Fannie Mae 2009 Annual Report Download - page 81

Fair Value of Guaranty Obligations
When we issue Fannie Mae MBS, we record in our consolidated balance sheets a guaranty asset that
represents the present value of cash flows expected to be received as compensation over the life of the
guaranty. As guarantor of our Fannie Mae MBS issuances, we also recognize at inception of the guaranty the
fair value of our obligation to stand ready to perform over the term of the guaranty. As described in “Note 1,
Summary of Significant Accounting Policies,” we record this amount in our consolidated balance sheets as a
component of “Guaranty obligations.” The fair value of our guaranty obligations consists of the following:
(1) compensation to cover estimated default costs, including estimated unrecoverable principal and interest that
will be incurred over the life of the underlying mortgage loans backing our Fannie Mae MBS; (2) estimated
foreclosure-related costs; (3) estimated administrative and other costs related to our guaranty; and (4) an
estimated market risk premium, or profit, that a market participant would require to assume the obligation.
Effective January 1, 2008, as part of our implementation of the new accounting standard related to fair value
measurements, we changed our approach to measuring the fair value of our guaranty obligations. Specifically,
we adopted a measurement approach that is based upon an estimate of the compensation that we would
require to issue the same guaranty in a standalone arm’s-length transaction with an unrelated party. For a
guaranty issued in a lender swap transaction after 2007, we measure the fair value of the guaranty obligation
at inception based on the fair value of the total compensation we expect to receive, which primarily consists of
the guaranty fee, credit enhancements, buy-downs, risk-based price adjustments and our right to receive
interest income during the float period in excess of the amount required to compensate us for master servicing.
See “Consolidated Results of Operations—Guaranty Fee Income” for a description of buy-downs and risk-
based price adjustments. Because the fair value of the guaranty obligation at inception for guaranty contracts
issued after 2007 is equal to the fair value of the total compensation we expect to receive, we no longer
recognize losses or record deferred profit at inception of our lender swap transactions, which represent the
bulk of our guaranty transactions.
We also changed how we measure the fair value of our existing guaranty obligations to be consistent with our
approach for measuring guaranty obligations at initial recognition. This change, which affects the fair value
amounts disclosed in “Supplemental Non-GAAP Information—Fair Value Balance Sheets” and in “Note 19,
Fair Value,” does not affect the amounts recorded in our results of operations or consolidated balance sheets.
The fair value of any guaranty obligation measured after its initial recognition represents our estimate of a
hypothetical transaction price we would receive if we were to issue our guaranty to an unrelated party in a
standalone arm’s-length transaction at the measurement date. We continue to use the models and inputs that
we used prior to our adoption of the new accounting standard related to fair value measurements to estimate
this fair value, which we calibrated to our current market pricing in 2008. Beginning in the first quarter of
2009, we concluded that the credit characteristics of the pools of loans upon which we were issuing new
guarantees increasingly did not reflect the credit characteristics of our existing guaranteed pools; thus, current
market prices for our new guarantees were not a relevant input to our estimate of the hypothetical transaction
price for our existing guaranty obligations. Therefore, our estimate of the fair value of our existing guaranty
obligations is based solely upon our model results, without further adjustment. The estimated fair value of our
guaranty obligations as of each balance sheet date will always be greater than our estimate of future expected
credit losses in our existing guaranty book of business as of that date because the fair value of our guaranty
obligations includes an estimated market risk premium, or profit, that a market participant would require to
assume our existing obligations.
Fair Value of Loans Purchased with Evidence of Credit Deterioration
We have the option to purchase delinquent loans underlying our Fannie Mae MBS under specified conditions,
which we describe in “Business—Mortgage Securitizations—Purchases of Loans from our 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 as to 24 monthly payments of
principal and interest and 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 under the terms of our guaranty
arrangement. As described in “Note 1, Summary of Significant Accounting Policies,” when we acquire loans
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