Freddie Mac 2009 Annual Report Download - page 195

sale mortgage-related securities that were identified as an economic offset to the changes in fair value of the guarantee asset
caused by interest rate movements, foreign-currency denominated debt and investments in securities classified as available-
for-sale securities and identified as within the scope of the accounting standards for investments in beneficial interests in
securitized financial assets. As a result of the adoption of the fair value option, we recognized a $1.0 billion after-tax
increase to our beginning retained earnings (accumulated deficit) at January 1, 2008. In addition, during the third quarter of
2008, we elected the fair value option for certain multifamily held-for-sale mortgage loans. For additional information on the
impact of the election of the fair value option, see “NOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES —
Recently Adopted Accounting Standards” to our consolidated financial statements. For information regarding our fair value
methods and assumptions, see “NOTE 18: FAIR VALUE DISCLOSURES” to our consolidated financial statements.
Allowance for Loan Losses and Reserve for Guarantee Losses
We maintain an allowance for loan losses on mortgage loans held-for-investment and a reserve for guarantee losses on
PCs, collectively referred to as our loan loss reserves, to provide for credit losses when it is probable that a loss has been
incurred. We use the same methodology to determine our allowance for loan losses and reserve for guarantee losses, as the
relevant factors affecting credit risk are the same.
To calculate the loan loss reserves for the single-family loan portfolio, we aggregate homogeneous loans into pools
based on common underlying characteristics, using a statistically based model to evaluate relevant factors affecting loan
collectibility. We consider the output of this model, together with other information about such factors as expected future
levels of loan modifications, expected repurchases of loans by seller/servicers as a result of their non-compliance with our
underwriting standards and the effects of such macroeconomic variables as unemployment and home price movements, to
determine the best estimate of losses incurred. To calculate loan loss reserves for the multifamily loan portfolio, we also use
a model and evaluate certain riskier loans individually for impairment by reviewing repayment prospects and collateral
values underlying individual loans.
We regularly evaluate the underlying estimates and models we use when determining the loan loss reserves and update
our assumptions to reflect our historical experience and current view of economic factors. Inputs used by those models are
regularly updated for changes in the underlying data, assumptions, valuation inputs, or market conditions.
Determining the adequacy of the loan loss reserves is a complex process that is subject to numerous estimates and
assumptions requiring significant management judgment about matters that involve a high degree of subjectivity. Key
estimates and assumptions that impact our loan loss reserves include:
• loss severity trends;
• default experience;
• expected proceeds from credit enhancements;
• collateral valuation;
• loss mitigation activities;
• expected repurchases by sellers for breach of selling representations and warranties;
• counterparty credit of mortgage insurers and seller/servicers; and
• identification and impact assessment of macroeconomic factors, such as home price declines, rental rates and
unemployment rates.
No single statistic or measurement determines the adequacy of the loan loss reserves. Changes in one or more of the
estimates or assumptions used to calculate the loan loss reserves could have a material impact on the loan loss reserves and
provision for credit losses. This management estimate is inherently difficult to predict due to the absence of historical
precedents relative to the current environment. As such, during 2009, management judgment continued to be a significant
aspect of the loan loss reserve estimation process.
We believe the level of our loan loss reserves is reasonable based on internal reviews of the factors and methodologies
used. A management sub-committee reviews the overall level of loan loss reserves, as well as the factors and methodologies
that give rise to the estimate, and recommends the best point estimate for review by senior management.
Application of the Static Effective Yield Method to Amortize the Guarantee Obligation
We amortize our guarantee obligation of our Single-family Guarantee and Multifamily segments into income on
guarantee obligation in our consolidated statements of operations under the static effective yield method. The static effective
yield is calculated and fixed at inception of the guarantee based on forecasted unpaid principal balances. The static effective
yield is evaluated and adjusted when significant changes in economic events cause a shift in the pattern of our economic
release from risk. For example, certain market environments may lead to sharp and sustained changes in home prices or
prepayments of mortgages, leading to the need for an adjustment in the static effective yield for specific mortgage pools
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