Fannie and Freddie stocks are still hot

The shares of both bailed-out mortgage giants were up considerably in trading Wednesday, a day after both popped over 30%.

By TheStreet Staff Mar 20, 2013 12:44PM

thestreet logo Miniature home on sheet of percent signs copyright Comstock, Getty ImagesBy Philip van Doorn

 

The wild action continues for Fannie Mae (FNMA) and Freddie Mac (FMCC).

 

Shares of both government-sponsored mortgage giants popped over 30% in trading Wednesday, a day after both soared on the prospect that the recapture of massive deferred tax valuation allowances could point the way to the repayment of government bailout money. The two companies were taken under government conservatorship in September 2008.

 

Fannie Mae's shares rose 38% to close at 72 cents on Tuesday, after the Wall Street Journal called attention to a filing last Thursday, when the company said it would delay filing its annual 10-K report to the Securities and Exchange Commission.

 

Fannie said it would need extra time to analyze whether or not it could recapture some of its $64.1 billion valuation allowance for deferred tax assets (DTA), as of Dec. 31.

 

Fannie's shares were up 16% in early trading on Wednesday, to 83 cents.

 

Shares of Freddie Mac rose 35% on Tuesday to close at 70 cents. The shares were up 14% in early trading, to 80 cents.

 

As of Sept. 30, the government had $116.1 billion in preferred Fannie Mae shares, and Fannie had paid the Treasury $28.5 billion in dividends.

 

Fannie reported a third-quarter profit of $1.8 billion, which was the company's third consecutive profit. Earnings for the first three quarters of 2012 were $9.7 billion, compared to a net loss of $14.4 billion during the first three quarters of 2011. The company was also able to pay its third-quarter dividend of $2.9 billion in the Treasury's preferred shares, without resorting to further government borrowings.

 

Fannie in the first quarter benefited from a major settlement (see TheStreet) of a long-term dispute with Bank of America (BAC). The bank agreed to pay Fannie $3.6 billion in cash and roughly $6.75 billion to repurchase about 30,000 mortgage loans.

 

Freddie Mac filed its 2012 10-K on time, according to the SEC, on Feb. 28, saying its valuation allowance for deferred tax assets was $31.7 billion, as of Dec. 31. The government held $72.2 billion in Freddie Mac preferred shares at the end of 2012. Freddie earned $11 billion during 2012, swinging from a loss of $11 billion in 2011. The company paid $7.2 billion in dividends to the Treasury during 2012, for a total of $23.8 billion in dividends paid since the company was taken under conservatorship.

 

Bloomberg on Tuesday reported Freddie Mac has sued 15 banks for damages from the alleged manipulation of the London Interbank Offered Rate. The banks being sued include Bank of America, JPMorgan Chase (JPM) and Citigroup (C).

 

The Federal Housing Finance Agency in August amended the agreements between Fannie, Freddie and the Treasury, to "phase in a requirement for the Enterprises to pay as dividends their positive net worth every quarter." The FHFA went on to say "the change in the dividend structure also will affect quarterly payments to Treasury, potentially resulting in the Enterprises returning more money to federal taxpayers sooner. Indeed, because of accounting treatment, sustained profitability of the Enterprises could result in a one-time large dividend payment from each Enterprise to Treasury."

 

So both companies, Fannie and Freddie, are now profitable and earning enough to pay their preferred dividends to the government, and then some. Investors see value in the penny common stocks, with the possibility that the government-sponsored enterprises (GSEs) can be significantly recapitalized through the recapture of DTA, enabling them to redeem large portions of government-held preferred shares. If that happens, Fannie and Freddie will likely have sufficient earnings to fully repay the government.

 

Even the preferred shares of both firms are rising, and all preferred dividend payments -- save those being paid to Uncle Sam -- have been suspended since September 2008. Fannie's preferred series E shares, with a coupon of 5.10% and a par value of $50, were up over 4% on Tuesday to close at $5.20. An early update for the Fannie preferred shares was delayed. Freddie's preferred series Z shares, with a coupon of 5.375% and a par value of $50.00, were up 5% in early trading to $3.15, following a 3% gain on Tuesday.

 

Day traders can obviously make a quick gain, or take a quick loss, on the shares. For investors who can go in for a period of years, the common shares could eventually provide very large returns, if the GSEs manage to survive. The preferred shares are also intriguing, for investors who can stay committed for many years: If the dividends were ever resumed, the annual payout would come close to the current investment price, for an outrageously high yield.

 

In that event, the preferred prices would, of course, recover quite a bit, enabling a quick killing. It would be wonderful to face the quandary of taking a huge profit or sitting back and collecting a huge dividend yield, based on a paltry investment price for the preferred.

 

So the big question remains: Will Fannie and Freddie survive? Why not? They dominate the U.S. secondary mortgage market to a greater extent than ever. Both firms and the FHFA are likely to stick with much stricter underwriting, investment and risk management policies than they did during the real estate bubble.

 

Over four years after the bailout, neither President Obama nor Congress has pushed hard for true GSE reform. As House Financial Services Committee Chairman Jeb Hensarling (R., Texas) said at a hearing on Tuesday, reforming the mortgage finance system with a divided government will be "a heavy lift."

 

FHFA acting director Edward DeMarco said during testimony before the that the companies would not return to their previous private form, but he will not get a deciding vote on the future of the U.S. mortgage market. For now, investors see a light at the end of the tunnel, for Fannie and Freddie.

 

 

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