Freddie Mac 2004 Annual Report Download - page 44

Credit Losses
We maintain a Reserve for losses on mortgage loans held-for-investment to provide for credit losses
incurred related to those mortgage loans. At December 31, 2004 and 2003, the Reserve for losses on
mortgages held-for-investment was $114 million and $174 million, respectively. The Reserve for losses on
mortgage loans held-for-investment is determined pursuant to the provisions of SFAS 5 and SFAS No. 114,
""Accounting by Creditors for Impairment of a Loan Ì an Amendment of FASB Statements No. 5 and 15,''
or SFAS 114. We also maintain a Reserve for guarantee losses on Participation CertiÑcates to provide for
losses incurred on mortgages underlying PCs or Structured Securities held by third parties. At December 31,
2004 and 2003, the Reserve for guarantee losses on Participation CertiÑcates was $150 million and $125
million, respectively. The Reserve for guarantee losses on Participation CertiÑcates is determined pursuant to
the provisions of SFAS 5 and SFAS 114. The Reserve for losses on mortgage loans held-for-investment and
the Reserve for guarantee losses on Participation CertiÑcates are collectively referred to as the loan loss
reserves. Increases in loan loss reserves that relate to both mortgage loans held as a component of our
Retained portfolio as well as PCs and Structured Securities held by third parties are reÖected in earnings as a
component of the (Provision) beneÑt for credit losses. Loan loss reserves decrease when charge-oÅs of such
balances (net of recoveries) occur or when we record realized losses, which reduces our (Provision) beneÑt
for credit losses.
Loan loss reserves are also increased upon the sale of PCs and Structured Securities for which we
incurred losses on the underlying mortgage loans while such securities were held by us. From an earnings
perspective, such incurred losses are recognized as a component of Gains (losses) on investment activity
through, where applicable, (a) the subsequent measurement of corresponding PC residuals that are classiÑed
as trading (and to which such PCs or Structured Securities relate), (b) the recognition of impairment-related
losses on such securities (i.e., to the extent that such securities do not have recognized PC residual balances
associated with them that are classiÑed as trading) or (c) as a component of gain (loss) on sale of such
securities. Upon the sale of such PCs or Structured Securities, incurred losses are classiÑed on the
consolidated balance sheets as Reserve for guarantee losses on Participation CertiÑcates. See ""NOTE 1:
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Ì Recently Adopted Accounting Stan-
dards and Accounting Changes Ì Accounting for Financial Guarantees'' to the consolidated Ñnancial
statements for a discussion of the impact of newly adopted accounting standards on the loan loss reserves in
2003. See ""NOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES'' and ""NOTE 6:
LOAN LOSS RESERVES'' to the consolidated Ñnancial statements for more information about our process
for determining the loan loss reserves.
The process for determining the level of loan loss reserves is subject to numerous estimates and
assumptions that are uncertain and require judgment. We regularly evaluate the underlying estimates and
assumptions we use when determining the loan loss reserves and update these assumptions to reÖect our own
historical experience and our current view of overall economic conditions and other relevant factors. Changes
in one or more of these underlying estimates and assumptions could have a material impact on the loan loss
reserves and the provision for credit losses. Key estimates and assumptions that could have an impact on loan
loss reserves include:
‚ loss severity trends;
‚ default experience;
‚ expected proceeds from credit enhancements;
‚ evaluation of collateral; and
‚ identiÑcation of relevant macroeconomic factors and assessment of their applications.
Our use of speciÑc estimates and assumptions is based on all available information and our knowledge
and experience in the single-family and multifamily loan markets. We exercise a signiÑcant amount of
judgment in selecting these factors and, had we made diÅerent determinations in the selection of these factors,
a materially diÅerent level of loan loss reserves could have resulted. Additionally, it is possible that, given the
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