Freddie Mac 2004 Annual Report Download - page 227

Limitations
The consolidated fair value balance sheets do not capture all elements of value that are implicit in
Freddie Mac's operations as a going concern since the consolidated fair value balance sheets only capture the
values of the current investment and securitization portfolios. For example, the consolidated fair value balance
sheets do not capture the value of new investment and securitization business that would likely replace
prepayments as they occur. In addition, the consolidated fair value balance sheets do not capture the value
associated with future growth opportunities in Freddie Mac's investment and securitization portfolios. Thus,
the fair value of net assets attributable to stockholders presented in the consolidated fair value balance sheets
does not represent an estimate of the net realizable, liquidation or market value of Freddie Mac as a whole.
Freddie Mac reports assets and liabilities that are not Ñnancial instruments (such as property, plant and
equipment and deferred taxes), as well as certain Ñnancial instruments that are not covered by the SFAS 107
disclosure requirements (such as pension liabilities) at their GAAP carrying amounts in the consolidated fair
value balance sheets. Management believes these items do not have a signiÑcant impact on Freddie Mac's
overall Ñnancial condition or fair value results.
Valuation Methods and Assumptions
Fair value is generally based on independent price quotations obtained from third-party pricing services,
dealer marks or direct market observations, where available. However, certain Ñnancial instruments are less
actively traded and, therefore, are not always able to be valued based on prices obtained from third parties. If
quoted prices or market data are not available, fair value is based on internal valuation models using market
data inputs or internally developed assumptions, where appropriate.
The following methods and assumptions were used to estimate the fair value of assets and liabilities at
December 31, 2004 and 2003.
Mortgage loans
Mortgage loans represent single-family and multifamily whole loans held in Freddie Mac's Retained
portfolio. For GAAP purposes, management must determine the fair value of these mortgage loans to
calculate lower-of-cost-or-market value adjustments for mortgages classiÑed as held-for-sale. Management
uses this same approach when determining the fair value of all whole loans, including those held for
investment, for fair value balance sheet purposes.
Freddie Mac determines the fair value of mortgage loans based on comparisons to actively traded
mortgage-related securities with similar characteristics, with adjustments for yield, credit and liquidity
diÅerences. SpeciÑcally, Freddie Mac aggregates mortgage loans into pools by product type, coupon and
maturity and then converts the pools into notional mortgage-related securities based on their speciÑc
characteristics. Freddie Mac then calculates fair values for these notional mortgage-related securities using
the process that is described in the ""Mortgage-related securities'' section, below.
As described above, the fair value of these mortgage loans also includes adjustments for yield, credit and
liquidity diÅerences. To accomplish this, the fair value of the single-family whole loans includes an adjustment
representing the estimated present value of the additional cash Öows on the mortgage coupon of the whole loan
in excess of the coupon expected on the notional mortgage-related securities. For multifamily whole loans, the
fair value adjustment is estimated by calculating the net present value of guarantee fees expected to be
retained by Freddie Mac. This retained guarantee fee is estimated by subtracting the expected cost of funding
and securitizing a multifamily whole loan of a comparable maturity and credit rating from the coupon on the
whole loan at the time of purchase.
The implied guarantee fee is also net of the related credit and other components inherent in the
company's guarantee obligation. For single-family whole loans, the process for estimating the related credit
and other guarantee obligation components is described in the ""Guarantee obligation for Participation
CertiÑcates'' section. For multifamily whole loans, the process for estimating the related credit and other
guarantee obligation components employs a market-based approach to estimate the potential credit obligation.
This obligation is estimated by extracting the credit risk premium that multifamily whole loan investors
require from market prices on similar securities. This credit risk premium is net of expected funding, liquidity
and other risk premiums that are embedded in the market price of the reference securities.
Freddie Mac
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