Freddie Mac 2010 Annual Report Download - page 280

Valuation Methods and Assumptions Not Subject to Fair Value Hierarchy
The following are valuation assumptions and methods for items not subject to the fair value hierarchy either because
they are not measured at fair value other than on the fair value balance sheet or are only measured at fair value at inception.
Cash and Cash Equivalents
Cash and cash equivalents largely consist of highly liquid investment securities with an original maturity of three
months or less used for cash management purposes, as well as cash held at financial institutions and cash collateral posted
by our derivative counterparties. Given that these assets are short-term in nature with limited market value volatility, the
carrying amount on our GAAP consolidated balance sheets is deemed to be a reasonable approximation of fair value.
Federal Funds Sold and Securities Purchased Under Agreements to Resell
Federal funds sold and securities purchased under agreements to resell principally consist of short-term contractual
agreements such as reverse repurchase agreements involving Treasury and agency securities and federal funds sold. Given
that these assets are short-term in nature, the carrying amount on our GAAP consolidated balance sheets is deemed to be a
reasonable approximation of fair value.
Mortgage Loans
Single-family mortgage loans are not subject to the fair value hierarchy since they are classified as held-for-investment
and recorded at amortized cost. Certain multifamily mortgage loans are subject to the fair value hierarchy since these are
either recorded at fair value with the fair value option elected or they are held for investment and recorded at fair value upon
impairment, which is based upon the fair value of the collateral as multifamily loans are collateral-dependent.
Single-Family Loans
We determine the fair value of single-family mortgage loans as an estimate of the price we would receive if we were to
securitize those loans, as we believe this represents the principal market for such loans. This includes both those held by
consolidated trusts and unsecuritized loans and excludes single-family loans for which a contractual modification has been
completed. Our estimate of fair value is based on comparisons to actively traded mortgage-related securities with similar
characteristics. We adjust to reflect the excess coupon (implied management and guarantee fee) and credit obligation related
to performing our guarantee.
To calculate the fair value, we begin with a security price derived from benchmark security pricing for similar actively
traded mortgage-related securities, adjusted for yield, credit, and liquidity differences. This security pricing process is
consistent with our approach for valuing similar securities retained in our investment portfolio or issued to third parties. See
“Valuation Methods and Assumptions Subject to Fair Value Hierarchy — Investments in Securities.”
We estimate the present value of the additional cash flows on the mortgage loan coupon in excess of the coupon on the
mortgage-related securities. Our approach for estimating the fair value of the implied management and guarantee fee at
December 31, 2010 used third-party market data as practicable. The valuation approach for the majority of implied
management and guarantee fee that relates to fixed-rate loan products with coupons at or near current market rates involves
obtaining dealer quotes on hypothetical securities constructed with collateral from our single-family credit guarantee
portfolio. The remaining implied management and guarantee fee relates to underlying loan products for which comparable
market prices were not readily available. These amounts relate specifically to ARM products, highly seasoned loans, or
fixed-rate loans with coupons that are not consistent with current market rates. This portion of the implied management and
guarantee fee is valued using an expected cash flow approach, including only those cash flows expected to result from our
contractual right to receive management and guarantee fees.
The implied management and guarantee fee for single-family mortgage loans is also net of the related credit and other
costs (such as general and administrative expense) and benefits (such as credit enhancements) inherent in our guarantee
obligation. We use entry-pricing information for all guaranteed loans that would qualify for purchase under current
underwriting guidelines (used for the majority of the guaranteed loans, but accounts for a small share of the overall fair value
of the guarantee obligation). For loans that do not qualify for purchase based on current underwriting guidelines, we use our
internal credit models, which incorporate factors such as loan characteristics, loan performance status information, expected
losses, and risk premiums without further adjustment (used for less than a majority of the guaranteed loans, but accounts for
the largest share of the overall fair value of the guarantee obligation).
For single-family mortgage loans for which a contractual modification has been completed, we estimate fair value based
on our estimate of prices we would receive if we were to sell these loans in the whole loan market, as this represents our
current principal market for modified loans. These prices are obtained from multiple dealers who reference market activity,
where available, for modified loans and use internal models and their judgment to determine default rates, severity rates, and
risk premiums.
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