Freddie Mac 2004 Annual Report Download - page 90

We generally do not hedge changes in the fair value of our existing credit guarantee portfolio, with two
exceptions discussed below. While periodic changes in the fair value of the guarantee portfolio may have a
signiÑcant impact on the fair value of net assets, we believe that changes in the fair value of our existing
guarantee portfolio are not the best indication of long-term fair value expectations because such changes do
not reÖect the strong probability that over time, replacement business will largely replenish guarantee fee
income lost because of prepayments.
We hedge interest rate exposure related to net buy-ups (up-front payments made by us that increase the
guarantee fee that we will receive over the life of the pool) and Öoat (expected gains or losses resulting from
our mortgage security program remittance cycles). These value changes are excluded from our estimate of the
change in fair value of the guarantee portfolio, so that it reÖects only the impact of changes in interest rates
and other market factors on the unhedged portion of the projected cash Öows from the credit guarantee
business. The value changes associated with net buy-ups and Öoat are considered in return on risk positions
(deÑned above) because they relate to hedged positions.
Fee income
Fee income includes miscellaneous fees, such as resecuritization fees, fees generated by our automated
underwriting service and delivery fees on some mortgage purchases.
Discussion of Fair Value Results
We believe fair value measures provide an important view of our business economics and risks because
fair value takes a consistent approach to the representation of all Ñnancial assets and liabilities, rather than an
approach that combines historical cost and fair value techniques, as is the case with our GAAP-based
consolidated Ñnancial statements. The consolidated fair value balance sheet is an important component of our
risk management processes as we use daily estimates of the changes in fair value to calculate our PMVS and
duration gap measures.
At December 31, 2004, the fair value of net assets (net of tax eÅect) was $30.9 billion, a $3.6 billion, or
13 percent, increase from December 31, 2003. For the same period, the fair value of net assets attributable to
common stockholders (representing the fair value balance sheet total net assets less the fair value of net assets
attributable to preferred stockholders) was $26.8 billion, a $3.9 billion, or 17 percent, increase from
December 31, 2003. The fair value of net assets attributable to common stockholders, before common
dividends and capital transactions, increased by $4.7 billion, or 21 percent, from December 31, 2003, a return
that exceeds our long-term expectations.
The primary contributors to the increase in fair value of net assets in 2004 were core spread income from
the Retained portfolio, fee-based income (including guarantee fees and credit fees related to our PCs and
Structured Securities) and a gain in the fair value of our guarantees related to our outstanding PCs and
Structured Securities. The fair value increase also included gains resulting from tighter mortgage-to-debt
option-adjusted spreads. In 2004, we made improvements to our fair value estimation methodologies,
including reÑnements that better capture available market data relevant to determining the fair value of our
debt. The implementation of these improvements resulted in net increases in the fair value of total net assets
of approximately $0.6 billion (after-tax).
The most signiÑcant change occurred in the fourth quarter of 2004 when we began using newly available
market prices received from broker/dealers and reliable third-party providers for the valuation of a greater
portion of our debt instruments. Previously, the calculation of the fair value of these instruments was based
primarily on an internal model using available market inputs. The eÅect of the change was an increase of
approximately $0.4 billion (after-tax) to the fair value of net assets.
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