Freddie Mac 2010 Annual Report Download - page 276

vintage. These securities are classified as Level 3 in the fair value hierarchy because key inputs are unobservable in the
market due to low levels of liquidity.
Asset-Backed Securities (Non-Mortgage-Related)
These private-label non-mortgage-related securities are dealer-priced. Some of the key valuation drivers include the
discount margin, subordination level, and prepayment speed, coupled with interest rates. They are classified as Level 2
because of their liquidity and tight pricing ranges.
Treasury Bills and Treasury Notes
Treasury bills and Treasury notes are classified as Level 1 in the fair value hierarchy since they are actively traded and
price quotes are widely available at the measurement date for the exact security we are valuing.
FDIC-Guaranteed Corporate Medium-Term Notes
Since these securities carry the FDIC guarantee, they are considered to have no credit risk. They are valued based on
yield analysis. They are classified as Level 2 because of their high liquidity and tight pricing ranges.
Mortgage Loans, Held-for-Sale
Mortgage loans, held-for-sale represent multifamily mortgage loans at December 31, 2010 with the fair value option
elected. Thus, all held-for-sale mortgage loans are measured at fair value on a recurring basis.
The fair value of multifamily mortgage loans is generally based on market prices obtained from a third party pricing
service provider for similar actively traded mortgages, adjusted for differences in loan characteristics and contractual terms.
The pricing service aggregates observable price points from two markets: agency and non-agency. The agency market
consists of purchases made by the GSEs of loans underwritten by our counterparties in accordance with our guidelines while
the non-agency market generally consists of secondary market trades between banks and other financial institutions of loans
that were originated and initially held in portfolio by these institutions. The pricing service blends the observable price data
obtained from these two distinct markets into a final composite price based on the expected probability that a given loan will
trade in one of these two markets. This estimated probability is largely a function of the loan’s credit quality, as determined
by its current LTV ratio and DSCR. The result of this blending technique is that lower credit quality loans receive a lower
percentage of agency price weighting and higher credit quality loans receive a higher percentage of agency price weighting.
Given the relative illiquidity in the marketplace for multifamily mortgage loans and differences in contractual terms,
these loans are classified as Level 3 in the fair value hierarchy.
On January 1, 2010, we reclassified single-family loans that were historically classified as held-for-sale to unsecuritized
mortgage loans held-for-investment. Therefore, these loans are reported at amortized cost and are no longer subject to the
fair value hierarchy at December 31, 2010. Prior to January 1, 2010, these loans were recorded at the lower-of-cost-or-fair-
value on our consolidated balance sheets and were measured at fair value on a non-recurring basis. See “Valuation Methods
and Assumptions Not Subject to Fair Value Hierarchy — Mortgage Loans” for additional information regarding the valuation
techniques we use for our single-family mortgage loans.
Mortgage Loans, Held-for-Investment
Mortgage loans, held-for-investment measured at fair value on a non-recurring basis represent 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. The valuation technique we use to measure the fair value of impaired multifamily mortgage loans, held-for-
investment is based on the value of the underlying property and may include assessment of third-party appraisals,
environmental, and engineering reports that we compare with relevant market performance to arrive at a fair value. Our
valuation technique incorporates one or more of the following methods: income capitalization, discounted cash flow, sales
comparables, and replacement cost. We consider the physical condition of the property, rent levels, and other market drivers,
including input from sales brokers and the property manager. We classify impaired multifamily mortgage loans, held-for-
investment as Level 3 in the fair value hierarchy as their valuation includes significant unobservable inputs.
Derivative Assets, Net
Derivative assets largely consist of interest-rate swaps, option-based derivatives, futures, and forward purchase and sale
commitments that we account for as derivatives. The carrying value of our derivatives on our consolidated balance sheets is
equal to their fair value, including net derivative interest receivable or payable, trade/settle receivable or payable and is net of
cash collateral held or posted, where allowable by a master netting agreement. Derivatives in a net unrealized gain position
are reported as derivative assets, net. Similarly, derivatives in a net unrealized loss position are reported as derivative
liabilities, net.
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