Fannie and Freddie Keep Flying High: Financial Winners (Update 1)

Updated from 12:48 ET with market close information and updated stock returns.

NEW YORK ( TheStreet) -- Investors on Monday kept pouring money into common stocks of Fannie Mae ( FNMA) and Freddie Mac ( FMCC).

Shares of Fannie Mae rose 21% to close at $2.53, following a 21% increase on Friday. Friday's rise followed a 58% loss over the previous two sessions though Thursday's close at $1.73. The shares are up 873% from their closing price of 26 cents at the end of 2012.

Freddie Mac's shares rose 21% to close at $2.45, following a 27.5% gain on Friday. Friday's action followed a two-day loss of 57% over the previous two sessions through Thursday's close at $1.60. Freddie's common shares are up 842% from their closing price of 26 cents at the end of last year.

Fannie and Freddie, 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 crucial to the U.S housing market as they purchase about 90% of newly originated mortgage loans in the U.S.

Because of its 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. Both GSEs returned to profitability last year, and have been making very significant dividend payments on the senior preferred shares, while private investors holding junior preferreds have had their dividends suspended since 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 (DTA) 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.

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.

There is not yet any light at the end of the tunnel for the GSEs, as there is no mechanism in place allowing either Fannie or Freddie to repurchase any government-held preferred stock.

Institutional investors Snap Up Junior Preferred Shares

Junior preferred shares of Fannie and Freddie have also been quite volatile. Investors see plenty of potential value because the GSEs are paying such high dividends to the government. Investors hope that when President Obama and Congress finally settle on a way forward for the U.S. mortgage financing market, there will be plenty of value left for all classes of shareholders, even if the GSEs are eventually dissolved.

For example, Fannie's preferred Series E shares, which are relatively illiquid and have a face value of $50, were up 18% to close at $14.81, following an increase of 22% on Friday, when they closed at $12.55, after falling by a combined 49% over the previous two sessions. The shares trade under the symbol FNMFM and have risen 826%, from a closing price of $1.60 on Dec 31.

The largest GSE preferred issues are much less volatile but trade at similar levels to par.

Fannie's preferred Series S shares (FNMAS), with a face value of $25, were down 2% to close at $6.00. Freddie Mac's preferred Series Z shares (FMCKJ), with a face value of $25, were down 2% to $6.03.

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

On Monday, Fairholme announced that its customers, including shareholders of The Fairholme Fund ( FAIRX) and The Fairholme Allocation Fund ( FAAFX), "own approximately $2.4 billion par value of Fannie Mae and Freddie Mac Preferred Stock and are ready to help with a restructuring that accelerates the return of meaningful investment to the secondary mortgage market."

While the government may not take the offer of assistance from Fairholme or Berkowitz seriously, the announcement provides plenty of comfort for retail investors wondering how much of a "floor" institutional investors might provide for the junior preferred shares.

Other Financial Services News

The Dow Jones Industrial Average S&P 500 ( SPX.X) strengthened late in the session to close with 1% gains, while the NASDAQ Composite ended with a slight gain. The KBW Bank Index ( I:BKX) recovered from earlier losses to send with a slight decline at 61.59.

Investors seemed comforted that a mixed set of economic data would mean a delay in the expected curtailment of the the Federal Reserve's monetary stimulus.

The Institute for Supply Management said "Economic activity in the manufacturing sector contracted in May for the first time since November 2012." The ISM manufacturing survey for May fell to 49 from 50.7 in April. The average estimate among economists polled by Thomson Reuters was for the purchasers' manufacturing index to remain at 50.7. A PMI reading above 50 indicates expansion, while a reading below 50 indicates contraction.

The Census Bureau on Monday said constructing spending rose by 0.4% in April after declining by an upwardly revised 0.8% in March. Economists on average had estimated a construction spending increase of 0.8% in April.

Also on Monday, Markit reported that the final estimate on the U.S. Manufacturing Purchasing Managers Index for May was 52.3, modestly higher than the final April reading of 52.1.

-- 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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