Freddie Mac 2012 Annual Report Download - page 63

We are exposed to significant credit risk related to the subprime, Alt-A, and option ARM loans that back the non-agency
mortgage-related securities we hold.
Our investments in non-agency mortgage-related securities include securities that are backed by subprime, Alt-A, and
option ARM loans. As of December 31, 2012, we held $69.0 billion of such securities, which represented approximately
12% of our total mortgage-related investments portfolio. Since 2007, mortgage loan delinquencies and credit losses in the
U.S. mortgage market have substantially increased, particularly in the subprime, Alt-A, and option ARM sectors of the
residential mortgage market. In addition, home prices have experienced significant cumulative declines, after extended
periods during which home prices appreciated. As a result, the fair value of these investments has declined significantly since
2007, and we have recorded substantial other-than-temporary impairments, which has adversely impacted our net worth. In
addition, most of these investments do not trade in a liquid secondary market and the size of our holdings relative to normal
market activity is such that, if we were to attempt to sell a significant quantity of these securities, the pricing in such markets
could be significantly disrupted and the price we ultimately realize may be materially lower than the value at which we carry
these investments on our consolidated balance sheets.
We could experience additional GAAP losses due to other-than-temporary impairments on our investments in these
non-agency mortgage-related securities if, among other things: (a) interest rates change; (b) delinquency and loss rates on
subprime, Alt-A, and option ARM loans further increase; (c) there is a future decline in actual or forecasted home prices; or
(d) there is a deterioration in servicing performance on the underlying loans. In addition, the fair value of these investments
may decline in the future due to additional ratings downgrades or market events, including overall uncertainty related to
recovery efforts, capital requirements or regulatory changes. Any such declines would adversely affect our net worth. Any
credit enhancements covering these securities, including subordination and other structural enhancements, may not prevent
us from incurring losses. During 2012, we continued to experience the erosion of structural credit enhancements on many
securities backed by subprime, option ARM, and Alt-A loans due to poor performance of the underlying mortgages. The
financial condition of bond insurers also continued to deteriorate in 2012. See “MD&A — CONSOLIDATED BALANCE
SHEETS ANALYSIS — Investments in Securities” for information about the credit ratings for these securities and the extent
to which these securities have been downgraded.
Certain strategies to mitigate our losses as an investor in non-agency mortgage-related securities may adversely affect our
relationships with some of our largest seller/servicers and counterparties.
In 2011, FHFA, as Conservator for Freddie Mac and Fannie Mae, filed lawsuits against 18 corporate families of
financial institutions and related defendants seeking to recover losses and damages sustained by Freddie Mac and Fannie
Mae as a result of their investments in certain residential non-agency mortgage-related securities issued or sold by, or backed
by mortgages originated by, these financial institutions or control persons thereof. These institutions include some of our
largest seller/servicers and counterparties, including counterparties to debt funding and derivatives transactions. One of these
lawsuits was settled recently.
At the direction of our Conservator, we are also working to enforce contractual rights of certain trusts with respect to the
non-agency mortgage-related securities we hold, and are engaged in other efforts to mitigate losses on our investments in
these securities, in some cases in conjunction with other investors. We have directed the trustees of certain of these non-
agency mortgage-related securities to initiate litigation on behalf of certificate holders against several financial institutions
(many of whom are Freddie Mac counterparties) for breach of contract claims.
These and other loss mitigation efforts may lead to further disputes with some of our largest seller/servicers and
counterparties that may result in further litigation. This could adversely affect our relationship with any such company and
could, for example, result in the loss of some or all of our business with a large seller/servicer. For more information, see
“Our financial condition or results of operations may be adversely affected if mortgage seller/servicers fail to repurchase
loans sold to us in breach of representations and warranties or fail to honor any related indemnification or recourse
obligations” and “NOTE 15: CONCENTRATION OF CREDIT AND OTHER RISKS.”
The effectiveness of these various loss mitigation efforts is highly uncertain, in part because our rights as an investor are
limited, and any potential recoveries may take significant time to realize.
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