Freddie Mac 2014 Annual Report Download - page 153

148 Freddie Mac
Consolidation and Equity Method of Accounting
The consolidated financial statements include our accounts and those of our subsidiaries. We consolidate entities in which
we have a controlling financial interest. All intercompany transactions have been eliminated in consolidation.
For each entity with which we are involved, we determine whether the entity should be consolidated in our financial
statements. The method for determining whether a controlling financial interest exists varies depending on whether the entity is
a VIE or non-VIE. A VIE is an entity: (a) that has a total equity investment at risk that is not sufficient to finance its activities
without additional subordinated financial support provided by another party; (b) where the group of equity holders does not
have: (i) the power, through voting rights or similar rights, to direct the activities of an entity that most significantly impact the
entity’s economic performance; (ii) the obligation to absorb the entity’s expected losses; or (iii) the right to receive the entity’s
expected residual returns; or (c) where the voting rights of some investors are disproportionate to their obligation to absorb
expected losses or their right to expected residual returns (or both) and substantially all of the entity’s activities are conducted
on behalf of an investor that has disproportionately few voting rights.
We consolidate VIEs in which we hold a controlling financial interest and are therefore deemed to be the primary
beneficiary. An enterprise has a controlling financial interest in, and thus is deemed to be the primary beneficiary of, a VIE if it
has both: (a) the power to direct the activities of the VIE that most significantly impact its economic performance; and
(b) exposure to losses or benefits of the VIE that could potentially be significant to the VIE. We perform ongoing assessments
to determine if we are the primary beneficiary of the VIEs with which we are involved and, as such, conclusions may change
over time as the nature and extent of our involvement changes.
We use securitization trusts, which are VIEs, in our securities issuance process. We are the primary beneficiary of trusts
that issue our single-family PCs and certain Other Guarantee Transactions. See “NOTE 3: VARIABLE INTEREST ENTITIES”
for more information. When we transfer assets into a VIE that we consolidate at the time of the transfer (or shortly thereafter),
we recognize the assets and liabilities of the VIE at the amounts that they would have been recognized if they had not been
transferred, and no gain or loss is recognized on these transfers. For all other VIEs that we consolidate, we recognize the assets
and liabilities of the VIE at fair value, and we recognize a gain or loss for the difference between: (a) the sum of the fair value
of the consideration paid, the fair value of any noncontrolling interests held by third parties and the reported amount of any
previously held interests; and (b) the net amount, measured on a fair value basis, of the assets and liabilities consolidated.
For entities that are not VIEs, the usual condition of a controlling financial interest is ownership of a majority voting
interest in an entity. We use the equity method of accounting for entities over which we have the ability to exercise significant
influence, but not control.
Fair Value Measurements
Consistent with the accounting guidance for fair value measurements and disclosures, we use a three-level fair value
hierarchy that prioritizes the inputs to the valuation techniques used to measure the fair value of assets and liabilities, giving
highest priority to quoted prices in active markets and lowest priority to unobservable inputs. Fair value represents the price
that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the
measurement date. Fair value measurements under this hierarchy are distinguished among three levels: quoted market prices,
observable inputs, and unobservable inputs. We use quoted market prices and valuation techniques that seek to maximize the
use of observable inputs, where available, and minimize the use of unobservable inputs. Our inputs are based on the
assumptions a market participant would use in valuing the asset or liability. Assets and liabilities are classified in their entirety
within the fair value hierarchy based on the lowest level input that is significant to the fair value measurement. When assets and
liabilities are transferred between levels, we recognize the transfer as of the beginning of the period. See “NOTE 16: FAIR
VALUE DISCLOSURES” for additional information regarding the fair value measurements and the hierarchy.
Securitization Activities through Issuances of Freddie Mac Mortgage-Related Securities
Overview
When we securitize mortgages that we purchase, we issue mortgage-related securities such as PCs that can be sold to
investors or held by us. We issue mortgage-related securities in the form of PCs, REMICs and Other Structured Securities, and
Other Guarantee Transactions. Guarantor swaps are transactions where financial institutions exchange mortgage loans for PCs
backed by these mortgage loans. Multilender swaps are similar to guarantor swaps, except that the formed PC pools include
loans that are contributed by more than one party. We issue PCs through various swap-based exchanges significantly more
often than through cash-based transfers. We issue REMICs and Other Structured Securities in transactions in which securities
dealers or investors sell us mortgage-related assets in exchange for REMICs and Other Structured Securities. We also issue
Other Guarantee Transactions to third parties in exchange for non-Freddie Mac mortgage-related securities.
PCs
Our PCs are pass-through debt securities that represent undivided beneficial interests in a pool of mortgages held by a
securitization trust. For our fixed-rate PCs, we guarantee the timely payment of interest and principal. For our ARM PCs, we
guarantee the timely payment of the weighted average coupon interest rate for the underlying mortgage loans. We do not
guarantee the timely payment of principal for ARM PCs; however, we do guarantee the full and final payment of principal.
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