Freddie Mac 2008 Annual Report Download - page 75

Table 11 summarizes components of our net interest income.
Table 11 — Net Interest Income
2008 2007 2006
Year Ended December 31,
(in millions)
Contractual amounts of net interest income................................................. $9,001 $ 6,038 $ 7,472
Amortization income (expense), net:
(1)
Accretion of impairments on available-for-sale securities
(2)
.................................... 551 4 7
Asset-related amortization. . ......................................................... (259) (272) (882)
Long-term debt-related amortization . . .................................................. (1,148) (1,342) (1,603)
Total amortization income (expense), net . . . . . . ......................................... (856) (1,610) (2,478)
Expense related to derivatives:
Amortization of deferred balances in AOCI
(3)
............................................. (1,257) (1,329) (1,620)
Accrual of periodic settlements of derivatives:
(4)
Receive-fixed swaps
(5)
........................................................... — — 502
Foreign-currency swaps. . ......................................................... — — (464)
Pay-fixed swaps . ............................................................... (92) — —
Total accrual of periodic settlements of derivatives . ..................................... (92) — 38
Total expense related to derivatives ...................................................... (1,349) (1,329) (1,582)
Net interest income . . ............................................................... 6,796 3,099 3,412
Fully taxable-equivalent adjustments . . . .................................................. 404 392 392
Net interest income (fully taxable-equivalent basis) . . ......................................... $7,200 $3,491 $ 3,804
(1) Represents amortization related to premiums, discounts, deferred fees and other adjustments to the carrying value of our financial instruments and the
reclassification of previously deferred balances from AOCI for certain derivatives in cash flow hedge relationships related to individual debt issuances
and mortgage purchase transactions.
(2) We estimate that the future expected principal and interest shortfall on impaired available-for-sale securities will be significantly less than the probable
impairment loss required to be recorded under GAAP, as 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.
(3) Represents changes in fair value of derivatives in cash flow hedge relationships that were previously deferred in AOCI and have been reclassified to
earnings as the associated hedged forecasted issuance of debt and mortgage purchase transactions affect earnings.
(4) Reflects the accrual of periodic cash settlements of all derivatives in qualifying hedge accounting relationships.
(5) Includes imputed interest on zero-coupon swaps.
Net interest income and net interest yield on a fully taxable-equivalent basis increased during 2008 compared to 2007
primarily due to purchases of fixed-rate assets at wider spreads relative to our funding costs, a decrease in funding costs, due
to the replacement of higher cost short- and long-term debt with lower cost debt issuances, and a significant increase in the
average size of the mortgage-related investments portfolio. During 2008, liquidity concerns in the market resulted in more
favorable investment opportunities for agency mortgage-related securities at wider spreads. FHFA’s directive that we acquire
and hold increased amounts of mortgage loans and mortgage-related securities in our mortgage-related investments portfolio
to provide additional liquidity to the mortgage market also led to the growth in the portfolio during the second half of 2008.
In response, we increased our purchase activities resulting in an increase in the average balance of our interest-earning assets.
Interest income for 2008 includes $551 million of income related to the accretion of other-than-temporary impairments of
investments in available-for-sale securities recorded during the second and third quarters of 2008. Net interest income and net
interest yield for 2008 also benefited from funding fixed-rate assets with a higher proportion of short-term debt in a steep
yield curve environment. However, our use of short-term debt funding has also been driven by the substantial levels of
volatility in the worldwide financial markets, which has limited our ability to obtain long-term and callable debt funding.
During 2008, our short-term funding balances increased significantly when compared to 2007. We use derivatives to
synthetically create the substantive economic equivalent of various debt funding structures. For example, the combination of
a series of short-term debt issuances over a defined period and a pay-fixed swap with the same maturity as the last debt
issuance is the substantive economic equivalent of a long-term fixed-rate debt instrument of comparable maturity. However,
the use of these derivatives exposes us to additional counterparty credit risk. See “Non-Interest Income (Loss) — Derivative
Gains (Losses)” for additional information about the impact of these pay-fixed swaps and other derivatives on our
consolidated statements of operations.
The increases in net interest income and net interest yield on a fully taxable-equivalent basis during 2008 were partially
offset by the impact of declining interest rates on our floating rate assets held in our mortgage-related investments portfolio
during 2008, as well as a decline in prepayment fees, or yield maintenance income, on our multifamily whole loans as a
result of a decline in prepayments. The shift within our cash and other investments portfolio during 2008 from higher-
yielding, longer-term non-mortgage-related securities to lower-yielding, shorter-term cash and cash equivalent investments,
such as commercial paper, in combination with lower short-term rates, also partially offset the increase in net interest income
and net interest yield.
During 2007, we experienced higher funding costs for our mortgage-related investments portfolio as our long-term debt
interest expense increased, reflecting the replacement of maturing debt that had been issued at lower interest rates with
higher cost debt. The decrease in net interest income and net interest yield on a fully taxable-equivalent basis for 2007
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