Mortgage Funding A letter from: Mark Hanson Vice President, Mortgage Funding Dear Freddie Mac Investor: Softness in the U. S. housing market and the downturn in the subprime market were at the forefront of the news in the first half of 2007. One of the main areas of focus has been the slowdown in house prices. While Freddie Mac s Conventional Mortgage Home Price Index (CMHPI) showed modest house price appreciation 4.4 percent for the 12 months ending March 31, 2007 it is important to remember that slower house price appreciation comes after a period of unprecedented appreciation between 2003 and 2005, when the average home in the U.S. gained approximately 27 percent in value. Additionally, while the subprime market has drawn a lot of attention over the last couple of months, at the end of 2006, Freddie Mac had basically no subprime exposure in our guarantee business, and about $124 billion of AAA rated subprime exposure in our retained portfolio. With that said, we are concerned with the problems facing subprime borrowers and are committed to working with the industry to develop solutions for borrowers with impaired credit. We want to ensure that products are available to allow subprime borrowers to make prudent and responsible choices. We have already taken steps to assist with the subprime issue. In February, we announced that we would no longer buy subprime mortgages that pose an unacceptable risk of excessive payment shock and possible foreclosure. Additionally, with many subprime borrowers with ARM mortgages facing payment increases this year, we announced in April that we would purchase up to $20 billion of fixed-rate and hybrid ARM products that are being developed to limit payment shock and provide lenders with more and safer choices to offer subprime borrowers. While the housing market does face some near term challenges, it appears that the troubles in the subprime market are having little impact on the prime mortgage market. With all of the focus on the housing market, and especially house prices and homeowner refinance activity, we continue to explore ways to provide information to help investors understand trends in the housing market. In an effort to provide additional information on house prices, we have expanded our CMHPI disclosure to include a purchase-only series, which we will explore in more detail in this issue. We will also explore additional disclosures we are providing to assist in understanding the refinance behavior of homeowners. We will review the cash-out refinance data that we disclose, as well as the publication of the refinance product transition report to help track the loan products borrowers select when they refinance their first-lien mortgage. As the market continues to change, we continue to pursue improvements and enhancements to our product offerings to better serve our investors. As such, we recently announced and issued our first calendar based Strip. The calendar based Strip is intended to increase the demand for our Gold PCs through greater predictability, greater transparency and broader distribution. In this issue, we will explore the features of the calendar based Strip in greater detail. We recognize that our investors are the key to Freddie Mac s success in fulfilling our housing mission. We remain committed to better serving you, the investors in our securities, as we serve the mortgage markets as a whole. We thank you for your continued interest and support. Very truly yours, Mark Hanson IN THIS ISSUE n Freddie Mac Expands Mortgage Market Data and Enhances Product Offerings During Challenging Market Environment n Volumes & Distribution
Freddie Mac Expands Mortgage Market Data and Enhances Product Offerings During Challenging Market Environment The first half of 2007 was a very challenging period in the U.S. housing and mortgage markets. The housing market impacts the macro economy through many channels and has therefore garnered a great deal of focus amid slowing house price growth, increasing inventories, rising mortgage rates and the downturn in the subprime market. Indeed, the housing sector directly shaved 0.8 percentage points off real economic growth in the first quarter, compared to the 1.2 percentage points it cut from growth in the second half of 2006, and many economists worry that slowing home price growth will diminish the ability of households to finance consumption expenditures through home-equity extraction. In an effort to provide investors and dealers additional insight into the attributes of refinanced loans, Freddie Mac s Office of the Chief Economist issues two reports on a quarterly basis the Cash-out Refinance Report and the newly added Refinance Product Transition Report. A new series was also added to the Conventional Mortgage Home Price Index (CMHPI) that is based only on home-purchase transactions, offering another view of the dynamics of home price changes for the nation and the nine Census divisions. As the market continues to evolve, we remain focused on creating and enhancing our product offerings to satisfy the needs of a broad range of investors. Our recent enhancement to our Strip program is one such enhancement. The calendar based Strip is intended to increase the demand for Gold PCs through greater predictability, greater transparency and broader distribution. Cash-out Refinance Report In 2006, as house price growth slowed in many sections of the United States and mortgage rates began to rise, the refinance share of mortgage originations hovered right around 50 percent and averaged an estimated 52 percent in the first quarter of 2007. Additionally, homeowners didn t just refinance into a new loan, they continued to extract equity from their homes throughout 2006 and into 2007. Of the Freddie Mac owned loans that were refinanced during the first quarter of 2007, 82 percent refinanced into new mortgages with loan amounts that were at least five percent higher than the balance of the original mortgage balance. This cash-out refinance activity translates into just over $70 billion in equity converted to cash during the first quarter, down from $77 billion extracted during the fourth quarter of 2006. Homeowners have continued to cash-out equity for a couple of reasons. To begin with, the current rate of house price appreciation is not what determines if a cash-out is a feasible option for a homeowner, but rather the cumulative gain that has occurred since the loan was originated. Homeowners benefited from robust price gains in 2004 and 2005 and in aggregate have $10.9 trillion in equity invested in their homes. The low level of long-term interest rates also provides an incentive to homeowners for cash-out refinancing. Rates on 30-year fixed-rate mortgages averaged 6.2 percent in the first quarter of 2007, allowing many homeowners to use cash-out refinance proceeds to pay off higher-cost debt or fund new purchases and investments.
