Investors Pump GSEs Again: Financial Winners

NEW YORK ( TheStreet) -- The Fannie Mae ( FNMA) and Freddie Mac ( FMCC) roller coaster continued on Friday, with shares of both companies rebounding after two days of significant losses.

Shares of Fannie Mae rose 21% on Friday to close at $2.10. The shares had suffered a decline of 58% over the previous two sessions though Thursday's close at $1.73. That decline followed an increase of 140% the preceding week through Tuesday when the stock closed at $4.08.

Freddie Mac's shares were up 27.5% to close at $2.04. Freddie's shares had fallen a 57% over the previous two sessions through Thursday's close $1.60. The shares had risen 150% through close at $3.75.

The extreme volatility reflects the uncertain future for the two companies, known as the government-sponsored enterprises, or GSEs, which were taken under government conservatorship in September 2008.

The GSEs together hold roughly $5.2 trillion in mortgage loans and mortgage-backed securities, and remain critical to the U.S housing market, as they purchase roughly 90% of newly originated mortgage loans in the U.S.

Common shares of both companies traded for just 26 cents at the end of 2012.

A major catalyst for GSE shares was provided last Friday by Ralph Nader, who describes himself as a "faithful" GSE shareholder. Nader in an op-ed piece in the Wall Street Journal wrote that the two companies' common shareholders should fight against the federal government's "great Fannie and Freddie rip-off."

As part of its bailout agreements with Fannie and Freddie, the GSEs granted the government warrants to purchase just under 80% of the common shares of the two GSEs at a strike price of $0.00001 per share.

"The zombie common shareholders have no rights or remedies against Fannie and Freddie, both operationally active companies, or their regulator -- the Federal Housing Finance Agency," Nader wrote on Friday. "FHFA ordered the Fannie and Freddie boards and executives to suspend communications with shareholders and abolish the annual stockholders meeting."

Anticipating the expected negotiations between President Obama and Congress over the GSEs future, Nader wrote that "the common shareholders of Fannie and Freddie need to organize and make their voices heard in Washington. Clearly, they should have a say in how Fannie and Freddie are managed -- in the board room and in Congress -- from here onward."

Plenty of GSE Profit to Go Around

The government holds $117.1 billion in Fannie Mae senior preferred shares and $72.3 billion in Freddie Mac senior preferred shares, for the bailout that began in September 2008. Fannie Mae announced on May 9 that it would pay the Treasury a second-quarter dividend of $59.5 billion, after determining it could recapture most of its valuation allowance for deferred tax assets at the end of the first quarter.

Freddie Mac announced on May 8 that it would pay a dividend of $7 billion to the Treasury in June.

Following the June dividend payments from Fannie and Freddie, the government will have received dividends totaling $131.6 billion on its combined GSE preferred investment of $189.4 billion.

While Fannie and Freddie are now solidly profitable, there's no sign of an end to the bailout or the conservatorship, since there is no mechanism allowing either GSE to repurchase any government-held preferred stock. Per their amended bailout agreements, both Fannie and Freddie are required to pay dividends to the government equal to all of their earnings, less $3 billion apiece in retained earnings, to provide a minimal equity buffer.

Junior Preferred Shares

Junior preferred shares of Fannie and Freddie have also been quite volatile.

Fannie's preferred Series E shares, with a face value of $50, rose 22% to close at $12.55, after falling by a combined 49% over the previous two sessions. The shares trade under the symbol FNMFM and have risen 684% this year from a closing price of $1.60 on Dec 31.

Dividend payments on junior preferred shares of Fannie and Freddie were suspended in September 2008 when the two companies were taken under conservatorship.

CNBC on Wednesday reported that Bruce Berkowitz's Fairholme Capital Management had taken a roughly $500 million position in GSE preferred shares.

Berkowitz in a note to CNBC wrote "taxpayer dollars expended by the government during a time of national crisis will be fully repaid," adding that "equitable treatment of taxpaying shareholders, including community banks and insurance companies, must be restored.

"The government's ability to fully recoup its investment and restoring value to shareholders are not mutually exclusive," Berkowitz wrote.

Other Financial Services News

The broad indices all saw significant declines and the KBW Bank Index ( I:BKX) was down 2% to close at 61.60, as investors continued to worry over the eventual curtailment of monetary stimulus by the Federal Reserve.

Economic reports were mixed:

The Chicago Institute for Supply Management reported that its business barometer index rose by 9.7 to 58.7 in May from April, the highest level since March 2012 and in sharp contrast to April's three and a half year low. "Order backlogs, suppliers' deliveries and employment aall snapped out of contraction," Chicago ISM said.

The May reading came in way ahead of the level of level of 50 expected by economists polled by Thomson Reuters. A reading of above 50 indicates expansion.

Also on Friday, the Bureau of Economic Analysis reported that personal income in the U.S. was down $5.6 billion, or less than 0.1%, during April, after increasing by 0.3% in March. Economists on average were expecting an increase of 0.1% in April.

Shares of American International Group ( AIG) were down 4% to close at $44.46, after the insurer announced that it hadn't received a 10% deposit by a May 30 deadline, as required under its agreement to sell a majority stake in International Lease Financial Corporation to an investor group led by New China Trust.

AIG has the right to cancel the deal, but hasn't chosen to do so, at least yet. A company spokesman declined to comment.

AIG is relying on receiving $4.2 billion through the sale of an 80.1% stake in ILFC, with the agreement allowing the investor group to purchase up to 90% of the leasing subsidiary.

Otherwise, the insurer may have to make a significant reduction in share buybacks this year.

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

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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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