Fannie Mae and Freddie Mac executives warned that their solid first-quarter profits are unsustainable and the government-sponsored enterprises remain in a precarious condition because they are restricted from building capital.

The GSEs are required to pay all their profits to the government, under terms of the 2008 bailout and subsequent amendments, and so cannot retain earnings. Operating in their sixth year of conservatorship, Fannie and Freddie have no formal mechanism to raise capital. If there were another recession — or even, some say, a regional housing downturn — the GSEs might once again have to tap Treasury for a taxpayer-funded bailout. Legal settlements alone contributed to the majority of both GSEs' earnings in the first quarter, and without such one-time items, Fannie and Freddie earnings' power is questionable.

"We are faced with running this business with no cushion," Timothy Mayopoulos, Fannie's CEO, said on a first-quarter earnings conference call Thursday. "So it really is a challenging situation for us. We do remain exposed to external events that we do not control, such that if losses exceed our revenue in any given quarter we would have to make a draw on the Treasury Department because we have no capital cushion."

U.S. taxpayers, he said, are "still in the first loss position... and that's not the best approach long-term."

The GSE's predicament could provide some impetus to reform efforts. Lawmakers abruptly postponed an April 29 markup of legislation to unwind Fannie and Freddie and have not set a new date for legislation sponsored by Senate Banking Committee Chairman Tim Johnson, D — S.D., and Mike Crapo, R-ID. The Johnson-Crapo bill would establish a new secondary mortgage market backed by a government guarantee in the event of catastrophic losses. Private companies would be mandated to put up 10% first-loss capital.

The GSEs may not turn out to be the "cash cows" that some industry experts had expected, says David Stevens, the president and CEO of the Mortgage Bankers Association.

"It's a matter of fact that we're going to have recessions and the GSEs have no capital so they will clearly have to tap into Treasury at some point," Stevens says. "What today's earnings should tell us all is that the status quo may be the most dangerous and precarious place to be for those that worry about a government guarantee on 30-year mortgages."

Last year the GSEs got a boost to earnings from one-time items such as settlement agreements, tax asset relief, and lower provisions for loan losses because of strong home price appreciation. Those items are not expected to boost earnings from now on, raising concerns that the GSEs cannot survive just on guarantee fees from lenders.

"At some point we are going to have an economic cycle or there could be a regional recession, and the GSEs are going to need to take draws from Treasury because they have zero capital and cannot recapitalize," says Stevens. "Now that we've adjusted for a more normalized market, the GSEs may not even make the money that is required to pay a normal dividend."

Current g-fees are too low, said Don Layton, Freddie's CEO, on a separate conference call. A proposed fee hike in January was postponed while the GSEs' regulator and conservator, the Federal Housing Finance Agency, accepts public comments on the issue.

"If we had a regulatory capital regime roughly comparable to what exists for other large financial institutions — which is a big if — the g-fee earn a return that is less than what private investors would want," Layton said. "We do not have a formal capital regime at this time."

Fannie also said the massive drop in home lending this year has forced more lenders to remove some of the so-called credit overlays, or requirements above and beyond GSE guidelines, as they try to drum up sales. The removal of credit overlays, such as higher FICO scores, is part of a gradual and natural evolution to normal credit environment, the GSE said.

"As loan production falls, lenders are unable to fill capacity needs by sticking to overlays … so they are naturally incented to remove overlays," Mayopoulos said.

For the first quarter, Fannie reported net income of $5.3 billion, its ninth consecutive quarterly profit. It expects to repay the Treasury $5.7 billion by the end of June, bringing its cumulative payment to $126 billion, which is $10 billion more than it received in the 2008 bailout.

But Mayopoulos also warned: "In 2014 we are operating with a different market and different business conditions."

Freddie posted net income of $4 billion in the first quarter, its tenth consecutive quarterly profit. It will pay $4.5 billion to the Treasury by June, bringing its total payment to $86.3 billion, or $14 billion more than it received. But Freddie also said its recent level of earnings is "not sustainable over the long term."

Technically, Treasury still holds senior preferred stock and the GSEs' dividend payments do not actually reduce its prior draws during the bailout.

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