Fannie Mae 2009 Annual Report Download - page 278

permissible while the loan is held in an MBS trust. Fannie Mae, as guarantor or as issuer, may also purchase
mortgage loans when other pre-defined contingencies have been met, such as when there is a material breach
of a representation and warranty. Under long-term standby commitments, we purchase loans from lenders
when the loans subject to these commitments meet certain delinquency criteria. Our acquisition cost for these
loans is the unpaid principal balance of the loans plus accrued interest.
For a loan that will be classified as HFI, when there is evidence of credit deterioration subsequent to the
loan’s origination and it is probable, at acquisition, that we will be unable to collect all contractually required
payments receivable (ignoring insignificant delays in contractual payments), we account for the loan as an
acquired credit-impaired loan. We record such loans at the lower of the acquisition cost or fair value. We
record each acquired loan that does not meet these criteria at its acquisition cost.
For MBS trusts where we are considered the transferor, we recognize the loan on our consolidated balance
sheets at fair value and record a corresponding liability to the MBS trust when the contingency on our options
to purchase loans from the trust has been met and we regain effective control over the transferred loan.
We base our estimate of the fair value of delinquent loans purchased from MBS trusts 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 acquired credit-impaired loans to be
individually impaired at acquisition. However, 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. We recognize any subsequent decreases in estimated future cash
flows to be collected subsequent to acquisition as impairment losses through the allowance for loan losses.
We place credit-impaired loans that we acquire from MBS trusts on nonaccrual status at acquisition in
accordance with our nonaccrual policy. If we subsequently determine that the collectability of principal and
interest is reasonably assured we return the loan to accrual status. We determine the initial accrual status of
acquired loans that are not credit-impaired in accordance with our nonaccrual policy. Accordingly, we place
loans purchased from trusts under other contingent call options 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 reasonably
assured.
When the acquired 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.
Allowance for Loan Losses and Reserve for Guaranty Losses
The allowance for loan losses is a valuation allowance that reflects an estimate of incurred credit losses related
to our recorded investment in HFI loans. The reserve for guaranty losses is a liability account in our
F-20
FANNIE MAE
(In conservatorship)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)