Freddie Mac 2006 Annual Report Download - page 118

We recognize interest on mortgage loans on an accrual basis, except when we believe the collection of principal or interest is
doubtful. See ""Non-Performing Loans'' for additional information.
Held-for-sale mortgages are reported at lower-of-cost-or-market, on a portfolio basis, with gains and losses reported in
Gains (losses) on investment activity. Premiums and discounts on loans classiÑed as held-for-sale are not amortized during
the period that such loans are classiÑed as held-for-sale. For a description of how we determine the fair value of our held-
for-sale mortgage loans, see ""NOTE 16: FAIR VALUE DISCLOSURES.''
Mortgage loans that we have the ability and intent to hold for the foreseeable future or to maturity are classiÑed as held-
for-investment. These mortgage loans are reported at their outstanding principal balances, net of deferred fees (including
premiums and discounts). These deferred items are amortized into interest income over the estimated lives of the
mortgages using the eÅective interest method. We use actual prepayment experience and estimates of future prepayments to
determine the constant yield needed to apply the eÅective interest method. For purposes of estimating future prepayments,
the mortgages are aggregated by similar characteristics such as origination date, coupon and maturity.
Reserves for Losses on Mortgage Loans Held-for-Investment and Losses on PCs
We maintain a reserve for losses on mortgage loans held-for-investment to provide for credit losses inherent in that
portfolio. We also maintain a reserve for guarantee losses on PCs to provide for credit losses inherent in mortgages underlying
PCs or Structured Securities held by third parties. The reserve for losses on mortgage loans held-for-investment and the
reserve for guarantee losses on PCs and Structured Securities held by third parties are collectively referred to as ""loan loss
reserves.'' Increases in loan loss reserves are reÖected in earnings as a component of the Provision for credit losses.
Decreases in loan loss reserves are reÖected through (a) charging-oÅ such balances (net of recoveries) when realized losses
are recorded or (b) a reduction in the Provision for credit losses.
Upon sale of PCs or Structured Securities, we re-establish a Guarantee obligation, which includes the consideration of
inherent credit losses. Also, upon sale, we recognize incurred losses as a component of Gains (losses) on investment activity.
Single-family loan portfolio Ì We estimate credit losses on homogeneous pools of single-family loans using statisti-
cally-based models that evaluate a variety of factors. The homogeneous pools of single-family mortgage loans are determined
based on common underlying characteristics, including year of origination, loan-to-value ratio and geographic region. In
determining the loan loss reserves for impaired single-family loans at the balance sheet date, we evaluate factors including:
‚ the year of loan origination;
‚ geographic location;
‚ actual and estimated amounts for loss severity trends for similar loans;
‚ default experience;
‚ expected proceeds from credit enhancements;
‚ pre-foreclosure real estate taxes and insurance; and
‚ estimated costs should the underlying property ultimately be foreclosed upon and sold.
Our best estimate of each of these factors is used to estimate the amount of our probable loss at the balance sheet date.
Favorable trends in these factors decrease our estimate of probable losses, while negative trends increase our estimate.
We frequently validate and update the models and factors to capture changes in actual loss experience, as well as
changes in underwriting practices and in our loss mitigation strategies. We also consider macroeconomic and other factors
including regional housing trends, applicable home price indices, unemployment and employment dislocation trends,
consumer credit statistics, recent changes in credit underwriting practices, the extent of third party insurance, and other
measurable factors that inÖuence the quality of the portfolio at the balance sheet date. We then adjust the loan loss reserves
to the level required based on our best assessment of these factors.
Multifamily loan portfolio Ì We estimate credit losses on the multifamily loan portfolio based on all available
evidence, including adequacy of third-party credit enhancements, evaluation of the repayment prospects, and fair value of
collateral underlying the individual loans. The review of the repayment prospects and value of collateral underlying
individual loans is based on property-speciÑc and market-level risk characteristics including apartment vacancy rates,
apartment rental rates, and property sales information. Loans individually evaluated for impairment include loans that
become 60 days past due for principal and interest, certain loans with observable collateral deÑciencies and loans whose
contractual terms were modiÑed due to credit concerns. When loan loss reserves for individual loans are established,
consideration is given to all available evidence, such as the present value of discounted expected future cash Öows, fair value
of collateral, and credit enhancements.
106 Freddie Mac