Freddie Mac 2010 Annual Report Download - page 275

Multiclass structures are valued using a variety of methods, depending on the product type. The predominant valuation
methodology uses the median prices from multiple pricing services. This method is used for structures for which there is
typically significant, relevant market activity. Some of the key valuation drivers used by the pricing services are the collateral
type, tranche type, weighted average life, and coupon, coupled with interest rates. Other tranche types that are more
challenging to price are valued using the median prices from multiple dealers. These include structured interest-only,
structured principal-only, inverse floaters, and inverse interest-only structures. Some of the key valuation drivers used by the
dealers are the collateral type, tranche type, weighted average life, and coupon, coupled with interest rates. In addition, there
is a subset of tranches for which there is a lack of relevant market activity that are priced using a proxy relationship where
the position is matched to the closest dealer-priced tranche, then valued by calculating an OAS using our proprietary
prepayment and interest rate models from the dealer-priced tranche. 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.
We then determine the fair values for these securities by using the estimated OAS as an input to the valuation calculation in
conjunction with interest-rate and prepayment models to calculate the NPV of the projected cash flows. These positions
typically have smaller balances and are more difficult for dealers to value. There is also a subset of positions for which
prices are published on a daily basis; these include trust interest-only and trust principal-only strips. These are fairly liquid
tranches and are quoted on a regular settlement date basis. In order to align the regular settlement date price with the balance
sheet date, the OAS is calculated based on the published prices. Then the tranche is valued using that OAS applied to the
balance sheet date.
Multiclass agency securities are classified as Level 2 or 3 depending on the significance of the inputs that are not
observable.
Commercial Mortgage-Backed Securities
CMBS are valued based on the median prices from multiple pricing services. Some of the key valuation drivers used by
the pricing services include the collateral type, collateral performance, capital structure, issuer, credit enhancement, coupon,
and weighted average life, coupled with the observed spread levels on trades of similar securities. The weighted average
coupon and weighted-average life of the collateral underlying our CMBS investments were 5.7% and 4.3 years, respectively,
as of December 31, 2010. Many of these securities have significant prepayment lockout periods or penalty periods that limit
the window of potential prepayment to a relatively narrow band. These securities are primarily classified in Level 2.
Subprime, Option ARM, and Alt-A and Other (Mortgage-Related)
These private-label investments are valued using either the median of multiple dealer prices or the median prices from
multiple pricing services. Some of the key valuation drivers used by the dealers and pricing services include the product
type, vintage, collateral performance, capital structure, credit enhancements, and coupon, coupled with interest rates and
spreads observed on trades of similar securities, where possible. The market for non-agency mortgage-related securities
backed by subprime, option ARM, and Alt-A and other loans is highly illiquid, resulting in wide price ranges as well as
wide credit spreads. These securities are primarily classified in Level 3.
Table 20.4 below presents the fair value of subprime, option ARM, and Alt-A and other investments we held by
origination year.
Table 20.4 — Fair Value of Subprime, Option ARM, and Alt-A and Other Investments by Origination Year
Year of Origination
Fair Value at
December 31, 2010
(in millions)
2004 and prior . ............................................................................ $ 4,998
2005 .................................................................................... 13,126
2006 .................................................................................... 19,333
2007 .................................................................................... 16,461
2008 and beyond............................................................................ —
Total .................................................................................. $53,918
Obligations of States and Political Subdivisions
These include housing revenue and municipal bonds, and are valued by taking the median prices from multiple pricing
services. Some of the key valuation drivers used by the pricing services include the structure of the bond, call terms, cross-
collateralization features, and tax-exempt features coupled with municipal bond rates, credit ratings, and spread levels. These
securities are unique, resulting in low trading volumes and are classified as Level 3 in the fair value hierarchy.
Manufactured Housing
Securities backed by loans on manufactured housing properties are dealer-priced and we arrive at the fair value by
taking the median of multiple dealer prices. Some of the key valuation drivers include the collateral’s performance and
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