Freddie Mac 2004 Annual Report Download - page 137

the original terms of their mortgages. Loan modiÑcations, the second most common type of foreclosure
alternative, involve changing the terms of a mortgage and therefore are a more favorable alternative to the
borrower during a declining interest-rate environment, such as we experienced during 2002 and the Ñrst half
of 2003. Forbearance agreements, the third most common type of foreclosure alternative, provide a temporary
suspension of the foreclosure process to allow additional time for the borrower to return to compliance with the
original terms of the borrower's mortgage or to implement another foreclosure alternative.
Other single-family loss mitigation activities include providing default management tools designed to help
single-family servicers manage non-performing loans more eÅectively. These tools include Early Indicator», a
system that estimates the probability that delinquent loans will be resolved or advanced through to a loss-
producing state. In addition, we provide the servicers with a suite of self-management tools such as Timeline
Manager, Workout Manager, Expense Manager and REO Manager. We also use Servicer Performance
ProÑle reports to evaluate and manage the performance of our mortgage servicers based on their management
of performing and non-performing loans.
We require multifamily servicers to closely manage mortgage loans they have sold us in order to mitigate
potential losses. At least once a year, for loans over $1 million, servicers must submit an assessment of the
mortgaged property to us based on an inspection of the property and a review of the property's Ñnancial
statements. We also evaluate these assessments internally and may direct the servicer to take speciÑc actions
to reduce the likelihood of delinquency or default. If a loan defaults despite this intervention, we then
determine whether it is in our best interest to oÅer a reasonable foreclosure alternative to the borrower. For
example, we may modify the terms of a multifamily mortgage loan which gives the borrower an opportunity to
bring the loan current and allows the borrower to retain ownership of the property. Since multifamily
seller/servicers are an important part of our loss mitigation process, we rate their performance regularly and
conduct on-site reviews of their servicing operations to conÑrm compliance with our standards.
Other Credit Risk Management Activities. As noted previously, we purchase a broad range of mortgage
products with diÅering degrees of default risk. To compensate us for unusual levels of risk in some mortgage
products we may charge incremental fees above a base guarantee fee calculated on credit risk factors such as
the mortgage product type, loan purpose, loan-to-value ratio, and other loan attributes. In addition, we
occasionally use Ñnancial incentives and credit derivatives, as described below, in situations where we believe
they will beneÑt our credit risk management strategy. These arrangements are intended to reduce our credit-
related expenses and to help us manage purchase quality, thereby improving our overall returns.
In some cases, we also provide Ñnancial incentives in the form of lump sum payments to selected
seller/servicers if they deliver a speciÑed volume or share of mortgage loans meeting speciÑed credit risk
standards over a deÑned period of time. These Ñnancial incentives may also take the form of a fee payable to
us by the seller if the mortgages delivered to us do not meet certain credit standards.
We have also entered into risk-sharing agreements that are accounted for as derivatives in accordance
with GAAP. In part because the agreements may result in us making payments to the seller/servicer
(depending upon actual default experience over the lives of the mortgages), they are considered credit
derivatives, rather than Ñnancial guarantees under GAAP. Under these agreements, default losses on speciÑc
mortgage loans delivered by sellers are compared to default losses on reference pools of mortgage loans with
similar characteristics. Based upon the results of that comparison, we remit or receive payments based upon
the default performance of the speciÑed mortgage loans. These payments are recorded in Management and
guarantee income on the consolidated statements of income. The total notional amount of mortgage loans
subject to these agreements was approximately $10.9 billion and $15.5 billion at December 31, 2004 and 2003,
respectively. These risk-sharing agreements are classiÑed as no hedge designation for purposes of applying
SFAS 133, with changes in fair value recorded as Derivative gains (losses) on the consolidated statements of
income. The fair value of these risk-sharing agreements is recorded in the Derivative assets, at fair value and
Derivative liabilities, at fair value on the consolidated balance sheets, with net amounts of $(2) million and
$5 million at December 31, 2004 and 2003, respectively.
Although these arrangements are part of our overall credit risk management strategy, we have not treated
them as credit enhancements for purposes of describing our Total mortgage portfolio characteristics because
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