Freddie Mac 2004 Annual Report Download - page 53

on our overall net interest yield. As the composition of the portfolios changes between higher or lower
yielding assets, the overall asset yield on these portfolios Öuctuates. Generally, during periods of relatively
low interest rates, as experienced in 2003 and 2004, the yield on portfolio assets will decline as higher-
yielding assets liquidate and new assets are acquired at lower rates. The composition of the Retained
portfolio and the Cash and investments portfolio is discussed later in the ""CONSOLIDATED
BALANCE SHEETS ANALYSIS.''
Amortization of premiums and discounts. When we purchase mortgage-related securities, the price we
pay for these assets generally does not equal the securities' unpaid principal balance. We pay more than
the unpaid principal balance (referred to as a premium) when the coupon on the security is greater than
the current market yield for that security. We pay less than the unpaid principal balance (referred to as a
discount) when the coupon on the security is less than the current market yield for that security.
Purchase premiums and discounts are amortized over the estimated life of the purchased assets as
adjustments to interest income based on the eÅective interest method in accordance with SFAS 91. This
method of amortization results in periodic adjustments to interest income, which are applied retrospec-
tively to the date of purchase of the underlying mortgage-related security, when the eÅective interest-rate
changes due to diÅerences between actual and previously estimated prepayments and changes in
estimated future prepayments.
As interest rates declined during the Ñrst half of 2003, we paid higher premiums to acquire
mortgage-related securities. This resulted in a shift in the Retained portfolio to an increasing premium
position in 2003. Mortgage interest rates Öuctuated throughout 2004; however, at year end, these rates
were comparable to rates at December 31, 2003. As a result, the Retained portfolio continued to be in a
net premium position at December 31, 2004. The net balance of unamortized premiums, discounts,
deferred fees and other basis adjustments related to all mortgage-related securities in the Retained
portfolio (both those classiÑed as available-for-sale and trading) equaled $3,965 million and $4,729 mil-
lion at December 31, 2004 and 2003, respectively.
Interest expense related to amounts Due to Participation CertiÑcate investors. As a result of the payment
remittance cycle associated with PCs and certain Structured Securities, interest expense related to
amounts Due to PC investors tends to increase during periods of rising prepayments and decrease during
periods of declining prepayments. We invest the proceeds from prepayments on mortgage loans
underlying PCs and Structured Securities in short-term investments until related payments are Due to
PC investors. The interest earned on these investments is reported as a component of interest income on
Cash and investments.
As described above, mortgage interest rates were relatively stable during 2004 in contrast to
declining mortgage interest rates during the Ñrst half of 2003. Consequently, the volume of liquidations
associated with outstanding PCs and Structured Securities peaked during 2003, causing interest expense
Due to Participation CertiÑcate investors to be at a higher level during 2003 compared to 2004 and 2002.
Liquidations associated with outstanding PCs and Structured Securities (excluding liquidations associ-
ated with PCs in our Cash and investment portfolio) totaled $224,283 million and $471,591 million
during 2004 and 2003, respectively.
Debt funding mix and derivatives activity. We communicate our anticipated issuances of both long-
term and short-term debt securities by publishing an annual Ñnancing calendar along with periodic
updates in the form of Quarterly Funding Announcements. We consider our commitments to issue debt
securities with certain maturity characteristics as well as the maturity characteristics of our existing debt
outstanding and other funding requirements when we evaluate our existing derivative portfolio. We adjust
the composition of that derivative portfolio to manage our interest-rate risk, including the relative
duration and convexity of our assets and liabilities.
As discussed in the analysis of Net interest income results for full year 2004, we moved a signiÑcant
amount of our pay-Ñxed swaps that were previously in hedge accounting relationships to no hedge
designation eÅective at the beginning of the second quarter of 2004, and we also moved a signiÑcant
amount of our receive-Ñxed swaps to no hedge designation in the fourth quarter of 2004. For periods
Freddie Mac
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