Freddie Mac 2008 Annual Report Download - page 166

Institutional Credit Risk
Our primary institutional credit risk exposure arises from agreements with:
• mortgage seller/servicers;
• mortgage insurers;
• issuers, guarantors or third-party providers of credit enhancements (including bond insurers);
• mortgage investors and originators;
• institutional counterparties of investments held in our cash and other investments portfolio and such investments
managed for our PC trusts; and
• derivative counterparties.
A significant failure by a major entity in one of these categories to perform could have a material adverse effect on our
mortgage-related investments portfolio, cash and other investments portfolio or credit guarantee activities. The recent
challenging market conditions adversely affected, and are expected to continue to adversely affect, the liquidity and financial
condition of a number of our counterparties. For example, some of our largest mortgage seller/servicers have failed, and
others experienced ratings downgrades and liquidity constraints. Other of our counterparties may also experience similar
problems. The weakened financial condition and liquidity position of some of our counterparties, insurers and mortgage
seller/servicers may adversely affect their ability to perform their obligations to us, or the quality of the services that they
provide to us. Consolidation in the industry could further increase our exposure to individual counterparties. In addition, any
efforts we take to reduce exposure to financially weakened counterparties could result in increased exposure to a smaller
number of institutions. During 2008, we terminated our arrangements with certain mortgage seller/servicers due to their
failure to meet our eligibility requirements and we continue to closely monitor the eligibility of mortgage seller/servicers
under our standards.
During the third quarter of 2008, we recorded a loss of $1.1 billion related to the Lehman short-term lending
transactions. In addition, we had trading relationships or otherwise conducted business with Lehman and several of its
affiliates, which gave rise to various claims that we may have with respect to Lehman and its affiliates. See “Derivative
Counterparty Credit Risk” and “Mortgage Seller/Servicers” for additional information about our exposure to Lehman and its
affiliates. We also recognized increased provision for loan losses during 2008 as a result of institutional counterparties that
failed to pay us or for which we have substantial uncertainty regarding their ability to perform on their obligations to us. The
failure of any other of our primary counterparties to meet their obligations to us could have additional material adverse
effects on our results of operations and financial condition.
Mortgage Seller/Servicers
We acquire a significant portion of our mortgage loans from several large lenders. These lenders, or seller/servicers, are
among the largest mortgage loan originators in the U.S. We are exposed to institutional credit risk arising from the
insolvency or non-performance by our mortgage seller/servicers, including non-performance of their repurchase obligations
arising from the representations and warranties made to us for loans they underwrote and sold to us. Under our agreements
with mortgage seller/servicers, we have the right to request that mortgage seller/servicers repurchase mortgages sold to us if
those mortgages do not comply with those agreements. As a result, our mortgage seller/servicers repurchase noncomplying
mortgages sold to us, or indemnify us against losses on those mortgages, whether we securitized the loans or held them in
our mortgage-related investments portfolio. During 2008 and 2007, repurchases of single-family mortgages by our mortgage
seller/servicers (without regard to year of original purchase) were approximately $1.8 billion and $681 million of unpaid
principal, respectively. When a mortgage seller/servicer repurchases a mortgage that is securitized by us, our guarantee asset
and obligation are extinguished similar to any other form of liquidation event for our PCs. However, when we have a seller/
servicer repurchase a noncomplying mortgage after we have repurchased it from the PC pool under our performance
guarantee, we remove the carrying value of our related mortgage asset and recognize recoveries on loans impaired upon
purchase.
The servicing fee charged by mortgage servicers varies by mortgage product. In order to compensate our seller/servicers
for their servicing duties, we generally require them to retain a minimum percentage fee for mortgages serviced on our
behalf, typically 0.25% of the unpaid principal balance of the mortgage loans. However, on an exception basis, we allow a
lower minimum servicing amount. The credit risk associated with servicing fees relates to whether, if a servicer is unable to
fulfill its repurchase or other responsibilities, we could sell the applicable servicing rights to a successor servicer and recover,
from the sale proceeds, amounts owed to us by the defaulting servicer. Previously, we believed that the value of those
servicing rights generally provided us with significant protection against our exposure to a seller/servicer’s failure to perform
its repurchase obligations. Under current market conditions, it is less likely that a buyer of servicing rights will be willing to
assume the responsibility of the defaulting servicer for representations and warranties about the eligibility of the mortgages
at the time of their sale to us. This might necessitate that we accept a price for the servicing rights that does not cover all
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