Fannie Mae 2009 Annual Report Download - page 85

Allowance for Loan Losses and Reserve for Guaranty Losses
We maintain an allowance for loan losses for loans in our mortgage portfolio classified as held-for-investment.
We maintain a reserve for guaranty losses for loans that back Fannie Mae MBS we guarantee and loans that
we have guaranteed under long-term standby commitments. We report the allowance for loan losses and
reserve for guaranty losses as separate line items in the consolidated balance sheets. These amounts, which we
collectively refer to as our combined loss reserves, represent probable losses incurred in our guaranty book of
business as of the balance sheet date. 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 consolidated balance sheets that reflects an estimate of incurred credit losses
related to our guaranty to each Fannie Mae MBS trust that we will supplement amounts received by the
Fannie Mae MBS trust as required to permit timely payment of principal and interest on the related Fannie
Mae MBS. As a result, the guaranty reserve considers not only the principal and interest due on the loan at
the current balance sheet date, but also any additional interest payments due to the trust from the current
balance sheet date up until the point of loan acquisition or foreclosure. We maintain separate loss reserves for
single-family and multifamily loans. Our single-family and multifamily loss reserves consist of a specific loss
reserve for individually impaired loans and a collective loss reserve for all other loans.
We have an established process, using analytical tools, benchmarks and management judgment, to determine
our loss reserves. Although our loss reserve process benefits from extensive historical loan performance data,
this process is subject to risks and uncertainties, including a reliance on historical loss information that may
not be representative of current conditions. We continually monitor delinquency and default trends and make
changes in our historically developed assumptions and estimates as necessary to better reflect the impact of
present conditions, including current trends in borrower risk and/or general economic trends, changes in risk
management practices, and changes in public policy and the regulatory environment. We also consider the
recoveries that we will receive on mortgage insurance and other credit enhancements entered into
contemporaneous with and in contemplation of a guaranty or loan purchase transaction, as such recoveries
reduce the severity of the loss associated with defaulted loans. Because of the stress in the housing and credit
markets, and the speed and extent of deterioration in these markets, our process for determining our loss
reserves has become significantly more complex and involves a greater degree of management judgment than
prior to this period of economic stress.
Single-Family Loss Reserves
We establish a specific single-family loss reserve for individually impaired loans, which includes loans we
restructure in a troubled debt restructuring, certain nonperforming loans in MBS trusts and acquired credit-
impaired loans that have been further impaired subsequent to acquisition. The single-family loss reserve for
individually impaired loans is a growing portion of the total single-family reserve and will continue to grow in
conjunction with our modification efforts. We typically measure impairment based on the difference between
our recorded investment in the loan and the present value of the estimated cash flows we expect to receive,
which we calculate using the effective interest rate of the original loan or the effective interest rate at
acquisition for credit-impaired loans. However, when foreclosure is probable, we measure impairment based
on the difference between our recorded investment in the loan and the fair value of the underlying property,
adjusted for the estimated discounted costs to sell the property and estimated insurance or other proceeds we
expect to receive.
We establish a collective single-family loss reserve, which represents the majority of our total single-family
loss reserve, for all other single-family loans in our single-family guaranty book of business using an
econometric model that estimates the probability of default of loans to derive an overall loss reserve estimate
given multiple factors such as: origination year, mark-to-market LTV ratio, delinquency status and loan
product type. This model was implemented in the fourth quarter of 2009 to replace our previous model. Our
previous model was used during 2008 and the first nine months of 2009 and was a loss curve-based model
that was driven primarily by original LTV ratio, loan product type, the age of the mortgage loan and the
performance to date of the vintage to which the loan belonged. The new model resulted in a decrease in our
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