Freddie Mac 2005 Annual Report Download - page 46

resulting in a move of pay-Ñxed swaps with a notional balance of approximately $108 billion from the cash Öow hedge
designation to no hedge designation. We also voluntarily discontinued hedge accounting treatment for a signiÑcant amount of
our receive-Ñxed interest-rate swaps eÅective November 1, 2004, resulting in a move of receive-Ñxed swaps with a notional
balance of approximately $50 billion from fair value hedge designation to no hedge designation. EÅective at the beginning
of the second quarter of 2005, we voluntarily discontinued hedge accounting treatment for all new forward purchase
commitments and the majority of our new commitments to forward sell mortgage-related securities. In addition, eÅective
March 31, 2006, we voluntarily discontinued hedge accounting treatment for all derivatives, with the exception of certain
commitments to forward sell mortgage-related securities and one foreign-currency hedge strategy. We believe that our
voluntary discontinuation of hedge accounting treatment for these derivatives assists us in addressing the operational
complexity and related control remediation eÅorts that would otherwise be needed to ensure ongoing compliance with the
requirements for obtaining and maintaining hedge accounting treatment. We may consider implementing new hedge
accounting strategies in the future.
Derivative Gains (Losses)
Derivative gains (losses) are aÅected by the change in the fair value of and the accrual of periodic settlements of all
derivatives not in hedge accounting relationships. We experienced signiÑcant income volatility due to changes in the fair
values of our derivatives and changes in the composition of our portfolio of derivatives not in hedge accounting relationships,
particularly due to the discontinuation of hedge accounting treatment described above. Table 13 provides a summary of the
period-end notional amounts and the gains and losses related to swaptions, swaps and other derivatives that we used to
manage interest-rate risk, but were not accounted for in hedge accounting relationships.
Table 13 Ì Derivatives Not in Hedge Accounting Relationships
Year Ended December 31,
2005 2004 2003
Derivative Derivative Derivative
Gains Gains Gains
Notional (Losses) Notional (Losses) Notional (Losses)
(in billions)
Call swaptions ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $146.6 $(0.4) $189.9 $ 0.4 $216.9 $(0.6)
Put swaptions ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 34.7 0.2 25.2 (1.4) 123.1 (0.3)
Receive-Ñxed swapsÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 81.2 (1.5) 25.6 (0.4) 13.8 (0.2)
Pay-Ñxed swaps ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 181.6 0.6 95.0 (0.8) 47.1 2.8
Other(1)(2) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 123.5 0.1 286.8 (0.6) 395.4 (0.7)
Subtotal ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 567.6 (1.0) 622.5 (2.8) 796.3 1.0
Accrual of periodic settlements(3) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (0.4) (1.7) (1.0)
Total ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $567.6 $(1.4) $622.5 $(4.5) $796.3 $ Ì
(1) Other consists of basis swaps, certain option-based contracts, futures, foreign-currency swaps, interest-rate caps, commitments, derivatives held as part
of our external Money Manager program (in 2003) and other derivatives not accounted for in hedge accounting relationships, including credit
derivatives, swap guarantee derivatives and a prepayment management agreement.
(2) Derivative gains (losses) in each period include gains or losses reclassiÑed from AOCI, net of taxes, as a result of the termination of cash Öow hedge
designations because we determined that the related forecasted transactions are probable of not occurring.
(3) Composed of receive-Ñxed swaps of $0.4 billion and $0.1 billion and pay-Ñxed swaps of $(0.8) billion and $(1.8) billion for the years ended
December 31, 2005 and 2004, respectively.
During 2005, long-term and short-term interest rates generally rose, with short-term interest rates increasing more
signiÑcantly than long-term interest rates. These interest-rate movements caused our pay-Ñxed swaps, which are primarily
long-term, to increase in fair value and our receive-Ñxed swaps, which are primarily short-term, to decrease in fair value.
The accrual of periodic settlements declined during 2005 compared to 2004 because interest accruals related to our pay-
Ñxed and receive-Ñxed swaps not in qualifying hedge accounting relationships largely oÅset one another during 2005, but
only did so for the later part of 2004, following the discontinuation of hedge accounting discussed above.
During 2004, we experienced net losses on our call and put swaption positions as the fair values of these positions were
driven down by changes in swap rates and the decline in implied volatilities of interest rates (i.e., the market's expectation of
potential changes in future interest rates). During 2004, a large portion of our pay-Ñxed swaps not in hedge accounting
relationships were forward-starting. Generally, spot and forward rates move in tandem. However, in the fourth quarter of
2004 forward rates declined, ending the year lower than the prior year-end, whereas spot rates increased, ending the year at
roughly the same level as the prior year-end. The net loss on our pay-Ñxed portfolio for 2004 was caused by the overall
decline in forward rates.
The movement of the pay-Ñxed and receive-Ñxed swaps to no hedge designation at diÅerent dates during 2004 was the
primary cause of the increase in the accrual of periodic settlements recorded in Derivative gains (losses) as compared to
2003. Had these pay-Ñxed and receive-Ñxed swaps remained in hedge accounting relationships, the related accrual of
periodic settlements would have instead been reported as a component of Net interest income (loss). The increase in the
30 Freddie Mac