Freddie Mac 2015 Annual Report Download - page 25

Management's Discussion and Analysis Consolidated Results of Operations | Provision for Credit Losses
Freddie Mac 2015 Form 10-K 23
BENEFIT (PROVISION) FOR CREDIT LOSSES
EXPLANATION OF KEY DRIVERS OF PROVISION FOR CREDIT LOSSES
The benefit (provision) for credit losses predominantly relates to single-family loans and includes
components for both collectively impaired loans and individually impaired loans.
• Collectively impaired loans - The provision for collectively impaired loans is primarily driven by the
volume of newly delinquent loans and changes in estimated probabilities of default and estimated
loss severities for the loans. Estimated probabilities of default and estimated loss severities are based
on current conditions and historical data and are heavily influenced by changes in home prices, but
are also affected by a number of other factors, such as local and regional economic conditions,
changes in reperformance and default rates, and the success of our borrower assistance programs.
• Individually impaired loans - The provision for individually impaired loans is primarily driven by the
volume of our loss mitigation activity (e.g., loan modifications) that results in loans being considered
TDRs, the payment performance of our individually impaired mortgage portfolio, and changes in
estimated probabilities of default and estimated loss severities, which affect the future cash flows we
expect to receive from these loans. Estimated probabilities of default and estimated loss severities for
individually impaired loans are based on the same current conditions and historical data and are
affected by the same factors noted above for collectively impaired loans.
As we continue to perform loss mitigation activities that result in loans being considered individually
impaired, the portion of our allowance for loan losses and provision for credit losses related to collectively
impaired loans continues to decline.
Our allowance for loan losses and provision for credit losses are significantly affected by the "interest rate
concessions" we make on loans that we have modified (i.e., reductions in the contractual interest rate).
When a loan is modified and considered individually impaired, we generally measure impairment based
on the present value of the expected future cash flows discounted at the loan’s original effective interest
rate. Under this methodology, we record a loss at the time a loan is modified equal to the difference in the
present value of expected cash flows resulting from the change in the modified loan’s contractual interest
rate, which increases the provision for credit losses in that period. When a modified loan subsequently
performs according to its new contractual terms and we receive the new contractual cash flows (i.e.,
principal and interest payments), a portion of the discount that was previously applied to those cash flows
is amortized into earnings each period and is recognized as a reduction in the provision for credit losses
in the period in which the cash flows are received. We refer to this reduction in the provision for credit
losses as the "amortization of interest rate concessions."
Our provision for credit losses and the amount of charge-offs that we record in the future will be affected
by a number of factors, such as the actual level of loan defaults; the effect of loss mitigation efforts; any
government actions or programs that affect the ability of borrowers to refinance loans with an LTV ratio
greater than 100% or obtain modifications; changes in property values; regional economic conditions,
including unemployment rates; additional delays in the foreclosure process; and third-party mortgage
insurance coverage and recoveries.