Freddie Mac 2004 Annual Report Download - page 128

servicer to repurchase that mortgage or make us whole in the event of a default. To assist us in purchasing
mortgages that can be sold to us, we provide originators with automated underwriting software tools, such as
Loan Prospector»and other quantitative credit risk management tools to evaluate and purchase single-family
mortgages and monitor the related mortgage credit risk. Loan Prospector» combines information on the key
indicators of mortgage default risk, such as loan-to-value ratios, credit scores and other mortgage and borrower
characteristics to generate credit risk classiÑcations. These statistically-based risk assessment tools increase
our ability to distinguish among single-family loans based on their risk, return and importance to our mission.
On a negotiated basis, we may allow seller/servicers to underwrite mortgages for sale to us using other
proprietary automated underwriting systems.
For 2004 and 2003, Loan Prospector» was used to evaluate approximately 61 percent and 64 percent,
respectively, of our single-family purchase volume prior to purchase. As part of our post-purchase quality
control review process, we use Loan Prospector» to evaluate the credit quality of virtually all single-family
mortgages that were not evaluated by Loan Prospector» prior to purchase. Loan Prospector» risk classiÑca-
tions inÖuence both the price we charge to guarantee loans and the sample of loans we review in quality
control. As such, Loan Prospector» provides an eÅective credit risk management tool.
For multifamily mortgage loans, unless the mortgage loans have signiÑcant credit enhancements, we use
an intensive pre-purchase underwriting process for the mortgages we purchase. Our underwriting process
includes assessments of the local market, the borrower, the property manager, the property's historical and
projected Ñnancial performance and the property's physical condition, which may include a physical inspection
of the property. In addition to our own inspections, we utilize third-party appraisals and environmental and
engineering reports.
Credit Enhancements. For most of the mortgage loans in our Total mortgage portfolio (other than non-
Freddie Mac mortgage-related securities and that portion of issued Structured Securities that is backed by
Ginnie Mae CertiÑcates), we retain the primary risk of loss in the event of default by the borrower on the
underlying mortgage. Our charter requires that, to be eligible for purchase, single-family mortgages with loan-
to-value ratios above 80 percent at the time of purchase be covered by (a) primary mortgage insurance or
(b) certain other credit protections. In addition, for some mortgage loans, we elect to share the default risk by
transferring a portion of that risk to various third parties through a variety of other credit enhancement
vehicles. Mortgage loans covered by primary mortgage insurance and these other credit protections are
referred to as credit-enhanced mortgages. Proceeds received from these credit enhancements are applied to
oÅset credit losses and to Net interest income for that portion that represents forgone interest not previously
recognized related to individual mortgage loans that default.
Table 59 shows the credit-enhanced portion of our Total mortgage portfolio (excluding non-Freddie Mac
mortgage-related securities and Structured Securities issued by us that are backed by Ginnie Mae
CertiÑcates).
Table 59 Ì Credit-Enhanced Percentage of the Total Mortgage Portfolio(1)
December 31,
2004 2003 2002
Credit-enhanced(2) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 19% 21% 27%
(1) Non-Freddie Mac mortgage-related securities are excluded from this table because they do not expose us to primary risk of loss in
the event of a default by the borrower on the underlying mortgage. That portion of Structured Securities backed by Ginnie Mae
CertiÑcates is excluded because the incremental credit risk to which it exposes us is considered de minimis. See ""Table 33 Ì Credit
Characteristics of Mortgages and Mortgage-Related Securities in the Retained Portfolio'' for additional information about our non-
Freddie Mac mortgage-related securities.
(2) Credit enhancements primarily include third party primary loan-level mortgage insurance, third party pool insurance and other
arrangements in which the lender or a third party has retained a portion of the default risk by pledging collateral or agreeing to accept
losses on loans that default. In many cases, the lender's or third party's risk is limited to a speciÑc level of losses at the time the credit
enhancement becomes eÅective.
The percentage of our Total mortgage portfolio (excluding Structured Securities backed by Ginnie Mae
CertiÑcates and non-Freddie Mac mortgage-related securities held by us) with credit-enhancements de-
creased from 2002 to 2004. This decrease was primarily due to a high level of reÑnance loans acquired in 2003
and 2004, which tend to have lower loan-to-value ratios and, therefore, generally do not require credit
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