Freddie Mac 2014 Annual Report Download - page 229

224 Freddie Mac
Multifamily
The underlying collateral is primarily valued using either an income capitalization technique or third-party appraisals.
Under the income capitalization technique, the collateral is valued by discounting the present value of future cash flows
by applying an overall capitalization rate to the forecasted net operating income. The significant unobservable input used in the
fair value measurement of these loans is the capitalization rate, which is determined through analysis of the DSCR. Significant
increases (decreases) in the capitalization rate in isolation would result in a significantly lower (higher) fair value measurement.
Under the third-party appraisal technique, we use the prices provided by third-party appraisers without adjustment. The
third-party appraisers consider the physical condition of the property and use comparable sales and other market data in
determining the appraised value.
Derivative Assets, Net and Derivative Liabilities, Net
Derivative assets and derivative liabilities consist of interest-rate swaps, option-based derivatives, and other derivatives,
such as exchange-traded futures and certain forward purchase and sale commitments.
Interest-Rate Swaps
Interest-rate swaps consist of receive-fixed, pay-fixed, and basis swaps. The majority of our interest-rate swaps are
valued using a discounted cash flow technique. Under this technique, interest-rate swaps are valued by using the appropriate
yield curves to discount the expected cash flows of both the fixed and variable rate components of the swap contracts. The
significant inputs used in the fair value measurement of these derivatives are market-based interest rates. These derivatives are
classified as Level 2 as the significant inputs used in the fair value measurement are observable in active markets.
Option-Based Derivatives
Option-based derivatives consist of interest rate caps, interest rate floors, call swaptions, and put swaptions. We value the
majority of our option-based derivatives using an option-pricing model. Dealer-supplied interest rate volatility matrices are a
key input into the model. Within each matrix, prices are provided for a range of option terms, swap terms, and strikes. Our
model then interpolates between swaption terms to determine the volatility for each instrument. This volatility is the input to
the option-pricing model to establish the price. These derivatives are classified as Level 2 as the significant inputs used are
observable in active markets.
Option-based derivatives also include options on exchange-traded futures. See "— Other Derivatives" for more
information.
Other Derivatives
Other derivatives consist of exchange-traded futures and certain forward purchase and sale commitments.
Exchange-traded futures are valued using quoted prices in active markets for identical assets or liabilities and are
classified as Level 1.
Certain purchase and sale commitments are also considered to be derivatives and are valued using the same techniques
we use to value the underlying instruments we are committing to purchase or sell. These instruments generally have observable
market pricing and are classified as Level 2. Valuation techniques for commitments to purchase or sell investment securities
and to extinguish or issue debt securities of consolidated trusts are further discussed in “Investments in Securities.” Valuation
techniques for commitments to purchase single-family mortgage loans are further discussed in “Valuation Techniques for
Assets and Liabilities Not Measured on Our Consolidated Balance Sheets at Fair Value, but for Which the Fair Value is
Disclosed — Mortgage Loans.”
Other Assets and Other Liabilities
Other assets consist of our guarantee asset related to guarantees issued to unconsolidated securitization trusts and
mortgage servicing rights. Other liabilities, from time to time, consist of mortgage servicing rights.
Guarantee Asset
Our guarantee asset is primarily related to our multifamily guarantees. The multifamily guarantee asset is valued using a
discounted cash flow technique. Under this technique, the present value of future cash flows related to our management and
guarantee fee is discounted based on the current OAS-to-benchmark interest rates for new guarantees, which are driven by
changes in our estimates of credit risk and changes in the credit profile of the multifamily guarantee portfolio. The significant
unobservable input used in the fair value measurement of the guarantee asset is the OAS-to-benchmark rates. Significant
increases (decreases) in the OAS in isolation would result in a significantly lower (higher) fair value measurement.
Our guarantee asset also consists of single family guarantees primarily related to long-term standby commitments, the
vast majority of which is valued using the median of external sources. Under this technique, we obtain multiple price quotes
from dealers, who provide estimates based on pricing for comparable benchmark securities with specific adjustments to reflect
the unique characteristics of this asset class.
The guarantee asset is classified as Level 3 as significant inputs used in the fair value measurement are unobservable.
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