Fannie Mae 2007 Annual Report Download - page 204

Our estimate of the fair value of delinquent loans purchased from MBS trusts is based upon an assessment of
what a market participant would pay for the loan at the date of acquisition. Prior to July 2007, we estimated
the initial fair value of these loans using internal prepayment, interest rate and credit risk models that
incorporated management’s best estimate of certain key assumptions, such as default rates, loss severity and
prepayment speeds.
Beginning in July 2007, the mortgage markets experienced a number of significant events, including a
dramatic widening of credit spreads for mortgage securities backed by higher risk loans, a large number of
credit downgrades of higher risk mortgage-related securities, and a severe reduction in market liquidity for
certain mortgage-related transactions. As a result of this extreme disruption in the mortgage markets, we
concluded that our model-based estimates of fair value for delinquent loans were no longer aligned with the
indicative market prices for these loans. Therefore, we began utilizing indicative market prices from large,
experienced dealers and used an average of these market prices to estimate the initial fair value of delinquent
loans purchased from MBS trusts.
We consider loans within the scope of SOP 03-3 as individually impaired at acquisition. However, in
accordance with SOP 03-3, no valuation allowance is established or carried over at acquisition. We record the
excess of the loan’s acquisition cost over its fair value as a charge-off against our “Reserve for guaranty
losses” at acquisition. Any subsequent decreases in estimated future cash flows to be collected are recognized
as impairment losses through the allowance for loan losses.
We place loans that we acquire from MBS trusts that are within the scope of SOP 03-3 on nonaccrual status at
acquisition. If such a loan subsequently becomes less than three months past due, or we subsequently modify
the loan and determine through a financial analysis that the borrower is able to make the modified payments,
we return the loan to accrual status. We determine the initial accrual status of acquired loans that are not
within the scope of SOP 03-3 in accordance with our nonaccrual policy. Accordingly, loans purchased under
other contingent call options are placed on accrual status at acquisition if they are current or if there has been
only an insignificant delay in payment, and there are no other facts and circumstances that would lead us to
conclude that the collection of principal and interest is not probable.
When the loan is returned to accrual status, the portion of the expected cash flows, excluding prepayment
estimates, that exceeds the recorded investment in the loan is accreted into interest income over the contractual
life of the loan. We prospectively recognize increases in future cash flows expected to be collected as interest
income over the remaining contractual life of the loan through a yield adjustment.
Advances to Lenders
Advances to lenders represent payments of cash in exchange for the receipt of mortgage loans from lenders in
a transfer that is accounted for as a secured lending arrangement under SFAS 140. These transfers primarily
occur when we provide early funding to lenders for loans that they will subsequently either sell to us or
securitize into a Fannie Mae MBS that they will deliver to us. We individually negotiate early lender funding
advances with our lender customers. Early lender funding advances have terms up to 60 days and earn a
short-term market rate of interest. In other cases, the transfers are of loans that the lender has the unilateral
ability to repurchase from us.
We report cash outflows from advances to lenders as an investing activity in the consolidated statement of
cash flows. Settlements of the advances to lenders, other than through lender repurchases of loans, are not
collected in cash, but rather in the receipt of either loans or Fannie Mae MBS. Accordingly, this activity is
reflected as a non-cash transfer in the consolidated statement of cash flows. Currently, advances settled
through receipt of securities are included in the line item of our consolidated statements of cash flows entitled
“Transfers from advances to lenders and investments in securities.”
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FANNIE MAE
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)