Freddie Mac 2009 Annual Report Download - page 82

The changes in fair value of future management and guarantee fees are driven by expected changes in interest rates that
affect the estimated life of the mortgages underlying our PCs and Structured Securities issued and the related discount rates
used to determine the net present value of the cash flows. For example, an increase in interest rates extends the life of the
guarantee asset and increases the fair value of future management and guarantee fees. Our valuation methodology for the
guarantee asset uses market-based information, including market values of excess servicing, interest-only mortgage securities,
to determine the fair value of future cash flows associated with the guarantee asset.
Table 14 — Attribution of Change — Gains (Losses) on Guarantee Asset
2009 2008 2007
Year Ended December 31,
(in millions)
Contractual management and guarantee fees . ............................................. $(2,922) $(2,871) $(2,288)
Portion attributable to imputed interest income ............................................ 923 1,121 549
Return of investment on guarantee asset . . . . ............................................. (1,999) (1,750) (1,739)
Change in fair value of future management and guarantee fees ................................. 5,298 (5,341) 255
Gains (losses) on guarantee asset. . . . . . . . . ............................................. $3,299 $(7,091) $(1,484)
Contractual management and guarantee fees shown in Table 14 represents cash received in each period related to our
PCs and Structured Securities with an established guarantee asset. A portion of these contractual management and guarantee
fees is attributed to imputed interest income on the guarantee asset. Contractual management and guarantee fees increased in
both 2009 and 2008, primarily due to increases in the average balance of our PCs and Structured Securities issued.
As shown in the table above, the change in fair value of future management and guarantee fees was $5.3 billion in 2009
compared to $(5.3) billion in 2008. The fair value gain on our guarantee asset in 2009 was principally attributed to an
increase in the valuations of excess-servicing, interest-only mortgage securities (which we use to estimate the value of our
guarantee asset) in 2009, as compared to the decrease in the valuations during the corresponding periods of 2008. Fair values
of excess-servicing, interest-only mortgage securities were positively affected in 2009 by an increase in interest rates, and to
a lesser extent, increased investor demand for mortgage-related securities. Fair values of excess-servicing, interest-only
mortgage securities were negatively affected in 2008 by significant declines in investor demand for mortgage-related
securities as well as decreases in interest rates.
Income on Guarantee Obligation
Upon issuance of our guarantee, we record a guarantee obligation on our consolidated balance sheets representing the
estimated fair value of our obligation to perform under the terms of the guarantee. Our guarantee obligation is amortized into
income using a static effective yield determined at inception of the guarantee based on forecasted repayments of the principal
balances on loans underlying the guarantee. Under the static effective yield method, the basic rate of amortization is
periodically evaluated and is adjusted when significant changes in economic events cause a shift in the pattern of our
economic release from risk, or the loss curve. For example, certain market environments may lead to sharp and sustained
changes in home prices or prepayments of mortgages, leading to the need for an adjustment in the basic amortization rate for
specific mortgage pools underlying the guarantee. When a change is required, a cumulative catch-up adjustment, which could
be significant in a given period, will be recognized and a new “basic” effective rate is used to determine our guarantee
obligation amortization. The resulting amortization recorded to income on guarantee obligation results in a pattern of revenue
recognition that is more consistent with our economic release from risk under the new economic environment and the timing
of the recognition of losses on the pools of mortgage loans that we guarantee. Over time, we recognize a provision for credit
losses on loans underlying a guarantee contract as those losses are incurred. Those incurred losses may equal, exceed or be
less than the expected losses we estimated as a component of our guarantee obligation at inception of the guarantee contract.
In the first quarter of 2009, we enhanced our methodology for evaluating significant changes in economic events to be more
in line with the current economic environment and to monitor the rate of amortization on our guarantee obligation so that it
remains reflective of our expected duration of losses.
Table 15 provides information about the components of income on guarantee obligation.
Table 15 — Income on Guarantee Obligation
2009 2008 2007
Year Ended December 31,
(in millions)
Static effective yield amortization:
Basic . . ........................................................................ $2,874 $2,660 $1,706
Cumulative catch-up ................................................................ 605 2,166 199
Total income on guarantee obligation . . .................................................... $3,479 $4,826 $1,905
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