Fannie Mae 2010 Annual Report Download - page 384

loans, through third-party pricing services or through a model approach incorporating both interest rate and
credit risk simulating a loan sale via a synthetic structure.
Fair value of single-family nonperforming loans represents an estimate of the prices we would receive if we
were to sell these loans in the nonperforming whole-loan market. We calculate the fair value of nonperforming
loans based on assumptions about key factors, including loan performance, collateral value, foreclosure related
expenses, disposition timeline, and mortgage insurance repayment. Using these assumptions, along with
indicative bids for a representative sample of nonperforming loans, we compute a market calibrated fair value.
The bids on sample loans are obtained from multiple active market participants. Fair value for loans that are
four or more months delinquent, in an open modification period, or in a closed modification and that have
performed for nine or fewer months, is estimated directly from a model calibrated to these indicative bids. Fair
value for loans that are one to three months delinquent is estimated by an interpolation method using three
inputs: (1) the fair value estimate as a performing loan; (2) the fair value estimate as a nonperforming loan;
and (3) the delinquency transition rate corresponding to the loan’s current delinquency status.
Fair value of a portion of our single-family nonperforming loans is measured using the value of the underlying
collateral. These valuations leverage our proprietary distressed home price model. The model assigns a value
using comparable transaction data. In determining what comparables to use in the calculations, the model
measures three key characteristics relative to the target property: (1) distance from target property, (2) time of
the transaction and (3) comparability of the nondistressed value. A portion of the nonperforming loans that are
impaired is measured at fair value in our consolidated balance sheets on a nonrecurring basis. These loans are
classified within Level 3 of the valuation hierarchy because significant inputs are unobservable.
Fair value of multifamily nonperforming loans is determined by external third-party valuations when available.
If third-party valuations are unavailable, we determine the value of the collateral based on a derived property
value estimation method using current net operating income of the property and capitalization rates.
Derivatives Assets and Liabilities (collectively “derivatives”)—Derivatives are recorded in our consolidated
balance sheets at fair value on a recurring basis. The valuation process for the majority of our risk
management derivatives uses observable market data provided by third-party sources, resulting in Level 2
classification. Interest rate swaps are valued by referencing yield curves derived from observable interest rates
and spreads to project and discount swap cash flows to present value. Option-based derivatives use a model
that projects the probability of various levels of interest rates by referencing swaption and caplet volatilities
provided by market makers/dealers. The projected cash flows of the underlying swaps of these option-based
derivatives are discounted to present value using yield curves derived from observable interest rates and
spreads. Exchange-traded futures are valued using market quoted prices, resulting in Level 1 classification.
Certain highly complex structured derivatives use only a single external source of price information due to
lack of transparency in the market and may be modeled using observable interest rates and volatility levels as
well as significant assumptions, resulting in Level 3 classification. Mortgage commitment derivatives use
observable market data, quotes and actual transaction price levels adjusted for market movement, and are
typically classified as Level 2. Adjustments for market movement based on internal model results that 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 recorded in our
consolidated balance sheets at fair value on a recurring basis and are classified within Level 3 of the valuation
hierarchy. Guaranty assets in lender swap transactions are recorded in our consolidated balance sheets at the
lower of cost or fair value. These assets, which are measured at fair value on a nonrecurring basis, are
classified within Level 3 of the fair value hierarchy.
We estimate the fair value of guaranty assets based on the present value of expected future cash flows of the
underlying mortgage assets using management’s best estimate of certain key assumptions, which include
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FANNIE MAE
(In conservatorship)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)