Freddie Mac 2010 Annual Report Download - page 16

investors is reduced by the amount of the prepayment. Unscheduled reductions in loan principal, regardless of whether they
are voluntary or involuntary (e.g. foreclosure), result in prepayments of security balances. Consequently, the owners of our
guaranteed securities are subject to prepayment risk on the related mortgage loans, which is principally that the investor will
receive an unscheduled return of the principal, and therefore may not earn the rate of return originally expected on the
investment.
We guarantee these mortgage-related securities in exchange for compensation, which consists primarily of a
combination of management and guarantee fees paid on a monthly basis as a percentage of the UPB of the underlying loans
and initial upfront payments referred to as delivery fees. We may also make upfront payments to buy-up the monthly
management and guarantee fee rate, or receive upfront payments to buy-down the monthly management and guarantee fee
rate. These fees are paid in conjunction with the formation of a PC to provide for a uniform coupon rate for the mortgage
pool underlying the issued PC.
We enter into mortgage purchase volume commitments with many of our larger customers in order to have a supply of
loans for our guarantee business. These commitments provide for the lenders to deliver us a specified dollar amount of
mortgages during a specified period of time. Some commitments may also provide for the lender to deliver to us a minimum
percentage of their total sales of conforming loans. The purchase and securitization of mortgage loans from customers under
these longer-term contracts have pricing schedules for our management and guarantee fees that are negotiated at the outset of
the contract with initial terms that may range from one month to one year. We call these transactions “flow” activity and
they represent the majority of our purchase volumes. The remainder of our purchases and securitizations of mortgage loans
occurs in cash, or “bulk,” transactions for which purchase prices and management and guarantee fees are negotiated on an
individual transaction basis. Mortgage purchase volumes from individual customers can fluctuate significantly. If a mortgage
lender fails to meet its contractual commitment, we have a variety of contractual remedies, which may include the right to
assess certain fees. Our mortgage purchase contracts contain no penalty or liquidated damages clauses based on our inability
to take delivery of presented mortgage loans. However, if we were to fail to meet our contractual commitment, we could be
deemed to be in breach of our contract and could be liable for damages in a lawsuit.
We seek to issue guarantees on our PCs with fee terms that we believe will, over the long-term, provide management
and guarantee fee income that exceeds our anticipated credit-related and administrative expenses on the underlying loans.
Our Single-family Guarantee segment is responsible for determining prices of our guarantee and delivery fees based on our
assessment of credit risk and loss mitigation related to single-family loans, including single-family loans underlying our
guaranteed mortgage-related securities. We vary our guarantee and delivery fee pricing for different mortgage products and
mortgage or borrower underwriting characteristics. We implemented several increases in delivery fees that became effective
in 2009 applicable to mortgages with certain higher-risk loan characteristics. We announced additional delivery fee increases
in the fourth quarter of 2010 that become effective March 1, 2011 (or later, as outstanding contracts permit) for loans with
higher LTV ratios. Given the uncertainty of the housing market in 2009 and 2010, we entered into arrangements with certain
existing customers at their renewal dates that allow us to change credit and pricing terms more quickly than in the past.
For information on how we account for our securitization activities, see “NOTE 1: SUMMARY OF SIGNIFICANT
ACCOUNTING POLICIES” and “NOTE 2: CHANGE IN ACCOUNTING PRINCIPLES.”
Securitization Activities
The types of mortgage-related securities we issue and guarantee include the following:
• PCs;
• REMICs and Other Structured Securities; and
• Other Guarantee Transactions.
PCs
Our PCs are pass-through securities that represent undivided beneficial interests in trusts that hold pools of mortgages
we have purchased. Holding single-family loans in the form of PCs rather than as unsecuritized loans gives us greater
flexibility in managing the composition of our mortgage portfolio, as it is generally easier to purchase and sell PCs than
unsecuritized mortgage loans, and allows more cost effective interest-rate risk management. For our fixed-rate PCs, we
guarantee the timely payment of principal and interest. For our ARM PCs, we guarantee the timely payment of the
weighted average coupon interest rate for the underlying mortgage loans. We also guarantee the full and final payment of
principal for ARM PCs; however, we do not guarantee the timely payment of principal on ARM PCs. We issue most of
13 Freddie Mac