Fannie Mae 2008 Annual Report Download - page 395

Valuation Classification
The following is a description of the fair value techniques used for instruments measured at fair value under
SFAS 157 as well as the general classification of such instruments pursuant to the valuation hierarchy
described above under SFAS 157.
Trading Securities and Available-for-Sale Securities—Fair value is determined using quoted market prices in
active markets for identical assets, when available. Securities, such as U.S. Treasuries, whose value is based on
quoted market prices in active markets for identical assets are classified as level 1. If quoted market prices in
active markets for identical assets are not available, we use quoted market prices in active markets for similar
securities that we adjust for observable or corroborated pricing services market information. A significant
amount of the population is valued using prices provided by four pricing services for identical assets. In the
absence of observable or corroborated market data, we use internally developed estimates, incorporating
market-based assumptions wherever such information is available. The fair values are estimated by using
pricing models, quoted prices of securities with similar characteristics, or discounted cash flows. Such
instruments may generally be classified within level 2 of the valuation hierarchy. Where there is limited
activity or less transparency around inputs to the valuation, securities are classified as level 3.
Mortgage Loans Held for Sale—Includes loans where fair value is determined on a pool level, loan level or
product and interest rate basis. Level 2 inputs include MBS values. Level 3 inputs include MBS values where
price is influenced significantly by extrapolation from observable market data, products in inactive markets or
unobservable inputs.
Mortgage Loans Held for Investment—Represents individually impaired loans, classified as level 3, where fair
value is less than carrying value. Includes modified and delinquent loans acquired from MBS trusts under
SOP 03-3. Valuations are based on regional prices and level 3 inputs include the collateral value used to value
the loan.
Acquired Property, Net—Includes foreclosed property received in full satisfaction of a loan. The fair value of
our foreclosed properties is determined by third-party appraisals, when available. When third-party appraisals
are not available, we estimate fair value based on factors such as prices for similar properties in similar
geographical areas and/or assessment through observation of such properties. Our acquired property is
classified within level 3 of the valuation hierarchy because significant inputs are unobservable.
Derivatives Assets and Liabilities (collectively, “Derivatives”)—The valuation of risk management derivatives
uses observable market data provided by third-party sources where available, resulting in level 2 classification.
Certain highly complex derivatives use only a single source of price information due to lack of transparency in
the market and may be modeled using significant assumptions, resulting in level 3 classification. Mortgage
commitment derivatives use observable market data, quotes and actual transaction levels adjusted for market
movement and are typically classified as level 2. Adjustments for market movement that require internal
model results and cannot be corroborated by observable market data are classified as level 3.
Guaranty Assets and Buy-ups—Guaranty assets related to our portfolio securitizations are measured at fair
value on a recurring basis and are classified within level 3 of the valuation hierarchy. Guaranty assets in a
lender swap transaction that are impaired under EITF 99-20 are measured at fair value on a non-recurring
basis and are classified within level 3 of the fair value hierarchy. As described above, level 3 inputs include
management’s best estimate of certain key assumptions.
Master Servicing Assets and Liabilities—We value our master servicing assets and liabilities based on the
present value of expected cash flows of the underlying mortgage assets using management’s best estimates of
certain key assumptions, which include prepayment speeds, forward yield curves, adequate compensation, and
discount rates commensurate with the risks involved. Changes in anticipated prepayment speeds, in particular,
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FANNIE MAE
(In conservatorship)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)