Freddie Mac 2015 Annual Report Download - page 182

Risk Factors Credit Risks
Freddie Mac 2015 Form 10-K 180
contracts with sellers describe mortgage eligibility and underwriting standards, and the sellers represent
and warrant to us that the loans they deliver to us meet these standards. We do not independently verify
most of the information provided to us before we purchase or securitize 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, or lender) misrepresented the facts about the underlying property,
borrower, or loan, or engaged in fraud.
We review a sample of these loans after we purchase them to determine if they are in compliance with
our contractual standards. However, our review may not detect any misrepresentations by the parties
involved in the transaction, deter loan fraud, or reduce our exposure to these risks.
In recent years, at the direction of FHFA, we significantly revised our representation and warranty
framework (including changes to remedies for certain defects) to relieve sellers of certain repurchase
obligations in specific cases. As a result, we may face greater exposure to credit and other losses
because our ability to seek recovery or repurchase from the seller under this revised framework is more
limited. Under the revised framework, it is critical that we identify breaches of representations and
warranties early in the life of the loan. We are enhancing our tools and processes designed to do this.
This change in practice may present operational and systems challenges. Once fully implemented, there
is a risk that the enhanced tools and processes will not enable us to identify all breaches in a timely
manner. For more information, see “MD&A - Risk Management - Credit Risk - Single-Family Mortgage
Credit Risk - Maintaining policies and procedures for new business activity, including prudent underwriting
standards.”
We are exposed to significant credit risk related to loans with lower credit quality that back the
non-agency mortgage-related securities we hold in our mortgage-related investments portfolio.
Our investments in non-agency mortgage-related securities include securities that are backed by
subprime, Alt-A, option ARM, and manufactured housing loans, and home equity lines of credit. The credit
performance of these loans remains weak. Over time, we will likely add additional securities to the
population of non-agency mortgage-related securities that we intend to sell. As we do so, we will be
required to immediately recognize any unrealized losses on such securities in earnings. Our net worth
has at times been adversely affected by declines in the fair value of these securities. We may experience
additional fair value declines in the future due to a number of factors, such as increased default rates, and
loss severities on the loans underlying these securities. The quality of the servicing performed on the
underlying loans can significantly affect the timing and amount of losses we recognize on these securities.
We also have exposure to loss on these securities as a result of:
• Our limited ability to influence servicing performance, including the volume and type of loan
modifications;
• The lack of transparency in the market for the non-agency mortgage-related securities we hold.
Information disclosed by the trustees of the trusts that issued the securities is often insufficient for us
to adequately analyze the servicers’ decisions and how these decisions affect the cash flows on the
securities;
• Concentration of loan servicing among several non-depository financial institutions. These servicers
may not have the same financial strength, or operational capacity, or be subject to the same level of
regulatory oversight, as depository servicers; and
• Inadequate protection from credit enhancements on these securities.