Freddie Mac 2008 Annual Report Download - page 138

of the processes and inputs they use to develop prices. We make no adjustments to the individual prices we receive from
third party pricing services or dealers for non-agency mortgage-related securities backed by subprime loans, Alt-A loans and
MTA loans beyond calculating median prices and discarding certain prices that are not valid based on our validation
processes. See “Controls over Fair Value Measurement” for information on our validation processes.
We consider credit risk in the valuation of our assets and liabilities. For foreign-currency denominated debt with the fair
value option elected, the total fair value change was a net gain of $0.4 billion for 2008. Of this amount, $0.3 billion was
attributable to changes in the instrument-specific credit risk. The changes in fair value attributable to changes in instrument-
specific credit risk were determined by comparing the total change in fair value of the debt to the total change in fair value
of the interest rate and foreign currency derivatives used to hedge the debt. Any difference in the fair value change of the
debt compared to the fair value change in the derivatives is attributed to instrument-specific credit risk. For multifamily
held-for-sale loans with the fair value option elected, we recorded $(14) million from the change in fair value in gains
(losses) on investment activity in our consolidated statements of operations during 2008. Of this amount, ($69) million was
attributable to changes in the instrument-specific credit risk partially offset by changes attributable to interest-rate risk. The
gains and losses attributable to changes in instrument-specific credit risk related to our multifamily held-for-sale loans were
determined primarily from the changes in OAS level.
In addition, we consider credit risk in the valuation of our derivative positions. For derivatives that are in an asset
position, we hold collateral against those positions in accordance with agreed upon thresholds. The amount of collateral held
depends on the credit rating of the counterparty and is based on our credit risk policies. See “CREDIT RISKS —
Institutional Credit Risk — Derivative Counterparty Credit Risk” for a discussion of our counterparty credit risk. Similarly,
for derivatives that are in a liability position we post collateral to counterparties in accordance with agreed upon thresholds.
The fair value of derivative assets considers the impact of institutional credit risk in the event that the counterparty does not
honor its payment obligation. Additionally, the fair value of derivative liabilities considers the impact of our institutional
credit risk.
For a description of how we determine the fair value of our guarantee asset, see “NOTE 3: RETAINED INTERESTS IN
MORTGAGE-RELATED SECURITIZATIONS” to our consolidated financial statements. At December 31, 2008 and 2007,
the total unpaid principal balances of PCs and Structured Securities outstanding were $1,827.2 billion and $1,738.8 billion,
respectively. At December 31, 2008 and 2007, we owned $424.5 billion and $357.0 billion, respectively, of PCs and
Structured Securities, or 23% and 21%, respectively, of the total PCs and Structured Securities outstanding. There are
inherent limitations when trying to extrapolate an amount of the total fair value of the guarantee asset and obligation
attributable to the PCs and Structured Securities we own. The credit performance of each pool differs, based on the
underlying characteristics of the loans, vintage, seasoning, and other factors that cannot be accurately factored into a pro-rata
allocation. As a result, a simple pro-rata allocation of the fair value of our guarantee asset and obligation based on the
percentage of PCs and Structured Securities we hold relative to total PCs and Structured Securities outstanding will not
necessarily provide a reasonable proxy for the adjustment to the fair value of our PCs and Structured Securities necessary to
derive the fair value of an unguaranteed security.
Our valuation process and related SFAS 157 hierarchy assessments require us to make judgments regarding the liquidity
of the marketplace. These judgments are based on the volume of securities traded in the marketplace, the width of bid/ask
spreads and dispersion of prices on similar securities. As previously mentioned, we have observed a significant reduction in
liquidity within the non-agency mortgage-related security markets. We continue to utilize the prices provided to us by
various pricing services and dealers and believe that the procedures executed by the pricing services and dealers, combined
with our internal verification process, ensure that the prices used to develop the financial statements are in accordance with
the guidance in SFAS 157.
We periodically evaluate our valuation techniques and may change them to improve our fair value estimates, to
accommodate market developments or to compensate for changes in data availability and reliability or other operational
constraints. We review a range of market quotes from pricing services or dealers and perform analysis of internal valuations
on a monthly basis to confirm the reasonableness of the valuations. See “QUANTITATIVE AND QUALITATIVE
DISCLOSURES ABOUT MARKET RISK — Interest-Rate Risk and Other Market Risks” for a discussion of market risks
and our interest-rate sensitivity measures, PMVS and duration gap. In addition, see “NOTE 3: RETAINED INTERESTS IN
MORTGAGE-RELATED SECURITIZATIONS” to our consolidated financial statements for a sensitivity analysis of the fair
value of our guarantee asset and other retained interests and the key assumptions utilized in fair value measurements.
135 Freddie Mac