Freddie Mac 2006 Annual Report Download - page 157

these items are generally recognized in the fair value of net assets when received or paid, with no basis reÖected on our fair
value balance sheets.
Valuation Methods and Assumptions
Fair value is generally based on independent price quotations obtained from third-party pricing services, dealer marks or
direct market observations, where available. However, certain Ñnancial instruments are less actively traded and, therefore,
are not always able to be valued based on prices obtained from third parties. If quoted prices or market data are not
available, fair value is based on internal valuation models using market data inputs or internally developed assumptions,
where appropriate.
During 2006 and 2005, our fair value results were impacted by several improvements in our approach for estimating the
fair value of certain Ñnancial instruments. In the Ñrst quarter of 2006, we enhanced our approach for estimating the fair
value of certain Ñnancial instruments resulting in (a) an increase in the fair value of Total net assets of approximately
$0.2 billion (after-tax) related to our guarantee-related assets and liabilities and (b) a net decrease in the fair value of Total
net assets of approximately $0.1 billion (after-tax) related to other Ñnancial instruments. In the Ñrst quarter of 2005, we
improved our approach for estimating the fair values of certain Ñnancial instruments resulting in (a) a decrease in the fair
value of Total net assets of approximately $0.8 billion (after-tax) related to our guarantee-related assets and liabilities and
(b) an increase in the fair value of Total net assets of approximately $0.3 billion (after-tax) related to our multifamily whole
loans, the minority interests in our consolidated REIT subsidiaries and other Ñnancial instruments. Also, in the second
quarter of 2005, we improved our approach for estimating the fair values of certain securities we hold, which increased the
fair value of Total net assets by approximately $0.1 billion. The changes in our approach for estimating the fair values of
these Ñnancial instruments are described below.
The following methods and assumptions were used to estimate the fair value of assets and liabilities at December 31,
2006 and 2005.
Mortgage loans
Mortgage loans represent single-family and multifamily whole loans held in our Retained portfolio. For GAAP
purposes, we must determine the fair value of these mortgage loans to calculate lower-of-cost-or-market adjustments for
mortgages classiÑed as held-for-sale. For fair value balance sheet purposes, we used this same approach when determining
the fair value of whole loans, including those held-for-investment.
We determine the fair value of mortgage loans, excluding delinquent single-family loans purchased out of pools, based
on comparisons to actively traded mortgage-related securities with similar characteristics, with adjustments for yield, credit
and liquidity diÅerences. SpeciÑcally, we aggregate mortgage loans into pools by product type, coupon and maturity and
then convert the pools into notional mortgage-related securities based on their speciÑc characteristics. We then calculate fair
values for these notional mortgage-related securities as described below in ""Mortgage-related securities, excluding PC
residuals.''
Part of the adjustments for yield, credit and liquidity diÅerences represent an implied guarantee fee. To accomplish this,
the fair value of the single-family whole loans, excluding delinquent single-family loans purchased out of pools, includes an
adjustment representing the estimated present value of the additional cash Öows on the mortgage coupon in excess of the
coupon expected on the notional mortgage-related securities. For multifamily whole loans, the fair value adjustment is
estimated by calculating the net present value of guarantee fees we expect to retain. This retained guarantee fee is estimated
by subtracting the expected cost of funding and securitizing a multifamily whole loan of a comparable maturity and credit
rating from the coupon on the whole loan at the time of purchase.
The implied guarantee fee for both single-family and multifamily whole loans is also net of the related credit and other
components inherent in our Guarantee obligation. For single-family whole loans, the process for estimating the related
credit and other Guarantee obligation components is described in the ""Guarantee obligation'' section. For multifamily whole
loans, the related credit and other Guarantee obligation components were estimated by extracting the credit risk premium
that multifamily whole loan investors require from market prices on similar securities. This credit risk premium is net of
expected funding, liquidity and other risk premiums that are embedded in the market price of the reference securities.
Beginning in 2005, we reÑned the fair value estimates of multifamily whole loans by incorporating additional
information and guidance from active market participants into the pricing of notional mortgage-related securities. In
addition, beginning in 2005, for single-family whole loans that are extremely delinquent and have been purchased out of
pools, we obtained dealer indications on aggregated groups of similar loans that reÖect their current performance status.
These market price indications reÖect the estimated present value of all cash Öows related to the whole loans, including
expected credit losses and recoveries.
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