Fannie Mae 2010 Annual Report Download - page 385

prepayment speeds, forward yield curves, and discount rates commensurate with the risks involved. These cash
flows are projected using proprietary prepayment, interest rate and credit risk models. Because guaranty assets
are like an interest-only income stream, the projected cash flows from our guaranty assets are discounted using
one-month LIBOR plus the option-adjusted spread (“OAS”) for interest-only trust securities. The interest-only
OAS is calibrated using prices of a representative sample of interest-only trust securities. We believe the
remitted fee income is less liquid than interest-only trust securities and more like an excess servicing strip. We
take a further haircut of the present value for liquidity considerations. The haircut is based on market quotes
from dealers.
The fair value of the guaranty assets include the fair value of any associated buy-ups, which is estimated in
the same manner as guaranty assets but is recorded separately as a component of “Other assets” in our
consolidated balance sheets. While the fair value of the guaranty assets reflect all guaranty arrangements, the
carrying value primarily reflects only those arrangements entered into subsequent to our adoption of the
accounting standard on guarantor’s accounting and disclosure requirements for guarantees.
Short-Term Debt and Long-Term Debt (collectively “debt”)—The majority of debt of Fannie Mae is recorded
in our consolidated balance sheets at the principal amount outstanding, net of cost basis adjustments. We
elected the fair value option for certain structured debt instruments, which are recorded in our consolidated
balance sheets at fair value on a recurring basis.
We use third-party pricing services that reference observable market data such as interest rates and spreads to
measure the fair value of debt, and thus classify that debt as Level 2. When third-party pricing is not
available, we use a discounted cash flow approach based on a yield curve derived from market prices observed
for Fannie Mae Benchmark Notes and adjusted to reflect fair values at the offer side of the market.
For structured debt instruments that are not valued by third-party pricing services, cash flows are evaluated
taking into consideration any structured derivatives through which we have swapped out of the structured
features of the notes. The resulting cash flows are discounted to present value using a yield curve derived from
market prices observed for Fannie Mae Benchmark Notes and adjusted to reflect fair values at the offer side of
the market. Market swaption volatilities are also referenced for the valuation of callable structured debt
instruments. Given that the derivatives considered in the valuations of these structured debt instruments are
classified as Level 3, the valuations of the structured debt instruments result in a Level 3 classification.
At the transition date, we recognized consolidated trusts’ debt held by third parties at their unpaid principal
balance in our consolidated balance sheets. Consolidated MBS debt is traded in the market as MBS assets.
Accordingly, we estimate the fair value of our consolidated MBS debt using quoted market prices in active
markets for similar liabilities when traded as assets. The valuation methodology and inputs used in estimating
the fair value of MBS assets are described under “Cash Equivalents, Trading Securities and Available-for-Sale
Securities.” Certain consolidated MBS debt with embedded derivatives is recorded in our consolidated balance
sheets at fair value on a recurring basis.
Other Liabilities—Represents dollar roll repurchase transactions that reflect prices for similar securities in the
market. They are recorded in our consolidated balance sheets at fair value on a recurring basis. Fair value is
based on observable market-based inputs, quoted market prices and actual transaction price levels adjusted for
market movement, and these liabilities are typically classified as Level 2. Adjustments for market movement
that require internal model results that cannot be corroborated by observable market data results in
classification as Level 3.
Nonrecurring Changes in Fair Value
The following tables display assets and liabilities measured in our consolidated balance sheets at fair value on
a nonrecurring basis; that is, the instruments are not measured at fair value on an ongoing basis but are subject
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FANNIE MAE
(In conservatorship)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)