Freddie Mac 2008 Annual Report Download - page 195

speeds, and increases or decreases in home price appreciation/depreciation. These triggers are based on objective measures
(i.e., defined percentages which are designed to identify symmetrical shifts in the loss curve) applied consistently period to
period. When a trigger is met, a cumulative catch-up adjustment is recognized to true up the cumulative amortization to the
amount that would have been recognized had the shift in the loss curve been included in the original effective yield
calculation. The new effective yield is applied prospectively based on the revised cash flow forecast and can subsequently
change when another trigger is met indicating another significant shift in the loss curve. The resulting recorded amortization
reflects our economic release from risk under changing economic scenarios.
Credit Enhancements
As additional consideration, we may receive the following types of seller-provided credit enhancements related to the
underlying mortgage loans. These credit enhancements are initially measured at fair value and recognized as follows:
(a) pool insurance is recognized as an other asset; (b) recourse and/or indemnifications that are provided by counterparties to
guarantor swap or cash auction transactions are recognized as an other asset; and (c) primary loan-level mortgage insurance
is recognized at inception as a component of the recognized guarantee obligation. The fair value of the credit enhancements
is estimated using an expected cash flow approach intended to reflect the estimated amount that a third party would be
willing to pay for the contracts. Recognized credit enhancement assets are subsequently amortized into earnings as other
non-interest expense under the static effective yield method in the same manner as our guarantee obligation. Recurring
insurance premiums are recorded at the amount paid and amortized over their contractual life.
Reserve for Guarantee Losses on Participation Certificates
When appropriate, we recognize a contingent obligation to make payments under our guarantee, in accordance with the
provisions of SFAS No. 5, “Accounting for Contingencies,” or SFAS 5. See “Allowance for Loan Losses and Reserve for
Guarantee Losses” below for information on our contingent obligation, when it is recognized, and how it is initially and
subsequently measured.
Deferred Guarantee Income or Losses on Certain Credit Guarantees
Prior to January 1, 2008, because the recognized assets (the guarantee asset and any credit enhancement-related assets)
and the recognized liability (the guarantee obligation) were valued independently of each other, net differences between these
recognized assets and liability existed at inception. If the amounts of the recognized assets exceeded the recognized liability,
the excess was deferred on our consolidated balance sheets as a component of guarantee obligation and referred to as
deferred guarantee income, and is subsequently amortized into earnings as income on guarantee obligation using a static
effective yield method consistent with the amortization of our guarantee obligation. If the amount of the recognized liability
exceeded the recognized assets, the excess was expensed immediately to earnings as a component of non-interest expense —
losses on certain credit guarantees.
Cash Payments at Inception
When we issue PCs, we often exchange buy-up and buy-down fees with the counterparties to the exchange, so that the
mortgage loan pools can fit into PC coupon increments. PCs are issued in 50 basis point coupon increments, whereas the
mortgage loans that underlie the PCs are issued in 12.5 basis point coupon increments. Buy-ups are upfront cash payments
made by us to increase the management and guarantee fee we will receive over the life of an issued PC, and buy-downs are
upfront cash payments made to us to decrease the management and guarantee fee we receive over the life of an issued PC.
The following illustrates how buy-ups and buy-downs impact the management and guarantee fees.
Buy-Up Example Buy-Down Example
Mortgage loan pool weighted average coupon 6.625% Mortgage loan pool weighted average coupon 6.375%
Loan servicing fee (.250)% Loan servicing fee (.250)%
Stated management and guarantee fee (.200)% Stated management and guarantee fee (.200)%
Buy-up (increasing the stated fee) (.175)% Buy-down (decreasing the stated fee) .075%
PC coupon 6.00% PC coupon 6.00%
We may also receive upfront, cash-based payments as additional compensation for our guarantee of mortgage loans,
referred to as delivery fees. These fees are charged to compensate us for any additional credit risk not contemplated in the
management and guarantee fee initially negotiated with customers.
Cash payments that are made or received at inception of a swap-based exchange related to buy-ups, buy-downs or
delivery fees are included as a component of our guarantee obligation and amortized into earnings as a component of income
on guarantee obligation over the life of the guarantee. Prior to the adoption of FIN 45, certain pre-2003 deferred delivery and
buy-down fees received by us were recorded as deferred income as a component of other liabilities and are amortized
through management and guarantee income.
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