Fannie Mae 2010 Annual Report Download - page 270

Use of Estimates
Preparing consolidated financial statements in accordance with GAAP requires management to make estimates
and assumptions that affect our reported amounts of assets and liabilities, and disclosure of contingent assets
and liabilities as of the dates of our consolidated financial statements, as well as our reported amounts of
revenues and expenses during the reporting periods. Management has made significant estimates in a variety
of areas including, but not limited to, valuation of certain financial instruments and other assets and liabilities,
the allowance for loan losses and reserve for guaranty losses, and other-than-temporary impairment of
investment securities. Actual results could be different from these estimates.
Our allowance for loan losses includes an estimate for the benefit of payments from lenders and servicers to
make us whole for losses on loans due to a breach of selling or servicing representations and warranties.
Historically, this estimate was based significantly on historical cash collections. In the fourth quarter of 2010,
the following factors impacted this estimate:
• we revised our methodology to take into account trends in management actions taken before cash
collections, which resulted in our allowance for loan losses being $1.1 billion higher than it would have
been under the previous methodology; and
• agreements with seller/servicers that addressed their loan repurchase and other obligations to us impacted
our expectation of future make-whole payments, resulting in a decrease in our allowance for loan losses
of approximately $700 million.
In the fourth quarter of 2010, we updated our allowance for loan loss models to incorporate more recent data
on prepayments and modified loan performance which reduced the allowance on individually impaired loans
by $670 million, driven primarily by more favorable default expectations for modified loans that withstood
successful trial periods. In the second quarter of 2010, we updated our allowance for loan loss model to reflect
a change in our cohort structure for our severity calculations which resulted in a change in estimate and a
decrease in our allowance for loan losses of approximately $1.6 billion.
Principles of Consolidation
Our consolidated financial statements include our accounts as well as the accounts of other entities in which
we have a controlling financial interest. The typical condition for a controlling financial interest is ownership
of a majority of the voting interests of an entity. A controlling financial interest may also exist in entities
through arrangements that do not involve voting interests, such as a variable interest entity (“VIE”).
VIE Assessment
We have interests in various entities that are considered VIEs. A VIE is an entity (1) that has total equity at
risk that is not sufficient to finance its activities without additional subordinated financial support from other
entities, (2) where the group of equity holders does not have the power to direct the activities of the entity that
most significantly impact the entity’s economic performance, or the obligation to absorb the entity’s expected
losses or the right to receive the entity’s expected residual returns, or both, or (3) where the voting rights of
some investors are not proportional to their obligations to absorb the expected losses of the entity, their rights
to receive the expected residual returns of the entity, or both, and substantially all of the entity’s activities
either involve or are conducted on behalf of an investor that has disproportionately few voting rights.
In order to determine if an entity is considered a VIE, we first perform a qualitative analysis, which requires
certain subjective decisions including, but not limited to, the design of the entity, the variability that the entity
was designed to create and pass along to its interest holders, the rights of the parties, and the purpose of the
F-12
FANNIE MAE
(In conservatorship)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)