Freddie Mac 2005 Annual Report Download - page 47

notional balance of our pay-Ñxed swaps not in hedge accounting relationships contributed to a $0.4 billion increase in the
net expense associated with the accrual of periodic settlements in the second quarter of 2004 as compared to the Ñrst
quarter of 2004. This expense continued to be high in the third and fourth quarters of 2004, but began to be partially oÅset by
the accrual of periodic settlements related to the receive-Ñxed swaps, which were moved to no hedge designation during the
fourth quarter of 2004.
Derivative gains (losses) Öuctuated signiÑcantly during 2003 due to the decrease in interest rates during the Ñrst half of
2003 compared to an increase in interest rates during the third quarter of 2003. As interest rates increased during the third
quarter of 2003, our call swaptions declined in value and we incurred losses on commitments to purchase or sell mortgages
and mortgage-related securities. These losses were partially oÅset by gains on pay-Ñxed swaps.
Hedge Accounting Gains (Losses)
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 amount of any hedge ineÅectiveness, which is the extent to which diÅerences
in the characteristics or terms of the derivative and the hedged item result in fair value or cash Öow changes that are not
exactly oÅset. Our net hedge ineÅectiveness gains in 2005 related to derivatives used to manage interest-rate risk associated
with our debt securities, along with other derivatives in other fair value hedge accounting relationships. Net hedge
ineÅectiveness gains in 2004 and 2003 related primarily to our fair value hedge accounting relationships where the derivative
is valued using forward rates while the hedged debt is valued using spot rates. As discussed in ""Derivative Overview'' above,
a substantial portion of our derivatives in fair value hedge accounting relationships were reclassiÑed to no hedge designation
during 2004.
Gains (Losses) on Investment Activity
Table 14 summarizes the components of Gains (losses) on investment activity.
Table 14 Ì Gains (Losses) on Investment Activity
Year Ended December 31,
2005 2004 2003
(in millions)
Gains (losses) on trading securities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $(289) $(1,071) $(1,606)
Gains (losses) on PC residuals, at fair value ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (95) 58 (144)
Gains (losses) on sale of mortgage loans(1) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 92 209 725
Gains (losses) on sale of available-for-sale securities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 546 584 826
Security impairments:
Mortgage-related interest-only security impairmentsÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (71) (66) (524)
Other security impairments ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (300) (60) (212)
Total security impairments ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (371) (126) (736)
Lower-of-cost-or-market adjustments ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (10) (2) (179)
Total gains (losses) on investment activity ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $(127) $ (348) $(1,114)
(1) Represents mortgage loans sold in connection with securitization transactions.
Gains (losses) on trading securities
The fair value of trading securities in our Retained portfolio declined in 2005 as medium- and long-term interest rates
increased during the year. Prior to 2005, our trading positions related primarily to our SS&TG business unit and external
Money Manager program, both of which ceased operations in the fourth quarter of 2004. The trading activities of our
SS&TG business unit resulted in spot-forward diÅerences, or trading losses, that totaled $1,101 million and $981 million in
2004 and 2003, respectively, which were oÅset by net interest income on the held positions. Absent these spot-forward
diÅerences, our trading gains (losses) netted to a $30 million gain in 2004 and a $625 million loss in 2003. These gains and
losses were primarily caused by changes in the prevailing medium- and long-term market interest rates (i.e., 10-year swap
rate). In 2004, trading losses were adversely impacted by prepayments on mortgage-related securities that we held in the
trading portfolios of our SS&TG business unit and external Money Manager program. In 2003, our trading securities
portfolio experienced losses as a result of prepayments that reduced the fair value of these securities during the Ñrst half of
2003. In addition, during the second half of 2003, the portfolio experienced losses as rising interest rates decreased the value
of these investments.
Gains (losses) on PC residuals, at fair value
Gains (losses) on PC residuals that we classify as trading securities relate to certain PCs and Structured Securities we
hold in our Retained portfolio and represent the net fair value of the future cash inÖows and cash outÖows related to our
guarantee of these securities. The fair value of PC residuals is aÅected by several factors including: (a) changes in interest
rates, which aÅect the expected lives of the related PCs and Structured Securities; (b) default experience and loss severity
trends related to our guarantee and (c) third party information with respect to fair value. In 2005, losses on PC residuals
31 Freddie Mac