Derivative Instruments

9 Months Ended

Sep. 30, 2011

Notes to Consolidated Financial Statements

9. Derivative Instruments

Derivative instruments are an integral part of our strategy in managing interest rate risk. Derivative instruments may be privately negotiated contracts, which are often referred to as over-the-counter derivatives, or they may be listed and traded on an exchange. We typically do not settle the notional amount of our risk management derivatives; rather, notional amounts provide the basis for calculating actual payments or settlement amounts. The derivatives we use for interest rate risk management purposes consist primarily of interest rate swaps, interest rate options, foreign currency swaps and futures.

We enter into forward purchase and sale commitments that lock in the future delivery of mortgage loans and mortgage-related securities at a fixed price or yield. Certain commitments to purchase mortgage loans and purchase or sell mortgage-related securities meet the criteria of a derivative. We typically settle the notional amount of our mortgage commitments that are accounted for as derivatives.

We recognize all derivatives as either assets or liabilities in our condensed consolidated balance sheets at their fair value on a trade date basis. Fair value amounts, which are netted to the extent a legal right of offset exists and is enforceable by law at the counterparty level and are inclusive of the right or obligation associated with the cash collateral posted or received, are recorded in “Other assets” or “Other liabilities” in our condensed consolidated balance sheets. We record all derivative gains and losses, including accrued interest, in “Fair value (losses) gains, net” in our condensed consolidated statements of operations and comprehensive loss.

Notional and Fair Value Position of our Derivatives

The following table displays the notional amount and estimated fair value of our asset and liability derivative instruments as of September 30, 2011 and December 31, 2010.

			As of September 30, 2011								As of December 31, 2010
			Asset Derivatives				Liability Derivatives				Asset Derivatives				Liability Derivatives
			Notional		Estimated		Notional		Estimated		Notional		Estimated		Notional		Estimated
			Amount		Fair Value		Amount		Fair Value		Amount		Fair Value		Amount		Fair Value
			(Dollars in millions)
Risk management derivatives:
Swaps:
	Pay-fixed		$	36,990	$	46	$	156,892	$	(17,154)	$	49,085	$	1,812	$	228,142	$	(14,115)
	Receive-fixed			144,603		7,740		35,205		(63)		172,174		6,493		52,003		(578)
	Basis			332		122		6,665		(18)		435		29		50		-
	Foreign currency			457		135		542		(82)		1,274		164		286		(51)
Swaptions:
	Pay-fixed			64,150		191		48,500		(275)		66,200		482		30,950		(1,773)
	Receive-fixed			38,845		6,707		48,500		(3,036)		48,340		4,992		30,275		(673)
Interest rate caps				7,000		2		-		-		7,000		24		-		-
Other⁽¹⁾				639		52		150		(4)		909		75		25		(1)
	Total gross risk management derivatives			293,016		14,995		296,454		(20,632)		345,417		14,071		341,731		(17,191)
	Accrued interest receivable (payable)			-		770		-		(1,319)		-		1,288		-		(1,805)
	Netting adjustment⁽²⁾			-		(15,539)		-		18,372		-		(15,175)		-		18,023
		Total net risk management derivatives	$	293,016	$	226	$	296,454	$	(3,579)	$	345,417	$	184	$	341,731	$	(973)

Mortgage commitment derivatives:
	Mortgage commitments to purchase whole loans		$	9,434	$	84	$	2,991	$	(12)	$	2,880	$	19	$	4,435	$	(105)
	Forward contracts to purchase mortgage-related
		securities		30,447		365		18,370		(86)		19,535		123		27,697		(468)
	Forward contracts to sell mortgage-related securities			15,077		48		50,896		(596)		40,761		811		24,562		(169)
		Total mortgage commitment derivatives	$	54,958	$	497	$	72,257	$	(694)	$	63,176	$	953	$	56,694	$	(742)
		Derivatives at fair value	$	347,974	$	723	$	368,711	$	(4,273)	$	408,593	$	1,137	$	398,425	$	(1,715)

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⁽¹⁾	Includes futures, swap credit enhancements and mortgage insurance contracts that we account for as derivatives. The mortgage insurance contracts have payment provisions that are not based on a notional amount.

⁽²⁾	The netting adjustment represents the effect of the legal right to offset under legally enforceable master netting agreements to settle with the same counterparty on a net basis, as well as cash collateral receivable and payable. Cash collateral receivable was $3.5 billion as of September 30, 2011 and December 31, 2010. Cash collateral payable was $653 million and $604 million as of September 30, 2011 and December 31, 2010, respectively.

A majority of our derivative instruments contain provisions that require our senior unsecured debt to maintain a minimum credit rating from S&P, Moody's or Fitch. If our senior unsecured debt were to fall below established thresholds in our governing agreements, which range from A- to BBB+, we would be in violation of these provisions, and the counterparties to the derivative instruments could request immediate payment or demand immediate collateralization on derivative instruments in net liability positions. The aggregate fair value of all derivatives with credit-risk-related contingent features that were in a net liability position as of September 30, 2011 was $7.0 billion, for which we posted collateral of $6.9 billion in the normal course of business. Had all of the credit-risk-related contingency features underlying these agreements been triggered, an additional $182 million of collateral would have been required to be posted as collateral or to immediately settle our positions based on the individual agreements and our fair value position at September 30, 2011.

