Freddie Mac 2008 Annual Report Download - page 44

Competitive and Market Risks
The future growth of our mortgage-related investments portfolio is significantly limited under the Purchase Agreement
and by FHFA regulation, which will result in greater reliance on our guarantee activities to generate revenue.
Under the Purchase Agreement and FHFA regulation, our mortgage-related investments portfolio as of December 31,
2009 may not exceed $900 billion, and must decline by 10% per year thereafter until it reaches $250 billion. In addition,
under the Purchase Agreement, without the prior consent of Treasury, we may not increase our total indebtedness above a
specified limit or become liable for any subordinated indebtedness. These limitations will reduce the earnings capacity of our
mortgage-related investments portfolio business and require us to place greater emphasis on our guarantee activities to
generate revenue. However, under conservatorship, our ability to generate revenue through guarantee activities may be
limited, as we may be required to adopt business practices that provide support for the mortgage market in a manner that
serves public policy and other non-financial objectives, but that may negatively impact our financial results. The cap on our
mortgage-related investments portfolio may force us to sell mortgage assets at unattractive prices and may prevent us from
purchasing mortgage assets at attractive prices.
We are subject to mortgage credit risks; increased credit costs related to these risks could adversely affect our financial
condition and/or results of operations.
We are exposed to mortgage credit risk within our single-family mortgage portfolio, which includes mortgage loans,
PCs, Structured Securities and other mortgage guarantees we have issued in our guarantee business. Mortgage credit risk is
the risk that a borrower will fail to make timely payments on a mortgage or an issuer will fail to make timely payments on a
security we own or guarantee, exposing us to the risk of credit losses and credit-related expenses. Factors that affect the level
of our mortgage credit risk include the credit profile of the borrower, the features of the mortgage loan, the type of property
securing the mortgage, and local and regional economic conditions, including regional increases in unemployment rates and
falling home prices. While mortgage interest rates have decreased since the middle of 2008, many borrowers may not be able
to refinance into lower interest mortgages due to substantial declines in home values and market uncertainty. Therefore, there
can be no assurance that a further decrease in mortgage interest rates or efforts to refinance mortgages pursuant to the HASP
will result in a decrease in our overall mortgage credit risk.
Alt-A loans made up approximately 10% and 11% of our single-family mortgage portfolio in 2008 and 2007,
respectively, but accounted for approximately 50% and 18% of our credit losses in 2008 and 2007, respectively. See
“MD&A — CONSOLIDATED BALANCE SHEETS ANALYSIS — Mortgage-Related Investments Portfolio — Higher Risk
Components of our Mortgage-Related Investments Portfolio” for information on our classification of loans and asset-backed
mortgage-related securities as Alt-A. Interest-only loans and option ARM loans made up approximately 10% of our single-
family mortgage portfolio in both 2008 and 2007. Our purchases of these mortgages and issuances of guarantees of them
expose us to greater credit risks than do other types of mortgages. Our holdings of these loan groups are concentrated in the
West region where home prices have experienced steep declines, accounting for 45% of our credit losses in 2008. We have
also experienced increases in delinquency rates for prime mortgages, due to deteriorating housing prices and increasing
unemployment rates. In addition, for a significant percentage of the mortgages we purchase, we agreed to permit our seller/
servicers to underwrite the loans using alternative automated underwriting systems. These alternative systems may use
different standards than our own, including, in some cases, lower standards with respect to borrower credit characteristics.
Those differences may increase our credit risk and may result in increases in credit losses. Furthermore, due to our relative
lack of experience in the jumbo mortgage market, purchases pursuant to the high-cost conforming loan limits may also
expose us to greater credit risks.
We are exposed to increased credit risk related to subprime, Alt-A and MTA loans that back our non-agency mortgage-
related securities investments.
We have invested in non-agency mortgage-related securities that are backed by subprime, Alt-A and Moving Treasury
Average, or MTA, loans, which are a type of option ARM. Our non-agency mortgage-related securities backed by subprime
and Alt-A and other loans do not include a significant amount of option ARMs. Throughout 2008 and continuing into 2009,
mortgage loan delinquencies and credit losses in the U.S. mortgage market have substantially increased, particularly in the
subprime, Alt-A and MTA sectors of the residential mortgage market. In addition, home prices have continued to decline,
after extended periods during which home prices appreciated. If delinquency and loss rates on subprime, Alt-A and MTA
loans continue to increase, or there is a further decline in home prices, we could experience additional GAAP losses due to
other-than-temporary impairments on our investments in these non-agency mortgage-related securities. If Congress enacts
legislation allowing bankruptcy judges to reduce the loan balance of mortgage loans, this could also result in additional
other-than-temporary impairments. In addition, the fair value of these investments has declined and may decline further due
to additional ratings downgrades or market events. Any credit enhancements covering these securities, including
subordination, may not prevent us from incurring losses. These factors could negatively affect our financial position and net
41 Freddie Mac