The Cash-out Refinance Report examines how the loan balances have changed between the original loan and the new refinanced loan including: n The percentage of refinanced loans that have at least a five percent higher loan amount than the loan paid off n The median ratio of the old interest rate to the new interest rate n The median age of the refinanced paid-off loan A total of six product categories are included in the report: n 1-year adjustable-rate mortgages (ARMs) n Hybrid ARMs n Balloon mortgages n 15-year fixed-rate mortgages n 20- and 25-year fixed-rate mortgages n 30-year fixed rate mortgages n The median appreciation of the refinanced property n The aggregate volume of equity converted to cash in the conventional prime market and the share of the new loan balances due to equity conversion n The aggregate volume by which total loan balances increased through refinances Freddie Mac discloses quarterly and annual cash-out statistics on its Web site at www.freddiemac.com/ news/finance/refi_archives.htm. The cash-out report is released early in the second month of each quarter and provides statistics on the prior quarter s activity. The Refinance Product Transition Report The Refinance Product Transition Report provides the distribution of loan products that borrowers selected when they refinanced their existing first-lien mortgage. The report shows for each type of loan initially held by borrowers, what proportion of borrowers kept the same product or opted for a different one. The estimates come from a sample of properties on which Freddie Mac has funded at least two successive loans. Transactions are further screened to verify that the latest loan is for refinance rather than for home purchase. Where applicable, data includes amortizing as well as interest-only or option-payment loans. During the first quarter of 2007, borrowers who originally had an adjustable-rate or balloon mortgage and then refinanced into a 30-year mortgage, decreased compared to the fourth quarter of 2006. See Exhibit 1. However, 82 percent of borrowers originally holding a 30-year fixed-rate mortgage refinanced back into the same product, compared to 81 percent in the fourth quarter of 2006, and 77 percent in the first quarter of 2006. See Exhibit 2. The Refinance Product Transition Report is available on Freddie Mac s Web site at www.freddiemac.com/ news/finance/refi_archives.htm. Freddie Mac currently provides the report on an annual basis for the period 1990 through 2006 and on a quarterly basis from first quarter 2002 through first quarter 2007. The Refinance Product Transition Report is published approximately 40 days after the end of each quarter. Exhibit 1 Percentage of adjustable-rate mortgages transitioning to 30-year fixed-rate mortgages 75 70 65 60 55 50 45 1Q2006 2Q2006 3Q2006 4Q2006 1Q2007 1-year ARM Hybrid ARM
Exhibit 2 30-year fixed-rate mortgage loans refinanced into the same product Percent 83 82 81 80 79 78 77 76 82 81 78 78 77 75 74 1Q2006 2Q2006 3Q2006 4Q2006 1Q2007 The CMHPI data both classic and purchase-only series are available on Freddie Mac s Web site at www. FreddieMac.com/finance/cmhpi and is released at the beginning of March, June, September and December. Exhibit 3 Conventional and Purchase-only CMHPI Statistics by Census Division Percent 10.0 8.0 Annual Change Q1 2006 Q1 2007 8.9 8.0 6.0 Conventional Mortgage Home Price Index Freddie Mac s Conventional Mortgage Home Price Index (CMHPI) provides a measure of typical price appreciation for houses within the United States. Jointly developed by Freddie Mac and Fannie Mae and first published by Freddie Mac in 1994, the CMHPI is constructed using regression techniques from observations of actual sales prices or appraised values of the same homes over time. The report relies on data from both purchase and refinance-appraisal transactions and provides the index values and growth