Freddie Mac 2008 Annual Report Download - page 77

The change in fair value of the guarantee asset reflects:
• reductions related to the management and guarantee fees received that are considered a return of our recorded
investment on the guarantee asset; and
• changes in present value of future management and guarantee fees we expect to receive over the life of the related
PCs or Structured Securities.
The changes in fair value of future management and guarantee fees are driven by expected changes in interest rates that
affect the estimated life of the mortgages underlying our PCs and Structured Securities issued and the related discount rates
used to determine the net present value of the cash flows. For example, an increase in interest rates extends the life of the
guarantee asset and increases the fair value of future management and guarantee fees. Our valuation methodology for the
guarantee asset uses market-based information, including market values of excess servicing, interest-only securities, to
determine the present, or fair value of future cash flows associated with the guarantee asset.
Table 13 — Attribution of Change — Gains (Losses) on Guarantee Asset
2008 2007 2006
Year Ended December 31,
(in millions)
Contractual management and guarantee fees . ............................................. $(2,871) $(2,288) $(1,873)
Portion related to imputed interest income . . ............................................. 1,121 549 580
Return of investment on guarantee asset . . . . ............................................. (1,750) (1,739) (1,293)
Change in fair value of management and guarantee fees . . . . .................................. (5,341) 255 315
Gains (losses) on guarantee asset. . . . . . . . . ............................................. $(7,091) $(1,484) $ (978)
Contractual management and guarantee fees shown in Table 13 represents cash received in each period related to our
PCs and Structured Securities with an established guarantee asset. A portion of these contractual management and guarantee
fees is attributed to imputed interest income on the guarantee asset. Contractual management and guarantee fees increased in
both 2008 and 2007, primarily due to increases in the average balance of our PCs and Structured Securities issued and, to a
lesser extent, increases in average management and guarantee fee rates.
Losses in fair value of management and guarantee fees in 2008 were primarily attributed to lower market valuations for
excess servicing, interest-only securities, which were caused by decreases in interest rates during 2008 combined with the
effects of a decline in investor demand for mortgage-related securities. Gains in fair value of management and guarantee fees
in 2007 were primarily due to an increase in interest rates.
Income on Guarantee Obligation
Upon issuance of a guarantee of securitized assets, we record a guarantee obligation on our consolidated balance sheets
representing the fair value of our obligation to perform under the terms of the guarantee. Our guarantee obligation is
amortized into income using a static effective yield calculated and fixed at inception of the guarantee based on forecasted
unpaid principal balances. The static effective yield is evaluated and adjusted when significant changes in economic events
cause a shift in the pattern of our economic release from risk, or the loss curve. For example, certain market environments
may lead to sharp and sustained changes in home prices or prepayments of mortgages, leading to the need for an adjustment
in the static effective yield for specific mortgage pools underlying the guarantee. When a change is required, a cumulative
catch-up adjustment, which could be significant in a given period, is recognized and a new static effective yield is used to
determine our guarantee obligation amortization. The resulting amortization recorded to income on guarantee obligation
results in a pattern of revenue recognition that is more consistent with our economic release from risk under changing
economic scenarios and the timing of the recognition of losses on the pools of mortgage loans that we guarantee. Over time,
we recognize a provision for credit losses on loans underlying a guarantee contract as those losses are incurred. Those
incurred losses may equal, exceed or be less than the expected losses we estimated as a component of our guarantee
obligation at inception of the guarantee contract.
Effective January 1, 2008, we began estimating the fair value of our newly issued guarantee obligations at their
inception using the practical expedient provided by FIN 45, as amended by SFAS 157. Using this approach, the initial
guarantee obligation is recorded at an amount equal to the fair value of the compensation received in the related guarantee
transactions, including upfront delivery and other fees. As a result, we no longer record estimates of deferred gains or
immediate “day one” losses (i.e., where the fair value of the guarantee obligation at issuance exceeded the fair value of the
guarantee and credit enhancement-related assets) on most guarantees. All unamortized amounts recorded prior to January 1,
2008 will continue to be deferred and amortized using the static effective yield method.
74 Freddie Mac