Fannie Mae 2007 Annual Report Download - page 207

The fair value of the guaranty asset at inception is based on the present value of expected cash flows using
management’s best estimates of certain key assumptions, which include prepayment speeds, forward yield
curves and discount rates commensurate with the risks involved. These cash flows are projected using
proprietary prepayment, interest rate and credit risk models. Because guaranty assets are like an interest-only
income stream, the projected cash flows from our guaranty assets are discounted using interest spreads from a
representative sample of interest-only trust securities. We adjust these discounted cash flows for the less liquid
nature of the guaranty asset as compared to the interest-only trust securities.
The fair value of the obligation to stand ready to perform over the term of the guaranty represents
management’s estimate of the amount that we would be required to pay a third party of similar credit standing
to assume our obligation. This amount is based on market information from spot transactions, when available.
In instances where such observations are not available, this amount is based on the present value of expected
cash flows using management’s best estimates of certain key assumptions, which include default and severity
rates and a market rate of return.
The initial recognition and measurement provisions of FIN 45 apply to our guaranties issued or modified on or
after January 1, 2003. For lender swap transactions entered into prior to the effective date of FIN 45, we
recognized guaranty fees in the consolidated statements of operations as “Guaranty fee income” on an accrual
basis over the term of the unconsolidated Fannie Mae MBS. We recognized a contingent liability under SFAS 5
based on management’s estimate of probable losses incurred on those loans as of each balance sheet date.
Prior to the effective date of FIN 45, upfront cash payments received in the form of risk-based pricing
adjustments or buy-downs were deferred as a component of “Other liabilities” in the consolidated balance
sheets and amortized into “Guaranty fee income” in the consolidated statements of operations over the life of
the guaranty using the interest method prescribed in SFAS 91. The accounting for buy-ups was not changed
when FIN 45 became effective.
Guaranties Issued in Connection with Portfolio Securitizations
In addition to retained interests in the form of Fannie Mae MBS, REMICs, and MSAs, we retain an interest in
securitized loans in a portfolio securitization, which represents our right to future cash flows associated
primarily with providing our guaranty. The retained guaranty interest in a portfolio securitization is recorded
in the consolidated balance sheets as a component of “Guaranty assets.” Retained guaranty interests in a
portfolio securitization entered into prior to our January 1, 2007 adoption of SFAS 155 are accounted for in
the same manner as AFS securities. Retained guaranty interests in a portfolio securitization entered into on or
after January 1, 2007 are accounted for in the same manner as trading securities. The fair value of the
guaranty asset is determined in the same manner as the fair value of the guaranty asset in a lender swap
transaction. We assume a recourse obligation in connection with our guaranty of the timely payment of
principal and interest to the MBS trust that we measure and record in the consolidated balance sheets under
“Guaranty obligations” based on the fair value of the recourse obligation at inception. Any difference between
the guaranty asset and the guaranty obligation in a portfolio securitization is recognized as a component of the
gain or loss on the sale of mortgage-related assets and is recorded as “Investment losses, net” in the
consolidated statements of operations.
We evaluate the component of the “Guaranty assets” that represents the retained interest in securitized loans
for other-than-temporary impairment under EITF 99-20. We amortize and account for the guaranty obligations
subsequent to the initial recognition in the same manner that we account for the guaranty obligations that arise
under lender swap transactions and record a “Reserve for guaranty losses” for estimable and probable losses
incurred on the underlying loans as of each balance sheet date. When we recognize a guaranty obligation and
do not receive an associated guaranty fee, we amortize the guaranty obligation using a systematic and rational
method, dependent on the risk profile of our guaranty.
F-19
FANNIE MAE
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)