Freddie Mac 2011 Annual Report Download - page 309

Valuation Methods and Assumptions Not Subject to Fair Value Hierarchy
The following are valuation assumptions and methods for items not subject to the fair value hierarchy either because
they are not measured at fair value other than on the fair value balance sheet or are only measured at fair value at
inception.
Cash and Cash Equivalents
Cash and cash equivalents largely consist of highly liquid investment securities with an original maturity of three
months or less used for cash management purposes, as well as cash held at financial institutions and cash collateral posted
by our derivative counterparties. Given that these assets are short-term in nature with limited market value volatility, the
carrying amount on our GAAP consolidated balance sheets is deemed to be a reasonable approximation of fair value.
Federal Funds Sold and Securities Purchased Under Agreements to Resell
Federal funds sold and securities purchased under agreements to resell principally consist of short-term contractual
agreements such as reverse repurchase agreements involving Treasury and agency securities and federal funds sold. Given
that these assets are short-term in nature, the carrying amount on our GAAP consolidated balance sheets is deemed to be
a reasonable approximation of fair value.
Mortgage Loans
Single-family mortgage loans are not subject to the fair value hierarchy since they are classified as held-for-
investment and recorded at amortized cost. Certain multifamily mortgage loans are subject to the fair value hierarchy
since these are either recorded at fair value with the fair value option elected or they are held for investment and recorded
at fair value upon impairment, which is based upon the fair value of the collateral as multifamily loans are collateral-
dependent.
Single-Family Loans
We determine the fair value of single-family mortgage loans as an estimate of the price we would receive if we were
to securitize those loans, as we believe this represents the principal market for such loans. This principal market
assumption applies to both loans held by consolidated trusts and unsecuritized loans and excludes single-family loans for
which a contractual modification has been completed. Our estimate of fair value is based on comparisons to actively
traded mortgage-related securities with similar characteristics. We adjust to reflect the excess coupon (implied
management and guarantee fee) and credit obligation related to performing our guarantee.
To calculate the fair value, we begin with a security price derived from benchmark security pricing for similar
actively traded mortgage-related securities, adjusted for yield, credit, and liquidity differences. This security pricing
process is consistent with our approach for valuing similar securities retained in our investment portfolio or issued to third
parties. See “Valuation Methods and Assumptions Subject to Fair Value Hierarchy — Investments in Securities.”
We estimate the present value of the additional cash flows, which consist of the implied management and guarantee
fees in excess of the coupon on the mortgage-related securities. Our approach for estimating the fair value of the implied
management and guarantee fees at December 31, 2011 used third-party market data as practicable. The valuation approach
for the majority of implied management and guarantee fees relates to fixed-rate loan products with coupons at or near
current market rates and involves obtaining dealer quotes on hypothetical securities constructed with collateral
characteristics from our single-family credit guarantee portfolio. The remaining portion of the implied management and
guarantee fees relates to underlying loan products for which comparable market prices were not readily available. These
relate specifically to ARM products, highly seasoned loans, and fixed-rate loans with coupons that are not consistent with
current market rates. For this portion of the single-family credit guarantee portfolio, the implied management and
guarantee fees are valued using an expected cash flow approach, leveraging the market information received on the more
liquid portion of the population and including only those cash flows expected to result from our contractual right to
receive management and guarantee fees.
The implied management and guarantee fee for single-family mortgage loans is also net of the related credit and
other costs (such as general and administrative expense) and benefits (such as credit enhancements) inherent in our
guarantee obligation. We use delivery and guarantee fees charged by us as a market benchmark for all guaranteed loans
that would qualify for purchase under current underwriting standards (used for the majority of the guaranteed loans, but
accounts for a small share of the overall fair value of the guarantee obligation). For loans that do not qualify for purchase
based on current underwriting standards, we use our internal credit models, which incorporate factors such as loan
characteristics, loan performance status information, expected losses, and risk premiums without further adjustment (used
304 Freddie Mac