Freddie Mac 2006 Annual Report Download - page 120

We often retain Structured Securities created through resecuritizations of mortgage-related securities held by us. The
new Structured Securities we acquire in these transactions are classiÑed as available-for-sale or trading based upon the
predominant classiÑcation of the mortgage-related security collateral we contributed.
For most of our investments in securities, interest income is recognized using the retrospective eÅective interest method.
Deferred items, including premiums, discounts and other basis adjustments, are amortized into interest income over the
estimated lives of the securities. We use actual prepayment experience and estimates of future prepayments to determine the
constant yield needed to apply the eÅective interest method. We recalculate the constant eÅective yield based on changes in
estimated prepayments as a result of changes in interest rates and other factors. When the constant eÅective yield changes,
an adjustment to interest income is made for the amount of amortization that would have been recorded if the new eÅective
yield had been applied since the mortgage assets were acquired.
For certain securities investments, interest income is recognized using the prospective eÅective interest method. We
speciÑcally apply this accounting to beneÑcial interests in securitized Ñnancial assets that (a) can contractually be prepaid or
otherwise settled in such a way that we may not recover substantially all of our recorded investment (such as interest-only
strips) or (b) are not of high credit quality at the acquisition date. We recognize as interest income (over the life of these
securities) the excess of all estimated cash Öows attributable to these interests over their principal amount using the
eÅective yield method. We update our estimates of expected cash Öows periodically and recognize changes in calculated
eÅective yield on a prospective basis.
We review securities for potential impairment on an ongoing basis. We consider a number of factors, including the
severity of the decline in fair value, credit ratings, the length of time the investment has been in an unrealized loss position
and the likelihood of sale in the near term. We also recognize impairment when qualitative factors indicate that it is likely
we will not recover the unrealized loss. When evaluating these factors, we consider our intent and ability to hold the
investment until a point in time at which recovery of the unrealized loss can be reasonably expected to occur. Impairment
losses on manufactured housing securities exclude the eÅects of separate Ñnancial guarantee contracts that are not
embedded in the securities because the beneÑts of such contracts are not recognized until claims become probable of
recovery under the contracts. We resecuritize securities held in the Retained portfolio and we typically retain the majority of
the cash Öows from resecuritization transactions in the form of Structured Securities. Certain securities in the Retained
portfolio have a high probability of being resecuritized and therefore, for those in an unrealized loss position, we may not
have the intent to hold for a period of time suÇcient to recover those unrealized losses. In that case, the impairment is
deemed other-than-temporary. For certain securities meeting the criteria of (a) or (b) in the preceding paragraph, other-
than-temporary impairment is deÑned as occurring whenever there is an adverse change in estimated future cash Öows
coupled with a decline in fair value below the amortized cost basis. When a security is deemed to be other-than-temporarily
impaired, the cost basis of the security is written down to fair value, with the loss recorded to Gains (losses) on investment
activity. Based on the new cost basis, the adjusted deferred amounts related to the impaired security are amortized over the
security's remaining life in a manner consistent with the amount and timing of the future estimated cash Öows. The security
cost basis is not changed for subsequent recoveries in fair value.
Gains and losses on the sale of securities are included in Gains (losses) on investment activity, including those gains
(losses) reclassiÑed into earnings from AOCI. We use the speciÑc identiÑcation method for determining the cost of a
security in computing the gain or loss.
Repurchase and Resale Agreements
We enter into repurchase and resale agreements primarily as an investor or to Ñnance our security positions. Such
transactions are accounted for as purchases and sales when the transferor relinquishes control over transferred securities and
as secured Ñnancings when the transferor does not relinquish control. Our policy is to take possession of securities purchased
under agreements to resell and reverse dollar roll transactions.
Debt Securities Issued
Debt securities that we issue are classiÑed as either due within one year or due after one year, based on their remaining
contractual maturity. The classiÑcation of interest expense on debt securities as either short-term or long-term is based on
the original contractual maturity of the debt security. Deferred items, including premiums, discounts, issuance costs and
hedging-related basis adjustments, are amortized and reported through interest expense using the eÅective interest method
over the contractual life of the related indebtedness. The balance of deferred items remaining when debt is extinguished prior
to its contractual maturity is reÖected in earnings in the period of extinguishment as a component of Gains (losses) on debt
retirement. Prior to 2005, for callable debt, deferred items were amortized over the period during which the related
indebtedness was expected to be outstanding and changes in the expected life were reÖected prospectively as an adjustment
108 Freddie Mac