Freddie Mac 2006 Annual Report Download - page 112

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
We are a stockholder-owned government-sponsored enterprise, or GSE, established by Congress in 1970 to provide a
continuous Öow of funds for residential mortgages. Our obligations are ours alone and are not insured or guaranteed by the
U.S. government, or any other agency or instrumentality of the U.S. We play a fundamental role in the U.S. housing
Ñnance system, linking the domestic mortgage market and the global capital markets. Our participation in the secondary
mortgage market includes providing our credit guarantee for residential mortgages originated by mortgage lenders and
investing in mortgage loans and mortgage-related securities that we hold in our Retained portfolio. Through our credit
guarantee activities, we securitize mortgage loans by issuing Mortgage Participation CertiÑcates, or PCs, to third-party
investors. We also resecuritize mortgage-related securities that are issued by us or the Government National Mortgage
Association, or Ginnie Mae, as well as non-agency entities. We also guarantee multifamily mortgage loans that support
housing revenue bonds issued by third parties and we guarantee other mortgage loans held by third parties. Securitized
mortgage-related assets that back PCs and Structured Securities that are held by third parties are not reÖected as our assets.
In return for providing our guarantee on issued PCs and Structured Securities, we may earn a management and guarantee
fee that is paid to us over the life of the related PCs and Structured Securities. Our obligation to guarantee the payment of
principal and interest on issued PCs and Structured Securities usually results in the recognition of a Guarantee asset and
Guarantee obligation.
Our Ñnancial reporting and accounting policies conform to U.S. generally accepted accounting principles, or GAAP.
Certain amounts in prior periods have been reclassiÑed to conform to the current presentation. We evaluate the materiality
of identiÑed errors in the Ñnancial statements using both an income statement, or ""rollover,'' and a balance sheet, or ""iron-
curtain,'' approach, based on relevant quantitative and qualitative factors. Our approach is consistent with the Securities and
Exchange Commission's StaÅ Accounting Bulletin No. 108, ""Considering the EÅects of Prior Year Misstatements when
Quantifying Misstatements in Current Year Financial Statements,'' or SAB 108, which is eÅective for the year ended
December 31, 2006.
Estimates
The preparation of Ñnancial statements requires us to make estimates and assumptions that aÅect (a) the reported
amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the Ñnancial statements and
(b) the reported amounts of revenues and expenses and gains and losses during the reporting period. Actual results could
diÅer from those estimates.
Our estimates and judgments include the following:
‚ estimating fair value for Ñnancial instruments (See ""NOTE 16: FAIR VALUE DISCLOSURES'' for a discussion
of our fair value estimates);
‚ determining the expected future cash Öows (including the timing and amounts of prepayments) of mortgage-related
assets in the Retained portfolio for the purpose of amortizing deferred amounts and assessing when securities are
other-than-temporarily impaired;
‚ assessing the reserves for credit losses on mortgage loans and guarantee losses on PCs;
‚ assessing our legal and tax contingencies;
‚ estimating the expected timing and amounts of future issuances of non-callable debt; and
‚ determining other matters that aÅect the reported amounts and disclosure of contingencies in the Ñnancial
statements.
Net income for 2006 was increased by approximately $8 million (after-tax), or $0.01 per diluted common share, due
primarily to changes in estimates related to the amortization of discounts, premiums and deferred fees for assets held in the
Retained portfolio and enhancements to our approach for certain valuations including the Guarantee asset and Guarantee
obligation.
EÅective January 1, 2006, we enhanced our process for forecasting interest rates and estimating prepayments used to
amortize discounts, premiums and deferred fees for assets held in the Retained portfolio. This change resulted in a
$49 million (after-tax) reduction in Net income for 2006, including the eÅect of the amortization of deferred credit fees.
Also, eÅective January 1, 2006, we enhanced our approach for Guarantee asset and Guarantee obligation valuations
primarily with respect to applying dealer prices in estimating the fair value of our guarantee-related assets. We also enhanced
our approach for applying loan characteristics in the valuation of our Guarantee obligation. These changes resulted in a
$57 million (after-tax) increase in Net income for 2006.
In 2005, Net income was reduced by approximately $206 million (after-tax), or $0.30 per diluted common share,
related to the implementation of enhancements to our approach for Guarantee asset and Guarantee obligation valuations, the
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