Freddie Mac 2005 Annual Report Download - page 48

were also aÅected by changes in the approach we use to estimate the fair values of our guarantee-related assets and
liabilities, which resulted in net pre-tax losses of $(78) million in the Ñrst quarter of 2005. In addition, PC residual losses in
2005 were aÅected by the impact of Hurricane Katrina, which increased the estimated future credit costs considered in the
valuation of the Guarantee obligation component of the PC residuals. In 2004, expected default costs declined due to
continued house price appreciation, generating gains, partially oÅset by declines in mortgage interest rates that reduced the
expected life of the Guarantee asset, generating losses. We recorded losses in 2003, primarily driven by reductions in
mortgage interest rates.
Gains (losses) on sale of mortgage loans
Gains and losses on the sale of mortgage loans are primarily determined based on the volume of mortgage loan sales and
interest rate movements from the time the loans are purchased until the time they are sold in any given period. Net gains on
sales of mortgage loans have declined since 2003 primarily due to the decline in the volume of loan sales as our guarantee
activities have trended toward a higher proportion of Guarantor Swap transactions as opposed to sales of mortgage loans
from our Retained portfolio. Net gains on the sales of mortgage loans from our Retained portfolio decreased in 2005 and
2004 from 2003 levels as the proceeds from such sales have declined to approximately $24 billion in 2005 from $31 billion
in 2004 and $84 billion in 2003 reÖecting the decline in volume.
Gains (losses) on sale of available-for-sale securities
Proceeds from the sale of available-for-sale securities totaled $95 billion, $86 billion and $144 billion during 2005, 2004
and 2003, respectively, and we recognized net gains during each year. Prior to 2005, we generated a large volume of these
sales through our SS&TG business unit and external Money Manager program, which ceased operations during the fourth
quarter of 2004. During 2005, our sales of available-for-sale securities were primarily from the Retained portfolio reÖecting
structuring activity designed to improve returns and to enhance liquidity by broadening the investor base for our mortgage-
related securities.
Total security impairments
Total security impairments for 2005 were $371 million. Of that amount, approximately $185 million relates to
impairments of certain commercial mortgage-backed securities, or CMBS, which involved cash Öows from mixed pools (i.e.,
mortgage loan pools containing both multifamily residential loans and non-residential commercial loans). In December
2005, HUD determined that such mixed-pool investments are not authorized under our charter. OFHEO concurred with
HUD's determination and subsequently directed us to provide a written plan for the divestiture of these assets, which we
have done. Accordingly, we determined that we no longer had the ability or intent to hold these investments and, pursuant to
relevant accounting guidance, recognized impairments on aÅected CMBS investments with an unrealized loss at
December 31, 2005. Accounting guidance does not permit the recognition of unrealized gains on other aÅected CMBS until
such securities are sold. As such, we anticipate that the sale of the related assets in 2006 would result in a net gain, absent
signiÑcant changes in market prices. Also included within the $371 million in total security impairments in 2005 were
$71 million of impairments of mortgage-related interest-only securities, primarily related to the decline in mortgage interest
rates experienced in the second quarter of 2005, and $115 million of remaining security impairments, mainly associated with
an adverse change in estimated cash Öows on securities in an unrealized loss position.
Impairments in 2004 and 2003 included impairments on manufactured housing securities totaling $44 million and
$208 million, respectively, as a result of the comparatively low credit quality of these securities. In 2003, we also recorded
impairments on mortgage-related interest-only securities totaling $524 million primarily driven by declines in mortgage
interest rates during the Ñrst half of the year.
Lower-of-cost-or-market adjustments
We value mortgage loans classiÑed as held-for-sale at the lower-of-cost-or-market with resulting valuation adjustments,
if any, reÖected in this caption. Increases in mortgage interest rates during 2005, particularly in the Ñrst, third and fourth
quarters, resulted in higher lower-of-cost-or-market adjustments than recorded in 2004. The sharp decline in mortgage
interest rates in the second quarter of 2003 resulted in an increase in mortgage loans purchased as the market experienced
heavy reÑnancing activity. A sharp increase in mortgage interest rates during the third quarter of 2003 reduced the value of
our held-for-sale mortgage loan portfolio, resulting in lower-of-cost-or-market valuation adjustments that totaled
$(178) million in the third quarter of 2003.
Gains (Losses) on Debt Retirement
During 2005, we recognized a pre-tax gain of $206 million on debt repurchases of $11.7 billion. During 2004 and 2003,
we recognized pre-tax losses of $(327) million and $(1,775) million, respectively, on debt repurchases of $14.5 billion and
$27.3 billion, respectively. We repurchase our outstanding debt securities on a regular basis to help preserve the liquidity of
32 Freddie Mac