Freddie Mac 2009 Annual Report Download - page 295

• 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 for which we elected the fair value option 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. In contrast, the following fair value
and impairment-related items are not included in Segment Earnings: (1) fair value adjustments to trading
securities related to investments that are economically hedged; (2) impairment on LIHTC partnership
investments; (3) impairments on securities we intend to sell or more likely than not will be required to sell prior
to the anticipated recovery; (4) non-credit-related impairments on securities recorded in our GAAP results within
AOCI; and (5) GAAP-basis accretion income that may result from impairment adjustments that were not
included in Segment Earnings.
• Fully taxable-equivalent adjustment:
• Interest income generated from tax-exempt investments is adjusted in Segment Earnings to reflect its equivalent
yield on a fully taxable basis.
We fund our investment assets with debt and derivatives to manage interest rate risk as evidenced by our PMVS and
duration gap metrics. As a result, in situations where we record gains and losses on derivatives, securities or debt buybacks,
these gains and losses are offset by economic hedges that we do not mark-to-fair-value for GAAP purposes. For example,
when we realize a gain on the sale of a security, the debt which is funding the security has an embedded loss that is not
recognized under GAAP, but instead over time as we realize the interest expense on the debt. As a result, in Segment
Earnings, we defer and amortize the security gain to interest income to match the interest expense on the debt that funded
the asset. Because of our risk management strategies, we believe that amortizing gains or losses on economically hedged
positions in the same periods as the offsetting gains or losses is a meaningful way to assess performance of our investment
activities.
The adjustments we make to present our Segment Earnings are consistent with the financial objectives of our
investment activities and related hedging transactions and provide us with a view of expected investment returns and
effectiveness of our risk management strategies that we believe is useful in managing and evaluating our investment-related
activities. Although we seek to mitigate the interest rate risk inherent in our investment-related activities, our hedging and
portfolio management activities do not eliminate risk. We believe that a relevant measure of performance should closely
reflect the economic impact of our risk management activities. Thus, we amortize the impact of terminated derivatives, as
well as gains and losses on asset sales and debt retirements, into Segment Earnings. Although our interest rate risk and asset/
liability management processes ordinarily involve active management of derivatives, asset sales and debt retirements, we
believe that Segment Earnings, although it differs significantly from, and should not be used as a substitute for GAAP-basis
results, is indicative of the longer-term time horizon inherent in our investment-related activities.
Credit Guarantee Activity-Related Adjustments
Credit guarantee activities consist largely of our guarantee of the payment of principal and interest on mortgages and
mortgage-related securities in exchange for management and guarantee and other fees. Over the longer-term, earnings consist
almost entirely of the management and guarantee fee revenues, which include management guarantee fees collected
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