NEW YORK – March 24, 2015 – Although the government-sponsored enterprises (GSEs) have been operating profitably for the last few years, adverse conditions could force the government to provide more draws in the future.

Following several consecutive years of earnings losses, Fannie Mae and Freddie Mac each returned to profitability in 2012.

But even though the improved financial performance is encouraging, it remains uncertain whether the pair of secondary lenders will remain in the black. That was according to "The Continued Profitability of Fannie Mae and Freddie Mac Is Not Assured" from the Federal Housing Finance Agency Office of Inspector General (OIG).

Because of the complex and cyclical nature of the mortgage industry, as well as sensitivity to changes economic conditions, mortgage rates, house prices, and other factors – Fannie and Freddie remain vulnerable.

The OIG said that both GSEs have publicly acknowledged that adverse market conditions and other changes could lead to additional losses. Such vulnerabilities could significantly impact earnings.

Among the challenges faced by Washington-based Fannie and McLean, Va.-based Freddie is the mandatory reduction in the size of their investment portfolios over the next few years. As the portfolios decline, so will income.

"These portfolios have been the enterprises' largest source of earnings in the past," the report stated.

The OIG noted that only 40 percent of net income in 2013 was derived from business segments – single-family guarantee, multifamily and investments. The rest came from non-recurring tax-related items and large settlements. Both of these revenue sources are unsustainable.

Last year, core earnings made up 55 percent of net income.

Another problem is that the mandatory Treasury dividend payments (from the GSEs into the federal government's general funds) that sweep accumulated equity makes it impossible for either firm to build up a financial cushion that would enable them to absorb future losses.

Fannie expects to remain profitable for the foreseeable future, though a decline in home prices or changes in interest rates could collude with a required reduction in its retained asset portfolio to create losses.

In a worst-case scenario like the financial crisis, the two companies would require additional Treasury draws of either $84.4 billion or $190 billion, depending on the treatment of tax assets.

Such a scenario could prompt the need for a Treasury draw.

"Absent congressional action, or a change in FHFA's current strategy, the conservatorships will go on indefinitely," the regulatory watchdog stated.

"The enterprises' future status is beyond their control. At present, it appears that congressional action will be needed to define what role, if any, the enterprises play in the housing finance system."

© 2015 Mortgage Daily