Freddie Mac 2014 Annual Report Download - page 227

222 Freddie Mac
changes reviewed at the Valuation Committee. Inputs used by models are regularly updated for changes in the underlying data,
assumptions, valuation inputs, and market conditions, and are subject to the valuation controls noted above.
Use of Third-Party Pricing Data in Fair Value Measurement
As discussed in the sections that follow, many of our valuation techniques use, either directly or indirectly, data provided
by third-party pricing services or dealers. The techniques used by these pricing services and dealers to develop the prices
generally are either: (a) a comparison to transactions involving instruments with similar collateral and risk profiles, adjusted as
necessary based on specific characteristics of the asset or liability being valued; or (b) industry-standard modeling, such as a
discounted cash flow model. The prices provided by the pricing services and dealers reflect their observations and assumptions
related to market activity, including risk premiums and liquidity adjustments. The models and related assumptions used by the
pricing services and dealers are owned and managed by them and, in many cases, the significant inputs used in the valuation
techniques are not reasonably available to us. However, we have an understanding of the processes and assumptions used to
develop the prices based on our ongoing due diligence, which includes discussions with our vendors at least annually and often
more frequently. We believe that the procedures executed by the pricing services and dealers, combined with our internal
verification and analytical procedures, provide assurance that the prices used in our financial statements comply with the
accounting guidance for fair value measurements and disclosures and reflect the assumptions that a market participant would
use in pricing our assets and liabilities. The price quotes we receive are non-binding both to us and to our counterparties.
In many cases, we receive prices from third-party pricing services or dealers and use those prices without adjustment. For
a large majority of the assets and liabilities we value using pricing services and dealers, we obtain prices from multiple external
sources and use the median of the prices to measure fair value. This technique is referred to below as “median of external
sources.” The significant inputs used in the fair value measurement of assets and liabilities that are valued using the median of
external sources pricing technique are the third-party prices. Significant increases (decreases) in any of the third-party prices in
isolation may result in a significantly higher (lower) fair value measurement. In limited circumstances, we may be able to
receive pricing information from only a single external source. This technique is referred to below as “single external source.”
In limited circumstances, we receive prices or pricing-related data that we adjust or use as an input to our models or other
valuation techniques to measure fair value, as described in “Valuation Techniques for Assets and Liabilities Measured on Our
Consolidated Balance Sheets at Fair Value — Derivative Assets, Net and Derivative Liabilities, Net.” In other limited
circumstances, we receive prices from a third-party provider and use those prices without adjustment, but the inputs used by the
third-party provider to develop the prices are reasonably available to us, as described in “Valuation Techniques for Assets and
Liabilities Measured on Our Consolidated Balance Sheets at Fair Value — Mortgage Loans, Held-for-Sale” and “— Other
Assets and Other Liabilities.”
Valuation Techniques for Assets and Liabilities Measured on Our Consolidated Balance Sheets at Fair Value
We categorize assets and liabilities that we measure and report on our consolidated balance sheets at fair value within the
fair value hierarchy based on the valuation techniques used to derive the fair value and our judgment regarding the
observability of the related inputs. The following is a description of the valuation techniques we use for fair value measurement
and disclosure; the significant inputs used in those techniques (if applicable); our basis for classifying the measurements as
Level 1, Level 2, or Level 3 of the fair value hierarchy; and, for those measurements classified as Level 3 of the hierarchy, a
narrative description of the sensitivity of the fair value measurement to changes in significant unobservable inputs and a
description of any interrelationships between those unobservable inputs. Although the sensitivities of the unobservable inputs
are generally discussed below in isolation, interrelationships exist among the inputs such that a change in one unobservable
input typically results in a change to one or more of the other inputs. For example, the most common interrelationship that
impacts the majority of our fair value measurements is between future interest rates, prepayment speeds, and probabilities of
default. Generally, a change in the assumption used for future interest rates results in a directionally opposite change in the
assumption used for prepayment speeds and a directionally similar change in the assumption used for probabilities of default.
Each technique discussed below may not be used in a given reporting period, depending on the composition of our assets
and liabilities measured at fair value and relevant market activity during that period.
Investments in Securities
Mortgage-Related Securities
Agency Securities
Agency securities, both trading and available-for-sale, consist of mortgage-related securities issued and guaranteed by
Freddie Mac, Fannie Mae, and Ginnie Mae. The valuation techniques for agency securities vary depending on the type of
security.
Fixed-rate single-class securities are valued using observable prices for similar securities in the TBA market. The
observable TBA prices vary based on agency, term, coupon, and settlement date. In addition, we may adjust the TBA price
accordingly based on matrices we receive from external dealers for securities with specific collateral characteristics if we
observe those collateral characteristics to be trading at a premium or discount to the TBA price. Significant inputs used in this
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