Fannie Mae 2010 Annual Report Download - page 83

The decrease in assets classified as Level 3 during 2010 includes a $2.6 billion decrease due to derecognition
of guaranty assets and buy-ups at the transition date as well as net transfers of approximately $6.0 billion in
assets to Level 2 from Level 3. The assets transferred from Level 3 consist primarily of Fannie Mae
guaranteed mortgage-related securities and private-label mortgage-related securities.
Assets measured at fair value on a nonrecurring basis and classified as Level 3, which are not presented in the
table above, primarily include held-for-sale loans, held-for-investment loans, acquired property and partnership
investments. The fair value of Level 3 nonrecurring assets totaled $63.0 billion during the year ended
December 31, 2010, and $21.2 billion during the year ended December 31, 2009.
Financial liabilities measured at fair value on a recurring basis and classified as Level 3 consisted of long-term
debt with a fair value of $1.0 billion as of December 31, 2010 and $601 million as of December 31, 2009, and
derivatives liabilities with a fair value of $143 million as of December 31, 2010 and $27 million as of
December 31, 2009.
Fair Value Control Processes
We have control processes that are designed to ensure that our fair value measurements are appropriate and
reliable, that they are based on observable inputs wherever possible and that our valuation approaches are
consistently applied and the assumptions used are reasonable. Our control processes consist of a framework
that provides for a segregation of duties and oversight of our fair value methodologies and valuations and
validation procedures.
Our Valuation Oversight Committee, which includes senior representation from our three business segments,
our Enterprise Risk Office and our Finance Division, is responsible for reviewing the valuation methodologies
used in our fair value measurements and any significant valuation adjustments, judgments, controls and results.
Actual valuations are performed by personnel independent of our business units. Our Price Verification Group,
which is an independent control group separate from the group responsible for obtaining prices, is responsible
for performing monthly independent price verification. The Price Verification Group also performs
independent reviews of the assumptions used in determining the fair value of products we hold that have
material estimation risk because observable market-based inputs do not exist.
Our validation procedures are intended to ensure that the individual prices we receive are consistent with our
observations of the marketplace and prices that are provided to us by pricing services or dealers. We verify
selected prices using a variety of methods, including comparing the prices to secondary pricing services,
corroborating the prices by reference to other independent market data, such as non-binding broker or dealer
quotations, relevant benchmark indices, and prices of similar instruments. We review prices for reasonableness
based on variations from prices provided in previous periods, comparing prices to internally calculated
expected prices and conducting relative value comparisons based on specific characteristics of securities. In
addition, we compare our derivatives valuations to counterparty valuations as part of the collateral exchange
process. We have formal discussions with the pricing services as part of our due diligence process in order to
maintain a current understanding of the models and related assumptions and inputs that these vendors use in
developing prices. The prices provided to us by independent pricing services reflect the existence of credit
enhancements, including monoline insurance coverage, and the current lack of liquidity in the marketplace. If
we determine that a price provided to us is outside established parameters, we will further examine the price,
including having follow-up discussions with the pricing service or dealer. If we conclude that a price is not
valid, we will adjust the price for various factors, such as liquidity, bid-ask spreads and credit considerations.
These adjustments are generally based on available market evidence. In the absence of such evidence,
management’s best estimate is used. All of these processes are executed before we use the prices in preparing
our financial statements.
We continually refine our valuation methodologies as markets and products develop and the pricing for certain
products becomes more or less transparent. While we believe our valuation methods are appropriate and
consistent with those of other market participants, using different methodologies or assumptions to determine
fair value could result in a materially different estimate of the fair value of some of our financial instruments.
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