Fannie Mae 2006 Annual Report Download - page 138

lender credit loss sharing or requiring the lender to repurchase a loan, depending on the severity of the issues
identified.
The use of credit enhancements is an important part of our acquisition policy and standards, although it also
exposes us to institutional counterparty risk. The amount of credit enhancement we obtain on any mortgage
loan depends on our charter requirements and our assessment of risk. In addition to the credit enhancement
required by our charter, we may obtain supplemental credit enhancement for some mortgage loans, typically
those with higher credit risk. Our use of discretionary credit enhancements depends on our view of the
inherent credit risk, the price of the credit enhancement, and our risk versus return objective.
Single-Family
Our Single-Family business is responsible for pricing and managing credit risk relating to the portion of our
single-family mortgage credit book of business consisting of single-family mortgage loans and Fannie Mae
MBS backed by single-family mortgage loans (whether held in our portfolio or held by third parties).
We have developed a proprietary automated underwriting system, Desktop Underwriter», which measures
default risk by assessing the primary risk factors of a mortgage, including the LTV ratio, the borrower’s credit
profile, the type of mortgage, the loan purpose, and other mortgage and borrower characteristics. Subject to
our review and approval, we also purchase and securitize mortgage loans that have been underwritten using
other automated underwriting systems, as well as mortgage loans underwritten to agreed-upon standards that
differ from our standard underwriting and eligibility criteria.
Based on our current acquisition policy and standards, we may accept single-family loans originated with LTV
ratios of up to 100%. Our charter requires that conventional single-family mortgage loans that we purchase or
that back Fannie Mae MBS with LTV ratios above 80% at acquisition be covered by one or more of the
following: (i) primary mortgage insurance; (ii) a seller’s agreement to repurchase or replace any mortgage loan
in default (for such period and under such circumstances as we may require); or (iii) retention by the seller of
at least a 10% participation interest in the mortgage loans.
Primary mortgage insurance is the most common type of credit enhancement in our single-family mortgage
credit book of business and is typically provided on a loan-level basis. Primary mortgage insurance transfers
varying portions of the credit risk associated with a mortgage loan to a third-party insurer. Mortgage insurers
may also provide pool mortgage insurance, which is insurance that applies to a defined group of loans. Pool
mortgage insurance benefits typically are based on actual loss incurred and are subject to an aggregate loss
limit. The percentage of our conventional single-family mortgage credit book of business with credit
enhancement, including primary mortgage, pool mortgage insurance, lender recourse and shared risk, was
19%, 18% and 19% as of December 31, 2006, 2005 and 2004, respectively. The percentage of our
conventional single-family mortgage credit book of business with credit enhancement has not changed
significantly since the end of 2006.
Housing and Community Development
Our HCD business is responsible for pricing and managing the credit risk on multifamily mortgage loans we
purchase and on Fannie Mae MBS backed by multifamily loans (whether held in our portfolio or held by third
parties).
Multifamily loans we purchase or that back Fannie Mae MBS are either underwritten by a Fannie Mae-
approved lender or subject to our underwriting review prior to closing. Many of our agreements delegate the
underwriting decisions to the lender, principally through our Delegated Underwriting and Servicing, or DUS»,
program. Loans delivered to us by DUS lenders represented approximately 94%, 87% and 89% of our
multifamily mortgage credit book of business as of December 31, 2006, 2005 and 2004, respectively.
We use various types of credit enhancement arrangements for our multifamily loans, including lender risk
sharing, lender repurchase agreements, pool insurance, subordinated participations in mortgage loans or
structured pools, cash and letter of credit collateral agreements, and cross-collateralization/cross-default
provisions. The most prevalent form of credit enhancement is lender risk sharing. Lenders in the DUS
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