The aggregate fair value of all derivatives with credit risk-related contingent features that were in a net liability position as of December 31, 2010 was $4.4 billion, for which we posted collateral of $3.5 billion in the normal course of business. Had all of the credit risk-related contingency features underlying these agreements been triggered, an additional $891 million would have been required to be posted as collateral or to immediately settle our positions based on the individual agreements and our fair value position at December 31, 2010.

The following table displays, by type of derivative instrument, the fair value gains and losses, net on our derivatives for the three and nine months ended September 30, 2011 and 2010.


		For the Three Months				For the Nine Months
		Ended September 30,				Ended September 30,
		2011		2010		2011		2010
		(Dollars in millions)
Risk management derivatives:
Swaps:
	Pay-fixed	$	(11,334)	$	(8,034)	$	(16,206)	$	(24,811)
	Receive-fixed		4,577		6,126		7,105		18,642
	Basis		75		43		104		73
	Foreign currency		31		149		114		138
Swaptions:
	Pay-fixed		533		17		805		(1,342)
	Receive-fixed		2,091		1,778		2,591		5,460
Interest rate caps			(4)		(16)		(22)		(115)
Other⁽¹⁾			(36)		(4)		(58)		33
	Total risk management derivatives fair value (losses) gains, net		(4,067)		59		(5,567)		(1,922)
Mortgage commitment derivatives fair value losses, net			(188)		(183)		(226)		(1,361)
	Total derivatives fair value losses, net	$	(4,255)	$	(124)	$	(5,793)	$	(3,283)

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⁽¹⁾	Includes futures, swap credit enhancements and mortgage insurance contracts.

Derivative Counterparty Credit Exposure

Our derivative counterparty credit exposure relates principally to interest rate and foreign currency derivative contracts. We are exposed to the risk that a counterparty in a derivative transaction will default on payments due to us. If there is a default, we may need to acquire a replacement derivative from a different counterparty at a higher cost or may be unable to find a suitable replacement. We estimate our exposure to credit loss on derivative instruments by calculating the replacement cost, on a present value basis, to settle at current market prices all outstanding derivative contracts in a net gain position by counterparty where the right of legal offset exists, such as master netting agreements, and by transaction where the right of legal offset does not exist. Typically, we seek to manage credit exposure by contracting with experienced counterparties that are rated A- (or its equivalent) or better by S&P, Moody's or Fitch. We also manage our exposure by requiring counterparties to post collateral. The collateral includes cash, U.S. Treasury securities, agency debt and agency mortgage-related securities.

The table below displays our credit exposure on outstanding risk management derivative instruments in a gain position by counterparty credit ratings, as well as the notional amount outstanding and the number of counterparties for all risk management derivatives as of September 30, 2011 and December 31, 2010.

		As of September 30, 2011
		Credit Rating⁽¹⁾
		AA+/AA/AA-		A+/A		Subtotal ⁽²⁾		Other⁽³⁾		Total
		(Dollars in millions)
Credit loss exposure ⁽⁴⁾		$	587	$	232	$	819	$	49	$	868
Less: Collateral held⁽⁵⁾			515		189		704		-		704
Exposure net of collateral		$	72	$	43	$	115	$	49	$	164
Additional information:
	Notional amount	$	152,829	$	434,712	$	587,541	$	1,929	$	589,470
	Number of counterparties		7		8		15				15

		As of December 31, 2010
		Credit Rating⁽¹⁾
		AA+/AA/AA-		A+/A		Subtotal ⁽²⁾		Other⁽³⁾		Total
		(Dollars in millions)
Credit loss exposure ⁽⁴⁾		$	350	$	325	$	675	$	75	$	750
Less: Collateral held⁽⁵⁾			273		325		598		-		598
Exposure net of collateral		$	77	$	-	$	77	$	75	$	152
Additional information:
	Notional amount	$	208,898	$	476,766	$	685,664	$	1,484	$	687,148
	Number of counterparties		7		8		15

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⁽¹⁾	We manage collateral requirements based on the lower credit rating of the legal entity, as issued by S&P and Moody’s. The credit rating reflects the equivalent S&P's rating for any ratings based on Moody’s scale.
⁽²⁾	We had exposure to 4 and 3 interest rate and foreign currency derivative counterparties in a net gain position as of September 30, 2011 and December 31, 2010, respectively. Those interest rate and foreign currency derivatives had notional balances of $135.1 billion and $106.5 billion as of September 30, 2011 and December 31, 2010, respectively.
⁽³⁾	Includes defined benefit mortgage insurance contracts and swap credit enhancements accounted for as derivatives where the right of legal offset does not exist. Also includes exchange-traded derivatives, such as futures and interest rate swaps, which are settled daily through a clearinghouse.
⁽⁴⁾	Represents the exposure to credit loss on derivative instruments, which we estimate using the fair value of all outstanding derivative contracts in a gain position. We net derivative gains and losses with the same counterparty where a legal right of offset exists under an enforceable master netting agreement. This table excludes mortgage commitments accounted for as derivatives.
⁽⁵⁾	Represents both cash and non-cash collateral posted by our counterparties to us. Does not include collateral held in excess of exposure. We reduce the value of non-cash collateral in accordance with the counterparty agreements to help ensure recovery of any loss through the disposition of the collateral.