Fannie Mae 2005 Annual Report Download - page 120

We have established underwriting guidelines for these loans that are intended to provide a comprehensive
analysis of borrowers and mortgage loans based upon known risk characteristics. We also have policies and
various quality assurance efforts to review a sample of loans to measure compliance with our underwriting and
eligibility criteria. We assess the characteristics and quality of a lender’s loans and processes through a post-
purchase loan review program, on-site reviews of lender operations and regular comparisons of actual loan
performance to expected performance.
Lenders generally represent and warrant compliance with our asset acquisition requirements when they sell
mortgage loans to us or deliver mortgage loans in exchange for Fannie Mae MBS. We may require the lender
to repurchase a loan or we may seek another remedy if we identify any underwriting or eligibility deficiencies.
We have developed a proprietary automated underwriting system, Desktop Underwriter», which measures
default risk by assessing the primary risk factors of a mortgage, including the loan-to-value ratio, the
borrower’s credit profile, the type of mortgage, the loan purpose, and other mortgage and borrower
characteristics. Subject to our review and approval, we also purchase and securitize mortgage loans that have
been underwritten using other automated underwriting systems, as well as mortgage loans underwritten to
agreed-upon standards that differ from our standard underwriting criteria.
The use of credit enhancements is an important part of our single-family acquisition policy and standards,
although it also exposes us to institutional counterparty risk. Based on our current acquisition policy and
standards, we may accept loans originated with loan-to-value ratios of up to 100%; however, from time to
time, we may make an exception to these guidelines and acquire loans with a loan-to-value ratio greater than
100%. Our charter requires that conventional single-family mortgage loans that we purchase or that back
Fannie Mae MBS with loan-to-value ratios above 80% at acquisition be covered by one or more of the
following:
• primary mortgage insurance;
• a seller’s agreement to repurchase or replace any mortgage loan in default (for such period and under
such circumstances as we may require); or
• retention by the seller of at least a 10% participation interest in the mortgage loans.
Primary mortgage insurance is the most common type of credit enhancement in our mortgage credit book of
business and is typically provided on a loan-level basis. Primary mortgage insurance, which is typically
provided by one of eight mortgage insurance companies, transfers varying portions of the credit risk associated
with a mortgage loan to a third-party insurer. As discussed below in “Institutional Counterparty Credit Risk
Management—Mortgage Insurers”, these insurers are subject to our eligibility requirements. The amount of
insurance we obtain on any mortgage loan depends on our requirements, which depend on our assessment of
risk. In addition to the credit enhancement required by our charter, we may require or obtain supplemental
credit enhancement for some mortgage loans, typically those with higher credit risk. Our use of discretionary
credit enhancements depends on our view of the inherent credit risk, the price of the credit enhancement, and
our risk versus return objective. The percentage of our conventional single-family mortgage credit book of
business with credit enhancement, including primary mortgage, pool mortgage insurance, lender recourse and
shared risk, was 18%, 19% and 21% as of December 31, 2005, 2004 and 2003, respectively. The percentage
of our conventional single-family mortgage credit book of business with credit enhancement has not changed
significantly since the end of 2005.
The remaining portion of our conventional single-family mortgage credit book of business consists of non-
Fannie Mae mortgage-related securities backed by single-family mortgage loans and credit enhancements that
we provide on single-family mortgage assets. Non-Fannie Mae mortgage-related securities held in our portfolio
include Freddie Mac securities, Ginnie Mae securities, private-label mortgage-related securities, Fannie Mae
MBS backed by private-label mortgage-related securities, and housing-related municipal revenue bonds. Our
Capital Markets group prices and manages credit risk related to this specific portion of our conventional
single-family mortgage credit book. We may not have access to detailed loan-level data on these particular
mortgage-related assets and therefore may not manage the credit performance of individual loans. However, a
substantial majority of these securities benefit from significant forms of credit enhancement, including
115