* FHA financial audit expected this week
* Mounting losses could lead FHA to tap Treasury for funds
* The mortgage insurer supports about $1.1 trillion in loans
WASHINGTON, Nov 13 (Reuters) - The U.S. Federal Housing Administration, weighed down by losses on souring loans, will release a report on its finances later this week that could point up the possibility it may require taxpayer aid for the first time in its 78-year history.
The annual analysis, overseen by an independent auditor, will calculate the solvency of the FHA's mortgage insurance fund under a range of economic assumptions.
The FHA has nearly exhausted its reserves for the more than $1.1 trillion in mortgages that it insures, though officials at the agency have repeatedly said that it could avoid turning to the Treasury Department for cash injections.
Critics maintain taxpayers could soon be on the hook if losses continue to mount at the agency, a key source of funding for first-time home buyers and those with modest incomes. FHA's cash reserves fell to a record low of $2.6 billion last year.
Republicans are likely to cry foul if the report points to a growing need for a cash infusion, although consumer advocates say the support the agency has given to low-income borrowers and the housing market as a whole has been worthwhile.
"The agency has managed a balancing act by financing affordable housing and at the same time trying to maintain a sound book of business," said James Carr, a senior policy fellow at Opportunity Agenda, a low-income advocacy group. "While the FHA has taken responsible actions to avert a larger financial hole, the report could indicate they need to draw from Treasury."
The FHA, which offers private mortgage lenders guarantees against homeowner default, increased its share of the home loan market when the housing bubble burst, more than tripling its loan portfolio. It now insures about one-third of all U.S. mortgages, up from about 5 percent in 2006.
FHA-backed loans made from 2005 to 2008 have eaten away at its cash reserves. The agency has struggled to manage the growing glut of delinquencies on home mortgages it insured during the housing crisis, and some analysts say profits on loans guaranteed over the past three years may not be enough to make up for those losses.
The FHA is legally required to keep a 2 percent capital ratio, which is a measure of the fund's ability to withstand losses. It has failed to meet that target for three straight years.
Edward Pinto, a former official at mortgage finance heavyweight Fannie Mae, believes the FHA is underestimating its future losses and that its growth strategy is problematic.
"A substantial portion of their loans continues to be high risk," said Pinto, a resident fellow at the conservative American Enterprise Institute. "While they've been trying to dig themselves out of this hole, to some extent the hole has gotten deeper."
The FHA has never needed an infusion of funds from the Treasury because it has been able to take other actions, including raising insurance premiums, to stay solvent. Those premiums help cover the costs related to defaulted mortgages, and it is possible the agency could raise them again to shore up its finances instead of turning to taxpayers.
The FHA avoided the need for a taxpayer bailout earlier this year because it received an almost $1 billion payment from a U.S. settlement with mortgage servicers on claims of lending abuses.
An audit last year said the FHA faced a nearly 50 percent chance of needing a bailout, leading Republican lawmakers to express alarm over the agency's precarious financial condition. They worried the FHA could become like Fannie Mae and Freddie Mac, the mortgage companies the government rescued in 2008 that have absorbed nearly $190 billion in taxpayer funds.
The divide over the government's role in the market will be a major hurdle for policymakers when they eventually revamp the U.S. housing finance system.
Analysts say FHA insolvency is not a sure bet, and supporters of the agency cite the role it has played in filling the gap left by the exit of private lenders and the drying up of credit when home prices fell sharply.
"They tend to take on risky loans, but what they have done over the last few years is still a good thing. They have stabilized the market," said Robert Van Order, a professor at George Washington University. "Going forward, they will have to realize their losses, which are a lot less than banks and what Fannie and Freddie have cost.