Freddie Mac 2004 Annual Report Download - page 58

made included enhancements to the prepayment models we use to determine the expected weighted average
lives of mortgage loans underlying our PCs, which in turn are used to calculate the recognition of deferred fees
based on the eÅective interest method. These improvements to our models were treated as a change in
estimate in accordance with Accounting Principles Board Opinion No. 20, ""Accounting Changes,'' or
APB 20, and resulted in the recognition of $110 million (1.5 basis points) of additional amortization income in
Management and guarantee income in the Ñrst quarter of 2003.
The decrease in amortization of deferred fees in 2004 as compared with 2003 also resulted from higher
mortgage interest rates in 2004 compared to 2003 and the associated impact on prepayment speeds used in our
amortization models, which increased the expected weighted average lives of outstanding PCs and slowed the
pace of amortization.
The contractual management and guarantee fee rate recognized in 2004 decreased to 16.5 basis points
compared with 17.3 basis points in 2003. The portfolio turnover we experienced in 2004 reduced our
contractual guarantee fee rates because newly issued PCs tended to have lower contractual guarantee fee rates
than the previously outstanding PCs, that were liquidated during 2004. This rate decline was partly driven by
the impact of our market adjusted pricing feature on new business purchases, which is discussed in more detail
below. Also, the contractual guarantee fee rate for 2004 declined because a greater proportion of our overall
credit guarantee compensation was received in the form of upfront fees paid to us by seller/servicers.
Beginning in 2003, these upfront fees are amortized into income as a component of Income on ""Guarantee
obligation for Participation CertiÑcates'' or are included in the determination of the gain or loss on the sale of
mortgage loans.
We expanded the use of our market adjusted pricing feature in late 2003 to oÅset the then-prevailing
weakness in prices of our PCs outstanding. This pricing provision adjusts guarantee fees upward or downward
to compensate for the strength or weakness of our PC prices relative to competing securities. This pricing
feature had an increased impact on new business guarantee fees generated in late 2003 and throughout all of
2004. Toward the end of 2004, our PC prices strengthened compared to the second half of 2003. The Ñnancial
impact of prior and current market adjusted pricing is generally recognized over the life of the PC, unless the
security is transferred to a third party in a transaction that qualiÑes as a sale under SFAS 140. Thus, the
impact will continue to be recognized in Contractual management and guarantee fees even though the prices
of our PCs have improved and similar adjustments on new purchases have decreased.
Total Management and guarantee income increased in 2003 by $126 million, or 8 percent, to
$1,653 million from $1,527 million in 2002. This increase was driven by an increase in average outstanding
PCs and an increase in the average total management and guarantee rate recognized in 2003, including
amortization of deferred fees. The total management and guarantee rate in 2003 was 23.3 basis points
compared with 22.2 basis points in 2002. The increase was driven by accelerated amortization of deferred fees,
partially oÅset by lower contractual management and guarantee fee rates on new business. Increased
amortization of deferred fees resulted from the decline in mortgage interest rates during the Ñrst half of 2003
and the related increase in mortgage prepayments, as well as the Ñrst quarter 2003 model change.
Freddie Mac
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