Freddie Mac 2005 Annual Report Download - page 79

counterparties for these derivatives were to have defaulted simultaneously on December 31, 2005, our maximum loss for
accounting purposes would have been approximately $190 million. Our economic loss, as measured by our potential
additional uncollateralized exposure, may be higher than the uncollateralized exposure of our derivatives if we were not able
to replace the defaulted derivatives in a timely fashion. We monitor the risk that our uncollateralized exposure to each of our
OTC counterparties for interest-rate swaps, option-based derivatives and foreign-currency swaps will increase under certain
adverse market conditions by performing daily market stress tests. These tests evaluate the potential additional uncollateral-
ized exposure we would have to each of these derivative counterparties assuming changes in the level and implied volatility
of interest rates and changes in foreign-currency exchange rates over a brief time period.
To date, we have not incurred any credit losses on OTC derivative counterparties or set aside speciÑc reserves for
institutional credit risk exposure. We do not believe such reserves are necessary, given our counterparty credit risk
management policies and collateral requirements.
OTC Forward Purchase and Sale Commitments Treated as Derivatives. Since the typical maturity for our OTC
commitments is less than one year, we do not require master netting and collateral agreements for the counterparties of these
commitments. However, we monitor the credit fundamentals of our OTC commitments counterparties on an ongoing basis
to ensure that they continue to meet our internal risk-management standards. As indicated in Table 35, the exposure to
OTC commitments counterparties of $35 million and $40 million at December 31, 2005 and 2004, respectively, was
uncollateralized.
Credit Risks
Our credit guarantee portfolio is subject primarily to two types of credit risk Ì mortgage credit risk and institutional
credit risk. Mortgage credit risk is the risk that a borrower will fail to make timely payments on a mortgage or security we
own or guarantee. Institutional credit risk is the risk that a counterparty that has entered into a business contract or
arrangement with us will fail to meet its obligations. See ""Table 46 Ì Total Mortgage Portfolio and Total Guaranteed PCs
and Structured Securities Issued Based on Unpaid Principal Balances'' for more information on the composition of our
Total mortgage portfolio.
Mortgage Credit Risk
Mortgage Credit Risk Management Strategies. Mortgage credit risk is primarily inÖuenced by the credit proÑle of
the borrower on the mortgage, the features of the mortgage itself, the type of property securing the mortgage and by the
general economy, especially the movement of house prices. To manage our mortgage credit risk, we focus on three key
areas: underwriting requirements and quality control standards; portfolio diversiÑcation; and portfolio management activities,
including loss mitigation, and the use of credit enhancements and credit risk transfers. While we have historically focused on
obtaining credit enhancements at the time of mortgage purchase, we are continuing to expand our capabilities in this area
to allow more active and ongoing credit portfolio rebalancing and risk transfers.
Underwriting Requirements and Quality Control Standards. All mortgages that we purchase or guarantee have an
inherent risk of default. We seek to manage the underlying risk in a given mortgage we securitize or purchase for our
Retained portfolio by adequately pricing for the risk we assume using our underwriting and quality control processes. We use
a process of delegated underwriting for the single-family mortgages we purchase or securitize. In this process, we provide
originators with a series of mortgage underwriting guidelines and they represent and warrant to us that the mortgages sold
to us meet these guidelines. We subsequently review a sample of these loans and, if we determine that any loan is not in
compliance with our underwriting standards, we may require the seller/servicer to repurchase that mortgage or make us
whole in the event of a default. We provide originators with written standards and/or automated underwriting software tools,
such as Loan Prospector» and other quantitative credit risk management tools that are designed to evaluate single-family
mortgages and monitor the related mortgage credit risk for loans we may purchase. Loan Prospector» generates a credit
risk classiÑcation by evaluating information on signiÑcant indicators of mortgage default risk, such as loan-to-value ratios,
credit scores and other mortgage and borrower characteristics. These statistically-based risk assessment tools increase our
ability to distinguish among single-family loans based on their expected risk, return and importance to our mission. We may
allow seller/servicers to underwrite mortgages for sale to us using other automated underwriting systems and agreed-upon
underwriting standards that diÅer from our normal standards.
The percentage of our single-family mortgage purchase volume evaluated using Loan Prospector»prior to purchase has
declined over the last three years. 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 classiÑcations inÖuence both the price we charge to guarantee loans and the loans we review
in quality control.
63 Freddie Mac