Freddie Mac 2009 Annual Report Download - page 319

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. 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.
Collateral is typically transferred within one business day based on the values of the related derivatives. This time lag in
posting collateral can affect our net uncollateralized exposure to derivative counterparties.
Collateral posted by a derivative counterparty is typically in the form of cash, although U.S. Treasury securities, our
PCs and Structured Securities or our debt securities may also be posted. In the event a counterparty defaults on its
obligations under the derivatives agreement and the default is not remedied in the manner prescribed in the agreement, we
have the right under the agreement to direct the custodian bank to transfer the collateral to us or, in the case of non-cash
collateral, to sell the collateral and transfer the proceeds to us.
Our uncollateralized exposure to counterparties for OTC interest-rate swaps, option-based derivatives and foreign-
currency swaps, after applying netting agreements and collateral, was $128 million and $181 million at December 31, 2009
and 2008, respectively. In the event that all of our counterparties for these derivatives were to have defaulted simultaneously
on December 31, 2009, our maximum loss for accounting purposes would have been approximately $128 million. Four of
our derivative counterparties each accounted for greater than 10% and collectively accounted for 92% of our net
uncollateralized exposure, excluding commitments, at December 31, 2009. These counterparties were JP Morgan Chase
Bank, Royal Bank of Canada, Royal Bank of Scotland and Merrill Lynch Capital Services, Inc., all of which were rated A or
higher at February 11, 2010.
The total exposure on our OTC forward purchase and sale commitments of $81 million and $537 million at
December 31, 2009 and 2008, respectively, which are treated as derivatives, was uncollateralized. Because the typical
maturity of our forward purchase and sale commitments is less than 60 days and they are generally settled through a
clearinghouse, we do not require master netting and collateral agreements for the counterparties of these commitments.
However, we monitor the credit fundamentals of the counterparties to our forward purchase and sale commitments on an
ongoing basis to ensure that they continue to meet our internal risk-management standards.
NOTE 20: NONCONTROLLING INTERESTS
The equity and net earnings attributable to the noncontrolling interests in consolidated subsidiaries are reported on our
consolidated balance sheets as noncontrolling interest and on our consolidated statements of operations as net (income) loss
attributable to noncontrolling interest. The majority of the balances in these accounts relate to our two majority-owned
REITs.
In February 1997, we formed two majority-owned REIT subsidiaries funded through the issuance of common stock
(99.9% of which is held by us) and a total of $4.0 billion of perpetual, step-down preferred stock issued to third party
investors. The dividend rate on the step-down preferred stock was 13.3% from initial issuance through December 2006 (the
initial term). Beginning in 2007, the dividend rate on the step-down preferred stock was reduced to 1.0%. Dividends on this
preferred stock accrue in arrears. The balance of the two step-down preferred stock issuances as recorded within minority
interests in consolidated subsidiaries on our consolidated balance sheets totaled $88 million and $89 million at December 31,
2009 and 2008, respectively. The preferred stock continues to be redeemable by the REITs under certain circumstances
described in the preferred stock offering documents as a “tax event redemption.”
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