Freddie Mac 2006 Annual Report Download - page 48

The accrual of periodic settlements for derivatives not in qualifying hedge accounting relationships increased during
2006 compared to 2005 as short-term interest rates increased and the net income due to the receive variable-rate leg of our
pay-Ñxed swaps was only partly oÅset by the net expense due to the pay variable-rate leg of our receive-Ñxed swaps.
The expense associated with accrual of periodic settlements for derivatives not in qualifying hedge accounting
relationships declined during 2005 compared to 2004 because interest accruals related to our pay-Ñxed and receive-Ñxed
swaps largely oÅset one another during 2005, but only did so for the later part of 2004, following the discontinuation of hedge
accounting for certain receive-Ñxed swaps in November 2004.
Hedge Accounting Gains (Losses)
Hedge accounting gains (losses) represent the extent to which diÅerences in the characteristics or terms of a derivative
in a hedge accounting relationship and the hedged item result in fair value or cash Öow changes that are not exactly oÅset.
Our net hedge ineÅectiveness gains in 2006 and 2005 were not signiÑcant. Net hedge ineÅectiveness gains in 2004 related
primarily to fair value hedge accounting relationships where the derivative was valued using forward rates while the hedged
debt was valued using spot rates. As discussed in ""NOTE 12: DERIVATIVES'' to our consolidated Ñnancial statements, a
substantial portion of our derivatives in fair value hedge accounting relationships was reclassiÑed to no hedge designation
during 2004 and 2006.
Gains (Losses) on Investment Activity
Table 16 summarizes the components of Gains (losses) on investment activity.
Table 16 Ì Gains (Losses) on Investment Activity
Year Ended December 31,
2006 2005 2004
(in millions)
Gains (losses) on trading securities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ (3) $(289) $(1,071)
Gains (losses) on PC residuals, at fair value ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (19) (95) 58
Gains (losses) on sale of mortgage loans(1) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 86 92 209
Gains (losses) on sale of available-for-sale securities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 22 546 584
Security impairments:
Interest-only security impairments ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (147) (71) (66)
Other security impairments ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (393) (300) (60)
Total security impairments ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (540) (371) (126)
Lower-of-cost-or-market adjustmentsÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (20) (10) (2)
Total gains (losses) on investment activity ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $(474) $(127) $ (348)
(1) Represents mortgage loans sold in connection with securitization transactions.
Gains (losses) on trading securities
In 2006 and 2005, the increases in long-term interest rates resulted in losses on mortgage-related securities classiÑed as
trading. However, these losses were signiÑcantly lower in 2006 than in 2005 as interest rates increased less in 2006 than in
2005. The losses in both years were partly oÅset by gains on interest-only mortgage-related securities classiÑed as trading,
which generally increased in fair value as interest rates rose.
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 valuation diÅerences, recorded as trading losses, that totaled $1,101 million in 2004, which were oÅset by net
interest income on the trading securities held. Absent the SS&TG business unit, our trading gains (losses) netted to a
$30 million gain in 2004.
Gains (losses) on PC residuals, at fair value
Gains (losses) on PC residuals 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 aÅects the expected lives
of the related PCs and Structured Securities; (b) default experience and loss severity trends related to our guarantees and
(c) third party information with respect to fair value.
The decrease in net losses on PC residuals in 2006 as compared to 2005 resulted from increasing interest rates in 2006
which increased the expected lives of related PCs and Structured Securities. In 2005, net losses on PC residuals included
the eÅect of changes in the approach we used to estimate the fair values of our guarantee-related assets and liabilities,
which resulted in net pre-tax losses of $78 million in the Ñrst quarter of 2005. In 2004, expected default costs declined due to
continued home price appreciation and generated gains, partially oÅset by declines in mortgage interest rates which reduced
the estimated fair value of future contractual guarantee fees related to securities we hold.
36 Freddie Mac