Fannie, Freddie: Winners on Bailout Payback Hopes

NEW YORK ( TheStreet) -- Fannie Mae ( FNMA) and Freddie Mac ( FMCC) were the big winners on Tuesday, among major U.S. financial companies.

Fannie Mae's shares were up 33% to close at 69 cents, while Freddie Mac's shares rose 30% to close at 66 cents. Shares of both government-sponsored mortgage giants pulled back from earlier gains of over 40%. The stocks popped early on Tuesday, after the Wall Street Journal brought attention to Fannie's filing last Thursday, saying the company would delay filing its annual 10-K report to the Securities and Exchange Commission.

Fannie delayed the 10-K in order to buy time needed 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.

Both Fannie Mae and Freddie Mac were taken under government conservatorship by the Federal Housing Finance Agency in September 2008.

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.

"We expect to report significant net income for the three months and the year ended December 31, 2012, compared with a net loss of $2.4 billion for the three months ended December 31, 2011 and a net loss of $16.9 billion for the year ended December 31, 2011," Fannie said in the filing last Thursday, even if it is unable to begin recapturing the DTA.

Fannie reported a third-quarter profit of $1.8 billion. That 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.

Freddie Mac said in its 2012 10-K report -- filed punctually on Feb. 28 -- that 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, compared to a net 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.

With the prospect for both mortgage giants to go a long way in repaying the government if they are able to recapture the bulk of their DTA, investors also pushed up the companies' preferred shares, which had their dividends suspended in September 2008. Fannie's preferred series E shares, with a coupon of 5.10% and a par value of $50.00, were up over 4% to close at $5.20. Freddie's preferred series Z shares, with a coupon of 5.375% and a par value of $50.00, were up over 3% to $3.01.

It isn't clear whether any sophisticated investors see potential value in Fannie or Freddie common stock. Fannie and Freddie preferred shares have drawn interest from some hedge funds, however. Probably the best-known investor to have acknowledged buying Fannie or Freddie preferred shares since the GSEs were put into conservatorship in 2008 is Kyle Bass of Hayman Capital. Bass told TheStreet in an email exchange in August that he had given up on the investment when he concluded that both Republicans and Democrats "wanted them dead."

In a follow-up email exchange on Tuesday, Bass wrote, "we have no position. Period. I won't comment on anything else."

Another investor, Michael Kao of Akanthos Capital Management, continues to believe the preferred shares are a good investment. Kao has consistently argued for more than two years that the preferred shares have value. Over that time the Freddie Mac preferred series Z shares, one of the most actively traded issues, have gone up and down -- from below $1 to more than $3, back below $1 and now back to over $3.

Investments in Fannie and Freddie are, of course, highly speculative, because neither President Obama nor Congress has arrived at a way forward for the U.S. mortgage finance market, which continues to be dominated by the two firms.

House Financial Services Committee Chairman Jeb Hensarling (R., Texas) on Tuesday said in a statement before FHFA Chairman Edward DeMarco was due to testify in front of the committee that "I am determined that this hearing will be the last time that Director DeMarco, or if you believe press reports, his successor, will testify before this Committee before we finally and belatedly markup true GSE reform legislation." The GSE, or government-sponsored enterprises, include Fannie and Freddie, as well as smaller agencies, such as Ginnie Mae.

In his prepared testimony, DeMarco said "few of us could have imagined in 2008 that we would be approaching the fifth anniversary of placing Fannie Mae and Freddie Mac in conservatorships and have made little meaningful progress to bring these government conservatorships to an end."

According to DeMarco, the conservatorship was meant to provide a "time out," in order for "Congress and the Administration could figure out how best to address future reforms to the housing finance system."

Still Looking to Cyprus

The broad indices ended mixed on Tuesday, after Cypriot parliament voted to reject a proposed deal for a 10 billion euro bailout of the nation's banks, which would have included a "stability levy" of 9.9% on bank deposits in excess of 100,000 euros, with smaller deposits being charged 6.75%. With the previous bailout deal on ice, the country is looking to negotiate a new bailout deal with European regulators, and/or the Russian government. KBW Bank Index ( I:BKX) was down slightly to close at 56.84, with 25 of the 23 index components seeing declines for the session.

Shares of Morgan Stanley ( MS) were down 3% to close at $22.39, following a 2.5% decline on Tuesday. The company reported net risk exposure to "European Peripherals," including Greece, Ireland, Italy, Spain and Portugal, of $6.3 billion as of Dec. 31.

-- Written by Philip van Doorn in Jupiter, Fla., and Dan Freed in New York City.

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Philip W. van Doorn is a member of TheStreet's banking and finance team, commenting on industry and regulatory trends. He previously served as the senior analyst for Ratings, responsible for assigning financial strength ratings to banks and savings and loan institutions. Mr. van Doorn previously served as a loan operations officer at Riverside National Bank in Fort Pierce, Fla., and as a credit analyst at the Federal Home Loan Bank of New York, where he monitored banks in New York, New Jersey and Puerto Rico. Mr. van Doorn has additional experience in the mutual fund and computer software industries. He holds a bachelor of science in business administration from Long Island University.

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