Freddie Mac 2004 Annual Report Download - page 129

enhancements. Our ability and desire to expand the portion of our Total mortgage portfolio with credit
enhancements will depend on our evaluation of the credit quality of new business purchase opportunities, our
portfolio risk proÑle and the future availability of eÅective credit enhancements at prices that permit an
attractive return.
Primary mortgage insurance is the most prevalent type of credit enhancement protecting our Total
mortgage portfolio and is obtained on a loan-level basis for certain single-family mortgages. Primary mortgage
insurance transfers varying portions of the credit risk associated with the mortgage to a third party insurer. The
amount we obtain on any mortgage depends on our charter requirement and our assessment of risk. We may
from time to time agree with the insurer to reduce the amount of coverage that is in excess of our charter's
minimum requirement and may also furnish certain services to the insurer in exchange for fees paid by the
insurer. As is the case with credit enhancement agreements generally, these agreements often improve the
overall value of purchased mortgages and thus may allow us to oÅer lower guarantee fees to sellers.
After primary mortgage insurance, the most prevalent type of credit enhancement that we use is pool
insurance. With pool insurance, a mortgage insurer provides insurance on a pool of loans up to a stated
aggregate loss limit. Our pool insurance contracts cover losses ranging between approximately 0.69 percent
and 5.00 percent of the aggregate unpaid principal balance of the pooled loans at the time of purchase. In
addition to a pool-level loss coverage limit, some pool insurance contracts may have limits on coverage at the
loan level. For pool insurance contracts that expire before the completion of the contractual term of the
mortgage loan, we seek to ensure that the contracts cover the period of time during which we believe the
mortgage loans are most likely to default.
Other forms of credit enhancements on single-family mortgage loans include collateral (including cash or
high-quality marketable securities) pledged by a lender, government guarantees, and recourse agreements
(under which we may require a lender to repurchase loans that default). In some instances, our agreements
with insurers limit the insurance to a stated aggregate loss.
For multifamily mortgages, we occasionally utilize credit enhancements to mitigate risk. The types of
credit enhancements used for multifamily mortgage loans include recourse, third-party guarantees or letters of
credit, subordinated participations in mortgage loans or structured pools, and cross-default and cross-
collateralization provisions. With a cross-default provision, if the loan on a property goes into default, we have
the right to declare speciÑed other mortgage loans of the same borrower or certain of its aÇliates to be in
default and to foreclose those other mortgages. With a cross-collateralization provision, we have the additional
right to apply excess proceeds from the foreclosure of one mortgage to amounts owed to us by the same
borrower or certain of its aÇliates relating to other multifamily mortgage loans we own. We also receive
similar credit enhancements for Multifamily PC guarantor swaps; for tax-exempt multifamily housing revenue
bonds that support pass-through certiÑcates issued by third parties for which we provide our guarantee of the
payment of principal and interest; for Freddie Mac pass-through certiÑcates that are backed by tax-exempt
multifamily housing revenue bonds and related taxable bonds and/or loans, and for multifamily mortgage
loans that are originated and held by state and municipal agencies to support tax-exempt multifamily housing
revenue bonds for which we provide our guarantee of the payment of principal and interest. For information
about our maximum coverage in regards to these credit enhancements, see ""NOTE 4: FINANCIAL
GUARANTEES'' to the consolidated Ñnancial statements.
While the use of credit enhancements reduces our exposure to mortgage credit risk, it increases our
exposure to institutional credit risk. See ""Institutional Credit Risk'' for more information.
Portfolio DiversiÑcation. A key characteristic of our credit risk portfolio is broad diversiÑcation along a
number of critical risk dimensions. We continually monitor a variety of mortgage loan characteristics such as
product mix, loan-to-value ratios and geographic concentration, which may aÅect the default experience on
our overall mortgage portfolio, and may seek to reinsure a portion of our portfolio if we observe unacceptable
levels of concentration.
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