Freddie Mac 2009 Annual Report Download - page 307

description of how we determine the fair value of our guarantee asset, see “NOTE 4: RETAINED INTERESTS IN
MORTGAGE-RELATED SECURITIZATIONS.”
Mortgage Loans, Held for Investment
Mortgage loans, held for investment include impaired multifamily mortgage loans, which are not measured at fair value
on an ongoing basis but have been written down to fair value due to impairment. We classify these impaired multifamily
mortgage loans as Level 3 in the fair value hierarchy as their valuation includes significant unobservable inputs.
Mortgage loans, held for investment also include single-family mortgage loans, including delinquent single-family loans
purchased out of pools. For valuation purposes, these loans are cohorted based on similar characteristics and then the
information is sent to several dealers who provide price quotes.
Mortgage Loans, Held for Sale
Mortgage loans, held for sale consist of both single-family and multifamily mortgage loans. For single-family mortgage
loans, we determine the fair value of these mortgage loans to calculate lower-of-cost-or-fair-value adjustments for mortgages
classified as held-for-sale for GAAP purposes, therefore they are measured at fair value on a non-recurring basis and subject
to classification under the fair value hierarchy. Beginning in the third quarter of 2008, we elected the fair value option for
multifamily mortgage loans that were purchased through our Capital Market Execution program to reflect our strategy in this
program. Thus, these multifamily mortgage loans are measured at fair value on a recurring basis.
We determine the fair value of single-family mortgage loans, excluding delinquent single-family loans purchased out of
pools, based on comparisons to actively traded mortgage-related securities with similar characteristics. To calculate the fair
value, we include adjustments for yield, credit and liquidity differences. Part of the adjustments represents an implied
management and guarantee fee. To accomplish this, the fair value of the single-family mortgage loans, excluding delinquent
single-family loans purchased out of pools, includes an adjustment representing the estimated present value of the additional
cash flows on the mortgage coupon in excess of the coupon expected on the notional mortgage-related securities. The
implied management and guarantee fee for single-family mortgage loans is also net of the related credit and other
components inherent in our guarantee obligation. The process for estimating the related credit and other guarantee obligation
components is described in the “Guarantee Obligation” section below. The valuation methodology for these single-family
mortgage loans was enhanced during 2009 to reflect delinquency status based on non-performing loan values from dealers
and transition rates to default. Since the fair values of these loans are derived from observable prices with adjustments that
may be significant, they are classified as Level 3 under the fair value hierarchy.
The fair value of multifamily mortgage loans is generally based on market prices obtained from a third-party pricing
service provider for similar mortgages, adjusted for differences in contractual terms and the current credit risk profile for
each loan. However, given the relative illiquidity in the marketplace for these loans, and differences in contractual terms, we
classified these loans as Level 3 in the fair value hierarchy.
Investments in Securities
Investments in securities consist of mortgage-related and non-mortgage-related securities. Mortgage-related securities
represent pass-throughs and other mortgage-related securities issued by us, Fannie Mae and Ginnie Mae, as well as non-
agency mortgage-related securities. They are classified as available for sale or trading, and are already reflected at fair value
on our GAAP consolidated balance sheets. Effective January 1, 2008, we elected the fair value option for selected mortgage-
related securities that were classified as available-for-sale securities and available-for-sale securities identified as in the scope
of interest income recognition analysis under the accounting standards for investments in beneficial interests in securitized
financial assets. In conjunction with our adoption of the accounting standards on the fair value option for financial assets and
financial liabilities, we reclassified these securities from available-for-sale securities to trading securities on our GAAP
consolidated balance sheets and recorded the changes in fair value during the period for such securities to gains (losses) on
investment activities as incurred.
The fair value of securities with readily available third-party market prices is generally based on market prices obtained
from broker/dealers or third-party pricing service providers. Such fair values may be measured by using third-party quotes
for similar instruments, adjusted for differences in contractual terms. Generally, these fair values are classified as Level 2 in
the fair value hierarchy. For other securities, a market OAS approach based on observable market parameters is used to
estimate fair value. OAS for certain securities are estimated by deriving the OAS for the most closely comparable security
with an available market price, using proprietary interest-rate and prepayment models. If necessary, our judgment is applied
to estimate the impact of differences in prepayment uncertainty or other unique cash flow characteristics related to that
particular security. Fair values for these securities are then estimated by using the estimated OAS as an input to the interest-
rate and prepayment models and estimating the net present value of the projected cash flows. The remaining instruments are
priced using other modeling techniques or by using other securities as proxies. These securities may be classified as Level 2
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