Freddie Mac 2010 Annual Report Download - page 191

and not deferred. For additional information on our election of the fair value option, see “NOTE 20: FAIR VALUE
DISCLOSURES.”
When we purchase a PC or a REMIC and Other Structured Security that is a single-class security from a third party, we
extinguish the debt of the related PC trusts and recognize a gain or loss related to the difference between the amount paid to
redeem the debt security and its carrying value, adjusted for any related purchase commitments accounted for as derivatives,
in earnings as a component of gains (losses) on extinguishment of debt securities of consolidated trusts. Cash flows related to
debt securities issued by our consolidated trusts are classified as either financing activities (e.g., repayment of principal to PC
holders) or operating activities (e.g., interest payments to PC holders included within net income (loss)). Other than interest
paid, cash flows related to other debt are classified as financing activities. Interest paid on other debt is classified as
operating activities.
When we repurchase or call outstanding other debt, we recognize a gain or loss related to the difference between the
amount paid to redeem the debt security and the carrying value in earnings as a component of gains (losses) on retirement of
other debt. Contemporaneous transfers of cash between us and a creditor in connection with the issuance of a new debt
security and satisfaction of an existing debt security are accounted for as either an extinguishment or a modification of an
existing debt security. If the debt securities have substantially different terms, the transaction is accounted for as an
extinguishment of the existing debt security. The issuance of a new debt security is recorded at fair value, fees paid to the
creditor are expensed and fees paid to third parties are deferred and amortized into interest expense over the life of the new
debt security using the effective interest method. If the terms of the existing debt security and the new debt security are not
substantially different, the transaction is accounted for as a modification of the existing debt. Fees paid to the creditor are
deferred and amortized over the life of the modified unsecured debt security using the effective interest method and fees paid
to third parties are expensed as incurred.
Derivatives
Derivatives are reported at their fair value on our consolidated balance sheets. Derivatives in a net asset position,
including net derivative interest receivable or payable, are reported as derivative assets, net. Similarly, derivatives in a net
liability position, including net derivative interest receivable or payable, are reported as derivative liabilities, net. We offset
fair value amounts recognized for the right to reclaim cash collateral or the obligation to return cash collateral against fair
value amounts recognized for derivative instruments executed with the same counterparty under a master netting agreement.
Changes in fair value and interest accruals on derivatives are recorded as derivative gains (losses) in our consolidated
statements of operations.
We evaluate whether financial instruments that we purchase or issue contain embedded derivatives. In accordance with
an amendment to derivatives and hedging accounting standards regarding certain hybrid financial instruments, we elected to
measure newly acquired or issued financial instruments that contain embedded derivatives at fair value, with changes in fair
value recorded in our consolidated statements of operations. At December 31, 2010, we did not have any embedded
derivatives that were bifurcated and accounted for as freestanding derivatives.
At December 31, 2010 and 2009, we did not have any derivatives in hedge accounting relationships; however, there are
amounts recorded in AOCI related to discontinued cash flow hedges which are recognized in earnings as the originally
forecasted transactions affect earnings. If it becomes probable the originally forecasted transaction will not occur, the
associated deferred gain or loss in AOCI would be reclassified to earnings immediately.
The changes in fair value of the derivatives in cash flow hedge relationships are recorded as a separate component of
AOCI to the extent the hedge relationships are effective, and amounts are reclassified to earnings as the forecasted
transaction affects earnings.
In the consolidated statements of cash flows, cash flows related to the acquisition and termination of derivatives, other
than forward commitments, are generally classified in investing activities.
REO
REO is initially recorded at fair value less costs to sell and is subsequently carried at the lower of cost or fair value less
costs to sell. When we acquire REO, losses arise when the carrying basis of the loan (including accrued interest) exceeds the
fair value of the foreclosed property, net of estimated costs to sell and expected recoveries through credit enhancements.
Losses are charged off against the allowance for loan losses at the time of REO acquisition. REO gains arise and are
recognized immediately in earnings when the fair value of the foreclosed property less costs to sell plus expected recoveries
through credit enhancements exceeds the carrying basis of the loan (including accrued interest). Amounts we expect to
receive from third-party insurance or other credit enhancements are recorded as receivables when REO is acquired. The
receivable is adjusted when the actual claim is filed and is reported as a component of other assets on our consolidated
balance sheets. Material development and improvement costs relating to REO are capitalized. Operating expenses specifically
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