Freddie Mac 2008 Annual Report Download - page 200

and trading are reported at fair value with changes in fair value included in AOCI, net of taxes, and gains (losses) on
investment activity, respectively. See “NOTE 17: FAIR VALUE DISCLOSURES” for more information on how we determine
the fair value of securities.
We record forward purchases and sales of securities that are specifically exempt from the requirements of SFAS 133, on
a trade date basis. Securities underlying forward purchases and sales contracts that are not exempt from the requirements of
SFAS 133 are recorded on the contractual settlement date with a corresponding commitment recorded on the trade date.
In connection with transfers of financial assets that qualify as sales under SFAS 140, we may retain individual securities
not transferred to third parties upon the completion of a securitization transaction. These securities may be backed by
mortgage loans purchased from our customers or PCs and Structured Securities. The new Structured Securities we acquire in
these transactions are classified as available-for-sale or trading. Our PCs and Structured Securities are considered guaranteed
investments. Therefore, the fair values of these securities reflect that they are considered to be of high credit quality and the
securities are not subject to credit-related impairments. They are subject to the credit risk associated with the underlying
mortgage loan collateral. Therefore, our exposure to credit losses on the loans underlying our retained securitization interests
is recorded within our reserve for guarantee losses on PCs. See “Allowance for Loan Losses and Reserve for Guarantee
Losses” above for additional information.
For most of our investments in securities, interest income is recognized using the retrospective effective interest method.
Deferred items, including premiums, discounts and other basis adjustments, are amortized into interest income over the
estimated lives of the securities. We use actual prepayment experience and estimates of future prepayments to determine the
constant yield needed to apply the effective interest method. We recalculate the constant effective yield based on changes in
estimated prepayments as a result of changes in interest rates and other factors. When the constant effective yield changes,
an adjustment to interest income is made for the amount of amortization that would have been recorded if the new effective
yield had been applied since the mortgage assets were acquired.
For certain securities investments, interest income is recognized using the prospective effective interest method. We
specifically apply this accounting to beneficial interests in securitized financial assets that (a) can contractually be prepaid or
otherwise settled in such a way that we may not recover substantially all of our recorded investment, (b) are not of high
credit quality at the acquisition date, or (c) have been determined to be other-than-temporarily impaired. We recognize as
interest income (over the life of these securities) the excess of all estimated cash flows attributable to these interests over
their book value using the effective yield method. We update our estimates of expected cash flows periodically and recognize
changes in calculated effective yield on a prospective basis.
We review securities for potential other-than-temporary impairment on an ongoing basis. We perform an evaluation on a
security-by-security basis considering available information. Important factors include the length of time and extent to which
the fair value of the security has been less than book value; the impact of changes in credit ratings (i.e., rating agency
downgrades); our intent and ability to retain the security in order to allow for a recovery in fair value; loan level default
modeling and an analysis of the performance of the underlying collateral relative to its credit enhancements using techniques
that require assumptions about future loss severity, default, prepayment and other borrower behavior. Implicit in this analysis
is information relevant to expected cash flows (such as collateral performance and characteristics) that also underlies the
other impairment factors mentioned above, and we qualitatively consider available information when assessing whether an
impairment is other-than-temporary. We recognize impairment losses when quantitative and qualitative factors indicate that it
is probable that the security will suffer a contractual cash shortfall. We also recognize impairment when qualitative factors
indicate that it is likely we will not recover the unrealized loss. Impairment losses on manufactured housing securities
exclude the effects of separate financial guarantee contracts that are not embedded in the securities because the benefits of
such contracts are not recognized until claims become probable of recovery under the contracts. We resecuritize securities
held in our mortgage-related investments portfolio and we typically retain the majority of the cash flows from
resecuritization transactions in the form of Structured Securities. Certain securities in our mortgage-related investments
portfolio have a high probability of being resecuritized and therefore, for those in an unrealized loss position, we may not
have the intent to hold for a period of time sufficient to recover those unrealized losses. In that case, the impairment is
deemed other-than-temporary. We compare our estimate of the future expected principal and interest shortfall on impaired
available-for-sale securities with the probable impairment loss required to be recorded under GAAP. Where we expect these
shortfalls to be less than the recent fair value declines, the portion of the impairment charges associated with these expected
recoveries is recognized as net interest income in future periods.
Prior to January 1, 2008, for certain securities that (a) can contractually be prepaid or otherwise settled in such a way
that we may not recover substantially all of our recorded investment or (b) are not of high credit quality at the acquisition
date other than-temporary impairment was defined in accordance with EITF 99-20 as occurring whenever there was an
adverse change in estimated future cash flows coupled with a decline in fair value below the amortized cost basis. When a
security subject to EITF 99-20 was deemed to be other-than-temporarily impaired, the cost basis of the security was written
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