Freddie Mac 2005 Annual Report Download - page 147

Euribor, or foreign-currency Öuctuations, or a combination of both. During 2005 and 2004, these derivatives in fair value
hedge relationships were executed to manage interest-rate risk or foreign-currency risk at an individual debt instrument level.
In 2004, these derivatives in fair value hedge relationships were also used to manage interest-rate risk at an aggregate
portfolio level. Derivatives executed to manage interest-rate risk at an aggregate portfolio level were linked to speciÑc debt
positions for hedge accounting purposes. We frequently reset the amount of Ñxed-rate debt being hedged in order to
maintain highly eÅective accounting hedges. To accomplish this, the accounting hedges were typically terminated at the time
of reset and the derivatives were contemporaneously redesignated in new hedge accounting relationships of Ñxed-rate debt.
Alternatively, when derivatives are executed for speciÑc debt instruments, redesignation is not necessary to maintain highly
eÅective accounting hedges. Derivatives used to manage interest-rate risk at an aggregate portfolio level were moved to no
hedge designation eÅective November 1, 2004 as part of the voluntary discontinuance of hedge accounting treatment, as
discussed above.
For a derivative in a fair value hedge relationship, we report changes in the fair value of the derivative as Hedge
accounting gains (losses) on the consolidated statements of income along with the oÅsetting changes in the fair value of the
hedged item attributable to the risk being hedged. Any diÅerences arising from fair value changes that are not exactly oÅset
result in hedge ineÅectiveness. Hedge accounting gains (losses) will vary from period to period based on the notional
amount of derivatives accounted for in hedge accounting relationships and the extent of hedge ineÅectiveness.
Table 12.1 summarizes certain gains (losses) recognized related to our hedge accounting categories.
Table 12.1 Ì Hedge Accounting Categories Information
Year Ended December 31,
2005 2004 2003
(in millions)
Fair value hedges
Hedge ineÅectiveness recognized in Hedge accounting gains (losses) Ì pre-tax(1) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 22 $742 $697
Cash Öow hedges
Hedge ineÅectiveness recognized in Hedge accounting gains (losses) Ì pre-tax(1) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Ì 1 (53)
Net pre-tax gains (losses) resulting from the determination that it was probable that forecasted transactions would
not occurÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (25) 2 29
(1) No amounts have been excluded from the assessment of eÅectiveness.
Cash Flow Hedges
Cash Öow hedges represent hedges of exposure to the variability in the cash Öows of a variable-rate or foreign-currency
denominated instrument or relate to a forecasted transaction. We use interest-rate swaps, foreign-currency swaps and
forward purchase and sale commitments to hedge the changes in cash Öows associated with the forecasted issuances of debt,
forecasted purchase or sale of mortgage-related assets, and foreign-currency Öuctuations.
For a derivative qualifying as a cash Öow hedge, changes in fair value are generally reported in AOCI, net of taxes, on
the consolidated balance sheets to the extent the hedge is eÅective. The remaining ineÅective portion of changes in fair
value is reported as Hedge accounting gains (losses) on the consolidated statements of income. As shown in Table 12.2
below, the total AOCI, net of taxes, related to cash Öow hedge relationships was a loss of $(6,287) million at December 31,
2005, primarily composed of deferred net losses on closed cash Öow hedges. Closed cash Öow hedges involve derivatives that
have been terminated or are no longer designated as cash Öow hedges. Fluctuations in prevailing market interest rates have
no impact on the deferred portion of AOCI relating to losses on closed cash Öow hedges.
Over the next 12 months, we estimate that approximately $1,280 million of deferred losses in AOCI, net of taxes, will be
reclassiÑed into earnings. The maximum remaining length of time over which we have hedged the exposure related to the
variability in future cash Öows on forecasted transactions, primarily forecasted debt issuances, is 28 years. However, over
90 percent of the AOCI, net of taxes, balance at December 31, 2005 relating to cash Öow hedges is linked to forecasted
transactions occurring in the next 10 years. The occurrence of forecasted transactions may be satisÑed by either periodic
issuances of short-term debt over the required time period or longer-term debt, such as Reference Notes» securities.
Table 12.2 presents the changes in AOCI, net of taxes, related to derivatives designated as cash Öow hedges. Net change
in fair value related to cash Öow hedging activities, net of tax, represents the net change in the fair value of the derivatives
that were designated as cash Öow hedges, after the eÅects of our statutory tax rate of 35 percent, to the extent the hedges
were eÅective. Net reclassiÑcations of losses to earnings, net of tax, represent the AOCI amount, after the eÅects of our
statutory tax rate of 35 percent, that was recognized in earnings as the originally hedged forecasted transactions aÅected
earnings unless it was deemed probable that the forecasted transaction would not occur. If it is probable that the forecasted
transaction will not occur, then the entire deferred gain or loss associated with the hedge related to the forecasted
transaction is reclassiÑed into earnings immediately.
131 Freddie Mac