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* FHA faces risks even with latest cash raising-Donovan
* Safeguarding FHA capital could help private market grow
WASHINGTON, Feb 28 (Reuters) - The U.S. Federal Housing Administration faces "considerable risks" to its finances and the Obama administration will continue to scale back the agency's presence in the mortgage market, the top U.S. housing official said on Tuesday.
Housing and Urban Development Secretary Shaun Donovan told Congress that efforts to protect the FHA's dwindling capital reserves were not only important in their own right, but that they could open the door to more private mortgage funding.
"Despite the unprecedented efforts of the (Obama) administration to alter the trajectory of FHA, considerable risks remain," he told the Senate Banking Committee.
To create a more "robust private system of housing finance and protect the FHA fund for the future" the government will gradually reduce the mortgage-guarantee agency's presence in the market, Donovan added.
The FHA's share of the mortgage market has increased sharply since the depth of the financial crisis in 2008. It currently backs about a third of all new mortgages; in 2006, its share of the new loan market was just 5 percent.
Taking into account the big presence of Fannie Mae and Freddie Mac, the government now backs about nine of every 10 new home loans.
As the FHA's presence has grown, so has the strain on its finances. The agency's capital reserves hit a record low $2.6 billion last year, and Donovan said it faced challenges even taking into account recent steps to raise cash.
On Monday, the agency said it was increasing the up-front fees it charges on mortgages it insures in an effort to raise about $1.25 billion.
The U.S. housing market has begun to show some signs of life in recent weeks, although a report on Tuesday showed home prices fell a further 0.5 percent in December.
Prices have dropped about one-third from their 2006 peak and nearly 11 million Americans owe more than their homes are worth.
Democrats on the panel voiced support for efforts to help these underwater homeowners, while some Republicans took jabs at the recent $25 billion settlement between the government and the nation's largest lenders over foreclosure abuses.
Alabama Senator Richard Shelby, the leading Republican on the panel, suggested the settlement could be overly broad. "Homeowners who suffered no legal harm appear to be eligible for compensation," he said.
Donovan said court filings spelling out the terms of the settlement will be made public as soon as next week and will provide further clarity on who is being helped.
The settlement requires some banks to work with troubled homeowners to reduce principal on their loans.
In addition, the Obama administration has encouraged government-controlled mortgage giants Fannie Mae and Freddie Mac to write down principal on loans they guarantee - a case Donovan pressed on Tuesday.
The administration's plan has run into resistance from the Federal Housing Finance Agency, which oversees the two firms.
Under fire from Democrats at the hearing, FHFA Acting Director Edward DeMarco repeated his contention that allowing borrowers to defer payments through loan forbearance can provide as much relief to homeowners at less cost to taxpayers. Fannie Mae and Freddie Mac have already received $169 billion in government support.
"It is economically approximately the same thing," he said.
Pressed whether or not the two firms had independently evaluated principal writedowns, DeMarco said they had and had determined it was not in their best interest.
The administration has tried to entice DeMarco into allowing Fannie Mae and Freddie Mac to reduce principal by offering money from the government's financial bail-out fund as an incentive.
FHFA has yet to say whether the financial support is enough to offset any increased costs Fannie Mae and Freddie Mac might face if they undertake a principal reduction program.
Still, DeMarco did not back down from his defense that principal write-downs have proven to go against his duty of "preserving and conserving" the assets of the two firms.