Freddie Mac 2005 Annual Report Download - page 119

We recognize a PC residual in connection with PCs or Structured Securities held by us that (a) were previously
transferred to third parties as part of transactions that were accounted for either as sales or in a manner described above for
Guarantor Swap transactions (such that a Guarantee asset and Guarantee obligation was previously established for held
PCs or Structured Securities), (b) were formed from mortgage loans purchased through our Cash Window (""Cash Window
Purchases'') and that were never transferred to third parties, (c) were purchased by us from third parties in contemplation
of the related issuance of such PCs through the Guarantor Swap program or (d) relate to Buy-Ups paid in connection with
purchased PCs that had not previously been included as part of a transfer that was accounted for as a sale or as part of a
guarantee transaction that was accounted for like Guarantor Swaps as described above.
Like a recognized Guarantee asset, a PC residual is accounted for like a debt security and is classiÑed as either
available-for-sale or trading under SFAS 115. PC residuals relating to PCs or Structured Securities that were transferred to
third parties and for which a Guarantee asset and Guarantee obligation was recognized are accounted for like debt securities
that are classiÑed as trading. PC residuals relating to PCs held in portfolio that were formed from Cash Window Purchases
and that were never transferred to third parties are generally accounted for like debt securities that are classiÑed as available-
for-sale.
All changes in the fair value of PC residuals that are designated as trading are reÖected in earnings as a component of
Gains (losses) on investment activity. All changes in the fair value of PC residuals that are accounted for as available-for-
sale are reÖected as a component of Accumulated other comprehensive income (loss), net of taxes, or AOCI, a component
of Stockholders' equity. All cash received over the life of the underlying loans with respect to the Guarantee asset
component of the PC residuals is reÖected in earnings as a component of Net interest income.
Due to Participation CertiÑcate Investors
Timing diÅerences between our receipt of scheduled and unscheduled principal and interest payments from
seller/servicers on mortgages underlying PCs and the subsequent pass through of those payments on PCs owned by third-
party investors result in the liability Due to Participation CertiÑcate investors. In those cases, the PC balance is not reduced
for payments of principal received from seller/servicers in a given month until the Ñrst day of the next month and we do not
release the cash received (principal and interest) to the PC investor until the Ñfteenth day of that next month. We generally
invest the principal and interest amounts we receive in short-term investments from the time the cash is received until the
time we pay the PC investor. Interest income resulting from investment of principal and interest payments from
seller/servicers is reported in interest income.
For unscheduled principal prepayments, these timing diÅerences result in an expense accrual upon prepayment of the
underlying mortgage. This is because the related PCs continue to bear interest due to the PC investor at the PC coupon rate
from the date of prepayment until the date the PC security balance is reduced, while generally no interest is received from
the mortgage on that prepayment amount during that period. The expense recognized upon prepayment is reported in
Interest expense Ì Due to Participation CertiÑcate investors. We report PC coupon interest amounts relating to our
investment in PCs consistent with the accounting practices generally applied by third party investors in PCs. Accordingly,
the PC coupon interest on prepayments of a mortgage pending remittance on PCs held by us is reported as both Interest
Income Ì Mortgage-related securities in the Retained portfolio and Interest expense Ì Due to Participation CertiÑcate
investors. Scheduled and unscheduled principal payments received by us that relate to our investment in PCs are reported as
a reduction to our investment in PCs on the consolidated balance sheets.
Mortgage Loans
Mortgage loans that we may sell are classiÑed as held-for-sale. If we decide to retain a loan, the loan is transferred to the
held-for-investment portfolio. Loans transferred to the held-for-investment portfolio are transferred at lower of cost or
market. Lower-of-cost-or-market valuation adjustments relating to these loans are treated as basis adjustments and are
subsequently amortized into interest income over the period held. We recognize interest on mortgage loans on an accrual
basis, except when we believe the collection of principal or interest is doubtful.
Held-for-sale mortgages are reported at lower-of-cost-or-market, on a portfolio basis, with losses reported in Gains
(losses) on investment activity. Premiums and discounts on loans classiÑed as held-for-sale are not amortized during the
period that such loans are classiÑed as held-for-sale. For a description of how we determine the fair value of our held-for-sale
mortgage loans, see ""NOTE 16: FAIR VALUE DISCLOSURES.''
Mortgage loans that we have the ability and intent to hold for the foreseeable future or to maturity are classiÑed as held-
for-investment. These mortgage loans are reported at their outstanding principal balances, net of deferred fees (including
premiums and discounts). These deferred items are amortized into interest income over the estimated lives of the
mortgages using the eÅective interest method. We use actual prepayment experience and estimates of future prepayments to
103 Freddie Mac