Fannie Mae 2006 Annual Report Download - page 139

program typically share in loan-level credit losses in one of two ways: either (i) they bear losses up to the first
5% of unpaid principal balance of the loan and share in remaining losses up to a prescribed limit or (ii) they
agree to share with us up to one-third of the credit losses on an equal basis. The percentage of our multifamily
credit book of business with credit enhancement was 96% as of December 31, 2006 and 95% as of
December 31, 2005 and 2004.
Monitoring and Portfolio Diversification
Single-Family
Our single-family mortgage credit book of business is diversified based on several factors that influence credit
quality, including the following:
•LTV ratio. LTV ratio is a strong predictor of credit performance. The likelihood of default and the gross
severity of a loss in the event of default are typically lower as the LTV ratio decreases.
•Product type. Certain loan product types have features that may result in increased risk. Intermediate-
term, fixed-rate mortgages generally exhibit the lowest default rates, followed by long-term, fixed-rate
mortgages. ARMs and balloon/reset mortgages typically exhibit higher default rates than fixed-rate
mortgages, partly because the borrower’s future payments may rise or fall, within limits, as interest rates
change. Negative-amortizing and interest-only loans also default more often than traditional fixed-rate
mortgage loans.
•Number of units. Mortgages on one-unit properties tend to have lower credit risk than mortgages on
multiple-unit properties.
•Property type. Certain property types have a higher risk of default. For example, condominiums
generally are considered to have higher credit risk than single-family detached properties.
•Occupancy type. Mortgages on properties occupied by the borrower as a primary or secondary residence
tend to have lower credit risk than mortgages on investment properties.
•Credit score. Credit score is a measure often used by the financial services industry, including our
company, to assess borrower credit quality. Credit scores are generated by credit repositories and
calculated based on proprietary statistical models that evaluate many types of information on a borrower’s
credit report and predict the likelihood that a borrower will repay future obligations as expected. A higher
credit score typically indicates a lower degree of credit risk.
•Loan purpose. Loan purpose indicates how the borrower intends to use the funds from a mortgage loan.
Cash-out refinancings have a higher risk of default than either mortgage loans used for the purchase of a
property or other refinancings that restrict the amount of cash back to the borrower.
•Geographic concentration. Local economic conditions affect borrowers’ ability to repay loans and the
value of collateral underlying loans. Geographic diversification reduces mortgage credit risk.
•Loan age. We monitor year of origination and loan age, which is defined as the number of years since
origination. Statistically, the peak ages for default are currently from two to six years after origination.
Table 35 presents our conventional single-family business volumes, based on the key risk characteristics
above, for 2006, 2005 and 2004 and our conventional single-family mortgage credit book of business as of the
end of each respective year.
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