Fannie Mae 2014 Annual Report Download - page 302

FANNIE MAE
(In conservatorship)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
F-87
Consensus: This technique utilizes an average of two or more vendor prices for similar securities. We generally validate these
observations of fair value through the use of a discounted cash flow technique whose unobservable inputs (for example,
default rates) are disclosed in the table above.
Discounted Cash Flow: In the absence of prices provided by third-party pricing services supported by observable market
data, we estimate the fair value of a portion of our securities using a discounted cash flow technique that uses inputs such as
default rates, prepayment speeds, loss severity and spreads based on market assumptions where available.
For private-label securities, an increase in unobservable prepayment speeds in isolation would generally result in an increase
in fair value, and an increase in unobservable spreads, severity rates or default rates in isolation would generally result in a
decrease in fair value. For mortgage revenue bonds classified as Level 3 of the valuation hierarchy, an increase in
unobservable spreads would result in a decrease in fair value. Although the sensitivities of the fair value of our recurring
Level 3 securities of the valuation hierarchy to various unobservable inputs are discussed above in isolation,
interrelationships exist among these inputs such that a change in one unobservable input typically results in a change to one
or more of the other inputs.
Mortgage Loans Held for Investment
The majority of HFI loans are reported in our consolidated balance sheets at the principal amount outstanding, net of cost
basis adjustments and an allowance for loan losses. We estimate the fair value of HFI loans using the build-up and consensus
valuation techniques, as discussed below, for periodic disclosure of financial instruments as required by GAAP. For our
remaining loans, which include those containing embedded derivatives that would otherwise require bifurcation and
consolidated loans of senior-subordinated trust structures, we elected the fair value option and therefore, we record these
loans at fair value in our consolidated balance sheets. We measure these loans on a recurring basis using the build-up,
consensus, discounted cash flow and single vendor price techniques. Certain impaired loans are measured at fair value on a
nonrecurring basis by using the fair value of their underlying collateral. Specific techniques used include internal models,
broker price opinions and appraisals.
A description of our loan valuation techniques is as follows:
Build-up: We derive the fair value of mortgage loans using a build-up valuation technique. In the build-up valuation
technique we start with the base value for our Fannie Mae MBS and then add or subtract the fair value of the associated
guaranty asset, guaranty obligation (“GO”) and master servicing arrangement. We use observable market values of Fannie
Mae MBS with similar characteristics, either on a pool or loan level, determined primarily from third party pricing services,
quoted market prices in active markets for similar securities, and other observable market data as a base value. We set the GO
equal to the estimated fair value we would receive if we were to issue our guaranty to an unrelated party in a stand-alone
arm’s length transaction at the measurement date. We estimate the fair value of the GO using our internal valuation models,
which calculate the present value of expected cash flows based on management’s best estimate of certain key assumptions
such as current mark-to-market LTV ratios, future house prices, default rates, severity rates and required rate of return. We
also estimate the fair value of the GO using our current guaranty pricing and adjust that pricing, as appropriate, for the
seasoning of the collateral when such transactions reflect credit characteristics of loans held in our portfolio. As a result, the
fair value of our mortgage loans will change when the pricing for our credit guaranty changes in the GSE securitization
market.
Our performing loans are generally classified as Level 2 of the valuation hierarchy to the extent that significant inputs are
observable. To the extent that unobservable inputs are significant, the loans are classified as Level 3 of the valuation
hierarchy.
Consensus: The 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 whole-loan market. These nonperforming loans are either two or more months delinquent, in an
open modification period, or in a closed modification state (both performing and nonperforming in accordance with the loan’s
modified terms). We calculate the fair value of nonperforming loans based on certain key factors, including collateral value,
cash flow characteristics and mortgage insurance repayment. Collateral value is derived from the current estimated mark-to-
market LTV ratio of the individual loan and, where appropriate, a state-level distressed property sales discount. Cash flow
characteristics include attributes such as the weighted average coupon rate and loan payment history. The fair value of
mortgage insurance is estimated by taking the loan level coverage and adjusting it by the expected claims paying ability of
the associated mortgage insurer. The expected claims paying abilities used for estimating the fair value of mortgage insurance
are consistent with our credit loss forecast. Fair value is estimated from the extrapolation of indicative sample bids obtained