Freddie Mac 2010 Annual Report Download - page 98

We continue to pursue strategies to mitigate our losses as an investor in non-agency mortgage-related securities. On
July 12, 2010, FHFA, as Conservator of Freddie Mac and Fannie Mae, announced that it had issued subpoenas to various
entities seeking loan files and other transaction documents related to non-agency mortgage-related securities in which the
two enterprises invested. FHFA stated that the documents will enable it to determine whether issuers of these securities and
others are liable to Freddie Mac and Fannie Mae for certain losses they have suffered on the securities. We are assisting
FHFA in this effort. In its announcement, FHFA noted that, before and during conservatorship, Freddie Mac and Fannie Mae
sought to assess and enforce their rights as investors in non-agency mortgage-related securities, in an effort to recoup losses
suffered in connection with their portfolios. However, difficulty in obtaining the loan documents has presented a challenge to
the companies’ efforts. There is no assurance as to how the various entities will respond to the subpoenas, or to what extent
the information sought will result in loss recoveries.
We also have joined an investor group that has delivered a notice of non-performance to Bank of New York Mellon, as
Trustee, and Countrywide Home Loans Servicing LP (now known as BAC Home Loans Servicing, LP). The notice related to
the possibility that certain mortgage pools backing certain mortgage-related securities issued by Countrywide Financial and
related entities include mortgages that may have been ineligible for inclusion in the pools due to breaches of representations
or warranties.
The effectiveness of these or any other loss mitigation efforts for these securities is highly uncertain and any potential
recoveries may take significant time to realize. These efforts could have a material impact on our estimate of future losses.
For purposes of our impairment analysis, our estimate of the present value of expected future credit losses on our
portfolio of non-agency mortgage-related securities increased to $14.3 billion at December 31, 2010 from $12.0 billion at
September 30, 2010. This deterioration was due to an increase in estimated cumulative losses on the collateral underlying
these securities and a reduction in the projected structural credit enhancement of the securities. The increase in estimated
cumulative losses resulted from declines in actual home prices, our expectation that home prices will be lower in 2011
compared to 2010 for the U.S. as a whole, as well as increasing interest rates, which affect the expected level of voluntary
prepayments and defaults on adjustable rate mortgages. Increasing interest rates also reduce the expected benefits of credit
enhancements by decreasing the excess interest available to the trust to absorb future collateral losses.
Since the beginning of 2007, we have incurred actual principal cash shortfalls of $705 million on impaired non-agency
mortgage-related securities, of which $598 million related to 2010. Many of the trusts that issued non-agency mortgage-
related securities we hold were structured so that realized collateral losses in excess of credit enhancements are not passed
on to investors until the investment matures. We currently estimate that the future expected principal and interest shortfalls
on non-agency mortgage-related securities we hold will be significantly less than the fair value declines experienced on these
securities. In addition, it is difficult to estimate the point at which credit enhancements will be exhausted. During 2010, we
continued to experience the depletion of credit enhancements on selected securities backed by subprime first lien, option
ARM, and Alt-A loans due to poor performance of the underlying collateral.
The investments in non-agency mortgage-related securities we hold backed by subprime first lien, option ARM, and
Alt-A loans were structured to include credit enhancements, particularly through subordination. Bond insurance is an
additional credit enhancement covering some of the non-agency mortgage-related securities. These credit enhancements are
one of the primary reasons we expect our actual losses, through principal or interest shortfalls, to be less than the underlying
collateral losses in aggregate. For more information, see “RISK MANAGEMENT — Credit Risk — Institutional Credit
Risk — Bond Insurers.”
The concerns about deficiencies in foreclosure documentation practices may also adversely affect the values of, and our
losses on, non-agency mortgage-related securities we hold, including by causing further delays in foreclosure timelines.
95 Freddie Mac