Freddie Mac 2008 Annual Report Download - page 211

Table 3.2 — Key Assumptions Used in Measuring the Fair Value of Guarantee Asset
Mean Valuation Assumptions
(1)
2008 2007 2006
For the Year Ended
December 31,
IRRs
(2)
................................................................................ 12.3% 6.4% 8.3%
Prepayment rates
(3)
........................................................................ 15.5% 17.1% 15.8%
(1) Assumptions reflect mean values of the weighted average of all estimated IRRs, prepayment rate and weighted average lives assumptions used during
the year.
(2) IRR assumptions represent an unpaid principal balance weighted average of the discount rates inherent in the fair value of the recognized guarantee
asset. We estimated the IRRs using a model which employs multiple interest rate scenarios versus a single assumption.
(3) Although prepayment rates are simulated monthly, the assumptions above represent annualized prepayment rates based on unpaid principal balances.
These prepayment rates imply an estimated weighted average life of our guarantee asset of 5.6, 5.2 and 5.5 years for 2008, 2007 and 2006, respectively.
The objective of the sensitivity analysis below is to present our estimate of the financial impact of an unfavorable
change in the input values associated with the determination of fair values of these retained interests. We do not use these
inputs in determining fair value of our retained interests as our measurements are principally based on third-party pricing
information. See “NOTE 17: FAIR VALUE DISCLOSURES” for further information on determination of fair values. The
weighted average assumptions within Table 3.3 represent our estimates of the assumed IRR and prepayment rates implied by
market pricing as of each period end and are derived using our internal models. Since we do not use these internal models
for determining fair value in our reported results under GAAP, this sensitivity analysis is hypothetical and may not be
indicative of actual results. In addition, the effect of a variation in a particular assumption on the fair value of the retained
interest is estimated independently of changes in any other assumptions. Changes in one factor may result in changes in
another, which might counteract the impact of the change.
Table 3.3 — Sensitivity Analysis of Retained Interests
2008 2007
As of December 31,
(dollars in millions)
Retained Interests, Mortgage-Related Securities
Weighted average IRR assumptions . ........................................................ 4.7% 5.5%
Impact on fair value of 100 bps unfavorable change . ........................................... $(2,762) $(4,109)
Impact on fair value of 200 bps unfavorable change . ........................................... $(5,366) $(7,928)
Weighted average prepayment rate assumptions ................................................. 37.3% 8.7%
Impact on fair value of 10% unfavorable change ............................................... $ (177) $ (30)
Impact on fair value of 20% unfavorable change ............................................... $ (323) $ (57)
Retained Interests, Guarantee Asset (Single-Family Mortgages)
Weighted average IRR assumptions . ........................................................ 21.1% 8.1%
Impact on fair value of 100 bps unfavorable change . ........................................... $ (90) $ (389)
Impact on fair value of 200 bps unfavorable change . ........................................... $ (177) $ (746)
Weighted average prepayment rate assumptions ................................................. 33.1% 16.5%
Impact on fair value of 10% unfavorable change ............................................... $ (357) $ (516)
Impact on fair value of 20% unfavorable change ............................................... $ (689) $ (977)
Changes in these IRR and prepayment rate assumptions are primarily driven by changes in interest rates. Interest rates
on conforming mortgage products have declined in 2008, especially in the fourth quarter of 2008 and resulted in a lower IRR
on mortgage-related securities retained interests. Lower mortgage rates typically induce borrowers to refinance their loan.
Expectations of continued low rates resulted in an increase in average prepayment assumptions on Mortgage-Related
Securities retained interests.
As noted above, our guarantee asset can be effectively equated with the market values for excess servicing interest-only
securities. The value of those securities declines when interest rates decline as it is expected that more borrowers will
refinance their loan. Due to this increased likelihood of prepayments and reduced fair values placed on mortgage assets by
third-party investors, the weighted average IRR implied by fair value measurements of our guarantee asset increased
significantly between December 31, 2007 and December 31, 2008.
We receive proceeds in securitizations accounted for as sales under SFAS 140 for those securities sold to third parties.
Subsequent to a securitization under SFAS 140 we receive cash flows related to interest income and repayment of principal
on the securities we retain for investment. Regardless of whether our issued PC or Structured Security is sold to third parties
or held by us for investment, we are obligated to make cash payment for foreclosed properties and certain delinquent or
impaired mortgages under our financial guarantees. Table 3.4 summarizes cash flows on retained interests related to
securitizations accounted for as sales under SFAS 140.
208 Freddie Mac