Fannie Mae 2007 Annual Report Download - page 77

Accounting in Each of Years 1 to 5:
• We collect $20 in guaranty fees per year, which represents one-fifth of the outstanding receivable amount,
and record this amount as a reduction in the guaranty asset.
• We reduce the guaranty obligation by a proportionate amount, or one-fifth, and record this amount, which
totals $24, in our consolidated statements of operations as guaranty fee income.
0 12345
Cumulative
Effect
For the Years Ended
Losses on certain guaranty contracts. . . . . . . . . . . . . . . . . . . . . $(20) $— $— $— $— $— $ (20)
Guaranty fee income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . — 24 24 24 24 24 120
Pre-tax income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $(20) $24 $24 $24 $24 $24 $100
As illustrated in the example, the $20 loss recognized at inception of the guaranty contract will be accreted
into earnings over time as a component of guaranty fee income. For additional information on our accounting
for guaranty transactions, which is more complex than the example presented, refer to “Notes to Consolidated
Financial Statements—Note 1, Summary of Significant Accounting Policies.”
When available, we base the fair value of the guaranty obligations that we record when we issue Fannie Mae
MBS on market information obtained from spot transaction prices. In the absence of spot transaction data,
which is the case for the substantial majority of our guaranties, we estimate the fair value using internal
models that project the future credit performance of the loans underlying our guaranty obligations under a
variety of economic scenarios. Key inputs and assumptions used in our models that affect the fair value of our
guaranty obligations are home price growth rates and an estimated market rate of return.
The fair value of our guaranty obligations is highly sensitive to changes in interest rates and the market’s
perception of future credit performance. When there is a market expectation of a decline in home prices,
which currently exists, the level of perceived credit risk for a mortgage loan tends to increase because the
market anticipates a likelihood of higher credit losses. Accordingly, the market requires a higher rate of return.
Incorporating these assumptions into our internal models has resulted in significant increases in the estimated
fair value of our guaranty obligations on new Fannie Mae MBS issuances and an increase in the losses
recognized at inception on certain guaranty contracts. We review the reasonableness of the results of our
models by comparing those results with available market information; however, it is possible that different
assumptions and inputs could produce materially different estimates of the fair value of our guaranty
obligations and losses on certain guaranty contracts, particularly in the current market environment.
Based on our experience, we expect our actual future credit losses to be significantly less than the fair value
of our guaranty obligations, as the fair value of our guaranty obligations includes not only future expected
credit losses but also an estimated market rate of return that a market participant would require to assume the
obligation Our combined allowance for loan losses and reserve for guaranty losses reflects our estimate of the
probable credit losses inherent in our guaranty book of business. We discuss our credit-related expenses and
credit losses in “Consolidated Results of Operations—Credit-Related Expenses.”
Fair Value of Loans Purchased with Evidence of Credit Deterioration—Effect on Credit-Related Expenses
We have the option to purchase delinquent loans underlying our Fannie Mae MBS trusts under specified
conditions, which we describe in “Item 1—Business—Business Segments—Single-Family Credit Guaranty
Business—MBS Trusts—Optional and Required Purchases of Mortgage Loans from Single-Family MBS
Trusts.” The acquisition cost for loans purchased from MBS trusts is the unpaid principal balance of the loan
plus accrued interest. We generally are required to purchase the loan if it is delinquent 24 consecutive months
or at the time of foreclosure, if it is still in the MBS trust at that time. As long as the loan or REO property
remains in the MBS trust, we continue to pay principal and interest to the MBS trust.
As described in “Notes to Consolidated Financial Statements—Note 1, Summary of Significant Accounting
Policies,” when we purchase loans that are within the scope of SOP 03-3, we record our net investment in
these seriously delinquent loans at the lower of the acquisition cost of the loan or the estimated fair value at
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