Freddie Mac 2008 Annual Report Download - page 197

transaction, which includes our guarantee to the securitization trust. As such, the fair value of Freddie Mac PCs and
Structured Securities held by us includes the implicit value of the guarantee. See “NOTE 17: FAIR VALUE
DISCLOSURES,” for disclosure of the fair values of our mortgage-related securities, guarantee asset, and guarantee
obligation. Upon subsequent sale of a Freddie Mac PC or Structured Security, we continue to account for any outstanding
recorded amounts associated with the guarantee transaction on the same basis as prior to the sale of the Freddie Mac PC or
Structured Security, because the sale does not result in the retention of any new assets or the assumption of any new
liabilities.
Due to PC Investors
Beginning December 2007 we introduced separate legal entities, or trusts, into our securities issuance process for the
purpose of managing the receipt and payments of cash flow of our PCs and Structured Securities. In connection with the
establishment of these trusts, we also established a separate custodial account in which cash remittances received on the
underlying assets of our PCs and Structured Securities are deposited. These cash remittances include both scheduled and
unscheduled principal and interest payments. The funds held in this account are segregated and are not commingled with our
general operating funds nor are they presented within our consolidated balance sheets. As securities administrator, we invest
the cash held in the custodial account, pending distribution to our PC and Structured Securities holders, in short-term
investments and are entitled to trust management fees on the trust’s assets which are recorded as other non-interest income.
The funds are maintained in this separate custodial account until they are due to the PC and Structured Securities holders on
their respective security payment dates.
Prior to December 2007, we managed the timing differences that exist for cash receipts from servicers on assets
underlying our PCs and Structured Securities and the subsequent pass-through of those payments on PCs owned by third-
party investors. In those cases, the PC balances were not reduced for payments of principal received from servicers in a
given month until the first day of the next month and we did not release the cash received (principal and interest) to the PC
investors until the fifteenth day of that next month. We generally invested the principal and interest amounts we received in
short-term investments from the time the cash was received until the time we paid the PC investors. In addition, for
unscheduled principal prepayments on loans underlying our PCs and Structured Securities, these timing differences resulted
in expenses, since the related PCs continued 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 no interest was received from the mortgage on that
prepayment amount during that period. The expense recognized upon prepayment was reported in interest expense — due to
Participation Certificate investors. We report coupon interest income amounts relating to our investment in PCs consistent
with the method used for PCs held by third-party investors.
Mortgage Loans
Upon loan acquisition, we classify the loan as either held-for-sale or held-for-investment. Mortgage loans that we have
the ability and intent to hold for the foreseeable future are classified as held-for-investment. Held-for-investment mortgage
loans are reported at their outstanding unpaid principal balances, net of deferred fees and cost basis adjustments (including
unamortized premiums and discounts). These deferred items are amortized into interest income over the estimated lives of
the mortgages using the effective interest method. We use actual prepayment experience and estimates of future prepayments
to determine the constant yield needed to apply the effective interest method. For purposes of estimating future prepayments,
the mortgages are aggregated by similar characteristics such as origination date, coupon and maturity. We recognize interest
on mortgage loans on an accrual basis, except when we believe the collection of principal or interest is not probable.
Mortgage loans not classified as held-for-investment are classified as held-for-sale. Held-for-sale mortgages are reported
at lower-of-cost-or-fair-value, with gains and losses reported in gains (losses) on investment activity. Premiums and discounts
on loans classified as held-for-sale are not amortized during the period that such loans are classified as held-for-sale.
Beginning in the third quarter of 2008, we elected the fair value option for multifamily mortgage loans that were purchased
through our Capital Market Execution program to reflect our strategy in this program. Thus, these multifamily mortgage
loans are measured at fair value on a recurring basis. Gains or losses on these loans related to sales or changes in fair value
are reported in gains (losses) on investment activity.
Allowance for Loan Losses and Reserve for Guarantee Losses
We maintain an allowance for loan losses on mortgage loans held-for-investment and a reserve for guarantee losses on
PCs, collectively referred to as our loan loss reserves, to provide for credit losses when it is probable that a loss has been
incurred. The held-for-investment loan portfolio is shown net of the allowance for loan losses on the consolidated balance
sheets. The reserve for guarantee losses is a liability account on our consolidated balance sheets. Increases in loan loss
reserves are reflected in earnings as the provision for credit losses, while decreases are reflected through charging-off such
balances (net of recoveries) when realized losses are recorded or as a reduction in the provision for credit losses. For both
single-family and multifamily mortgages where the original terms of the mortgage loan agreement are modified, resulting in
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