rates for the nation as a whole as well as for the nine Census divisions, the 50 states and the District of Columbia, and 392 metropolitan statistical areas (MSAs) and metropolitan divisions. With the release of the first quarter 2007 home price growth results, Freddie Mac announced that its CMHPI now features a new purchase-transaction only series for the nation and nine Census divisions. See Exhibit 3. The classic CMHPI index can lag market trends because the refinance transactions are based on appraisals, which take into account previous sales for comparable valuations. The benefit of the purchaseonly series is that it is based solely on market transactions. However, we view both the classic and purchase-transaction only series as valuable tools for research on trends in housing markets, and due to the large sample sizes required for statistical robustness, the purchase-transaction only series is not reliable for smaller geographic areas. 4.0 2.0 (2.0) (4.0) Pacific West South South Mountain Atlantic East South Conventional CMHPI Middle Atlantic Calendar Based Strip Issuance West North New England Purchase-only CMHPI East North The United States In June, Freddie Mac launched an enhanced Strip offering designed to provide dealers and investors with predictable, calendar based Strip issuance opportunities. Our first transaction a $3.0 billion, 30-year, 5.5% security received broad interest in the market. The expansion of our existing Strip issuance program is intended to increase the demand for Gold PCs through greater predictability, greater transparency and broader distribution. See Exhibit 4 for additional details for the product offering. The offering calendar for these Strips will be pre-announced. For the remainder of this year, we expect to offer calendar based Strip issuance opportunities in September and December. If issuance activity and market interest warrants additional offering periods, we would consider increasing the frequency of the offering periods to monthly.
The calendar based Strips will have a longer marketing period than our existing Strip issuances, beginning on the first business day of the month and lasting through the close of business six days prior to the Securities Industry and Financial Markets Association (SIFMA) Regular Date (Reg Date). See Exhibit 5 for sample deal issuance timeline. Additional information about the enhanced Strip offering is available on Freddie Mac s Web site at www.freddiemac. com/mbs/docs/calendar_based_strip_issuance.pdf. Exhibit 4 Calendar Based Strip Details Calendar Based Strip Details Minimum Deal Size $2 Billion Maximum Deal Size Determined by Freddie Mac on a transaction specific basis and based on estimated collateral availability Minimum Number of Dealers Per Transaction Six (6) Maximum Single Dealer Allocation 25% if the established minimum deal size until the minimum deal size and minimum number of dealers has been met. Thereafter, 50% of maximum deal size. In the event orders are received in excess of the maximum deal size, Freddie Mac will allocate with a preference for orders from end investors. Offered Coupons Collateral Stipulations Transaction Fees As determined by Freddie Mac in consultation with the dealer community. Expect to offer the two on-the-run coupons closest to par. As determined by Freddie Mac in consultation with the dealer community. Preference would be no Stips/TBA delivery. ½ tick issuance fee (due diligence fee paid by Freddie Mac) Free combinations into/out of IO/PO and the underlying Giant PC for the life of the deal 1/32 nd fee for all floater/inverse combinations outside of the standard 90-day free period Order Status All orders are final. Downsizing of orders will not be permitted. All orders must include account type, order type and geographic information. Order for dealer retention are permitted. Exhibit 5 Example of Issuance Timing 1 st Business Day of the Month June 1 Announcement of offered coupons, deal min/max size, collateral Stips (if any) and transaction fees Reg Date 5 Business Days June 5 9 am: Order books open Noon: Order books close Reg Date June 12 Reg Date Reg Date + 5 Business Days June 19 Collateral lists due Reg Date + 6 Business Days June 20 Collateral delivery / Giant formation Reg Date + 10 Business Days June 26 Strip settlement day
