Freddie Mac 2006 Annual Report Download - page 79

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
rely on third-party appraisals and environmental and engineering reports. Beginning in 2007, we also expect to begin a
program of delegated underwriting for certain multifamily mortgages we purchase or securitize.
Credit Enhancements. Our charter requires that single-family mortgages with loan-to-value ratios above 80 percent at
the time of purchase must be covered by one or more of the following: (a) primary mortgage insurance; (b) a seller's
agreement to repurchase or replace any mortgage in default (for such period and under such circumstances as we may
require); or (c) retention by the seller of at least a 10 percent participation interest in the mortgages. 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 enhancements. 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.
At December 31, 2006 and 2005, credit-enhanced single-family mortgages and mortgage-related securities represented
approximately 16 percent and 17 percent of the $1,541 billion and $1,395 billion, respectively, unpaid principal balance of
the Total mortgage portfolio, excluding non-Freddie Mac mortgage-related securities and that portion of issued Structured
Securities that is backed by Ginnie Mae CertiÑcates. We exclude non-Freddie Mac mortgage-related securities because
they expose us primarily to institutional credit risk. We exclude that portion of Structured Securities backed by Ginnie Mae
CertiÑcates because the incremental credit risk to which we are exposed is considered de minimis. See ""CONSOLI-
DATED BALANCE SHEETS ANALYSIS Ì Table 19 Ì Characteristics of Mortgage Loans and Mortgage-Related
Securities in the Retained Portfolio'' for additional information about our non-Freddie Mac mortgage-related securities. Our
ability and desire to expand or reduce the portion of our Total mortgage portfolio with credit enhancements will depend on
our evaluation of the credit quality of new business purchase opportunities, the risk proÑle of our portfolio and the future
availability of eÅective credit enhancements at prices that permit an attractive return. While the use of credit enhancements
reduces our exposure to mortgage credit risk, it increases our exposure to institutional credit risk.
Primary mortgage insurance is the most prevalent type of credit enhancement protecting our Total mortgage portfolio
and is typically provided on a loan-level basis for certain single-family mortgages. Primary mortgage insurance transfers
varying portions of the credit risk associated with a mortgage to a third-party insurer. The amount of insurance we obtain on
any mortgage depends on our requirements and on 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.
The second most prevalent type of credit enhancement that we use is pool insurance. Pool insurance provides insurance
on a pool of loans up to a stated aggregate loss limit. 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.
As of December 31, 2006 and 2005, in connection with PCs and Structured Securities backed by single-family
mortgage loans, we had maximum coverage totaling $30.7 billion and $27.5 billion, respectively, in primary mortgage
insurance. Other forms of credit enhancements on single-family mortgage loans include indemniÑcation agreements (under
which we may require a lender to reimburse us for credit losses realized on mortgages), government guarantees, collateral
(including cash or high-quality marketable securities) pledged by a lender, excess interest and subordinated security
structures. As of December 31, 2006 and 2005, in connection with PCs and Structured Securities backed by single-family
mortgage loans, we had maximum coverage totaling $8.9 billion and $5.6 billion, respectively, in recourse to lenders and
$3.2 billion and $3.4 billion, respectively, in other credit enhancements.
We occasionally use credit enhancements to mitigate risk on multifamily mortgages. The types of credit enhancements
used for multifamily mortgage loans include recourse, third-party guarantees or letters of credit, cash escrows, subordinated
participations in mortgage loans or structured pools, sharing of losses with sellers, and cross-default and cross-
collateralization provisions. Cross-default and cross-collateralization provisions typically work in tandem. 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. In cases where the borrower
agrees to cross-collateralization, 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 its speciÑed 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
67 Freddie Mac