Freddie Mac 2006 Annual Report Download - page 42

Table 9 summarizes components of our Net interest income.
Table 9 Ì Net Interest Income Year Ended December 31,
2006 2005(1) 2004(1)
(in millions)
Contractual amounts of Net interest income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 8,059 $ 8,897 $11,735
Amortization expense, net:(2)
Asset-related amortization expense, netÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (639) (1,023) (1,397)
Debt-related amortization expense, net ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (1,603) (1,446) (1,301)
Total amortization expense, net ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (2,242) (2,469) (2,698)
Income (expense) related to derivatives:
Amortization of deferred balances in Accumulated other comprehensive income(3) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (1,620) (1,966) (1,814)
Accrual of periodic settlements of derivatives:(4)
Pay-Ñxed swapsÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Ì Ì (427)
Receive-Ñxed swaps(5) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 502 1,185 1,968
Foreign-currency swaps ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (464) (277) 376
Other ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Ì Ì (3)
Total accrual of periodic settlements of derivatives ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 38 908 1,914
Total income (expense) related to derivatives ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (1,582) (1,058) 100
Net interest income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 4,235 5,370 9,137
Fully taxable-equivalent adjustments ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 392 339 267
Net interest income (fully taxable-equivalent basis) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 4,627 $ 5,709 $ 9,404
(1) Certain amounts for 2005 and 2004 have been revised to conform with the 2006 presentation.
(2) Represents amortization related to premiums, discounts, deferred fees and other adjustments to the carrying value of our Ñnancial instruments and the
reclassiÑcation of previously deferred balances from Accumulated other comprehensive income, or AOCI, for certain derivatives in cash Öow hedge
relationships related to individual debt issuances and mortgage purchase transactions.
(3) Represents changes in fair value of derivatives in cash Öow hedge relationships that were previously deferred in AOCI and have been reclassiÑed to
earnings as the associated hedged forecasted issuance of debt and mortgage purchase transactions aÅect earnings.
(4) ReÖects the accrual of periodic cash settlements of all derivatives in qualifying hedge accounting relationships.
(5) The accrual of periodic settlements of Receive-Ñxed swaps includes imputed interest on zero-coupon swaps.
2006 versus 2005
Net interest income and net interest yield on a fully taxable-equivalent basis decreased in 2006 as spreads on Ñxed-rate
investments continued to narrow, driven by increases in long- and medium-term interest rates. The increase in our long-term
debt interest costs reÖects the turnover of medium-term debt that we issued during the past few years to fund our
investments in Ñxed-rate mortgage-related investments when the yield curve was steep (i.e. short- and medium-term interest
rates were low as compared to long-term interest rates). As the yield curve Öattened during 2005 and 2006, we experienced
increased funding costs associated with replacing maturing lower-cost debt used to fund existing Ñxed-rate mortgage
investments. During 2006, net interest margins declined as a result of changes in interest rates on variable-rate assets
acquired in 2004 and 2005 impacted our results. Also, we adjusted our funding mix in 2006 by increasing the proportion of
callable debt outstanding, which we use to manage prepayment risk associated with our mortgage-related investments, and
which generally has a higher interest cost than non-callable debt. In 2006, we considered the issuance of callable debt to be
more cost eÅective than alternative interest-rate risk management strategies, primarily the issuance of non-callable bullet
debt combined with the use of derivatives. We also reduced the balance of our short-term debt securities to approximately
23 percent of total outstanding debt as of December 31, 2006, from approximately 26 percent at the beginning of the year, to
take advantage of the attractive funding spreads relative to LIBOR on our long-term debt. The impact of rising short-term
rates on our short-term debt was largely oÅset by the impact of rising rates on our variable-rate assets in our Retained
portfolio and our Cash and investments portfolio.
Net interest income for 2006 also reÖected lower net interest income on derivatives in qualifying hedge accounting
relationships. Net interest income associated with the accrual of periodic settlements declined as the benchmark LIBOR and
the Euro Interbank OÅered Rate, or Euribor, interest rates increased during the year, adversely aÅecting net settlements on
our receive-Ñxed swaps and foreign-currency swaps (primarily Euro-denominated). Net interest income was also aÅected
by our decisions in March and December 2006 to discontinue hedge accounting treatment for a signiÑcant amount of our
receive-Ñxed swaps and foreign-currency swaps, as discussed in ""NOTE 12: DERIVATIVES'' to our consolidated Ñnancial
statements. The net interest expense related to these swaps is no longer a component of Net interest income, after hedge
accounting was discontinued, but instead is recognized as a component of Derivative gains (losses). By the end of 2006,
nearly all of our derivatives were not in hedge accounting relationships.
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 in estimate resulted in
a $93 million pre-tax reduction in Net interest income on mortgage-related securities.
30 Freddie Mac