Fannie Mae 2002 Annual Report Download - page 71

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FANNIE MAE 2002 ANNUAL REPORT
Fannie Mae’s overall objective in managing mortgage credit risk is
to deliver consistent earnings growth and target returns on capital in
a wide range of economic environments. Central elements of our
approach include: (1) managing the profile and quality of mortgages
in the mortgage credit book, (2) using credit enhancements to reduce
credit losses, (3) assessing the sensitivity of the profitability of the
mortgage credit book of business to changes in composition and the
economic environment, and (4) managing problem assets to mitigate
credit losses.
Given the important differences in the nature and
management of credit risk between single-family and
multifamily loans, we manage and discuss these two types
of loans separately.
Single-family
The single-family mortgage credit book primarily consists
of loans, MBS in our mortgage portfolio, MBS and other
mortgage-related securities guaranteed by Fannie Mae and
held by other investors (outstanding MBS), and other
mortgage-related securities we own backed by loans on
properties that have four or fewer residential units. This
section details our single-family risk management practices,
risk characteristics, and performance. While we manage the
credit risk on the entire single-family mortgage credit book,
in some cases we may not have certain loan-level information
to report risk characteristics and performance disclosures.
Therefore, unless otherwise noted, the credit statistics on
Fannie Mae’s conventional single-family mortgage credit
book presented in this section will generally include only
mortgage loans in portfolio, MBS in portfolio, and
outstanding MBS where we have more comprehensive,
detailed loan-level transaction information. These loans
represent 96 percent of our single-family mortgage credit
book at the end of 2002. Most of the remaining 4 percent of
our conventional single-family mortgage credit book consists
of mortgage-related securities rated AAA at acquisition,
including mortgage-related securities guaranteed by
Freddie Mac and Ginnie Mae.
1. Managing the profile and quality of mortgages in the
single-family mortgage credit book.
Mortgage credit risk on a particular single-family loan is
affected by numerous characteristics, including the type of
loan, the down-payment amount, and the strength of the
borrower’s credit history. These and other factors, such as
home price appreciation, affect both the level of expected
credit loss on a given loan and the sensitivity of that loss to
changes in the economic environment. We attempt to
understand the overall credit risk in our loans, earn an
attractive risk-adjusted return from appropriate guaranty
fee pricing, and mitigate our risks through the use of credit
enhancements and effective asset management. Our risk
mitigating activities reduce the incidence and severity of
loss and minimize the volatility of credit losses, which helps
Fannie Mae in achieving stable earnings growth and a
competitive return on equity over time.
We establish detailed policies and employ various processes
to validate that the characteristics of the loans purchased or
guaranteed comply with key underwriting and eligibility
criteria. We also assess the characteristics and quality of a
lender’s loans and processes through an audit program and
our customer relationship management teams. Mortgage
loans that we buy or guarantee must comply with certain
underwriting and eligibility characteristics to ensure that the
overall risk of the particular loan is within acceptable limits.
Lenders represent and warrant compliance with our asset
acquisition requirements when they sell mortgage loans or
securities to us or seek a guarantee from us. We may require
the lender to repurchase a loan or enforce some other
remedy if we identify any deficiencies. Since 1995, we have
developed and refined DU to assist lenders in underwriting
and complying with our other loan eligibility criteria.
DU consistently and objectively applies risk analytics,
underwriting, and eligibility standards to prospective
mortgage loans. Approximately 60 percent of the single-
family conventional loans we purchased or guaranteed in
2002 were processed through DU, up from 59 percent in
2001 and 56 percent in 2000. We also buy or guarantee
loans underwritten manually or through other automated
underwriting systems, subject to appropriate lender
representations and warranties. In certain circumstances
involving use of automated underwriting, we may relieve
lenders of a limited number of the standard representations
and warranties.
2. Using credit enhancements to reduce credit losses.
Credit enhancements are contracts in which a third party
agrees to pay Fannie Mae if there is a credit event, such as a
loan default. Credit enhancements enable us to transform
the risk and return profile of the mortgage credit book of
business to be consistent with our objectives. Single-family
credit enhancements include primary loan-level mortgage
insurance, pool mortgage insurance, recourse arrangements
with lenders, and other customized risk-sharing contracts.
The majority of our single-family credit enhancement is
primary loan-level mortgage insurance. When we require
primary loan-level mortgage insurance on loans with loan-
to-value ratios above 80 percent, we typically require greater
coverage than the minimum level of credit enhancement
required by our Charter Act if primary mortgage insurance