Freddie Mac 2014 Annual Report Download - page 235

230 Freddie Mac
The following is a description of the valuation techniques we use for items not measured on our consolidated balance
sheets at fair value, but for which the fair value is disclosed, the significant inputs used in those techniques (if applicable), and
our basis for classifying the measurements as Level 1, Level 2, or Level 3 of the valuation hierarchy. 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.
Cash and Cash Equivalents (including Restricted Cash and Cash Equivalents)
Cash and cash equivalents (including restricted 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. Cash and restricted cash are classified as Level 1.
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 U.S. 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. Federal funds sold and securities purchased under agreements to resell are classified as
Level 2 because these assets have observable market pricing, but quoted prices for identical assets are not available.
Mortgage Loans
Single-family and multifamily mortgage loans classified as held-for-investment are recorded at amortized cost. Certain
held-for-investment single-family and multifamily mortgage loans are recorded at the fair value of the underlying collateral
upon impairment. Multifamily held-for-sale mortgage loans are recorded at fair value due to the election of the fair value
option.
Single-Family Loans
Determination of Principal Market
In determining the fair value of single-family mortgage loans, valuation outcomes can vary widely based on management
judgments and decisions used in determining: (a) the principal market; (b) modeling assumptions, including default, severity,
home prices, and risk premiums; and (c) inputs used to determine variables including risk premiums, credit costs, security
pricing, and implied management and guarantee fees. Our principal markets include the GSE securitization market and the
whole loan market. To determine the principal market, we considered the market with the greatest volume and level of activity
and our ability to access that market. In the absence of a market with active trading, we determined the market that would
maximize the amount we would receive upon sale. We determined that the principal market is the whole loan market for loans
that: (a) are four or more months delinquent; (b) are in foreclosure; (c) have completed a loan modification but have not been
current for at least 6 consecutive months; (d) have completed a loan modification and have a current LTV ratio greater than
125%; or (e) have been modified through a process that included forbearance on a portion of the outstanding balance. The total
UPB of loans where the whole loan market is the principal market was approximately $72.0 billion and $101.2 billion as of
December 31, 2014 and 2013, respectively. We determined that the principal market for all other loans, regardless of whether
the loan is currently securitized or whether the loan is eligible for purchase under current underwriting standards, is the GSE
securitization market. The total UPB of loans where the GSE securitization market is the principal market was approximately
$1.6 trillion and $1.5 trillion as of December 31, 2014 and 2013, respectively.
Whole Loan Market as Principal Market
Loans where we determine that the principal market is the whole loan market are valued using the median of external
sources. Under the median of external sources technique, prices for single-family loans are obtained from multiple dealers.
These dealers reference market activity for deeply delinquent and modified loans, where available, and use internal models and
their judgment to determine default rates, severity rates, home prices, and risk premiums. Single-family mortgage loans valued
using this technique are classified as Level 3 due to the low volume and level of activity in this market.
GSE Securitization Market as Principal Market
Loans where we determine that the principal market is the GSE securitization market are valued using the build-up
technique. Under the build-up technique, the fair value of single-family mortgage loans is based on the estimate of the price we
would receive if we were to securitize the loans. These loans are valued by starting with benchmark security pricing for
actively traded mortgage-related securities with similar characteristics, adjusting for the value of our management and
guarantee fee, which is the compensation we receive for performing our management and guarantee activities, and our credit
obligation related to performing our guarantee.
The security price is based on benchmark security pricing for similar actively traded mortgage-related securities, adjusted
as necessary based on security characteristics. This security pricing process is consistent with our approach for valuing similar
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