Freddie Mac 2011 Annual Report Download - page 295

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 all of our active OTC derivative 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,
Freddie Mac mortgage-related 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, foreign-
currency swaps, and purchased interest-rate caps, after applying netting agreements and collateral, was $71 million and
$32 million at December 31, 2011 and 2010, respectively. In the event that all of our counterparties for these derivatives
were to have defaulted simultaneously on December 31, 2011, our maximum loss for accounting purposes would have
been approximately $71 million. Three counterparties each accounted for greater than 10% and collectively accounted for
97% of our net uncollateralized exposure to derivative counterparties, excluding commitments, at December 31, 2011.
These counterparties were HSBC Bank USA, Royal Bank of Scotland, and UBS AG, all of which were rated “A” or
above by S&P as of February 27, 2012.
The total exposure on our OTC forward purchase and sale commitments, which are treated as derivatives, was
$38 million and $103 million at December 31, 2011 and 2010, respectively. These commitments are 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 17: FAIR VALUE DISCLOSURES
Fair Value Hierarchy
The accounting guidance for fair value measurements and disclosures establishes a fair value hierarchy that
prioritizes the inputs to valuation techniques used to measure fair value. Fair value represents the price that would be
received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the
measurement date. Observable inputs reflect market data obtained from independent sources. Unobservable inputs reflect
assumptions based on the best information available under the circumstances. We use valuation techniques that seek to
maximize the use of observable inputs, where available, and minimize the use of unobservable inputs.
The three levels of the fair value hierarchy are described below:
• Level 1: Quoted prices (unadjusted) in active markets that are accessible at the measurement date for identical
assets or liabilities;
• Level 2: Quoted prices for similar assets and liabilities in active markets; quoted prices for identical or similar
assets and liabilities in markets that are not active; inputs other than quoted market prices that are observable for
the asset or liability; and inputs that are derived principally from or corroborated by observable market data for
substantially the full term of the assets; and
• Level 3: Unobservable inputs for the asset or liability that are supported by little or no market activity and that are
significant to the fair values.
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