Freddie Mac 2010 Annual Report Download - page 164

— derivatives with no hedge designation, which are recorded in derivative gains (losses); and
— debt securities recorded at fair value, which are recorded in gains (losses) on debt recorded at fair value.
• For other financial instruments that are recorded in the consolidated balance sheets at fair value, changes in fair value
are recognized, net of tax, in AOCI. These include:
— mortgage-related and non-mortgage related securities classified as available-for-sale. These unrealized gains and
losses may affect earnings over time through amortization, sale or impairment recognition; and
— the effective portion of the changes in derivatives that were designated in cash flow hedge accounting
relationships. The deferred gains and losses on closed cash flow hedges are reclassified from AOCI and
recognized in earnings as the originally forecasted transactions affect earnings. If it is probable the originally
forecasted transaction will not occur, the associated deferred gain or loss in AOCI is reclassified to earnings
immediately.
• Mortgage loans held for sale are reported at the lower of cost or fair value, except for loans for which we elected the
fair value option. We elected the fair value option for multifamily mortgage loans held for sale purchased through our
CME initiative. Changes in fair value are recognized in earnings in other income.
• REO is initially recorded at fair value less estimated costs to sell and is subsequently carried at the lower of cost or
fair value less estimated costs to sell. When a loan is transferred to REO, losses are charged-off against the allowance
for loan losses and any gains are recognized immediately in earnings. Subsequent declines in fair value are recognized
in REO operations expense.
Allowance for Loan Losses and Reserve for Guarantee Losses
The allowance for loan losses and the reserve for guarantee losses represent estimates of incurred credit losses. The
allowance for loan losses pertains to all single-family and multifamily loans classified as held-for-investment on our
consolidated balance sheets, whereas the reserve for guarantee losses relates to single-family and multifamily loans
underlying our non-consolidated Freddie Mac mortgage-related securities and other guarantee commitments. 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. 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.
We estimate credit losses related to homogeneous pools of loans in accordance with the accounting standards for
contingencies. Loans that we evaluate for individual impairment are measured in accordance with the subsequent
measurement requirements of the accounting standards for receivables.
Single Family Loan Loss Reserves
Single-family loans are aggregated into pools based on similar risk characteristics and measured collectively using a
statistically based model that evaluates a variety of factors affecting collectibility. We consider the output of this model,
together with other information such as expected future levels of loan modifications and expected repurchases of loans by
seller/servicers as a result of their non-compliance with our underwriting standards, and the effects of macroeconomic
variables such as rates of unemployment and the effects of home price changes on borrower behavior.
There is significant risk and uncertainty associated with our estimate of losses incurred on our single-family loans. The
process for determining the estimate is complex, and requires us to make judgments about matters that are difficult to
predict, the most significant of which are the probability of default and estimated loss severity. To accomplish this, we
evaluate many factors, including current LTV ratios, a loan’s product type, and geographic location.
Individually impaired single-family loans include loans that have undergone a TDR and are measured for impairment as
the excess of our recorded investment in the loan over the present value of the expected future cash flows. Our expectation
of future cash flows incorporates many of the judgments indicated above.
We identified an error in the application of this process in the second quarter of 2010 that impacted our provision for
credit losses and allowance for loan losses. For additional information, see “NOTE 1: SUMMARY OF SIGNIFICANT
POLICIES — Basis of Presentation — Out-of-Period Accounting Adjustment.”
Multifamily Loan Loss Reserves
To calculate loan loss reserves for the multifamily loan portfolio, we consider all available evidence including, but not
limited to, operating cash flows from the underlying property as represented by its current DSCR, the fair value of collateral
underlying the impaired loans, evaluation of the repayment prospects, the adequacy of third-party credit enhancements, loss
severity trends, rates of reperformance and other available economic data related to multifamily real estate, including
apartment vacancy and rental rates. Individually impaired multifamily loans are measured for impairment based on the fair
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