Freddie Mac 2004 Annual Report Download - page 42

unilaterally cause the holder of a transferred PC or Structured Security to return speciÑc assets (i.e., other
than through a clean up call).
If a transfer of PCs or Structured Securities qualiÑes as a sale, we recognize a gain or loss on the sale
immediately in earnings based upon the diÅerence in value between cash received, the recognized carrying
value of interests sold and the fair value of liabilities incurred upon sale. In this case, our obligation to
guarantee the payment of principal and interest on PCs and Structured Securities results in the recognition of
a guarantee asset and guarantee obligation on our consolidated balance sheets.
Many of the transfers of PCs and Structured Securities that are made to third parties do not qualify as
sales or secured borrowings, but are accounted for as Ñnancial guarantee transactions pursuant to the
provisions of FIN 45. For such transactions, we recognize at the inception of an executed guarantee a
guarantee obligation that is initially measured to be the greater of (a) fair value or (b) the contingent liability
amount required to be recognized at inception of the guarantee by SFAS No. 5, ""Accounting For
Contingencies,'' or SFAS 5. We also recognize the fair value of any consideration received on such
transactions. Positive diÅerences between the fair value of consideration expected and received, and guarantee
obligations incurred are deferred as a component of recognized guarantee obligations, while negative
diÅerences between such amounts are recognized immediately in earnings as a component of Other expense.
Table 12 summarizes securitization activity in 2004, 2003 and 2002 that relates to transfers of PCs or
Structured Securities that were accounted for as sales.
Table 12 Ì Securitization Activity Accounted for as Sales
Year Ended December 31,
2004 2003 2002
(dollars in millions)
Transfers of Freddie Mac securities that were accounted for as sales ÏÏÏÏ $152,662 $347,874 $241,214
Gain on saleÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 356 $ 711 $ 874
With respect to all transfers of PCs and Structured Securities to third parties, the measurement of
recognized guarantee assets, guarantee obligations and credit enhancement-related assets involves our best
estimate with respect to key assumptions, including expected credit losses and the exposure to credit losses
that could be greater than expected credit losses, prepayment rates, forward yield curves and discount rates.
We believe that the assumptions we made in this regard are comparable to those used by other market
participants. The use of diÅerent pricing models and assumptions could produce materially diÅerent results.
See ""NOTE 2: TRANSFERS OF SECURITIZED INTERESTS IN MORTGAGE-RELATED AS-
SETS'' to the consolidated Ñnancial statements for further discussion of methodologies and judgments we
used to determine the fair values of guarantee assets and obligations, as well as sensitivity analyses to show the
eÅects of hypothetical changes in key assumptions.
Derivative Instruments and Hedging Activities
The determination of whether a derivative qualiÑes for hedge accounting requires signiÑcant judgment
and has a signiÑcant impact on how such instruments are accounted for in our consolidated Ñnancial
statements. As described more fully in ""CONSOLIDATED RESULTS OF OPERATIONS Ì Derivative
Gains (Losses),'' we discontinued substantially all of our cash Öow hedge accounting relationships eÅective as
of April 2, 2004, because they no longer met the hedge eÅectiveness requirements of SFAS 133, as amended
by SFAS No. 138, ""Accounting for Certain Derivative Instruments and Certain Hedging Activities'' and
SFAS No. 149 ""Amendment of Statement 133 on Derivative Instruments and Hedging Activities,'' which we
collectively refer to as SFAS 133. In addition, we voluntarily discontinued a signiÑcant portion of our fair
value hedging relationships eÅective November 1, 2004. Accordingly, the portion of our derivatives portfolio
that was designated in hedge accounting relationships was signiÑcantly reduced by the end of 2004.
Our Retained portfolio activities and our funding of these investments with a mix of short- and long-term
debt expose us to interest-rate risk and other market risks. In particular, a mortgage borrower's prepayment
option makes the timing and amount of mortgage prepayments very sensitive to changes in interest rates. The
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