Fannie Mae 2014 Annual Report Download - page 77

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delinquency, default and cumulative loss expectations, that are implied by market prices for similar securities and collateral
structure types. Because this valuation technique relies on significant unobservable inputs, the fair value estimation is
classified as Level 3. The process for determining fair value using unobservable inputs is generally more subjective and
involves a high degree of management judgment and assumptions. These assumptions may have a significant effect on our
estimates of fair value, and the use of different assumptions as well as changes in market conditions could have a material
effect on our results of operations or financial condition.
Fair Value Hierarchy—Level 3 Assets and Liabilities
The assets and liabilities that we have classified as Level 3 consist primarily of financial instruments for which there is
limited market activity and therefore little or no price transparency. As a result, the valuation techniques that we use to
estimate the fair value of Level 3 instruments involve significant unobservable inputs, which generally are more subjective
and involve a high degree of management judgment and assumptions. Our Level 3 assets and liabilities consist of certain
mortgage-backed securities and residual interests, certain mortgage loans, acquired property, certain long-term debt
arrangements and certain highly structured, complex derivative instruments. We provide a detailed discussion of our Level 3
assets and liabilities, including the valuation techniques and significant unobservable inputs used to measure the fair value of
these instruments, in “Note 18, Fair Value.”
Valuation 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, as well as validation procedures. We provide a detailed discussion
of our valuation control processes in “Note 18, Fair Value.”
Total Loss Reserves
Our total loss reserves consist of the following components:
• Allowance for loan losses;
• Allowance for accrued interest receivable;
• Reserve for guaranty losses; and
• Allowance for preforeclosure property tax and insurance receivable.
These components can be further allocated into our single-family and multifamily loss reserves.
We maintain an allowance for loan losses and an allowance for accrued interest receivable for loans classified as held for
investment, including both loans we hold in our portfolio and loans held in consolidated Fannie Mae MBS trusts. We
maintain a reserve for guaranty losses for loans held in unconsolidated Fannie Mae MBS trusts we guarantee and loans we
have guaranteed under long-term standby commitments and other credit enhancements we have provided. We also maintain
an allowance for preforeclosure property tax and insurance receivable on delinquent loans that is included in “Other assets”
in our consolidated balance sheets. These amounts, which we collectively refer to as our total loss reserves, represent
probable losses incurred related to loans in our guaranty book of business, including concessions granted to borrowers upon
modifications of their loans, as of the balance sheet date.
The allowance for loan losses, allowance for accrued interest receivable and allowance for preforeclosure property tax and
insurance receivable are valuation allowances that reflect an estimate of incurred credit losses related to our recorded
investment in loans held for investment. The reserve for guaranty losses is a liability account in our consolidated balance
sheets that reflects an estimate of incurred credit losses related to our guaranty to each unconsolidated Fannie Mae MBS trust
that we will supplement amounts received by the Fannie Mae MBS trust as required to permit timely payments of principal
and interest on the related Fannie Mae MBS. As a result, the guaranty reserve considers not only the principal and interest
due on the loan at the current balance sheet date, but also an estimate of any additional interest payments due to the trust from
the current balance sheet date until the point of loan acquisition or foreclosure. Our loss reserves consist of a specific loss
reserve for individually impaired loans and a collective loss reserve for all other loans.
We have an established process, using analytical tools, benchmarks and management judgment, to determine our loss
reserves. Our process for determining our loss reserves is complex and involves significant management judgment. Although
our loss reserve process benefits from extensive historical loan performance data, this process is subject to risks and
uncertainties, including a reliance on historical loss information that may not be representative of current conditions. We
continually monitor prepayment, delinquency, modification, default and loss severity trends and periodically make changes in