Freddie Mac 2009 Annual Report Download - page 196

underlying the guarantee. When a change is required, a cumulative catch-up adjustment, which could be significant in a
given period, is recognized and a new static effective yield is used to determine our guarantee obligation amortization. These
cumulative catch-up adjustments, which may be positive or negative, are recorded to provide a pattern of revenue recognition
that is consistent with our economic release from risk and the timing of the recognition of losses on the pools of mortgage
loans we guarantee. See “CONSOLIDATED RESULTS OF OPERATIONS — Non-Interest Income (Loss) — Income on
Guarantee Obligation” for further information.
Application of the Effective Interest Method
As described in “NOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES” to our consolidated financial
statements, we use the effective interest method in our Investments segment to: (a) recognize interest income on our
investments in debt securities; and (b) amortize related deferred items into interest income. The application of the effective
interest method requires us to estimate the effective yield at each period end using our current estimate of future
prepayments. Determination of these estimates requires significant judgment, as expected prepayment behavior is inherently
uncertain. Estimates of future prepayments are derived from market sources and our internal prepayment models. Judgment
is involved in making initial determinations about prepayment expectations and in updating those expectations over time in
response to changes in market conditions, such as interest rates and other macroeconomic factors. See the discussion of
market risks and our interest-rate sensitivity measures under “QUANTITATIVE AND QUALITATIVE DISCLOSURES
ABOUT MARKET RISK — Interest-Rate Risk and Other Market Risks.” We believe that our current estimates of future
prepayments are reasonable and comparable to those used by other market participants.
Impairment Recognition on Investments in Securities and LIHTC Partnership Investments
Investments in Securities
We recognize impairment losses on available-for-sale securities through gains (losses) on investments in our
consolidated statements of operations when we have concluded that a decrease in the fair value of a security is not
temporary. We prospectively adopted an amendment to the accounting standards for investments in debt and equity securities
on April 1, 2009, which provides additional guidance in accounting for and presenting impairment losses on debt securities.
This amendment changes the recognition, measurement and presentation of other-than-temporary impairment for debt
securities, and is intended to bring greater consistency to the timing of impairment recognition and provide greater clarity to
investors about the credit and non-credit components of impaired debt securities that are not expected to be sold. It also
changes (a) the method for determining whether an other-than-temporary impairment exists, and (b) the amount of an
impairment charge to be recorded in earnings. See “NOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES—
Recently Adopted Accounting Standards — Change in the Impairment Model for Debt Securities” for further information
regarding the impact of this amendment on our consolidated financial statements.
We conduct quarterly reviews to identify and evaluate each available-for-sale security that has an unrealized loss, in
accordance with an amendment to the accounting standards for investments in debt and equity securities. An unrealized loss
exists when the current fair value of an individual security is less than its amortized cost basis.
The evaluation of unrealized losses on our available-for-sale portfolio for other-than-temporary impairment contemplates
numerous factors. We perform an evaluation on a security-by-security basis considering all available information. For
available-for-sale securities, a critical component of the evaluation for other-than-temporary impairments is the identification
of credit-related impairment, where we do not expect to receive cash flows sufficient to recover the entire amortized cost
basis of the security. The relative importance of this information varies based on the facts and circumstances surrounding
each security, as well as the economic environment at the time of assessment. Important factors include:
• loan level default modeling for single-family residential mortgages that considers individual loan characteristics,
including current LTV ratio, FICO score and delinquency status, requires assumptions about future home prices and
interest rates, and employs internal default and prepayment models. The modeling for CMBS employs third-party
models that require assumptions about the economic conditions in the areas surrounding each individual property;
• analysis of the performance of the underlying collateral relative to its credit enhancements using techniques that
require assumptions about future loss severity, default, prepayment and other borrower behavior. Implicit in this
analysis is information relevant to expected cash flows (such as collateral performance and characteristics). We
qualitatively consider available information when assessing whether an impairment is other-than-temporary;
• the length of time and extent to which the fair value of the security has been less than the book value and the
expected recovery period;
• the impact of changes in credit ratings (i.e., rating agency downgrades); and
• our conclusion that we do not intend to sell our available-for-sale securities and it is not more likely than not that we
will be required to sell these securities before sufficient time elapses to recover all unrealized losses.
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