Freddie Mac 2004 Annual Report Download - page 175

entities in accordance with other applicable requirements under GAAP. Finally, the company also has
signiÑcant variable interests in certain variable interest entities that are not consolidated because the company
is not the primary beneÑciary. See ""NOTE 3: VARIABLE INTEREST ENTITIES'' for more information
concerning variable interest entities.
Accounting For Financial Guarantees Ì EÅective January 1, 2003, Freddie Mac adopted FIN 45 and
FASB StaÅ Position FIN 45-2, ""Whether FASB Interpretation No. 45, "Guarantor's Accounting and
Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others,' Provides
Support for Subsequently Accounting for a Guarantor's Liability at Fair Value'' (""FSP FIN 45-2''). FIN 45
requires that Freddie Mac recognize the fair value of the company's obligation to guarantee the payment of
principal and interest on PCs and other mortgage pass-through certiÑcates that are issued by the company that
are transferred to third parties. Such guidance also requires that the company recognizes the fair value of any
consideration received in connection with the execution of such guarantees, which primarily includes the
company's contractual right to receive guarantee fees. In consideration of FSP FIN 45-2, eÅective January 1,
2003, Freddie Mac subsequently measures that portion of recognized guarantee obligations that relates to the
company's non-contingent obligation to stand ready to perform using a systematic and rational method of
amortization, while the company's contingent obligation to make payments under executed guarantees is
accounted for pursuant to the requirements of SFAS 5. The implementation of FIN 45 and other such
accounting changes in 2003 had a signiÑcant impact on Freddie Mac's accounting for PC guarantees.
Additionally, on January 1, 2003, Freddie Mac reclassiÑed $110 million to Reserve for guarantee losses on
Participation CertiÑcates representing that portion of recognized guarantee obligations that was attributable to
estimated incurred losses on outstanding PCs or Structured Securities on that date.
Accounting For Credit Enhancements Ì EÅective January 1, 2003, Freddie Mac no longer measures
recognized credit enhancements on a fair value basis subsequent to the initial recognition of the credit
enhancement. This change was made in conjunction with the change in the method by which recognized
guarantee obligations are subsequently measured for consolidated Ñnancial statement purposes. This change
necessitated a corresponding modiÑcation in the balance sheet classiÑcation of those credit enhancements that
were previously recognized as a component of GAs and PC residuals since recognized GAs and PC residuals
are subsequently measured on a fair value basis. In this regard, eÅective January 1, 2003, $189 million related
to credit enhancements was reclassiÑed to Other assets ($128 million from the GA and $61 million from PC
residuals) and, correspondingly, is amortized into earnings as a component of Other expenses at the greater of
amounts calculated by amortizing recognized credit enhancements (a) in proportion to the rate of unpaid
principal balance decline of covered mortgage loans or (b) on a straight-line basis over a credit enhancement
contract term. The implementation of FIN 45 also resulted in a change in when credit enhancements were
recognized for consolidated Ñnancial statement purposes. Based upon the view expressed in FIN 45 that
guarantee transactions constitute exchange transactions, Freddie Mac now recognizes the fair value of credit
enhancements as consideration received in connection with Guarantor and MultiLender Swap transactions
(and other, similar transactions) as of the issuance date of those PCs that were issued on or after January 1,
2003. Prior to January 1, 2003, Freddie Mac did not recognize credit enhancements for consolidated balance
sheet purposes until a PC or Structured Security to which such credit enhancements related was included in a
transfer that qualiÑed as a sale under SFAS 125/140.
Derivative Instruments and Hedging Activities Ì On July 1, 2003, Freddie Mac adopted SFAS No. 149
""Amendment of Statement 133 on Derivative Instruments and Hedging Activities'' (""SFAS 149'').
SFAS 149 amended and clariÑed the Ñnancial accounting and reporting for derivatives to incorporate
decisions made by the FASB and the FASB's Derivative Implementation Group subsequent to the original
issuance of SFAS 133 and in connection with other FASB projects. Under SFAS 149, purchase commitments
for certain loans to be classiÑed as held-for-investment must be accounted for as derivatives. The implementa-
tion of SFAS 149 did not have a material eÅect on the consolidated Ñnancial statements.
In September 2003, the OÇce of the Chief Accountant of the Securities and Exchange Commission
(""SEC'') published interpretive guidance on SFAS 133. To be consistent with the SEC guidance published at
that time, Freddie Mac is reporting the income statement eÅects of derivatives not currently designated in
hedge accounting relationships under SFAS 133 in a single line item on the company's consolidated
statements of income, Derivative gains (losses) for all periods presented. Prior to 2003, the accrual for
periodic cash settlements in accordance with the contractual terms of derivatives not in hedge accounting
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