Freddie Mac 2010 Annual Report Download - page 160

Core Management and Guarantee Fees, Net
Core management and guarantee fees, net represents a fair value estimate of the annual income of our credit guarantee
activities, based on current credit guarantee characteristics and market conditions. This estimate considers both contractual
management and guarantee fees collected over the life of the credit guarantees 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 Credit Guarantee Activities
Change in the fair value of credit guarantee activities represents the estimated impact on the fair value of the credit
guarantee business resulting from increases in the amount of such business we conduct plus the effect 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 flow
discounting). Our estimated fair value of credit guarantee activities will change as credit conditions change.
We generally do not hedge changes in the fair value of our existing credit guarantee activities, with two exceptions
discussed below. While periodic changes in the fair value of credit guarantee activities may have a significant impact on the
fair value of net assets, we believe that changes in the fair value of our existing credit guarantee activities are not the best
indication of long-term fair value expectations because such changes do not reflect our expectation that, over time,
replacement business will largely replenish management and guarantee fee income lost because of prepayments. However, to
the extent that projections of the future credit outlook reflected in the changes in fair value are realized, our fair value results
may be affected.
We hedge interest rate exposure related to net buy-ups (up front payments we make that increase the management and
guarantee fee that we will receive over the life of the pool) and float (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
credit guarantee activities, so that it reflects only the impact of changes in interest rates and other market factors on the
unhedged portion of the projected cash flows from the credit guarantee business. The fair value changes associated with net
buy-ups and float are considered in asset-liability management return (described above) because they relate to hedged
positions.
Discussion of Fair Value Results
Table 64 summarizes the change in the fair value of net assets for 2010 and 2009.
Table 64 — Summary of Change in the Fair Value of Net Assets
2010 2009
(in billions)
Beginning balance . . ......................................................................... $(62.5) $(95.6)
Changes in fair value of net assets, before capital transactions . .......................................... (2.9) 0.3
Capital transactions:
Dividends, share repurchases and issuances, net
(1)
.................................................. 6.8 32.8
Ending balance . . . . ......................................................................... $(58.6) $(62.5)
(1) Includes the funds received from Treasury of $12.5 billion and $36.9 billion for 2010 and 2009, respectively, under the Purchase Agreement, which
increased the liquidation preference of our senior preferred stock.
Our consolidated fair value measurements are a component of our risk management procedures, as we use daily
estimates of the changes in fair value to calculate our PMVS and duration gap measures. The fair value of net assets as of
December 31, 2010 was $(58.6) billion, compared to $(62.5) billion as of December 31, 2009. Our fair value results for the
year ended December 31, 2010 included funds received from Treasury of $12.5 billion under the Purchase Agreement that
increased the liquidation preference of our senior preferred stock, which was partially offset by the $5.7 billion of dividends
paid to Treasury on our senior preferred stock. During 2010, the fair value of net assets, before capital transactions,
decreased by $2.9 billion compared to a $0.3 billion increase during 2009.
During 2010, the decrease in the fair value of net assets, before capital transactions, was primarily due to: (a) an
increase in the risk premium related to our single-family loans as higher capital assumptions were applied reflecting the
continued weak and uncertain credit environment; and (b) a change in the estimation of a risk premium assumption
embedded in our model to apply credit costs, which led to a $6.9 billion decrease in our fair value measurement of mortgage
loans. The decrease in fair value was partially offset by high estimated core spread income and an increase in the fair value
of our investments in residential and commercial mortgage-related securities driven by the tightening of OAS levels.
During 2009, the increase in the fair value of net assets, before capital transactions was principally related to an
increase in the fair value of our mortgage loans and our investments in mortgage-related securities, resulting from higher
core spread income and net tightening of mortgage-to-debt OAS. The increase in fair value was partially offset by an
increase in the guarantee obligation related to the declining credit environment. Included in the reduction of the fair value of
157 Freddie Mac