Freddie Mac 2006 Annual Report Download - page 117

Recognized Credit Enhancements
Credit enhancements that are separately recognized as Other assets are amortized into earnings as Non-interest
expense. Such assets are amortized over related contract terms at the greater of amounts calculated by amortizing recognized
credit enhancements (a) commensurate with the observed decline in the unpaid principal balance of covered mortgage
loans or (b) on a straight-line basis over a credit enhancement's contract term. Recurring insurance premiums are recorded
at the amount paid and amortized over their contractual life and, if provided quarterly, then the amortization period is three
months.
PC Residuals
PC residuals relate to certain PCs or Structured Securities that we hold as investments and represent the fair value of
the expected future cash Öows associated with the guarantee contracts (including cash Öows related to Management and
guarantee fees and our Guarantee obligation) that are inherent within such securities.
We recognize a PC residual in connection with PCs or Structured Securities that we hold that (a) were previously
transferred to third parties as part of transactions that were accounted for either as sales or in a manner described above for
Guarantor Swap transactions (such that a Guarantee asset and Guarantee obligation were previously established for held
PCs or Structured Securities), or (b) were formed from mortgage loans purchased through our Cash Window, referred to
as ""Cash Window Purchases,'' and that were never transferred to third parties.
Similar to our recognized Guarantee asset, a PC residual is accounted for like a debt security and is classiÑed as either
available-for-sale or trading under SFAS 115. PC residuals relating to PCs or Structured Securities that were transferred to
third parties and for which a Guarantee asset and Guarantee obligation was recognized are accounted for like debt
securities that are classiÑed as trading. PC residuals relating to PCs held in portfolio that were formed from Cash Window
Purchases and that were never transferred to third parties are generally accounted for like debt securities that are classiÑed
as available-for-sale.
PC residuals are subsequently carried at fair value considering the future inherent credit obligation. All changes in the
fair value of PC residuals that are designated as trading are reÖected in earnings as a component of Gains (losses) on
investment activity. All changes in the fair value of PC residuals that are accounted for as available-for-sale are reÖected as
a component of Accumulated other comprehensive income (loss), net of taxes, or AOCI, a component of Stockholders'
equity. All cash received over the life of the underlying loans with respect to the Guarantee asset component of the PC
residuals is reÖected in earnings as a component of Net interest income.
Due to Participation CertiÑcate Investors
Timing diÅerences between our receipt of scheduled and unscheduled principal and interest payments from seller/
servicers on mortgages underlying PCs and the subsequent pass through of those payments on PCs owned by third-party
investors result in the liability Due to Participation CertiÑcate investors. In those cases, the PC balance is not reduced for
payments of principal received from seller/servicers in a given month until the Ñrst day of the next month and we do not
release the cash received (principal and interest) to the PC investor until the Ñfteenth day of that next month. We generally
invest the principal and interest amounts we receive in short-term investments from the time the cash is received until the
time we pay the PC investor. Interest income resulting from investment of principal and interest payments from seller/
servicers is reported in interest income.
For unscheduled principal prepayments, these timing diÅerences result in an expense accrual upon prepayment of the
underlying mortgage. This is because the related PCs continue to bear interest due to the PC investor at the PC coupon rate
from the date of prepayment until the date the PC security balance is reduced, while generally no interest is received from
the mortgage on that prepayment amount during that period. The expense recognized upon prepayment is reported in
Interest expense Ì Due to Participation CertiÑcate investors. We report PC coupon interest amounts relating to our
investment in PCs consistent with GAAP applied by third party investors in PCs. Accordingly, the PC coupon interest on
prepayments of a mortgage pending remittance on PCs held by us is reported as both Interest Income Ì Mortgage-related
securities in the Retained portfolio and Interest expense Ì Due to Participation CertiÑcate investors. Scheduled and
unscheduled principal payments received by us that relate to our investment in PCs are reported as a reduction to our
investment in PCs on our consolidated balance sheets.
Mortgage Loans
Mortgage loans that we intend to sell are classiÑed as held-for-sale. If we decide to retain a loan, the loan is transferred
to the held-for-investment portfolio. Loans transferred to the held-for-investment portfolio are transferred at lower of cost or
market. Lower-of-cost-or-market valuation adjustments relating to these loans are treated as basis adjustments and are
subsequently amortized into interest income over the estimated lives of the mortgages using the eÅective interest method.
105 Freddie Mac