Supplement, including the Consolidated Financial Statements and Core Tables, dated February 28, 2008, a slide presentation, as well as a Summary of Adjusted Operating Income and two papers – A Comparison of House Price Measures and Analysis of Freddie Mac’s ABS Portfolio that will be available on the Investor Relations page of the company’s Web site at www.FreddieMac.com/investors.

Additional information about Freddie Mac and its business is also set forth in the company's Information Statement and Annual Report dated February 28, 2008, available on the Investor Relations page of the company's Web site at www.FreddieMac.com/investors. Printed copies of these documents may be obtained free of charge upon request from the company's Investor Relations department by writing or calling the company at shareholder@freddiemac.com, (703) 903-3883 or (800) 373-3343. Freddie Mac encourages all investors and interested members of the public to review these materials for a more complete understanding of the company's financial results and related disclosures.

Announcement of Conference Call and Webcast

Management will host a conference call discussing today's announcement at 1 p.m. Eastern Time today. Domestic investors should call 1-800-230-1074 and international investors can access the call at 612-288-0329. The conference call will be webcast live on the company's Web site. A telephone recording of this conference call will be available continuously beginning at approximately 5 p.m. Eastern Time on February 28, 2008 until midnight on March 13, 2008. To access this recording in the United States, call 1-800-475-6701 and use access code 909706. Outside of the United States, call 320-365-3844 and use access code 909706.

This press release contains forward-looking statements pertaining to management's current expectations as to the company's future business plans, capital management, remediation initiatives, returns on investments, results of operations and/or financial condition on a GAAP, Adjusted operating income, or fair value basis. Management's expectations for the company's future necessarily involve a number of assumptions, judgments and estimates, and various factors, including changes in market conditions, liquidity, mortgage-to-debt OAS, credit outlook, and the impacts of newly enacted legislation or regulations, could cause actual results to differ materially from these expectations. These assumptions, judgments, estimates and factors are discussed in the company's Information Statement and Annual Report dated February 28, 2008, which is available on the Investor Relations page of the company's Web site at www.FreddieMac.com/investors.

Freddie Mac is a stockholder-owned corporation established by Congress in 1970 to support homeownership and rental housing. Freddie Mac purchases single-family and multifamily residential mortgages and mortgage-related securities, which it finances primarily by issuing mortgage-related securities and debt instruments in the capital markets. Over the years, Freddie Mac has made home possible more than 50 million times, ensuring financing for one in six homebuyers and more than four million renters.

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