Freddie Mac 2014 Annual Report Download - page 39

34 Freddie Mac
Our single-family credit guarantee and multifamily mortgage portfolios are subject to mortgage credit risks, including
mortgage credit risk relating to off-balance sheet arrangements; credit costs related to these risks could adversely affect our
financial results.
Mortgage credit risk is the risk that a borrower will fail to make timely payments on a mortgage we own or guarantee,
exposing us to the risk of credit losses and credit-related expenses. We are primarily exposed to mortgage credit risk with
respect to the single-family and multifamily loans and securities that we own or guarantee. We are also exposed to mortgage
credit risk with respect to securities and guarantee arrangements that are not reflected as assets on our consolidated balance
sheets. These relate primarily to: (a) Freddie Mac mortgage-related securities backed by multifamily loans (e.g., K Certificates
we guarantee); (b) certain single-family Other Guarantee Transactions; and (c) other guarantee commitments, including long-
term standby commitments and liquidity guarantees.
We expect our single-family credit losses to remain elevated in the near term in part due to the substantial number of
delinquent and underwater (i.e., where the borrower's debt on the property is greater than its market value) mortgage loans in
our single-family credit guarantee portfolio that will likely be resolved. We also continue to have significant amounts of
mortgage loans in our single-family credit guarantee portfolio with certain characteristics, such as Alt-A loans, interest-only
loans, option ARM loans, loans with original LTV ratios greater than 90%, and loans to borrowers with credit scores less than
620 at the time of origination, that expose us to greater credit risk than other types of mortgage loans. See “Table 45 — Certain
Higher-Risk Categories in the Single-Family Credit Guarantee Portfolio” for more information.
Our loan loss reserves may not reflect the total of all future credit losses we will ultimately incur with respect to the
single-family and multifamily mortgage loans we currently own or guarantee. Pursuant to GAAP, our reserves only reflect
probable losses we believe we have already incurred as of the balance sheet date. Accordingly, it is likely that the credit losses
we ultimately incur on the loans we currently own or guarantee will exceed the amounts we have already reserved for such
loans. If we were to experience another recession or another sharp drop in home prices, it is possible that the credit losses we
ultimately incur related to such an event could be larger, perhaps substantially larger, than our current loan loss reserves.
We use certain credit enhancements (e.g., mortgage insurance and risk transfer transactions) to mitigate some of our
potential credit losses. However, such credit enhancements may provide less protection than we expect. Our ability to use
certain types of risk transfer transactions (and the cost to us of doing so) could change rapidly, depending on market conditions.
Some of our risk transfer transactions (e.g., STACRs and ACIS) are new, and it is uncertain if there will be adequate demand
for these products over the long term. For more information, see "NOTE 4: MORTGAGE LOANS AND LOAN LOSS
RESERVES — Credit Protection and Other Forms of Credit Enhancement."
For more information on our mortgage credit risk with respect to single-family and multifamily loans and our use of
credit enhancements, see “MD&A — RISK MANAGEMENT — Credit Risk Overview — Single-Family Mortgage Credit
Risk Framework and Profile" and " — Multifamily Mortgage Credit Risk Profile.”
We face significant risks related to our delegated underwriting process for single-family mortgages, including risks related
to data accuracy and mortgage fraud. Recent changes to the process could increase our risks.
We use a process of delegated underwriting for the single-family mortgages we purchase or securitize. In this process, our
contracts with sellers describe mortgage eligibility and underwriting standards, and the sellers represent and warrant to us that
the mortgages they sell to us meet these standards. We do not independently verify most of the information that is provided to
us before we purchase a loan. This exposes us to the risk that one or more of the parties involved in a transaction (such as the
borrower, seller, broker, appraiser, title agent, loan officer, lender or servicer) will misrepresent the facts about the underlying
property, borrower, or loan, or otherwise engage in fraud. While we review a sample of these loans to determine if they are in
compliance with our contractual standards, there can be no assurance that this will detect any misrepresented facts or deter
mortgage fraud, or otherwise reduce our exposure to these risks. We are also exposed to fraud by third parties in the mortgage
servicing function, particularly with respect to sales of REO properties, short sales, and other dispositions of non-performing
assets.
In 2013 and 2014, we significantly revised our representation and warranty framework by relieving sellers of certain
repurchase obligations in specific cases. We may face greater exposure to credit and other losses under this revised framework
because our ability to seek recovery or repurchase from the seller is more limited. As a result of these changes to the
framework, it is critical that we identify breaches of representations and warranties early in the life of the loan. This represents
a significant change in practice and presents a number of operational and systems challenges. We have not fully implemented
systems and processes designed to do this. Once fully implemented, there is a risk that such systems and processes will not
enable us to identify all breaches within the accelerated timelines. For more information, see “BUSINESS — Our Business —
Our Business Segments — Single-Family Guarantee Segment — Underwriting Requirements, Quality Control Standards, and
the Representation and Warranty Framework.”
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