Freddie Mac 2010 Annual Report Download - page 120

In the event of counterparty default, our economic loss may be higher than the uncollateralized exposure of our
derivatives if we are not able to replace the defaulted derivatives in a timely and cost-effective fashion. We could also incur
economic loss if the collateral held by us cannot be liquidated at prices that are sufficient to recover the amount of such
exposure. We monitor the risk that our uncollateralized exposure to each of our OTC counterparties for interest-rate swaps,
option-based derivatives, foreign-currency swaps, and purchased interest rate caps will increase under certain adverse market
conditions by performing daily market stress tests. These tests, which involve significant management judgment, evaluate the
potential additional uncollateralized exposure we would have to each of these derivative counterparties on OTC derivatives
contracts assuming certain changes in the level and implied volatility of interest rates and certain changes in foreign currency
exchange rates over a brief time period. Our actual exposure could vary significantly from amounts forecasted by these tests.
As indicated in Table 41, the total exposure on our OTC forward purchase and sale commitments, which are treated as
derivatives, was $103 million and $81 million at December 31, 2010 and 2009, respectively. These commitments are
uncollateralized. Because the typical maturity of our forward purchase and sale commitments is less than 60 days and they
are generally settled through a clearinghouse, we do not require master netting and collateral agreements for the
counterparties of these commitments. However, we monitor the credit fundamentals of the counterparties to our forward
purchase and sale commitments on an ongoing basis in an effort to ensure that they continue to meet our internal risk-
management standards.
Document Custodians
We use third-party document custodians to provide loan document certification and custody services for some of the
loans that we purchase and securitize. In many cases, our seller/servicer customers or their affiliates also serve as document
custodians for us. Our ownership rights to the mortgage loans that we own or that back our PCs and REMICs and Other
Structured Securities could be challenged if a seller/servicer intentionally or negligently pledges or sells the loans that we
purchased or fails to obtain a release of prior liens on the loans that we purchased, which could result in financial losses to
us. When a seller/servicer or one of its affiliates acts as a document custodian for us, the risk that our ownership interest in
the loans may be adversely affected is increased, particularly in the event the seller/servicer were to become insolvent. We
seek to mitigate these risks through legal and contractual arrangements with these custodians that identify our ownership
interest, as well as by establishing qualifying standards for document custodians and requiring transfer of the documents to
our possession or to an independent third-party document custodian if we have concerns about the solvency or competency
of the document custodian.
Mortgage Credit Risk
We are exposed to mortgage credit risk on our total mortgage portfolio because we either hold the mortgage assets or
have guaranteed mortgages in connection with the issuance of a Freddie Mac mortgage-related security, or other guarantee
commitment. Mortgage credit risk is primarily influenced by the credit profile of the borrower on the mortgage, the features
of the mortgage itself, the type of property securing the mortgage and the general economy. All mortgages that we purchase
or guarantee have an inherent risk of default. To manage our mortgage credit risk in our single-family credit guarantee and
multifamily mortgage portfolios, we focus on three key areas: underwriting standards and quality control process; portfolio
diversification; and portfolio management activities, including loss mitigation and the use of credit enhancements.
Through our delegated underwriting process, single-family mortgage loans and the borrowers’ ability to repay the loans
are evaluated using several critical risk characteristics, including but not limited to the borrower’s credit score and credit
history, the borrower’s monthly income relative to debt payments, the original LTV ratio, the type of mortgage product and
the occupancy type of the loan. See “BUSINESS — Our Business” for information about our charter requirements for single-
family loans purchases, and “BUSINESS — Our Business Segments — Single-Family Guarantee Segment — Underwriting
Requirements and Quality Control Standards” for information about delegated underwriting and quality control monitoring.
See “BUSINESS — Regulation and Supervision — Federal Housing Finance Agency —Affordable Housing Goals” for a
discussion of factors that may cause us to purchase loans that do not meet our normal standards.
We were significantly adversely affected by deteriorating conditions in the single-family housing and mortgage markets
during 2008 and 2009. In recent years, particularly 2005 to 2007, financial institutions significantly increased mortgage
lending and securitization of certain higher risk mortgage loans, such as subprime, option ARM, interest-only and Alt-A, and
these loans comprised a much larger proportion of origination and securitization issuance volumes during 2006 and 2007,
and to a lesser extent in 2005, as compared to prior or subsequent years. During this time, we increased our participation in
the market for these products through our purchases of non-agency mortgage-related securities and through our guarantee
activities. Our expanded participation in these products was driven by a combination of competing objectives and pressures,
including meeting our affordable housing goals, competition, the desire to maintain or increase market share, and generating
returns for investors. The mortgage market has changed significantly since 2007. Financial institutions tightened their
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