Freddie Mac 2008 Annual Report Download - page 254

financial results that is more consistent with our business objectives and helps us better evaluate the performance of our
business, both from period-to-period and over the longer term.
As described below, Segment Earnings is calculated for the segments by adjusting GAAP net income (loss) for certain
investment-related activities and credit guarantee-related activities. Segment Earnings includes certain reclassifications among
income and expense categories that have no impact on net income (loss) but provide us with a meaningful metric to assess
the performance of each segment and our company as a whole.
Investment Activity-Related Adjustments
The most significant risk inherent in our investing activities is interest rate risk, including duration, convexity and
volatility. We actively manage these risks through asset selection and structuring, financing asset purchases with a broad
range of both callable and non-callable debt and the use of interest rate derivatives, designed to economically hedge a
significant portion of our interest rate exposure. Our interest rate derivatives include interest rate swaps, exchange-traded
futures and both purchased and written options (including swaptions). GAAP-basis earnings related to investment activities of
our Investments segment are subject to significant period-to-period variability, which we believe is not necessarily indicative
of the risk management techniques that we employ and the performance of these segments.
Our derivative instruments not in hedge accounting relationships are adjusted to fair value under GAAP with resulting
gains or losses recorded in GAAP-basis income. Certain other assets are also adjusted to fair value under GAAP with
resulting gains or losses recorded in GAAP-basis income. These assets consist primarily of mortgage-related securities
classified as trading and mortgage-related securities classified as available-for-sale when a decline in fair value of available-
for-sale securities is deemed to be other than temporary.
In preparing Segment Earnings, we make the following adjustments to earnings as determined under GAAP. We believe
Segment Earnings enhances the understanding of operating performance for specific periods, as well as trends in results over
multiple periods, as this measure is consistent with assessing our performance against our investment objectives and the
related risk-management activities.
• Derivative and foreign currency denominated debt-related adjustments:
• Fair value adjustments on derivative positions, recorded pursuant to GAAP, are not recognized in Segment
Earnings as these positions economically hedge the volatility in fair value of our investment activities and debt
financing that are not recognized in GAAP earnings.
• Payments or receipts to terminate derivative positions are amortized prospectively into Segment Earnings on a
straight-line basis over the associated term of the derivative instrument.
• The accrual of periodic cash settlements of all derivatives not in qualifying hedge accounting relationships is
reclassified from derivative gains (losses) into net interest income for Segment Earnings as the interest
component of the derivative is used to economically hedge the interest associated with the debt.
• Payments of up-front premiums (e.g., payments made to third parties related to purchased swaptions) are
amortized prospectively on a straight-line basis into Segment Earnings over the contractual life of the instrument.
The up-front payments, primarily for option premiums, are amortized to reflect the periodic cost associated with
the protection provided by the option contract.
• Foreign-currency translation gains and losses as well as the unrealized fair value adjustments associated with
foreign-currency denominated debt along with the foreign currency derivatives gains and losses are excluded
from Segment Earnings because the fair value adjustments on the foreign-currency swaps that we use to manage
foreign-currency exposure are also excluded through the fair value adjustment on derivative positions as
described above as the foreign currency exposure is economically hedged.
• Investment sales, debt retirements and fair value-related adjustments:
• Gains and losses on investment sales and debt retirements that are recognized at the time of the transaction
pursuant to GAAP are not immediately recognized in Segment Earnings. Gains and losses on securities sold out
of our mortgage-related investments portfolio and cash and other investments portfolio are amortized
prospectively into Segment Earnings on a straight-line basis over five years and three years, respectively. Gains
and losses on debt retirements are amortized prospectively into Segment Earnings on a straight-line basis over
the original terms of the repurchased debt.
• Trading losses or impairments that reflect expected or realized credit losses are realized immediately pursuant to
GAAP and in Segment Earnings since they are not economically hedged. Fair value adjustments to trading
securities related to investments that are economically hedged are not included in Segment Earnings. Similarly,
non-credit related impairment losses on securities as well as GAAP-basis accretion income that may result from
impairment adjustments are not included in Segment Earnings.
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