* Fannie Mae posts fourth quarter profit of $1.3 billion
* Firm will make smallest dividend payment to taxpayers since 2010
* CEO sees risks it could need to draw from the Treasury (Adds comments by firm CEO)
By Jason Lange
WASHINGTON, Feb 20 (Reuters) - Fannie Mae will make its smallest payment to taxpayers in more than four years after large derivatives losses crimped its fourth-quarter profit, the government-controlled mortgage financier said on Friday.
Fannie Mae said a drop in long-term interest rates sharply reduced the value of the derivatives contracts it uses as hedges in financial markets, adding that low capital buffers are raising the risk it could need taxpayer money in the future.
The derivatives losses helped reduce quarterly profit to $1.3 billion, about 80 percent less than a year earlier, and the $1.9 billion check that Fannie Mae will cut for the Treasury in March will be the smallest since the second quarter of 2010.
"Because we will have an ever smaller cushion to absorb losses, the possibility of our need to take a draw from Treasury increases over time," Tim Mayopoulos, Fannie Mae's chief executive, said in a call with journalists.
Fannie Mae, the nation's largest source of mortgage fund, and its sister firm Freddie Mac were bailed out by the government at the height of the financial crisis in 2008. Under the terms of their rescue, they are required to sweep their profits into the Treasury, a provision being challenged in court by several groups of investors.
The sensitivity of the firms' profits to financial market swings underscores the risk that they could have to draw taxpayer aid again, as the bailout rules limit how much capital they can hold in reserve.
Even so, rising interest rates can help the firm's profits by boosting the value of its derivatives, a scenario many analysts see as likely given expectations the Federal Reserve will begin a cycle of interest rate hikes this year.
Mayopoulos said Fannie Mae expects to remain profitable on an annual basis for the foreseeable future, but changes in rates could lead to "significant" swings in quarterly results.
The possibility of another taxpayer draw raises pressure on the U.S. Congress to overhaul housing finance laws, although a real push on legislation is not expected anytime soon.
Taxpayers pumped $116.1 billion into Fannie Mae following the U.S. housing market collapse, while Freddie Mac was propped up with $71.3 billion.
Like Fannie Mae, Freddie Mac was also hit by derivatives losses in the fourth quarter, which led to its smallest quarterly dividend payment since 2009.
Both firms have already paid in dividends more than they received in aid. Once payments related to their fourth-quarter earnings are made, they will have forked over about $228 billion between them. (Reporting by Jason Lange; Editing by Chizu Nomiyama, Lisa Von Ahn and Meredith Mazzilli)