Freddie Mac 2004 Annual Report Download - page 179

Securities that were accounted for as sales under SFAS 125/140. In connection with the derivation of such
gains (losses), Freddie Mac has:
‚ developed and consistently applied a methodology for determining the order in which to record
extinguishments of GOs and the recognition of retained interests because PCs within an individual
CUSIP are fungible in nature;
‚ de-recognized for Ñnancial statement purposes the carrying value of the sold portion of securitized
assets as of the end of the month in which a sale has occurred; and
‚ recorded extinguishments of GOs as of the beginning of the month in which the purchase of
corresponding PCs or Structured Securities has occurred.
Key Valuation Assumptions Associated with Recognized GAs, GOs, Credit Enhancements and PC
Residuals that Correspond to PCs or Structured Securities Backed by Single-Family Mortgages
Freddie Mac recognizes GAs and GOs for PCs backed by residential mortgage loans and multifamily
mortgage loans in conjunction with transfers accounted for as sales under SFAS 125/140 as well as, beginning
on January 1, 2003, transactions that do not qualify as sales, but are accounted for as guarantees pursuant to
the requirements of FIN 45. At December 31, 2004 and 2003, GAs totaled $4,516 million and $3,686 million
on Freddie Mac's consolidated balance sheets and of these amounts, approximately $88 million (or
approximately 2 percent) and $24 million (or less than 1 percent), respectively, related to guarantees of
multifamily mortgage loans. Consequently, the following discussion of key valuation assumptions and
corresponding sensitivity analysis of recognized GAs, GOs, credit enhancements and PC residuals focuses
solely on PCs and Structured Securities backed by single-family mortgage loans.
Recognized GAs
Fair values of recognized GAs were calculated using an expected cash Öow approach. SpeciÑcally, Monte
Carlo simulations were used to project monthly prepayment and default rates across 300 house price and
interest rate scenarios. Through December 31, 2002, Monte Carlo simulations were also used to project
monthly loss severity rates because recognized GAs for those periods included the fair value of pool insurance,
recourse and indemniÑcations. As discussed in ""NOTE 1: SUMMARY OF SIGNIFICANT ACCOUNT-
ING POLICIES,'' Freddie Mac discontinued the inclusion of these credit enhancements as components of
recognized GAs eÅective January 1, 2003 and monthly loss severity rates are no longer included as part of
Monte Carlo simulations used to project future cash Öows associated with GAs. Monte Carlo projections were
used to forecast GA-related future cash Öows associated with approximately 360,000, 330,000 and 210,000
groups of mortgage loans for 2004, 2003 and 2002, respectively, that are distinguished based upon diÅering
combinations of various loan attributes (these groups of loans are referred to as ""Loan Group''). Freddie Mac
then discounted their forecasted cash Öows using factors that were derived from modeled forward interest rates
(for each scenario path) to which Freddie Mac then applied a trailing average option-adjusted spread of up to
24 months that was based on spot interest-only security prices. The trailing average option-adjusted spreads
ranged between 127 and 313 basis points from January 1, 2004 to December 31, 2004, and between 313 and
766 basis points from January 1, 2003 to December 31, 2003.
Based upon the foregoing, Freddie Mac recognized as GAs the average of the present value of the GA-
related cash Öows generated for each Loan Group for each of the referenced scenarios. EÅective January 1,
2003, Freddie Mac modiÑed the composition of GA-related cash Öows used to derive fair value as a result of
changes to its accounting policies (which are further described in ""NOTE 1: SUMMARY OF SIGNIFI-
CANT ACCOUNTING POLICIES'').
Recognized GOs
GOs are recognized at fair value at the inception of an executed guarantee. The fair value of a GO
constitutes a component of the valuation of a PC residual (where a recognized PC residual is eÅectively
equivalent to the net fair value of the underlying GA and GO). Like the cash Öows associated with recognized
GAs, GO-related future cash Öows associated with each referenced Loan Group are estimated using Monte
Freddie Mac
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