Freddie Mac 2004 Annual Report Download - page 180

Carlo simulation. The components of estimated future cash Öows associated with GOs include: (a) estimates
of expected future credit losses using statistically based models that evaluate a variety of factors (such as
default experience and loss severity trends), as well as an estimated risk premium for the uncertainty in
expected credit losses that would be required to be paid to a third party with a credit standing similar to
Freddie Mac; (b) estimates of the costs to administer the collection and distribution of payments on the
mortgage loans underlying a PC; and (c) expected net cash Öows due to security program cycles. When
deriving the present value of GO-related cash Öows for each scenario for each Loan Group, Freddie Mac uses
a convention that is similar to the methodology described above to discount GA-related future cash Öows,
except that a London Interbank OÅered Rate (""LIBOR'') rate is generally used to discount such cash Öows.
Additionally, projected credit related costs that are factored into the GO-related cash Öows are benchmarked
periodically to the non-conforming loan securitization market.
Like recognized GAs, Freddie Mac recognized as GOs the average of the present value of the GO-
related cash Öows generated for each Loan Group for each of the scenarios.
Recognized PC residuals
PC residuals relate to certain PCs and Structured Securities held by Freddie Mac in its Retained
portfolio and Cash and investments portfolio and represent the fair value of the future cash Öows of guarantee
contracts that speciÑcally correspond to such PCs. By the end of 2004, the company had ceased certain PC
market-making and support activities and the Cash and investments portfolio no longer held mortgage-related
securities. Since the future cash Öows associated with such guarantee contracts are represented by those that
deÑne a PC's corresponding GA and GO, the fair value of a recognized PC residual is eÅectively equivalent to
the fair value of a GA less that of a corresponding GO. Accordingly, the fair value of recognized PC residuals
is determined in a manner that is reÖective of the methodologies described above for recognized GAs and
GOs.
Recognized Credit Enhancements
Many of the credit enhancements that Freddie Mac employs in connection with securitized mortgage
loans are recognized at fair value at the inception of each contract. Future credit enhancement-related cash
Öows associated with each referenced Loan Group are estimated using a Monte Carlo simulation. More
speciÑcally, based upon the terms of a credit-enhancement contract, the portion of the total GO-related future
cash Öows estimated for each Loan Group that would be reimbursed to Freddie Mac by a third party (e.g., a
mortgage insurer) are identiÑed as the estimated future cash inÖows due Freddie Mac on each of such
contracts. These projected cash inÖows are then discounted using a LIBOR rate.
Freddie Mac recognizes as an Other asset the average of the present value of the credit enhancement-
related cash Öows generated for each Loan Group for each of the scenarios related to pool insurance, recourse
and indemniÑcations. The average of the present value of the credit enhancements-related cash Öows
generated for each Loan Group for each of the scenarios related to primary mortgage insurance is recognized
at inception at fair value as a reduction of recognized GOs.
Credit enhancements that were recognized as Other assets had a carrying value of approximately
$232 million and $200 million at December 31, 2004 and 2003, respectively.
Other Retained Interests
Other Retained Interests (as deÑned in footnote 3 to ""Table 2.3 Ì Sensitivity Analysis'') are valued
based upon observed market or matrix-based prices (for the latter, prices for comparable securities, as
adjusted for product-speciÑc attributes, are used as a basis to value such interests). Because these interests are
not model-valued, the corresponding valuation assumptions are not provided in Table 2.2 below. Sensitivity
analysis of these interests (as shown in ""Table 2.3 Ì Sensitivity Analysis'') is estimated using a company
model that is not the source of the actual valuation used to determine their carrying value.
Freddie Mac
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