Freddie Mac 2014 Annual Report Download - page 68

63 Freddie Mac
receive and pay-fixed swaps, respectively. The fair values of both purchased and written call and put swaptions are sensitive to
changes in interest rates and are also driven by the market’s expectation of potential changes in future interest rates (referred to
as “implied volatility”). Purchased swaptions generally become more valuable as implied volatility increases and less valuable
as implied volatility decreases. Recognized losses on purchased options in any given period are limited to the premium paid to
purchase the option plus any unrealized gains previously recorded. Potential losses on written options are unlimited.
During 2014, we recognized net losses on derivatives of $8.3 billion primarily as a result of net fair value losses of $7.3
billion on our interest-rate swap portfolio as a result of a flattening of the yield curve as shorter-term interest rates increased
and longer-term interest rates declined. Net losses on derivatives also resulted from the accrual of periodic settlements on
interest-rate swaps, as we were a net payer on our interest-rate swaps based on the coupons of the instruments. These losses
were partially offset by fair value gains on our option-based derivatives resulting from gains on our purchased call swaptions
due to the decline in longer-term interest rates.
During 2013, we recognized a net gain on derivatives of $2.6 billion as net fair value gains of $8.6 billion on our interest-
rate swap portfolio, primarily driven by an increase in longer-term interest rates, were partially offset by: (a) a net loss of $3.5
billion related to the accrual of periodic settlements on interest-rate swaps, as we were a net payer on our interest-rate swaps
based on the coupons of the instruments; and (b) a fair value loss of $2.4 billion on our option-based derivatives.
During 2012, we recognized losses on derivatives of $2.4 billion, primarily due to losses related to the accrual of periodic
settlements on interest-rate swaps, as we were a net payer on our interest-rate swaps based on the coupons of the instruments.
We recognized fair value losses on our pay-fixed swaps, which were offset by: (a) fair value gains on our receive-fixed swaps;
and (b) fair value gains on our option-based derivatives resulting from gains on our purchased call swaptions due to a decrease
in interest rates. In 2012, the effect of the decline in interest rates and a steepening of the yield curve was coupled with a change
in the mix of our derivative portfolio, as we increased our holdings of receive-fixed swaps relative to pay-fixed swaps to
rebalance our portfolio during a period of steadily declining interest rates, and increased our issuances of debt with longer-term
maturities.
Investment Securities-Related Activities
Impairments of Available-For-Sale Securities
We recorded net impairments of available-for-sale securities recognized in earnings of $938 million, $1.5 billion, and $2.2
billion during 2014, 2013, and 2012, respectively, related to non-agency mortgage-related securities. The impairments during
2014 were primarily driven by an increase in the population of available-for-sale securities in an unrealized loss position that
we intend to sell. This generally reflects our efforts to reduce the balance of less liquid assets in the mortgage-related
investments portfolio. During 2013, we recognized a benefit from improvements in forecasted home prices over the expected
life of our available-for-sale securities, offset primarily by: (a) the incorporation in the fourth quarter of 2013 of new
information, which enhanced the assumptions used to estimate the contractual loan terms for certain modified loans
collateralizing non-agency mortgage-related securities for which actual data about those terms was unavailable to the market;
and (b) an increase in the population of available-for-sale securities in an unrealized loss position which we intended to sell.
During 2012, we recognized a benefit from improvements in forecasted home prices, which was offset by the impact of our
implementation, in the fourth quarter of 2012, of a third-party model, which enhanced our approach to estimating other-than-
temporary impairments of our single-family non-agency mortgage-related securities. The decision to transition to a third-party
model was made to increase the level of disaggregation for certain assumptions used in projecting cash flow estimates of these
securities.
See “CONSOLIDATED BALANCE SHEETS ANALYSIS — Investments in Securities — Mortgage-Related Securities
— Other-Than-Temporary Impairments on Available-For-Sale Mortgage-Related Securities,” and “NOTE 7: INVESTMENTS
IN SECURITIES” for additional information.
Other Gains (Losses) on Investment Securities Recognized in Earnings
Other gains (losses) on investment securities recognized in earnings consists of gains (losses) on trading securities and
gains (losses) on sales of available-for-sale securities. Trading securities mainly consist of Treasury securities and agency
mortgage-related securities, including inverse floating-rate, interest-only and principal-only securities. With the exception of
principal-only securities, our agency securities, classified as trading, were valued at a net premium (i.e., net fair value was
higher than UPB) as of December 31, 2014.
Other gains (losses) on investment securities recognized in earnings does not include the interest earned on investment
securities, which is recorded as part of net interest income. For information about our interest-rate risk management strategy
and framework, see “QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.”
We recognized $(218) million, $(1.6) billion, and $(1.7) billion related to losses on trading securities during 2014, 2013,
and 2012, respectively. The losses on trading securities during all periods were primarily due to the movement of securities
with unrealized gains towards maturity. The losses on trading securities during 2014 were partially offset by the effect of the
decline in longer-term interest rates.
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