Freddie Mac 2004 Annual Report Download - page 83

The notional balance of our derivative portfolio declined to $756.8 billion at December 31, 2004 from
$1,083.9 billion at December 31, 2003, driven by a reduction in the notional balance of option-based
derivatives, interest-rate swaps and commitments. The following factors contributed to the reduction in the
notional amounts of our derivatives during 2004. The asset mix in the Retained portfolio has moved toward a
greater proportion of non-agency, Öoating-rate mortgage-related securities, which generally require lower
interest-rate protection than Ñxed-rate products. Also, the gradual increase in market interest rates and the
Öattening of the yield curve in 2004 has reduced the interest-rate risk of our existing Ñxed-rate investments,
thereby lowering our need for option-based derivatives to manage the related risk. During 2004, we also oÅset
the optionality risk in the Retained portfolio by increasing the amount of our callable debt outstanding.
The notional balance of option-based derivatives declined by $127.2 billion, as a result of adjusting the
option portfolio for risk management purposes in response to changes in market conditions and mortgage
portfolio composition. The notional balance of interest-rate swaps declined by $108.9 billion, as a result of the
termination of certain oÅsetting positions prior to their contractual maturity. The notional balance of
commitments declined by $56.6 billion, primarily as the result of a reduction in commitments related to the
Cash and investments portfolio as we ceased the PC market-making and support activities conducted through
our Securities Sales & Trading Group business unit and external Money Manager Program during the fourth
quarter of 2004.
As noted previously, changes in fair values either are recorded in current income or, to the extent our
accounting hedge relationships are eÅective, may be deferred in AOCI or oÅset by basis adjustments to the
related hedged item. As a result, the increases or decreases in fair value by derivative categories, described
above, will not correspond directly to Derivative gains (losses) or Hedge accounting gains (losses) on our
consolidated statements of income.
Guarantee Asset for Participation CertiÑcates
The Guarantee asset for Participation CertiÑcates represents the fair value of future cash inÖows related
to our guarantee of PCs and Structured Securities transferred to third parties in transactions that qualify as
sales under SFAS 125/140 or that were subject to the requirements of FIN 45.
The guarantee asset balances increased by $0.8 billion, or 23 percent, to $4.5 billion at December 31,
2004 from $3.7 billion at December 31, 2003. The changes in the guarantee asset balances during 2004 and
2003 are summarized in Table 36.
Table 36 Ì Changes in Guarantee Asset for Participation CertiÑcates, at Fair Value
2004 2003
(dollars in millions)
Beginning Balance, at January 1 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $3,686 $2,445
Adjustment for change in accounting(1) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Ì (128)
Additions, net of repurchases(2) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 1,965 2,830
Gains (losses) on ""Guarantee asset for Participation CertiÑcates, at fair value''(3)ÏÏÏÏÏ (1,135) (1,461)
Ending balance, at December 31 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $4,516 $3,686
(1) As of January 1, 2003, the fair value of those credit enhancements previously recognized as a component of guarantee assets were
reclassiÑed to Other assets.
(2) Subsequent to the issuance of our Information Statement dated September 24, 2004, we reclassiÑed $7 million from Gains
(losses) on ""Guarantee asset for Participation CertiÑcates, at fair value'' to Additions, net of repurchases.
(3) Individual guarantee assets are marked to fair value based on the related PCs or Structured Securities. Consequently, the fair value
of some guarantee assets increases, while the fair value of other guarantee assets decreases.
In 2004 and 2003, the primary business drivers aÅecting the net increase in our guarantee asset balance
were our business volumes and changes in mortgage interest rates. Additions, net of repurchases declined from
2003 primarily because we issued 49 percent fewer PCs and Structured Securities (based on unpaid principal
balances) in 2004. Gains (losses) on guarantee asset decreased from 2003 due primarily to a smaller overall
decline in mortgage interest rates. Other factors contributing to the change in the fair value of the guarantee
asset are discussed in ""CONSOLIDATED RESULTS OF OPERATIONS Ì Net Interest Income.''
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