Freddie Mac 2008 Annual Report Download - page 140

consider the existence of credit enhancements, including monoline insurance coverage and the current lack of liquidity in the
marketplace. These processes are executed prior to the use of the prices in the financial statements.
Where models are employed to assist in the measurement of fair value, material changes made to those models during
the periods presented are reviewed and approved by the Valuation Committee. Inputs used by those models are regularly
updated for changes in the underlying data, assumptions, valuation inputs, or market conditions. In addition, the Model
Governance Committee is responsible for the review and approval of the pricing models used in our fair value measurements.
The Fair Value Option for Financial Assets and Financial Liabilities
Effective January 1, 2008, we adopted SFAS 159 for certain eligible financial instruments. This statement permits
entities to choose to measure many financial instruments and certain other items at fair value that are not currently required
to be measured at fair value in order to improve financial reporting by providing entities with the opportunity to mitigate
volatility in reported earnings caused by measuring related assets and liabilities differently without having to apply complex
hedge accounting provisions. The effect of the first measurement to fair value is reported as a cumulative-effect adjustment
to the beginning balance of retained earnings (accumulated deficit). We elected the fair value option for certain available-for-
sale mortgage-related securities that were identified as an economic offset to the changes in fair value of the guarantee asset
caused by interest rate movements, foreign-currency denominated debt and investments in securities classified as available-
for-sale securities and identified as within the scope of EITF 99-20. As a result of the adoption of SFAS 159, we recognized
a $1.0 billion after-tax increase to our beginning retained earnings (accumulated deficit) at January 1, 2008. In addition,
during the third quarter of 2008, we elected the fair value option for certain multifamily held-for-sale mortgage loans. For
additional information on the impact of the election of the fair value option, see “NOTE 1: SUMMARY OF SIGNIFICANT
ACCOUNTING POLICIES — Recently Adopted Accounting Standards” to our consolidated financial statements. For
information regarding our fair value methods and assumptions, see “NOTE 17: FAIR VALUE DISCLOSURES” to our
consolidated financial statements.
Allowance for Loan Losses and Reserve for Guarantee Losses
We maintain an allowance for loan losses on mortgage loans held-for-investment and a reserve for guarantee losses on
PCs, collectively referred to as our loan loss reserves, to provide for credit losses when it is probable that a loss has been
incurred. We use the same methodology to determine our allowance for loan losses and reserve for guarantee losses, as the
relevant factors affecting credit risk are the same.
To calculate the loan loss reserves for the single-family loan portfolio, we aggregate homogeneous loans into pools
based on common underlying characteristics, using statistically based models to evaluate relevant factors affecting loan
collectibility. We consider the output of these models, together with other information about such factors as expected future
levels of loan modifications, expected repurchases of loans by seller/servicers as a result of their non-compliance with our
underwriting standards and the effects of such macroeconomic variables as unemployment and home price movements, to
determine the best estimate of losses incurred. To calculate loan loss reserves for the multifamily loan portfolio, we also use
models, evaluate certain larger loans for impairment, and review repayment prospects and collateral values underlying
individual loans.
We regularly evaluate the underlying estimates and models we use when determining the loan loss reserves and update
our assumptions to reflect our historical experience and current view of economic factors. Inputs used by those models are
regularly updated for changes in the underlying data, assumptions, valuation inputs, or market conditions.
Determining the adequacy of the loan loss reserves is a complex process that is subject to numerous estimates and
assumptions requiring significant management judgment about matters that involve a high degree of subjectivity. Key
estimates and assumptions that impact our loan loss reserves include:
• loss severity trends;
• default experience;
• expected proceeds from credit enhancements;
• collateral valuation;
• loss mitigation activities;
• counterparty credit of mortgage insurers and seller/servicers; and
• identification and impact assessment of macroeconomic factors, such as home price declines, rental rates and
unemployment rates.
No single statistic or measurement determines the adequacy of the loan loss reserves. Changes in one or more of the
estimates or assumptions used to calculate the loan loss reserves could have a material impact on the loan loss reserves and
provision for credit losses. This management estimate is inherently more difficult to predict due to the absence of historical
137 Freddie Mac