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Fannie and Freddie Stocks Are Still Hot (Update 4)

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 34% to close at $6.99. Freddie's preferred series Z shares, with a coupon of 5.375% and a par value of $25, were up over 6% trading to close at $3.20.

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.

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