Fannie Mae 2013 Annual Report Download - page 74

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continually monitor delinquency and default trends and make changes in our historically developed assumptions and
estimates as necessary to better reflect present conditions, including current trends in borrower risk and/or general economic
trends, changes in risk management practices, and changes in public policy and the regulatory environment. We also consider
the recoveries that we expect to receive on mortgage insurance and other loan-specific credit enhancements entered into
contemporaneously with and in contemplation of a guaranty or loan purchase transaction, as such recoveries reduce the
severity of the loss associated with defaulted loans.
We provide more detailed information on our accounting for the allowance for loan losses in “Note 1, Summary of
Significant Accounting Policies.”
Single-Family Loss Reserves
We establish a specific single-family loss reserve for individually impaired loans, which includes loans we restructure in
troubled debt restructurings (“TDRs”), certain nonperforming loans in MBS trusts and acquired credit-impaired loans that
have been further impaired subsequent to acquisition. The single-family loss reserve for individually impaired loans
represents the majority of our single-family loss reserves due to the high volume of restructured loans. We typically measure
impairment based on the difference between our recorded investment in the loan and the present value of the estimated cash
flows we expect to receive, which we calculate using the effective interest rate of the original loan or the effective interest
rate at acquisition for an acquired credit-impaired loan. However, when foreclosure is probable on an individually impaired
loan, we measure impairment based on the difference between our recorded investment in the loan and the fair value of the
underlying property, adjusted for the estimated discounted costs to sell the property and estimated insurance or other proceeds
we expect to receive. We then allocate a portion of the reserve to interest accrued on the loans as of the balance sheet date.
We establish a collective single-family loss reserve for all other single-family loans in our single-family guaranty book of
business using a model that estimates the probability of default of loans to derive an overall loss reserve estimate given
multiple factors such as: origination year, mark-to-market LTV ratio, delinquency status and loan product type. We believe
that the loss severity estimates we use in determining our loss reserves reflect current available information on actual events
and conditions as of each balance sheet date, including current home prices. Our loss severity estimates do not incorporate
assumptions about future changes in home prices. We do, however, use a look back period to develop our loss severity
estimates for all loan categories. We then allocate a portion of the reserve to interest accrued on the loans as of the balance
sheet date.
We regularly monitor prepayment, default and loss severity trends and periodically make changes in our historically
developed assumptions to better reflect present conditions of loan performance. In the second quarter of 2013, we updated the
assumptions and data used to estimate our allowance for loan losses for individually impaired single-family loans based on
current observable performance trends as well as future expectations of payment behavior. These updates reflect faster
prepayment and lower default expectations for these loans, primarily as a result of improvements in loan performance, in part
due to increases in home prices. Increases in home prices reduce the mark-to-market LTV ratios on these loans and, as a
result, borrowers’ equity increases. Faster prepayment and lower default expectations shortened the expected average life of
modified loans, which reduced the expected credit losses and lowered concessions on modified loans. This resulted in a
decrease to our allowance for loan losses and an incremental benefit for credit losses of approximately $2.2 billion.
Multifamily Loss Reserves
We establish a collective multifamily loss reserve for all loans in our multifamily guaranty book of business that are not
individually impaired using an internal model that applies loss factors to loans in similar risk categories. Our loss factors are
developed based on our historical default and loss severity experience. Management may also apply judgment to adjust the
loss factors derived from our models, taking into consideration model imprecision and specific, known events, such as
current credit conditions, that may affect the credit quality of our multifamily loan portfolio but are not yet reflected in our
model-generated loss factors. We then allocate a portion of the reserve to interest accrued on the loans as of the balance sheet
date.
We establish a specific multifamily loss reserve for multifamily loans that we determine are individually impaired. We
identify multifamily loans for evaluation for impairment through a credit risk assessment process. As part of this assessment
process, we stratify multifamily loans into different internal risk categories based on the credit risk inherent in each individual
loan and management judgment. We categorize loan credit risk, taking into consideration available operating statements and
expected cash flows from the underlying property, the estimated value of the property, the historical loan payment experience
and current relevant market conditions that may impact credit quality. If we conclude that a multifamily loan is impaired, we
measure the impairment based on the difference between our recorded investment in the loan and the fair value of the
underlying property less the estimated discounted costs to sell the property and any lender loss sharing or other proceeds we