Freddie Mac 2006 Annual Report Download - page 61

over the life of the credit guarantee portfolio and credit-related delivery fees collected up-front when pools are formed, and
associated costs and obligations, which include default costs.
Change in the fair value of the credit guarantee portfolio
Change in the fair value of the credit guarantee portfolio represents the estimated impact on the fair value of the credit
guarantee business resulting from additions to the portfolio (net diÅerence between the fair values of the Guarantee asset
and Guarantee obligation recorded when pools are formed) plus the eÅect of changes in interest rates, projections of the
future credit outlook and other market factors (e.g., impact of the passage of time on cash Öow discounting). In 2005, we
changed our method for estimating the fair values of the Guarantee asset and Guarantee obligation. See ""NOTE 2:
TRANSFERS OF SECURITIZED INTERESTS IN MORTGAGE-RELATED ASSETS'' to our consolidated Ñnancial
statements for additional information.
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 credit 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 credit guarantee portfolio are not the best
indication of long-term fair value expectations because such changes do not reÖect our expectation that, over time,
replacement business will largely replenish guarantee fee income lost because of prepayments. However, to the extent that
projections of the future credit outlook are realized our fair value results may be aÅected.
We hedge interest-rate exposure related to net buy-ups (up-front payments we made 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 changes in fair value of the credit
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 fair value changes associated with net buy-ups
and Öoat are considered in asset-liability management return (described 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
In 2006, the fair value of net assets attributable to common stockholders, before capital transactions, increased by
$2.5 billion, resulting in a return on the average fair value of net assets attributable to common stockholders of approximately
9.5 percent, compared to a $1.0 billion increase, or 3.7 percent return, in 2005. In addition, the payment of common
dividends and the repurchase of common shares reduced total fair value by $3.3 billion. The fair value of net assets
attributable to common stockholders as of December 31, 2006 was $26.0 billion, compared to $26.8 billion as of
December 31, 2005.
Estimated impact of changes in mortgage-to-debt OAS on fair value results
For the years ended December 31, 2006 and 2005, we estimate that on a pre-tax basis the increases in the fair value of
net assets attributable to common stockholders, before capital transactions included decreases of approximately $0.9 billion
and $2.7 billion, respectively, due to a net widening of mortgage-to-debt OAS.
We believe disclosing the estimated impact of changes in mortgage-to-debt OAS on the fair value of net assets is
helpful to understanding our current period fair value results in the context of our long-term fair value return expectation.
Our long-term expectation is to generate returns, before capital transactions, over time on the average fair value of net assets
attributable to common stockholders in the low- to mid-teens. However, period-to-period returns may Öuctuate
substantially due to market conditions. These market conditions include changes in interest rates and other market factors
that aÅect certain components of our fair value changes, including those which we do not attempt to hedge or actively
manage, speciÑcally, the change in mortgage-to-debt OAS with respect to our Retained portfolio and the change in the fair
value of the single-family guarantee portfolio.
Our estimate of the periodic increases or decreases in the fair value of net assets associated with Öuctuations in option-
adjusted spreads provides insight into a component of our fair value results that we do not believe will signiÑcantly aÅect the
long-term fair value of the Retained portfolio. This belief is based on our expectation that diÅerences between the
prepayments forecasted by our models and the actual prepayments we will experience are not likely to be signiÑcant.
How we estimate the impact of changes in mortgage-to-debt OAS on fair value results
The impact of changes in OAS on fair value should be understood as an estimate rather than a precise measurement. To
estimate the impact of OAS changes, we use models that involve the forecast of interest rates and prepayment behavior and
other inputs. We also make assumptions about a variety of factors, including macroeconomic and security-speciÑc data,
49 Freddie Mac