Fannie Mae 2007 Annual Report Download - page 277

characteristics. Specifically, we use the observable market value of our Fannie Mae MBS as a base value, from
which we subtract or add the fair value of the associated guaranty asset, guaranty obligation and master
servicing arrangements.
Mortgage Loans Held for Investment, net of allowance for loan losses—HFI loans are recorded in the
consolidated balance sheets at the principal amount outstanding, net of unamortized premiums and discounts,
cost basis adjustments and an allowance for loan losses. We determine the fair value of our mortgage loans
based on comparisons to Fannie Mae MBS with similar characteristics. Specifically, we use the observable
market value of our Fannie Mae MBS as a base value, from which we subtract or add the fair value of the
associated guaranty asset, guaranty obligation and master servicing arrangements.
Advances to Lenders—The carrying value of our advances to lenders approximates the fair value of the
majority of these instruments due to their short-term nature. Advances to lenders for which the carrying value
does not approximate fair value are valued based on comparisons to Fannie Mae MBS with similar
characteristics, and applying the same pricing methodology as used for HFI loans as described above.
Derivatives Assets and Liabilities (collectively, “Derivatives”)—Our risk management derivatives and
mortgage commitment derivatives are recognized in the consolidated balance sheets at fair value, taking into
consideration the effects of any legally enforceable master netting agreements that allow us to settle derivative
asset and liability positions with the same counterparty on a net basis. We use observable market prices or
market prices obtained from third parties for derivatives, when available. For derivative instruments where
market prices are not readily available, we estimate fair value using model-based interpolation based on direct
market inputs. Direct market inputs include prices of instruments with similar maturities and characteristics,
interest rate yield curves and measures of interest rate volatility. Details of these estimated fair values by type
are displayed in “Note 10, Derivative Instruments.”
Guaranty Assets and Buy-ups—We estimate the fair value of guaranty assets based on the present value of
expected future cash flows of the underlying mortgage assets using management’s best estimate 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 the 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 reduce the spreads on interest-only trusts to adjust for the less liquid nature of the guaranty
asset. The fair value of the guaranty asset as presented in the table above includes the fair value of any
associated buy-ups, which is estimated in the same manner as guaranty assets but are recorded separately as a
component of “Other assets” in the consolidated balance sheets. While the fair value of the guaranty asset
reflects all guaranty arrangements, the carrying value primarily reflects only those arrangements entered into
subsequent to our adoption of FIN 45.
Federal Funds Purchased and Securities Sold Under Agreements to Repurchase—The carrying value of our
federal funds purchased and securities sold under agreements to repurchase approximate the fair value of these
instruments due to the short-term nature of these liabilities, exclusive of dollar roll repurchase transactions.
Short-Term Debt and Long-Term Debt—As of December 31, 2007, we estimate the fair value of our non-
callable debt using an average of vendor bid prices and then applying an adjustment to convert the average
vendor bid prices to ask level prices. As of December 31, 2006, and when vendor pricing is not available, we
estimate the fair value of our non-callable debt using the discounted cash flow approach based on the Fannie
Mae yield curve with an adjustment to reflect fair values at the offer side of the market. We estimate the fair
value of our callable bonds using an option adjusted spread (“OAS”) approach using the Fannie Mae yield
curve and market-calibrated volatility. The OAS applied to callable bonds approximates market levels where
we have executed secondary market transactions. We continue to use third party prices for subordinated debt.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)