Freddie Mac 2010 Annual Report Download - page 158

elimination of $28.8 billion in our Level 3 assets on January 1, 2010, including: (a) certain mortgage-related securities issued
by our consolidated trusts that are held by us; and (b) the guarantee asset for guarantees issued to our consolidated trusts. In
addition, we transferred $0.4 billion of other Level 3 assets to Level 2 during 2010, resulting from improved liquidity and
availability of price quotes received from dealers and third-party pricing services.
During 2009, our Level 3 assets increased by $48.1 billion primarily due to the transfer of CMBS securities from
Level 2 to Level 3 given the continued weakness in the market for non-agency CMBS, as evidenced by low transaction
volumes and wide spreads, as investor demand for these assets remained limited. As a result, we continued to observe
significant variability in the quotes received from dealers and third-party pricing services. Consequently, we transferred
$46.4 billion of Level 2 assets to Level 3 during 2009. These transfers were primarily within non-agency CMBS in the first
quarter of 2009 where inputs that are significant to their valuation became limited or unavailable, as previously discussed.
We recorded a gain of $4.4 billion, primarily in AOCI, on these transferred assets during 2009, which were included in our
Level 3 reconciliation.
See “NOTE 20: FAIR VALUE DISCLOSURES — Table 20.2 — Fair Value Measurements of Assets and Liabilities
Using Significant Unobservable Inputs” for the Level 3 reconciliation. For discussion of types and characteristics of
mortgage loans underlying our mortgage-related securities, see “RISK MANAGEMENT — Credit Risk” and “Table 23 —
Characteristics of Mortgage-Related Securities on Our Consolidated Balance Sheets.”
Consideration of Credit Risk in Our Valuation
We consider credit risk in the valuation of our assets and liabilities through consideration of credit risk of the
counterparty in asset valuations and through consideration of our own institutional credit risk in liability valuations on our
GAAP consolidated balance sheets.
For our foreign-currency denominated debt and certain other debt securities with the fair value option elected, we
considered institutional credit risk as a component of the fair value determination. The changes in fair value attributable to
changes in instrument-specific credit risk were primarily determined by comparing the total change in fair value of the debt
to the total change in fair value of the interest rate and foreign currency derivatives used to hedge the debt. Any difference in
the fair value change of the debt compared to the fair value change in the derivatives is attributed to instrument-specific
credit risk.
For multifamily held-for-sale loans with the fair value option elected, we consider the ability of the underlying property
to generate sufficient cash flow to service the debt and the relative loan to property value in determining fair value. Gains
and losses attributable to changes in the credit risk of these held-for-sale mortgage loans were determined primarily from the
changes in OAS level.
We also consider credit risk when we evaluate the valuation of our derivative positions. The fair value of derivative
assets considers the impact of institutional credit risk in the event that the counterparty does not honor its payment
obligation. For derivatives that are in an asset position, we hold collateral against those positions in accordance with agreed
upon thresholds. The amount of collateral held depends on the credit rating of the counterparty and is based on our credit
risk policies. Similarly, for derivatives that are in a liability position, we post collateral to counterparties in accordance with
agreed upon thresholds. Based on this evaluation, our fair value of derivatives is not adjusted for credit risk because we
obtain collateral from, or post collateral to, most counterparties, typically within one business day of the daily market value
calculation, and substantially all of our credit risk arises from counterparties with investment-grade credit ratings of A or
above. See “RISK MANAGEMENT — Credit Risk — Institutional Credit Risk — Derivative Counterparties” for a discussion
of our counterparty credit risk.
Controls over Fair Value Measurement
We employ control processes to validate the techniques and models we use to determine fair value. These processes are
designed to ensure that fair value measurements are appropriate and reliable. These control processes include review and
approval of new transaction types, price verification and review of valuation judgments, methods, models, process controls
and results. Groups within our Finance and Enterprise Risk Management divisions, independent of our trading and investing
function, execute, validate, and review the valuation process. Additionally, the Valuation & Finance Model Committee
(Valuation Committee), which includes senior representation from business areas, and our Enterprise Risk Management and
Finance divisions, participates in the review and validation process.
Our control process includes performing monthly independent verification of fair value measurements by comparing the
methodology driven price to other market source data (to the extent available), and uses independent analytics to determine if
assigned fair values are reasonable. This review covers all categories of products with increased attention to higher risk/
impact valuations. Validation processes are intended to ensure that the individual prices we receive from third parties are
consistent with our observations of the marketplace and prices that are provided to us by other dealers or pricing services.
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