Fannie and Freddie: Financial Winners

NEW YORK ( TheStreet) -- Fannie Mae ( FNMA) and Freddie Mac ( FMCC) were the big winners among major financial names, on an otherwise weak day for the stock market.

Shares of Fannie Mae were up 15% to close at $2.10, while Freddie Mac was up 20% to close at $2.00. The two mortgage giants together are known as the government-sponsored enterprises, or GSEs, and were taken under government conservatorship in September 2008.

Fannie's shares have returned 708% this year, while Freddie's shares have returned 669%, as both companies have shown very strong profits.

The very strong action for the GSEs on Thursday was apparently driven by strong housing numbers reported by their regulator, the Federal Housing Finance Agency. The FHFA on Thursday reported that U.S. home prices rose by 1.9% sequentially and 6.7% year-over-year, during the first quarter, which bodes very well for Fannie and Freddie.

Because of the massive bailout of the GSEs the U.S. Treasury holds $117.1 billion in Fannie Mae senior preferred shares and $72.3 billion in Freddie Mac senior preferred shares. After determining it would be able to recapture most of its valuation allowance for deferred tax assets (DTA) at the end of the first quarter, Fannie Mae announced on May 9 that it would pay the Treasury a second-quarter dividend of $59.5 billion.

The U.S. government's investment in Fannie Mae and Freddie Mac is paying off quite handsomely. Freddie is expected soon to recapture its DTA, setting up another special dividend, and no matter how much in dividends the GSEs pay to Uncle Sam, there is still no mechanism for either GSE to repurchase any government-held preferred stock.

Junior Preferred

Dividend payments on junior preferred shares of Fannie Mae and Freddie Mac were suspended when the GSEs were taken under conservatorship in September 2008, instantly sinking in price to pennies on the dollar.

But with investors seeing a possibility for life for the GSEs after a full repayment of the government bailout, the junior preferred shares have also rallied this year. After all, Fannie May had $3.2 trillion in total assets, while Freddie had $2.0 trillion in assets, as of March 31.

Here are two examples of GSE junior preferred issues:

Fannie's preferred series E shares, with a coupon of 5.10% and a par value of $50.00, closed at $8.79 Thursday, down 10% for the day but rising 449% from $1.60 at the end of 2012. The shares trade under the ticker FNMFM.

Freddie's preferred series Z shares, with a coupon of 5.375% and a par value of $25.00, closed at $5.84 Thursday, rising 14.5% on Thursday and up 234% from $1.75 at the end of last year. The shares trade under the ticker FMCKJ.

At this point, it's anybody's guess what structure U.S. mortgage loan financing will take when Congress and President Obama, or the next president, finally get around to agreeing on what to do with Fannie and Freddie. But the junior preferred shareholders do have ownership rights in these companies, and if their dividends are restored, the junior preferred shares can easily trade up to par, or even higher.

Fannie's preferred series E shares are supposed to pay annual dividends of $2.25 a share. If the dividend were restored, an investor who went in at Thursday's close would see a dividend yield of 26.60%.

Freddie's preferred series Z shares are supposed to pay annual dividends of $1.34 a share. If the dividend were restored, an investor who purchased the preferred Z shares at Thursday's close would see a dividend yield of 23.95%.

Those investors would be in a wonderful quandary: Either sit back and let the amazing dividends flow, or dump the junior preferreds and make a killing.

Stocks Down on Mixed Signals

The broad indices all ended lower, as investors continued to react to the mixed signals Wednesday, on when the Federal Reserve might curtail its monetary stimulus.

The Fed has kept the short-term federal funds rate in a range of zero to 0.25% since late 2008. Since September, the Fed has been expanding its balance sheet through net monthly purchases of $85 billion in long-term securities, in an effort to hold long-term rates down

In a strong bull market so far this year, one of the biggest questions for investors is when the Federal Reserve will finally pull back on its economic stimulus efforts, and how dramatically the central bank's policy will change. .

During testimony on Wednesday before the Joint Economic Committee of Congress, Bernanke repeated the words of the Federal Open Market Committee's last several statements, saying the federal funds rate would stay in its current range at least until the U.S. unemployment rate remained above 6.5%, as long as inflation remained in-check.

Bernanke also discussed the timing of a possible slowdown in securities purchases by the Federal Reserve, saying "if we see continued improvement and we have confidence that that's going to be sustained then we could in the next few meetings... take a step down in our pace of purchases."

Later on Wednesday the minutes of the last FOMC meeting on April 30 and May 1 were released, indicating that the committee as a whole might lean toward curtailing asset purchases more quickly than Bernanke desires:

"A number of participants expressed willingness to adjust the flow of purchases downward as early as the June meeting if the economic information received by that time showed evidence of sufficiently strong and sustained growth; however, views differed about what evidence would be necessary and the likelihood of that outcome," according to the minutes.

In China, fears of a slowing economic recovery were being sparked by a drop in the flash HSBC Purchasing Managers' Index on Thursday. The preliminary report on manufacturing showed that China's factory activity slowed for the first time since October, with the index declining to 49.6 in May, below the level of 50 level dividing expansion and contraction.

The concern over China and the eventual end of the Fed's stimulus offset the strong housing price numbers from the FHFA, as well as two other positive U.S. economic reports:
  • The Department of Labor reported that first-time unemployment claims for the week ended May 18 totaled 340,000, declining by 23,000 from a revised figure of 363,000 the previous week. The new-claims figure was slightly below the average estimate of 345,000, among economists polled by Thomson Reuters. The four-week average for jobless claims was 339,500, down slightly from a revised 340,000 the previous week. The Labor Department also said continuing claims were down by 112,000 during the week ended May 11 to 2.912 million. Economists had expected continuing claims to come in at 3 million.
  • The Census Bureau reported that sales of new single-family houses rose 2.3% to a seasonally adjusted annual rate of 454,000 in April, from an upwardly-revised rate of 444,000 during. Economists were expecting the pace of sales in April to increase to an annual rate of 425,000.

The KBW Bank Index ( I:BKX) was down 0.4% to close at 60.68, with all but six of the 24 index components showing declines for the session.

-- Written by Philip van Doorn in Jupiter, Fla.

>Contact by Email.

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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