Freddie Mac 2008 Annual Report Download - page 262

as interest expense in our consolidated statements of operations. See “NOTE 1: SUMMARY OF SIGNIFICANT
ACCOUNTING POLICIES — Debt Securities Issued” for additional information about the measurement and recognition of
interest expense on debt securities issued.
Multifamily Held-For-Sale Mortgage Loans with the Fair Value Option Elected
Beginning in the third quarter of 2008, we elected the fair value option for multifamily mortgage loans that were
purchased through our Capital Market Execution program to reflect our strategy in this program. Under this program, we
acquire loans we intend to sell. While this is consistent with our overall strategy to expand our multifamily loan holdings, it
differs from the traditional buy-and-hold strategy that we have used with respect to multifamily loans. These multifamily
mortgage loans were classified as held-for-sale mortgage loans in our consolidated balance sheets to reflect our intent to sell
these loans in the future.
We recorded $(14) million from the change in fair value in gains (losses) on investment activity in our consolidated
statements of operations for the year ended December 31, 2008. The fair value changes that were attributable to changes in
the instrument-specific credit risk were $(69) million for the year ended December 31, 2008. The gains and losses
attributable to changes in instrument specific credit risk were determined primarily from the changes in option-adjusted
spread, or OAS, level.
The difference between the aggregate fair value and the aggregate unpaid principal balance for multifamily held-for-sale
loans with the fair value option elected was $14 million at December 31, 2008. Related interest income continues to be
reported as interest income in our consolidated statements of operations. See “NOTE 1: SUMMARY OF SIGNIFICANT
ACCOUNTING POLICIES — Mortgage Loans” for additional information about the measurement and recognition of
interest income on our mortgage loans.
Valuation Methods and Assumptions Subject to Fair Value Hierarchy
We categorize assets and liabilities in the scope of SFAS 157 within the fair value hierarchy based on the valuation
process used to derive the fair value and our judgment regarding the observability of the related inputs. Those judgments are
based on our knowledge and observations of the markets relevant to the individual assets and liabilities and may vary based
on current market conditions. In applying our judgments, we look to ranges of third party prices, transaction volumes and
discussions with dealers and pricing service vendors to understand and assess the extent of market benchmarks available and
the judgments or modeling required in their processes. Based on these factors, we determine whether the fair values are
observable in active markets or that the markets are inactive.
We have reviewed FSP SFAS 157-3, “Determining the Fair Value of a Financial Asset When the Market for that Asset
is Not Active” for products with inactive markets, and continue to classify these products as Level 3 in the fair-value
hierarchy, while still relying on pricing services and dealer quotes. Even though market information is limited due to market
inactivity, the sources we use have access to transaction information, bid lists, spread indications, market inquiry information,
asset performance, rating agency information and feedback from their clients. We believe leveraging all sources available
gives us the most access to market information possible, which we then analyze and evaluate, maximizing the quality of
information used to determine our fair values.
Our Level 1 financial instruments consist of exchange-traded derivatives where quoted prices exist for the exact
instrument in an active market. Our Level 2 instruments generally consist of high credit quality agency mortgage-related
securities, commercial mortgage-backed securities, non-mortgage-related asset-backed securities, interest-rate swaps, option-
based derivatives and foreign-currency denominated debt. These instruments are generally valued through one of the
following methods: (a) dealer or pricing service values derived by comparison to recent transactions of similar securities and
adjusting for differences in prepayment or liquidity characteristics; or (b) modeled through an industry standard modeling
technique that relies upon observable inputs such as discount rates and prepayment assumptions.
Our Level 3 assets primarily consist of non-agency residential mortgage-related securities, our guarantee asset and
multifamily mortgage loans held-for-sale. While the non-agency mortgage-related securities market has become significantly
less liquid, resulting in lower transaction volumes, wider credit spreads and less transparency in 2008, we value our non-
agency mortgage-related securities based primarily on prices received from third party pricing services and prices received
from dealers. The techniques used to value these instruments generally are either (a) a comparison to transactions of
instruments with similar collateral and risk profiles; or (b) industry standard modeling such as the discounted cash flow
model. For a description of how we determine the fair value of our guarantee asset, see “NOTE 3: RETAINED INTERESTS
IN MORTGAGE-RELATED SECURITIZATIONS.”
Mortgage Loans, Held-for-Investment
Mortgage loans, held for investment include impaired multifamily mortgage loans, which are not measured at fair value
on an ongoing basis but have been written down to fair value due to impairment. We classify these impaired multifamily
mortgage loans as Level 3 in the fair value hierarchy as their valuation includes significant unobservable inputs.
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