The new report from the Federal Housing Finance Agency’s Office of Inspector General says that while Fannie Mae and Freddie Mac returned to profitability in 2012, but that profitability is not a sure thing going forward.

The report notes that the mortgage industry is complex, cyclical, and sensitive to changes in economic conditions, mortgage rates, house prices, and other factors. “The enterprises have acknowledged in their public disclosures that adverse market and other changes could lead to additional losses and that their financial results are subject to significant variability from period to period,” the OIG says.

As noted by the Urban Institute, Freddie Mac’s profits are not pulling in the same results as its counterpart Fannie Mae, in addition to results being drastically lower than a couple years ago.

The significant drop has caused industry concern that it may be headed for another draw on Treasury, something both enterprises have avoided since 2012. Indeed, just last month the Wall Street Journal ran an article citing Freddie's results and quoting the CEO of Fannie, as reason behind the speculation.

Freddie Mac posted net income of $7.7 billion for the full-year 2014, compared to $48.7 billion for the full-year 2013. Freddie’s 2014 net income and comprehensive income declined from 2013 by $41 billion and $42.2 billion, respectively. 2013 results included an income tax benefit of $23.3 billion that primarily resulted from the release of the deferred tax asset valuation allowance in the third quarter of 2013.

On the other side, Fannie Mae reported annual net income of $14.2 billion and annual comprehensive income of $14.7 billion in 2014. This compares to net income of $84.0 billion and comprehensive income of $84.8 billion in 2013, which included the release of the company’s valuation allowance against its deferred tax assets.

The challenges the GSEs face, according to the OIG, are:

  • The Enterprises must reduce the size of their retained investment portfolios over the next few years pursuant to the terms of agreements with the U.S. Department of Treasury (Treasury) and additional limits from FHFA. Declines in the size of these portfolios will reduce portfolio earnings over the long term. These portfolios have been the Enterprises’ largest source of earnings in the past.
  • Core earnings from the Enterprises’ business segments—single-family guarantee, multifamily, and investments—comprised only 40% of net income in 2013. Sixty percent of the Enterprises’ net income came from non-recurring tax-related items and large settlements of legal actions and business disputes, which are not sustainable sources of revenue. Core earnings comprised 55% of net income in 2014.
  • The Enterprises are unable to accumulate a financial cushion to absorb future losses. Pursuant to the terms of agreements with Treasury, the Enterprises are required to pay Treasury each quarter a dividend equal to the excess of their net worth over an applicable capital reserve amount. The applicable capital reserve amount decreases to zero by January 1, 2018.
  • Stress test results released by the Federal Housing Finance Agency (FHFA) in April 2014 indicate that the Enterprises, under the worst scenario—a scenario generally akin to the recent financial crisis— would require additional Treasury draws of either $84.4 billion or $190 billion, depending on the treatment of deferred tax assets, through the end of the stress test period, which is the fourth quarter of 2015.
  • Absent Congressional action, or a change in FHFA’s current strategy, the conservatorships will go on indefinitely. 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.
  • Fannie Mae reports that it expects to remain profitable for the foreseeable future; however, it acknowledges that a decrease in home prices or changes in interest rates, combined with provisions of their agreements with Treasury that require the reduction of their retained asset portfolios, could lead to losses.1 Thus, if these losses result in an Enterprise reporting a negative net worth, that Enterprise would be obligated to draw on Treasury’s funding commitment.