Volumes & Distribution Total Guaranteed PCs & Structured Securities Activity (In $ Millions) Full Year 2006 YTD PC Issuance YTD Liquidations Net PC Activitiy Total Single-Family $ 1,468,610 $ 191,499 $ (95,759) $ 95,740 $ 1,564,350 CONVENTIONAL 30-year fixed rate (1) 949,293 127,118 (51,831) 75,287 1,024,580 15-year fixed rate (2) 290,325 8,100 (20,789) (12,689) 277,636 ARMs (3) 100,814 7,290 (10,202) (2,912) 97,902 Interest Only (4) 76,116 48,781 (6,338) 42,443 118,559 Option ARMs (5) 2,808 - (456) (456) 2,352 Balloons/resets (2) 21,553 26 (1,888) (1,862) 19,691 STRUCTURED SECURITIZATIONS (ALTERNATIVE COLLATERAL OR T DEALS) Structured Securities Backed by Option ARMs (6) 18,546 - (3,186) (3,186) 15,360 Structured Securities Backed by Ginnie Mae Certificates 1,510 40 (129) (89) 1,421 Other (7) 6,247 - (729) (729) 5,518 FHA/VA FHA/VA (8) 1,398 144 (211) (67) 1,331 Total Multifamily 8,413 56 (743) (687) 7,726 Total Guaranteed PCs & Structured Securities Issued $ 1,477,023 $ 191,555 $ (96,502) $ 95,053 $ 1,572,076 YTD May (9) FOOTNOTES: 2007 (1) Also includes 40- and 20-year fixed-rate mortgages and Rural Housing Service (RHS) (2) Includes RHS (3) Includes ARMs with 1-, 3-, 5-, 7- and 10-year initial fixed-rate periods and RHS (4) Represents loans where the borrower pays interest only for a period of time before the borrower begins making principal payments (5) Includes Whole Loan REMICs (6) Includes Negative Amortization (7) Includes Structured Securities backed by non-agency securities, which were backed by a mixture of prime and subprime mortgage loans (8) Excludes Federal Housing Administration and Veterans Affairs loans that may be collateral for alternative collateral deals and includes RHS (9) Estimate subject to change Resecuritization Activity (In $ Millions) REMICs (10) Reference REMICs (11) Strips Alternative Collateral (T-deals) Net Structured Resecuritizations Giant PCs (12) Total Total 2004 $ 203,725 - $ 4,500 $ 7,205 $ 215,430 $ 49,370 $ 264,800 Total 2005 $ 179,479 $ 6,440 $ 17,150 $ 5,374 $ 208,443 $ 157,389 $ 365,832 Total 2006 $ 121,498 $ 16,575 $ 21,500 $ 8,591 $ 168,164 $ 186,867 $ 355,031 FOOTNOTES: (10) Includes Whole Loan REMICs (11) Only includes the Guaranteed Final Maturity class; other classes are included in the REMICs column (12) Excludes MultiLender Giants (13) Estimate subject to change January 5,100 - - - 5,100 22,242 27,342 February 8,020 1,605 - - 9,625 20,737 30,362 March 10,964 - - - 10,964 22,728 33,692 April 10,693 1,600 6,000-18,293 26,214 44,507 May 12,446 1,600 - - 14,046 18,706 32,752 YTD 2007 (13) $ 47,223 $ 4,805 $ 6,000 - $ 58,028 $ 110,627 $ 168,655 Reference REMIC Investor Type Distribution Reference REMIC Geographical Distribution Investment Manager 38% Other 4% Bank 27% N. America 62% Europe 1% Asia 37% Insurance & Pension 14% Bank 17% Other < 1% As of May 31, 2007 As of May 31, 2007 FOR MORE INFORMATION: Freddie Mac Funding & Investor Relations 1551 Park Run Drive, McLean, Virginia 22102 USA Robin Phillips, Director (571) 382-4393 Amy Crews Cutts, Director (703) 903-2321 Chau Pham, Analyst (571) 382-4513 is not an offer to sell any Freddie Mac securities. Offers for any given security are made only through applicable offering circulars and related supplements, which incorporate Freddie Mac s information statement and related supplements. 2007 by Freddie Mac. Information from this document may be used with proper attribution. Alteration of this document is strictly prohibited.