Freddie Mac 2009 Annual Report Download - page 294

Segment Earnings
In managing our business, we present the operating performance of our segments using Segment Earnings. Segment
Earnings differs significantly from, and should not be used as a substitute for, net income (loss) attributable to Freddie Mac
as determined in accordance with GAAP. There are important limitations to using Segment Earnings as a measure of our
financial performance. Among them, the need to obtain funding under the Purchase Agreement is based on our GAAP
results, as are our regulatory capital requirements (which are suspended during conservatorship). Segment Earnings adjusts
for the effects of certain gains and losses and mark-to-fair value items which, depending on market circumstances, can
significantly affect, positively or negatively, our GAAP results and which, in recent periods, have contributed to our
significant GAAP net losses. GAAP net losses will adversely impact our GAAP total equity (deficit), as well as our need for
funding under the Purchase Agreement, regardless of results reflected in Segment Earnings. Also, our definition of Segment
Earnings may differ from similar measures used by other companies. However, we believe that the presentation of Segment
Earnings highlights the results from ongoing operations and the underlying results of the segments in a manner that is useful
to the way we manage and evaluate the performance of our business.
Segment Earnings presents our results on an accrual basis as the cash flows from our segments are earned over time.
The objective of Segment Earnings is to present our results in a manner more consistent with our business models. The
business model for our investment activity is one where we generally buy and hold our investments in mortgage-related
assets for the long term, fund our investments with debt and use derivatives to minimize interest rate risk. The business
model for our credit guarantee activity is one where we are a long-term guarantor in the conforming mortgage markets,
manage credit risk and generate guarantee and credit fees, net of incurred credit losses. We believe it is meaningful to
measure the performance of our investment and guarantee businesses using long-term returns, not short-term value. As a
result of these business models, we believe that an accrual-based metric is a meaningful way to present our results as actual
cash flows are realized, net of credit losses and impairments. We believe Segment Earnings provides us with a view of our
financial results that is more consistent with our business objectives and helps us better evaluate the performance of our
business, both from period-to-period and over the longer term.
As described below, Segment Earnings is calculated for the segments by adjusting GAAP net income (loss) attributable
to Freddie Mac for certain investment-related activities and credit guarantee-related activities. Segment Earnings includes
certain reclassifications among income and expense categories that have no impact on net income (loss) but provide us with
a meaningful metric to assess the performance of each segment and our company as a whole. Segment earnings does not
include the effect of the establishment of the valuation allowance against our deferred tax assets, net.
Investment Activity-Related Adjustments
The most significant risk inherent in our investing activities is interest rate risk, including duration, convexity and
volatility. We actively manage these risks through asset selection and structuring, financing asset purchases with a broad
range of both callable and non-callable debt and the use of interest rate derivatives, designed to economically hedge a
significant portion of our interest rate exposure. Our interest rate derivatives include interest rate swaps, exchange-traded
futures and both purchased and written options (including swaptions). GAAP-basis earnings related to investment activities
of our Investments segment are subject to significant period-to-period variability, which we believe is not necessarily
indicative of the risk management techniques that we employ and the performance of this segment.
Our derivative instruments not in hedge accounting relationships are adjusted to fair value under GAAP with resulting
gains or losses recorded in GAAP-basis results. Certain other assets are also adjusted to fair value under GAAP with
resulting gains or losses recorded in GAAP-basis results. These assets consist primarily of mortgage-related securities
classified as trading and mortgage-related securities classified as available-for-sale when a decline in fair value of available-
for-sale securities is deemed to be other than temporary.
In preparing Segment Earnings, we make the following adjustments to earnings as determined under GAAP. We believe
Segment Earnings enhances the understanding of operating performance for specific periods, as well as trends in results over
multiple periods, as this measure is consistent with assessing our performance against our investment objectives and the
related risk-management activities.
• Derivative and debt-related adjustments:
• Fair value adjustments on derivative positions, recorded pursuant to GAAP, are not recognized in Segment
Earnings as these positions economically hedge the volatility in fair value of our investment activities and debt
financing that are not recognized in GAAP earnings.
• Payments or receipts to terminate derivative positions are amortized prospectively into Segment Earnings on a
straight-line basis over the associated term of the derivative instrument.
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