Fannie Mae 2005 Annual Report Download - page 237

(“VIEs”) under Financial Accounting Standards Board (“FASB”) Interpretation (“FIN”) No. 46R (revised
December 2003), Consolidation of Variable Interest Entities (an interpretation of ARB No. 51) (“FIN 46R”),to
determine when we must consolidate the assets, liabilities and non-controlling interests of a VIE. A VIE is an
entity (i) that has total equity at risk that is not sufficient to finance its activities without additional
subordinated financial support from other entities, (ii) where the group of equity holders does not have the
ability to make significant decisions about the entity’s activities, or the obligation to absorb the entity’s
expected losses or the right to receive the entity’s expected residual returns, or both, or (iii) where the voting
rights of some investors are not proportional to their obligations to absorb the expected losses of the entity,
their rights to receive the expected residual returns of the entity, or both, and substantially all of the entity’s
activities either involve or are conducted on behalf of an investor that has disproportionately few voting rights.
The primary types of entities we evaluate under FIN 46R include those special purpose entities (“SPEs”)
established to facilitate the securitization of mortgage assets in which we have the unilateral ability to liquidate
the trust, those SPEs that do not meet the qualifying special purpose entity (“QSPE”) criteria, our Low-Income
Housing Tax Credit (“LIHTC”) partnerships, other partnerships that provide tax benefits and other entities that
meet the VIE criteria.
If an entity is a VIE, we determine if our variable interest causes us to be considered the primary beneficiary.
We are the primary beneficiary and are required to consolidate the entity if we absorb the majority of expected
losses or expected residual returns, or both. In making the determination as to whether we are the primary
beneficiary, we evaluate the design of the entity, including the risks that cause variability, the purpose for
which the entity was created, and the variability that the entity was designed to create and pass along to its
interest holders. When the primary beneficiary cannot be identified through a qualitative analysis, we use
internal cash flow models, which may include Monte Carlo simulations, to compute and allocate expected
losses or residual returns to each variable interest holder. The allocation of expected cash flows is based upon
the relative contractual rights and preferences of each interest holder in the VIE’s capital structure. If we
determine when we first become involved with a VIE or at subsequent reconsideration events (e.g. a purchase
of additional beneficial interests) that we are the primary beneficiary, then we initially record the assets and
liabilities of the VIE in the consolidated financial statements at the current fair value. For entities that hold
only financial assets, any difference between the current fair value and the previous carrying amount of our
interests in the VIE is recorded as “Extraordinary gains (losses), net of tax effect” in the consolidated
statements of income, as required by FIN 46R. If we determine that we are the primary beneficiary when the
VIE is created, we initially record the assets and liabilities of the VIE in the consolidated financial statements
by carrying over our investment in the VIE to the consolidated assets and liabilities and no gain or loss is
recorded.
If a consolidated VIE subsequently should not be consolidated because we cease to be deemed the primary
beneficiary or we qualify for one of the scope exceptions of FIN 46R (for example, the entity is a QSPE in
which we no longer have the unilateral ability to liquidate), we deconsolidate the VIE by carrying over our net
basis in the consolidated assets and liabilities to our investment in the VIE.
As a result of our adoption of FIN 46R in 2003, we recorded a gain to reflect the cumulative effect of a
change in accounting principle of $34 million, net of taxes, related to the difference between the net amount
added to the consolidated balance sheet and the amount of previously recognized interest in the newly
consolidated entity.
Prior to our adoption of FIN 46R, the decision of whether to consolidate SPEs for which we did not have the
unilateral ability to liquidate or that did not meet the criteria to be a QSPE primarily included consideration of
whether a third party had made a substantive equity investment in an SPE, which party had voting rights, if
any, which party made decisions about the assets in an SPE, which party was at risk of loss and whether we
were the sponsor of an SPE. We consolidated an SPE if we retained or acquired control over the risks and
rewards of the assets in the SPE of which we were the sponsor. We also consolidated an SPE if we had the
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FANNIE MAE
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)