Freddie Mac 2006 Annual Report Download - page 92

credit risk in this portfolio. We regularly evaluate these investments to determine if any impairment in fair value requires an
impairment loss recognition in earnings, warrants divestiture or requires a combination of both.
OFF-BALANCE SHEET ARRANGEMENTS
We enter into certain business arrangements that are not recorded on our consolidated balance sheets or may be
recorded in amounts that diÅer from the full contract or notional amount of the transaction. Most of these arrangements
relate to our Ñnancial guarantee and securitization activity for which we record guarantee-related assets and obligations, but
the related securitized assets are owned by third parties. See ""CRITICAL ACCOUNTING POLICIES AND
ESTIMATES Ì Issuances and Transfers of PCs and Structured Securities'' for more discussion of oÅ-balance sheet
arrangements. These oÅ-balance sheet arrangements may expose us to potential losses in excess of the amounts recorded on
our consolidated balance sheets.
Guarantee of PCs and Structured Securities
As discussed in ""BUSINESS Ì Business Activities Ì Credit Guarantee Activities,'' we guarantee the payment of
principal and interest on issued PCs or Structured Securities. Mortgage-related assets that back PCs and Structured
Securities held by third parties are not reÖected as our assets, unless we retained or repurchased an interest in the PCs that
back Structured Securities that were issued and sold to third parties.
We manage the risks of our credit guarantee activity carefully, sharing the risk in some cases with third parties through
the use of primary loan-level mortgage insurance, pool insurance and other credit enhancements. ""NOTE 4: FINANCIAL
GUARANTEES'' of our consolidated Ñnancial statements provides information about our guarantees, including details
related to credit protections and maximum coverages that we obtain through credit enhancements. Also, see ""RISK
MANAGEMENT Ì Credit Risks'' for more information.
Credit guarantee activity also occurs through the Guarantor Swap program in the form of mortgage swap transactions.
In a mortgage swap transaction, a mortgage lender delivers mortgages to us in exchange for our guaranteed PCs that
represent undivided interests in those same mortgages. We receive various forms of consideration in exchange for providing
our guarantee on issued PCs, including (a) the contractual right to receive a management and guarantee fee, (b) delivery
or credit fees for higher-risk mortgages and (c) other forms of credit enhancements received from counterparties or
mortgage loan insurers.
Credit guarantee activity also occurs through our Cash Window and our MultiLender Swap program. Single-family
mortgage loans we purchase for cash through the Cash Window are typically either retained by us in our Retained portfolio
or pooled together with other single-family mortgage loans we purchase in connection with PC swap-based transactions in
our MultiLender Program executed with various lenders. We may issue such PCs to these lenders in exchange for the
mortgage loans we purchase from them or, to the extent these loans are pooled with loans purchased for cash, we may sell
them to third parties for cash consideration through an auction.
In addition to the issuance and transfer of PCs to third parties, we also sell PCs from our Retained portfolio in
resecuritized form. We issue single- and multi-class Structured Securities that are backed by securities held in our Retained
portfolio and subsequently transfer such Structured Securities to third parties in exchange for cash, PCs or other mortgage-
related securities. We generally earn resecuritization fees in connection with the creation of Structured Securities and can
earn an ongoing management and guarantee fee for certain issued Structured Securities. Our principal credit risk exposure
on Structured Securities relates only to that portion of resecuritized assets that consists of non-Freddie Mac mortgage-
related securities. For information about our purchase, securitization and resecuritization activities, see ""PORTFOLIO
BALANCES AND ACTIVITIES.''
Our maximum potential exposure to credit losses relating to our outstanding guaranteed mortgage-related securities
held by third parties is primarily represented by the unpaid principal balance of those securities, which was $1,123 billion as
of December 31, 2006. Based on our historical credit losses, which in 2006 averaged approximately 1.4 basis points of the
balance of guaranteed securities outstanding (including those owned in our Retained portfolio), we do not believe that the
maximum exposure is representative of our actual exposure on these guarantees. The maximum exposure does not take into
consideration the recovery we would receive through exercising our rights to the collateral backing the underlying loans nor
the available credit enhancements, which includes recourse and primary insurance with third parties.
The accounting policies and fair value estimation methodologies we apply to our credit guarantee activities signiÑcantly
aÅect the volatility of our reported earnings. See ""CONSOLIDATED RESULTS OF OPERATIONS Ì Non-Interest
Income (Loss)'' for an analysis of the eÅects on our consolidated statements of income related to our credit guarantee
activities. See ""CONSOLIDATED BALANCE SHEETS ANALYSIS'' for a description of our Guarantee asset and
Guarantee obligation. The accounting for our securitization transactions and the signiÑcant assumptions used to determine
80 Freddie Mac