Freddie Mac 2005 Annual Report Download - page 45

Derivative Overview
Table 12 shows the notional amount for each of our hedge accounting classiÑcations and the corresponding impact of
those positions on our consolidated Ñnancial statements. The application and eÅectiveness of our hedge accounting
strategies can materially aÅect stockholders' equity and the timing of our recognition of earnings because those strategies
determine the accounting for the derivatives involved.
Table 12 Ì Summary of the Effect of Derivatives on Selected Consolidated Financial Statement Captions
Consolidated Balance Sheets
December 31, 2005 December 31, 2004
Notional Fair Value AOCI Notional Fair Value AOCI
Description Amount (Pre-Tax)(1) (Net of Taxes)(2) Amount (Pre-Tax)(1) (Net of Taxes)(2)
(in millions)
Fair value hedges-open ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $115,146 $ 3,402 $ Ì $113,101 $12,317 $ Ì
Cash Öow hedges-open ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 668 (26) 4 21,214 228 (25)
No hedge designation(3) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 567,558 3,131 Ì 622,463 2,486 Ì
SubtotalÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 683,372 6,507 4 756,778 15,031 (25)
Balance related to closed cash Öow hedges ÏÏ Ì Ì (6,291) Ì Ì (7,899)
Total ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $683,372 $ 6,507 $(6,287) $756,778 $115,031 $(7,924)
Consolidated Statements of Income for the Years Ended December 31,
2005 2004 2003
Hedge Hedge Hedge
Derivative Accounting Derivative Accounting Derivative Accounting
Gains Gains Gains Gains Gains Gains
Description (Losses) (Losses)(4) (Losses) (Losses)(4) (Losses) (Losses)(4)
(in millions)
Fair value hedges-open(5) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ Ì $ 22 $ Ì $742 $Ì $697
Cash Öow hedges-open(5)(6) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (25) Ì 2 1 29 (53)
No hedge designation(3) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (1,332) Ì (4,477) Ì 10 Ì
Total ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $(1,357) $ 22 $(4,475) $743 $39 $644
(1) The fair values of derivatives (netted by counterparty) are presented as Derivative assets, at fair value, and Derivative liabilities, at fair value, on our
consolidated balance sheets.
(2) Derivatives that meet speciÑc criteria may be accounted for as cash Öow hedges. Changes in the fair value of the eÅective portion of these open
derivatives contracts are recorded in AOCI, net of taxes. Net deferred gains and losses on closed cash Öow hedges (i.e., where the derivative is either
terminated or redesignated) are also included in AOCI, net of taxes, until the related forecasted transaction is determined to be probable of not
occurring or aÅects earnings.
(3) For most derivatives not qualifying as an accounting hedge, fair value gains and losses are reported as Derivative gains (losses) on our consolidated
statements of income. For forward purchase and sale commitments of securities classiÑed as trading (with notional balances of approximately
$Ì billion, $Ì billion and $78 billion at December 31, 2005, 2004 and 2003, respectively), fair value gains and losses are reported as Gains (losses)
on investment activity on our consolidated statements of income and therefore, those fair value gains and losses are not included above.
(4) Hedge accounting gains (losses) arise when the fair value change of a derivative does not exactly oÅset the fair value change of the hedged item
attributable to the hedged risk. For further information, see ""Hedge Accounting Gains (Losses)'' below and ""NOTE 12: DERIVATIVES'' to our
consolidated Ñnancial statements.
(5) For all derivatives in qualifying hedge accounting relationships, the accrual of periodic cash settlements is recorded in Net interest income on our
consolidated statements of income and therefore, those amounts are not included above. For derivatives not in qualifying hedge accounting
relationships, the accrual of periodic cash settlements is recorded in Derivative gains (losses) on our consolidated statements of income.
(6) Derivative gains (losses) in each period include gains or losses reclassiÑed from AOCI, net of taxes, as a result of the termination of cash Öow hedge
designations because we determined that the related forecasted transaction is probable of not occurring.
As Table 12 shows, the majority of our derivatives were not designated in hedge accounting relationships at
December 31, 2005 and 2004. Derivatives that are not in qualifying hedge accounting relationships generally increase the
volatility of reported Non-interest income (loss) because the fair value gains and losses on the derivatives are recognized in
earnings without the oÅsetting recognition in earnings for the change in value of the economically hedged exposures.
A receive-Ñxed swap results in our receipt of a Ñxed interest-rate payment from our counterparty in exchange for a
variable-rate payment to our counterparty. Conversely, a pay-Ñxed swap requires us to make a Ñxed interest-rate payment to
our counterparty in exchange for a variable-rate payment from our counterparty. Call and put swaptions are options to enter
into receive- and pay-Ñxed swaps, respectively. We use swaptions and other option-based derivatives to adjust the
contractual funding of our debt in response to changes in the expected lives of mortgage-related assets in the Retained
portfolio. Generally, receive-Ñxed swaps increase in value and pay-Ñxed swaps decrease in value when interest rates decrease
(with the opposite being true when interest rates increase). The fair values of purchased call and put swaptions are sensitive
to changes in interest rates. Swaption values are also driven by the market's expectation of potential changes in future
interest rates (referred to as ""implied volatility''). Swaptions generally become more valuable as implied volatility increases
and less valuable as implied volatility decreases. Recognized losses on these purchased options in any given period are limited
to the premium paid to purchase the option plus any unrealized gains previously recorded.
EÅective at the beginning of the second quarter of 2004, we determined that substantially all pay-Ñxed interest-rate
swaps and other derivatives that previously had been in cash Öow hedge accounting relationships no longer met hedge
accounting requirements. Consequently, we discontinued hedge accounting treatment for these relationships at that time
29 Freddie Mac