Freddie Mac 2004 Annual Report Download - page 233

Master Netting and Collateral Agreements. Freddie Mac uses master netting and collateral agreements
to reduce its credit risk exposure to its active OTC derivative counterparties for interest-rate swaps, option-
based derivatives and foreign-currency swaps. Master netting agreements provide for the netting of amounts
receivable and payable from an individual counterparty, which reduces Freddie Mac's exposure to a single
counterparty in the event of default. For example, if Freddie Mac has a gain position on one derivative and a
loss position on another derivative with the same counterparty, then the gain can be netted with the loss to
determine the amount of the company's net exposure to the counterparty. On a daily basis, the market value of
each counterparty's derivatives outstanding is calculated to determine the amount of the company's net credit
exposure, which is equal to derivatives in a net gain position by counterparty after giving consideration to
collateral posted. Freddie Mac's collateral agreements require most counterparties to post collateral for the
amount of the company's net exposure to them above the applicable threshold. Collateral posting thresholds
are generally tied to a counterparty's credit rating. Derivative exposures and collateral amounts are monitored
on a daily basis using both internal pricing models and dealer price quotes. Freddie Mac's derivative
counterparties typically transfer collateral within one to three business days based on the values of the related
derivatives. This time lag in posting collateral can aÅect Freddie Mac's net uncollateralized exposure to
derivative counterparties.
The collateral posted by counterparties serves to protect Freddie Mac against the risk of counterparty
credit losses. Collateral posted by a derivative counterparty is typically in the form of cash, U.S. Treasury
securities, agency securities or other mortgage-related securities. In the event a counterparty defaults on its
obligations under the derivatives agreement and the default is not remedied in the manner prescribed in the
agreement, Freddie Mac has the right under the agreement to direct the custodian bank to transfer the
collateral to the company or, in the case of non-cash collateral, to sell the collateral and transfer the proceeds
to the company.
Freddie Mac's uncollateralized exposure to counterparties for OTC interest-rate swaps, option-based
derivatives and foreign-currency swaps, after applying netting agreements and collateral, was $601 million and
$796 million at December 31, 2004 and 2003, respectively. In the extremely unlikely event that all of Freddie
Mac's counterparties for these derivatives were to have defaulted simultaneously on December 31, 2004, the
maximum loss to Freddie Mac for accounting purposes would have been approximately $601 million.
Freddie Mac's exposure to counterparties for OTC forward purchase and sale commitments treated as
derivatives was $40 million and $101 million as of December 31, 2004 and 2003, respectively. Since the typical
maturity for OTC commitments is less than one year, Freddie Mac does not require master netting and
collateral agreements for the counterparties of these commitments. Therefore, Freddie Mac's exposure to its
OTC commitments counterparties is uncollateralized. Similar to counterparties for its OTC interest-rate
swaps, option-based derivatives and foreign-currency swaps, Freddie Mac monitors the credit fundamentals of
its OTC commitments counterparties on an ongoing basis to ensure that they continue to meet internal risk-
management standards.
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