Freddie Mac 2015 Annual Report Download - page 136

Management's Discussion and Analysis Risk Management | Institutional Credit Risk
Freddie Mac 2015 Form 10-K 134
members in connection with exchange-traded derivatives. The posting of this margin exposes us to
institutional credit risk in the event that our clearing members or the exchanges' clearinghouse fail to
meet their obligations. However, the use of exchange-traded derivatives mitigates our institutional
credit risk exposure to individual counterparties because a central counterparty is substituted for
individual counterparties, and changes in the value of open exchange-traded contracts are settled
daily via payments made through the financial clearinghouse established by each exchange.
• OTC derivatives - OTC derivatives expose us to institutional credit risk to individual counterparties,
because these transactions are executed and settled directly between us and each counterparty,
exposing us to potential losses if a counterparty fails to meet its contractual obligations. When a
counterparty in OTC derivatives that is subject to a master netting agreement has a net obligation to
us with a market value above an agreed upon threshold, the counterparty is obligated to deliver
collateral in the form of cash, securities, or a combination of both to satisfy its obligation to us under
the master netting agreement. Our OTC derivatives also require us to post collateral to counterparties
in accordance with agreed upon thresholds when we are in a derivative liability position. The
collateral posting thresholds we assign to our OTC counterparties, as well as the ones they assign to
us, are generally based on S&P or Moody’s credit rating. The lowering or withdrawal of our credit
rating by S&P or Moody’s may increase our obligation to post collateral, depending on the amount of
the counterparty’s exposure to Freddie Mac with respect to the derivative transactions.
In the event a counterparty defaults, 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 (e.g., due to a significant interest rate movement during the period or other factors). We could
also incur economic losses if non-cash collateral posted to us by the defaulting counterparty and held by
the custodian cannot be liquidated at prices that are sufficient to recover the amount of such exposure.
Evaluating Counterparty Financial Strength and Performance and Monitoring Our Exposure
Over time, our exposure to derivative counterparties varies depending on changes in fair values, which
are affected by changes in interest rates and other factors. Due to risk limits with certain counterparties,
we may be forced to execute transactions with lower returns with our counterparties when managing our
interest-rate risk. We manage our exposure through master netting and collateral agreements and stress-
testing to evaluate potential exposure under possible adverse market scenarios. Collateral is typically
transferred within one business day based on the values of the related derivatives. We regularly review
the market values of the securities pledged to us as non-cash collateral to manage our exposure to loss.
We conduct additional reviews of our exposure when market conditions dictate or certain events affecting
an individual counterparty occur. When non-cash collateral is posted to us, we require collateral in excess
of our exposure to satisfy the net obligation to us in accordance with the counterparty agreement.
The table below reconciles the net asset fair value of derivative contracts on our consolidated balance
sheets to our net exposure after considering non-cash collateral held, which is not netted on our
consolidated balance sheets.