Freddie Mac 2012 Annual Report Download - page 136

Risk management is a critical aspect of our business. We manage risk through a framework whereby our executive
management is responsible for independent risk evaluation. Within this framework, executive management monitors
performance against our risk management strategies and established risk limits and reporting thresholds, identifies and
assesses potential issues and provides oversight regarding changes in business processes and activities. For information about
our Board’s role in oversight of risk management, see “CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS,
AND DIRECTOR INDEPENDENCE — Board Leadership Structure and Role in Risk Oversight.”
We utilize an internal economic capital framework and models to help inform our risk management process. Our
economic capital framework provides a risk-based measurement of capital to reflect relevant market, credit, counterparty,
and operational risks. We assign economic capital internally to asset classes based on their respective risks. We use economic
capital as an input to inform economic decisions, establish risk limits, measure profitability, and estimate fair values.
Overall, the legal, political and regulatory influences on the financial services industry have continued to create
significant challenges and, as a result, we believe that our risk profile remained elevated in 2012. Drivers of this continued
elevated risk are: (a) continued uncertainty in the mortgage industry, including the future structure of the U.S. housing
market; (b) continued pressure on mortgage seller/servicers, including changing practices in underwriting and foreclosure
processes as well as on-going litigation by federal agencies related to prior practices; and (c) continued deterioration of the
mortgage insurer sector, resulting in further concentration issues.
Internally, our environment has also contributed to an elevated risk profile. Management took actions in 2012 to
mitigate these risks. For a discussion of the operational risks we face, see “Operational Risks.”
We expect legal, political and regulatory influences to continue to be significant factors in 2013, which could further
increase uncertainty in the mortgage industry, increase our operational and people risks, or increase the uncertainty
associated with the use of our models.
Credit Risk
We are subject primarily to two types of credit risk: mortgage credit risk and institutional credit risk. Mortgage credit
risk is the risk that a borrower will fail to make timely payments on a mortgage we own or guarantee. We are exposed to
mortgage credit risk on our total mortgage portfolio because we either hold the mortgage assets or have guaranteed
mortgages in connection with the issuance of a Freddie Mac mortgage-related security, or other guarantee commitment.
Institutional credit risk is the risk that a counterparty that has entered into a business contract or arrangement with us will fail
to meet its obligations to us.
Mortgage Credit Risk
We are exposed to mortgage credit risk principally in our single-family credit guarantee and multifamily mortgage
portfolios because we either hold the mortgage assets or have guaranteed mortgages in connection with the issuance of a
Freddie Mac mortgage-related security, or other guarantee commitment. All mortgages that we purchase or guarantee have
an inherent risk of default. We are also exposed to mortgage credit risk related to our investments in non-Freddie Mac
mortgage-related securities. For information about our holdings of these securities, see “CONSOLIDATED BALANCE
SHEETS ANALYSIS — Investments in Securities — Mortgage-Related Securities.”
Single-Family Mortgage Credit Risk
Single-family mortgage credit risk is primarily influenced by the credit profile of the borrower of the mortgage (e.g.,
credit score, credit history, and monthly income relative to debt payments), documentation level, the number of borrowers,
the features of the mortgage itself, the purpose of the mortgage, occupancy type, property type and value, the LTV ratio, and
local and regional economic conditions, including home prices and unemployment rates.
We use a process of delegated underwriting for the single-family mortgages we purchase or securitize. In this process,
our contracts with seller/servicers describe mortgage underwriting standards and the seller/servicers represent and warrant to
us that the mortgages sold to us meet these standards. In our contracts with individual seller/servicers, we may waive or
modify selected underwriting standards. Through our delegated underwriting process, mortgage loans and the borrowers’
ability to repay the loans are evaluated using a number of critical risk characteristics, including, but not limited to, the
borrower’s credit score and credit history, the borrower’s monthly income relative to debt payments, the original LTV ratio,
the type of mortgage product, the property type and market value, and the occupancy type of the loan. Our single-family
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