Freddie Mac 2008 Annual Report Download - page 271

none of our bond insurers has failed to meet its obligations concerning any of our non-agency securities; however, we
recognized significant impairment losses during 2008 as a result of our uncertainty over whether or not certain insurers will
meet our future claims. See “NOTE 5: INVESTMENTS IN SECURITIES” for further information on these impairment
charges.
Principal and Interest Securitization Trusts
Effective December 2007 we established securitization trusts for the administration of cash remittances received on the
underlying assets of our PCs and Structured Securities. We receive trust management income, which represents the fees we
earn as master servicer, issuer, trustee and administrator for our PCs and Structured Securities. These fees, which are
included in our non-interest income, are derived from interest earned on principal and interest cash flows held in the trust
between the time funds are remitted to the trust by servicers and the date of distribution to our PC and Structured Securities
holders. The trust management income will be offset by interest expense we incur when a borrower prepays a mortgage, but
the full amount of interest for the month is due to the PC investor. We have off-balance sheet exposure to the trust of the
same maximum amount that applies to our credit risk of our outstanding guarantees; however, we also have exposure to the
trust and its institutional counterparties for any investment losses that are incurred in our role as the securities administrator
for the trust. We recognized trust management income (expense) of $(71) million, $18 million and $— million during 2008,
2007 and 2006, respectively, within other income on our consolidated statements of operations.
In accordance with the trust agreements, we invest the funds of the trusts in eligible short-term financial instruments that
are mainly the highest-rated debt types as classified by a nationally-recognized statistical rating organization. To the extent
there is a loss related to an eligible investment for the trust, we, as the administrator are responsible for making up that
shortfall. As of December 31, 2008 and 2007, there were $11.6 billion and $12.5 billion, respectively, of cash and other non-
mortgage assets in this trust. As of December 31, 2008, these consisted of: (a) $3.7 billion of cash equivalents invested in
seven counterparties that had short-term credit ratings A-1+ on the S&P’s or equivalent scale, (b) $4.9 billion of cash
deposited with the Federal Reserve Bank, and (c) $3.0 billion of securities sold under agreements to resell with two
counterparties, which had short-term S&P ratings of A-1 or above. During 2008, we recognized $1.1 billion of losses on
investment activity associated with our role as securities administrator for this trust on unsecured loans made to Lehman on
the trust’s behalf. These short-term loans were due to mature on September 15, 2008, the date Lehman filed for bankruptcy;
however, Lehman failed to repay these loans and the accrued interest. See “NOTE 13: LEGAL CONTINGENCIES” for
further information on this claim.
Derivative Portfolio
On an ongoing basis, we review the credit fundamentals of all of our derivative counterparties to confirm that they
continue to meet our internal standards. We assign internal ratings, credit capital and exposure limits to each counterparty
based on quantitative and qualitative analysis, which we update and monitor on a regular basis. We conduct additional
reviews when market conditions dictate or events affecting an individual counterparty occur.
Derivative Counterparties
Our use of derivatives exposes us to counterparty credit risk, which arises from the possibility that the derivative
counterparty will not be able to meet its contractual obligations. Exchange-traded derivatives, such as futures contracts, do
not measurably increase our counterparty credit risk because changes in the value of open exchange-traded contracts are
settled daily through a financial clearinghouse established by each exchange. Over-the-counter, or OTC, derivatives, however,
expose us to counterparty credit risk because transactions are executed and settled between us and our counterparty. Our use
of OTC interest-rate swaps, option-based derivatives and foreign-currency swaps is subject to rigorous internal credit and
legal reviews. Our derivative counterparties carry external credit ratings among the highest available from major rating
agencies. All of these counterparties are major financial institutions and are experienced participants in the OTC derivatives
market.
Master Netting and Collateral Agreements
We use master netting and collateral agreements to reduce our credit risk exposure to our active OTC derivative
counterparties for interest-rate swaps, option-based derivatives and foreign-currency swaps. Master netting agreements
provide for the netting of amounts receivable and payable from an individual counterparty, which reduces our exposure to a
single counterparty in the event of default. On a daily basis, the market value of each counterparty’s derivatives outstanding
is calculated to determine the amount of our net credit exposure, which is equal to derivatives in a net gain position by
counterparty after giving consideration to collateral posted. Our collateral agreements require most counterparties to post
collateral for the amount of our net exposure to them above the applicable threshold. Bilateral collateral agreements are in
place for the majority of our counterparties. Collateral posting thresholds are tied to a counterparty’s credit rating. Derivative
exposures and collateral amounts are monitored on a daily basis using both internal pricing models and dealer price quotes.
268 Freddie Mac