(Updated from 6:00 a.m. ET with Fannie Mae's earnings Tuesday)
NEW YORK ( TheStreet) -- Expectations that Fannie Mae (FNMA) and Freddie Mac (FMCC) will pay out on their preferred shares is "total fantasy," says Brian Gardner, senior vice president of Washington Research at KBW.
"The companies are not returning to their former status," Gardner said in an interview with TheStreet on Monday. A political change after the mid-term elections might change things two years from now, but the KBW analyst says there's broad consensus to wind the agencies down or replace them with something else.
Betting on a scenario where the agencies make a payment on the preferred shares is "highly speculative," Gardner added. "It's based on some good financial analysis but it disregards political reality."Fannie Mae reported earnings Tuesday morning, posting a record $17.2 billion profit, reversing its nearly $17 billion loss in 2011, on the back of a housing recovery. "We expect to remain profitable for the foreseeable future and return significant value to taxpayers." Susan McFarland, executive vice president and chief financial officer said in a statement. The agency also said it expects to release the valuation allowance on its deferred tax asset as early as the first quarter of 2013. Fannie Mae had a valuation allowance of $58.9 billion as of Dec. 31, 2012.
The recapture of Fannie's DTA would provide a major boost to the company's effort to redeem about $117 billion in preferred stock held by the U.S. Treasury, for bailout assistance since September 2008. Fannie Mae's shares were up over 18% in early trading Tuesday, to 84 cents. Freddie Mac's shares were up 14% to 87 cents. Preferred shares of both mortgage giants have also been quite volatile. For example, Fannie's preferred series E (FNMFM) shares, with a par value of $50.00 and a coupon of 5.10%, were up 46% in early trading to $0.50. Freddie Mac's preferred series Z (FMCKJ) shares, with a coupon of 5.375% and a par value of $25, were up 15% in early trading, to $3.90. Both common shares and preferred shares of Fannie Mae and Freddie Mac have jumped in recent weeks, amid speculation that the government-sponsored enterprises might soon be able to repay the Treasury, and also have some money left over for shareholders who were wiped-out in the 2008 bailout.
Some hedge funds have held on to preferred shares of the housing giants on a political bet that the government will stop seizing all the profits of Fannie and Freddie and show some willingness to make payments to preferred shareholders. The preferred shares are seen as a better bet than common shares, which have the lowest priority in the order of repayment.
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