Freddie Mac 2005 Annual Report Download - page 42

During the Ñrst quarter of 2004, we implemented enhancements to certain assumptions and calculations in the amortization
process for deferred fees recorded as basis adjustments on assets in our Retained portfolio. The eÅect on Net interest income
of these enhancements, which were treated as changes in estimates, was the recognition of $86 million of additional
amortization expense during the Ñrst quarter of 2004.
During 2004, total interest expense on debt securities increased by $990 million. Interest expense related to long-term
debt increased by $867 million, or 4 percent, during 2004 as the average balance of long-term debt increased by
approximately $53 billion, or 11 percent, compared to 2003. This increase more than oÅset the beneÑt from the maturity and
repurchase of higher-rate long-term debt and the issuance of new long-term debt at lower rates. Interest expense related to
short-term debt increased by $123 million, or 4 percent, in 2004 as average short-term interest rates were higher in 2004 than
2003, partially oÅset by a 10 percent decline in the average balance of short-term debt.
Income (expense) related to derivatives improved to income of $100 million during 2004 from expense of $(1,091) mil-
lion in 2003 primarily as a result of moving certain pay-Ñxed swaps out of hedge accounting relationships. In 2004, we
discontinued hedge accounting treatment for pay-Ñxed swaps with a notional balance of approximately $108 billion, moving
them from cash Öow hedge designation to no hedge designation. This movement had a signiÑcant impact on Net interest
income during 2004 because the net interest expense on these swaps is no longer reported as a component of Net interest
income in periods following the move, but as a component of Derivative gains (losses). We also voluntarily discontinued
hedge accounting treatment for a signiÑcant amount of our receive-Ñxed interest-rate swaps eÅective November 1, 2004,
resulting in receive-Ñxed interest-rate swaps with a notional balance of approximately $50 billion being moved from the fair
value hedge designation to no hedge designation.
Interest expense related to amounts due to PC investors decreased by $933 million as liquidation rates on outstanding
PCs and Structured Securities declined to 29 percent in 2004 from 63 percent in 2003.
Non-Interest Income (Loss)
Management and Guarantee Income
Table 9 provides summary information about Management and guarantee income. The total management and
guarantee rate consists of the contractual management and guarantee fee rate, and the eÅects of the amortization of certain
pre-2003 deferred fees, including credit fees and buy-down fees. Management and guarantee income is the primary
component of the revenue we earn from our credit guarantee activities. Other guarantee-related revenue is deferred and
recognized over time as a component of Income on Guarantee obligation.
Table 9 Ì Management and Guarantee Income(1)
Year Ended December 31,
2005 2004 2003
Amount Rate Amount Rate Amount Rate
(dollars in millions, rate in basis points)
Contractual management and guarantee feesÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $1,431 15.7 $1,303 16.5 $1,229 17.3
Amortization of credit and buy-down fees included in Other liabilities(2) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 19 0.2 79 1.0 424 6.0
Total management and guarantee income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $1,450 15.9 $1,382 17.5 $1,653 23.3
Unamortized balance of credit and buy-down fees included in Other liabilities, at period
end(3) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 186 $ 323 $ 465
(1) Excludes amounts related to PCs we held, which are reported in Net interest income.
(2) Credit and buy-down fees are amortized over the estimated lives of the underlying securities using the retrospective eÅective interest method. This
method of amortization results in periodic adjustments when the eÅective interest rate changes due to diÅerences between actual and estimated
prepayments and changes in estimated future prepayments. Catch-up adjustments are made to the unamortized balances of the deferred items to
reÖect the application of the updated eÅective yield as if it had been in eÅect since acquisition.
(3) Previous periods' balances have been revised to conform with the 2005 presentation.
2005 vs. 2004
Management and guarantee income increased in 2005 as compared to 2004 primarily driven by a 15 percent increase in
the average outstanding PCs balance, partially oÅset by lower amortization of deferred fees. The total management and
guarantee fee rate was lower for 2005 at 15.9 basis points as compared to 17.5 basis points for 2004. The contractual
management and guarantee fee rate recognized in 2005 decreased to 15.7 basis points from 16.5 basis points in 2004
reÖecting lower fee rates on new business and the liquidation of existing business with relatively higher fee rates. The lower
fee rates on new business were the result of competitive pricing pressures, an increase in buy-down activity, where lenders
pay a portion of their guarantee fee up-front resulting in a lower contractual guarantee fee rate over the life of the related
PCs, and continued use of market adjusted pricing through which guarantee fees are adjusted upward or downward to
compensate for the strength or weakness of our PC prices relative to competing securities. It is important to note that the
increase in buy-downs generates up-front fees that, beginning in 2003, are deferred and recognized over time as a
component of Income on Guarantee obligation.
26 Freddie Mac