Fannie Mae 2013 Annual Report Download - page 332

FANNIE MAE
(In conservatorship)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
F-108
of the valuation hierarchy to the extent that significant inputs are observable. To the extent that significant inputs are
unobservable, the loans are classified within Level 3 of the valuation hierarchy.
HARP Loans—We measure the fair value of loans that are delivered under the Home Affordable Refinance Program
(“HARP”) using a modified build-up approach while the loan is performing. Under this modified approach, we set the credit
component of the consolidated loans (that is, the guaranty obligation) equal to the compensation we would currently receive
for a loan delivered to us under the program because the total compensation for these loans is equal to their current exit price
in the GSE securitization market. For a description of the build-up valuation methodology, refer to “Fair Value Measurement
—Mortgage Loans Held for Investment.” We will continue to use this pricing methodology as long as the HARP program is
available to market participants. If, subsequent to delivery, the refinanced loan becomes past due or is modified as a part of a
troubled debt restructuring, the fair value of the guaranty obligation is then measured consistent with other loans that have
these characteristics.
The total compensation that we receive for the delivery of a HARP loan reflects the pricing that we are willing to offer
because HARP is a part of a broader government program intended to provide assistance to homeowners and prevent
foreclosures. If these benefits were not reflected in the pricing for these loans (that is, if the loans were valued using our
standard build-up approach), the fair value disclosed in the table above would be lower by $11.5 billion as of December 31,
2013 and $7.6 billion as of December 31, 2012. The total fair value of our mortgage loans that have been refinanced under
HARP as presented in the table above is $306.9 billion as of December 31, 2013 and $255.2 billion as of December 31, 2012.
Advances to Lenders—The carrying value for the majority of our advances to lenders approximates fair value due to the
short-term nature and the negligible inherent credit risk. Were we to calculate the fair value of these instruments we would
use discounted cash flow models that use observable inputs such as spreads based on market assumptions, resulting in Level
2 classification.
Advances to lenders also include loans for which the carrying value does not approximate fair value. These loans do not
qualify for Fannie Mae MBS securitization and are valued using market-based techniques including credit spreads, severities
and prepayment speeds for similar 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. We classify these valuations as Level 3 given that
significant inputs are not observable or are determined by extrapolation of observable points.
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 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 an option-adjusted spread that is
calibrated using a representative sample of interest-only swaps that reference Fannie Mae MBS. We believe the remitted fee
income is less liquid than interest-only swaps and more like an excess servicing strip. We take a further discount of the
present value for these liquidity considerations. This discount is based on market quotes from dealers.
The fair value of the guaranty assets includes 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.
Guaranty Obligations—The fair value of all guaranty obligations, measured subsequent to their initial recognition, is our
estimate of a hypothetical transaction price we would receive if we were to issue our guaranty to an unrelated party in a
standalone arm’s-length transaction at the measurement date. These obligations are classified within Level 3. The valuation
methodology and inputs used in estimating the fair value of the guaranty obligation are described under “Fair Value
Measurement—Mortgage Loans Held for Investment, Build-up.”