Freddie Mac 2009 Annual Report Download - page 91

Provision for Credit Losses
Our reserves for mortgage loan and guarantee losses reflect our best projection of defaults we believe are likely as a
result of loss events that have occurred through December 31, 2009. The ongoing weakness in the national housing market,
the uncertainty in other macroeconomic factors, such as trends in unemployment rates, and the uncertainty of the effect of
government actions to address the housing crisis, make forecasting default rates inherently imprecise. Our reserves also
reflect the projected recoveries of losses through credit enhancement and the projected impact of strategic loss mitigation
initiatives (such as our efforts under the MHA Program), including our temporary suspensions of certain foreclosure
transfers, loan modifications, and projections of recoveries through repurchases by seller/servicers of defaulted loans due to
failure to follow contractual underwriting requirements at the time of the loan origination. An inability to realize the benefits
of our loss mitigation plans, a lower realized rate of seller/servicer repurchases, further increases in loss severities due to
further deterioration in home values, deterioration in the financial condition of our mortgage insurer counterparties, or default
rates that exceed our current projections would cause our losses to be significantly higher than those currently estimated.
The provision for credit losses was $29.5 billion in 2009 compared to $16.4 billion in 2008, as continued weakness in
the housing market and a rapid rise in unemployment affected our single-family mortgage portfolio. An increasing portion of
our provision for credit losses in 2009 is associated with delinquent interest on past due loans, including those where the
borrower is in the trial period under HAMP. A portion of our provision relates to interest income due to PC investors each
month where a loan is delinquent but remains in the PC pool. The provision for credit losses for 2009 was also affected by
observed changes in economic drivers impacting borrower behavior and delinquency trends for certain loans and, in the
second quarter of 2009, a change in our methodology for estimating loan loss reserves. For more information on how we
derive our estimate for the provision for credit losses and these changes, see “NOTE 1: SUMMARY OF SIGNIFICANT
ACCOUNTING POLICIES — Allowance for Loan Losses and Reserve for Guarantee Losses” to our consolidated financial
statements. See “Table 7 — Credit Statistics, Single-Family Mortgage Portfolio” for a presentation of certain credit statistics
on a quarterly basis.
In 2009, we recorded a $18.2 billion increase in our loan loss reserve, which is a reserve for credit losses on mortgage
loans held-for investment, and mortgages underlying our PCs, Structured Securities and other mortgage-related guarantees.
The primary drivers of this increase are outlined below:
• increased estimates of incurred losses on single-family mortgage loans that are expected to experience higher default
rates. In particular, our estimates of incurred losses are higher for single-family loans we purchased or guaranteed
during 2006, 2007 and, to a lesser extent, 2005 and 2008. We expect such loans to continue experiencing higher
default rates than loans originated in other years. We purchased a greater percentage of higher risk loans in 2005
through 2008, such as Alt-A, interest-only and other such products, and these mortgages have performed particularly
poorly during the current housing and economic downturn;
• a significant increase in the size of the non-performing single-family loan portfolio for which we maintain loan loss
reserves. This increase is primarily due to deteriorating market conditions and initiatives to prevent or avoid
foreclosures. Our single-family non-performing loans increased to $100.2 billion at December 31, 2009, compared to
$44.8 billion and $16.4 billion at December 31, 2008 and 2007, respectively;
• an observed trend of increasing delinquency rates and foreclosure timeframes. We experienced significant increases in
delinquency rates in certain regions and states within the U.S. that have been most affected by home price declines, as
well as loans with second lien, third-party financing. For example, as of December 31, 2009, at least 14% of loans in
our single-family mortgage portfolio had second lien, third-party financing at the time of origination and we estimate
that these loans comprised 21% of our delinquent loans, based on unpaid principal balances;
• increases in the estimated average loss per loan, or severity of losses, net of expected recoveries from credit
enhancements, driven in part by declines in home sales and home prices during the last three years. States with large
declines in home prices during the last three years and highest severity of losses in 2009 include California, Florida,
Nevada, Michigan and Arizona;
• to a lesser extent, increases in counterparty exposure related to our estimates of recoveries through repurchases by
seller/servicers of defaulted loans due to failure to follow contractual underwriting requirements at origination and
under separate recourse agreements. Several of our seller/servicers have been acquired by the FDIC, declared
bankruptcy or merged with other institutions. These and other events increase our counterparty exposure, or the
likelihood that we may bear the risk of mortgage credit losses without the benefit of recourse, if any, to our
counterparty. See “RISK MANAGEMENT — Credit Risks — Institutional Credit Risk” for additional information.
Modest home price improvements in certain regions and states during 2009, which we believe were positively affected
by the impact of state and federal government actions, including incentives to first time homebuyers and foreclosure
suspensions, led to a stabilization in loss severity used to estimate our single-family loan loss reserves in the last half of
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