Freddie Mac 2012 Annual Report Download - page 314

Whole Loan Market as Principal Market
Loans where we determine that the principal market is the whole loan market are valued using the median of external
sources. Under the median of external sources technique, prices for single-family loans are obtained from multiple dealers.
These dealers reference market activity for deeply delinquent and modified loans, where available, and use internal models
and their judgment to determine default rates, severity rates, home prices, and risk premiums. Single-family mortgage loans
valued using this technique are classified as Level 3 due to the low volume and level of activity in this market.
GSE Securitization Market as Principal Market
Loans where we determine that the principal market is the GSE securitization market are valued using the build-up
technique. Under the build-up technique, the fair value of single-family mortgage loans is based on the estimate of the price
we would receive if we were to securitize the loans. These loans are valued by starting with benchmark security pricing for
actively traded mortgage-related securities with similar characteristics; adding in the value of our management and guarantee
fee, which is the compensation we receive for performing our management and guarantee activities; and subtracting the value
of the credit obligation related to performing our guarantee.
The security price is based on benchmark security pricing for similar actively traded mortgage-related securities,
adjusted as necessary based on security characteristics. This security pricing process is consistent with our approach for
valuing similar securities retained in our investment portfolio or issued as debt to third parties. See “Valuation Techniques
for Assets and Liabilities Measured at Fair Value in Our Consolidated Balance Sheets — Investments in Securities.”
The management and guarantee fee is valued by estimating the present value of the additional cash flows related to our
management and guarantee fee. The management and guarantee fees for the majority of our loans are valued using third-
party dealer prices on hypothetical interest-only securities based on collateral characteristics from our single-family credit
guarantee portfolio. For loans where third-party market data is not readily available, we use a discounted cash flow approach,
leveraging the dealer prices received for the majority of our loans and including only those cash flows related to our
management and guarantee fee.
The credit obligation related to performing our guarantee is valued by estimating the fair value of the related credit and
other costs (such as general and administrative expenses) and benefits (such as credit enhancements) inherent in our
guarantee obligation. For loans that qualify for purchase under current underwriting standards, we use the delivery and
guarantee fees that we charge under our current market pricing as a market observation. 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.
Single-family mortgage loans that qualify for purchase under current underwriting standards are classified as Level 2 as
the significant inputs used for the valuation of these loans, such as security pricing, our externally published credit pricing
matrices, and third-party prices used in valuing the management and guarantee fee, are observable, while the unobservable
inputs, such as general and administrative expenses and credit enhancements, are not significant to the fair value
measurement. Single-family mortgage loans that do not qualify for purchase under current underwriting standards are
classified as Level 3 as the credit cost is based on our internal credit models which use unobservable inputs that are
significant to the fair value measurement.
HARP Loans
For loans that have been refinanced under HARP, we value our guarantee obligation using the delivery and guarantee
fees currently charged by us under that initiative. HARP loans valued using this technique are classified as Level 2, as the
fees charged by us are observable. If, subsequent to delivery, the refinanced loan no longer qualifies for purchase based on
current underwriting standards (such as becoming past due or being modified), the fair value of the guarantee obligation is
then measured using: (a) our internal credit models; or (b) the median of external sources, if the loan’s principal market has
changed to the whole loan market. HARP loans valued using either of these techniques are classified as Level 3 as significant
inputs are unobservable. The majority of our HARP loans are classified as Level 2.
The total compensation that we receive for the delivery of a HARP loan reflects the pricing that we are willing to offer
because HARP is a part of a broader government program intended to provide assistance to homeowners and prevent
foreclosures. When HARP ends, the beneficial pricing afforded to HARP loans will no longer be reflected in our delivery
and guarantee fee pricing structure. If these benefits were not reflected in the pricing for these loans, the fair value of our
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