Freddie Mac 2005 Annual Report Download - page 43

Management and guarantee income includes amortization of pre-2003 deferred credit fees and buy-down fees on our
PCs. The unamortized balance of deferred fees related to outstanding PCs was approximately $186 million, $323 million
and $465 million at December 31, 2005, 2004 and 2003, respectively, and will ultimately be reduced to zero over time. The
portion of the management and guarantee fee rate related to the amortization of deferred fees was 0.2 basis points and
1.0 basis point for 2005 and 2004, respectively. The decrease was primarily driven by higher average interest rates for 2005
compared to 2004, resulting in longer estimated lives of the loans underlying our PCs and a decrease in the pace of
amortization. In addition, during the Ñrst quarter of 2005, we improved our approach for estimating the expected weighted
average lives of mortgages underlying our PCs with related deferred credit fees, which in turn are used to calculate the
recognition of deferred fees based on the eÅective interest method. This change in estimate reduced amortization income for
the Ñrst quarter 2005 by $17 million. The decline in the unamortized balance of credit and buy-down fees between 2005 and
2004 relates primarily to the correction of an error in the calculation of the amortization of this balance in prior periods that
reduced the balance by $103 million with a corresponding increase recorded in Other income in 2005.
2004 vs. 2003
Management and guarantee income decreased in 2004 as compared to 2003. This decrease was primarily driven by an
81 percent decrease in amortization of pre-2003 deferred fees, the eÅect of a change in our approach to amortizing deferred
fees implemented in the Ñrst quarter of 2003, which is discussed below, and the decline in the balance of deferred fees
contributed to this decrease. The total management and guarantee income rate declined to 17.5 basis points in 2004 from
23.3 basis points in 2003. The management and guarantee rate related to the amortization of deferred fees decreased from
6.0 basis points in 2003 to 1.0 basis point in 2004. The primary drivers of the decrease in amortization of deferred fees in
2004 were higher interest rates in 2004 resulting in longer estimated lives of the loans underlying our PCs and a reduction in
the unamortized balances of deferred fees being amortized through Management and guarantee income.
In the Ñrst quarter of 2003, improvements to our amortization approach with respect to deferred fees resulted in the
recognition of $110 million (i.e., 1.5 basis points) of additional amortization income in Management and guarantee income.
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 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 previously outstanding PCs that were liquidated
during 2004. This rate decline was partly driven by the impact of market adjusted pricing on new business purchases. 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.
Gains (Losses) on Guarantee Asset
The change in fair value of the Guarantee asset reÖects:
‚ reductions related to the portion of cash received that is considered a return of our recorded investment in the
Guarantee asset; and
‚ changes in the fair value of expected future cash inÖows.
Factors AÅecting the Fair Value of the Guarantee Asset. Two principal factors aÅect the fair value of the Guarantee
asset. First, with the passage of time, actual expected cash Öows are realized when received, resulting in a reduction in the
value of the Guarantee asset. Cash Öows received, which are recorded as Management and guarantee income, represent in
part a reduction of our investment in the Guarantee asset. As shown on ""Table 10 Ì Attribution of Change Ì Gains
(Losses) on Guarantee Asset,'' cash Öows received on the Guarantee asset are allocated between interest income (imputed
income on the asset based on the discount rate used in the calculation of the fair value of the Guarantee asset) and return of
investment (the portion of actual cash Öows that represents a reduction of the Guarantee asset receivable).
Second, the fair value of the Guarantee asset is also aÅected by changes in the fair value of future expected cash Öows.
The value of expected cash Öows is driven by changes in the expected interest rates and related discount rates that aÅect the
estimated life of the mortgages underlying the outstanding PCs and Structured Securities and other economic factors that
inÖuence the amount and timing of the future cash Öows. Changes in the estimated lives of the underlying mortgages aÅect
the value of the Guarantee asset because our right to receive guarantee fees ceases when borrowers prepay the underlying
mortgages. See ""Table 24 Ì Changes in Guarantee Asset'' for additional information about the Guarantee asset.
27 Freddie Mac