Fannie Mae and Freddie Mac: Obama Losers (Update 1)

Updated from 2:50 p.m. EDT with the DOJ lawsuit against Bank of America and market close information.

NEW YORK ( TheStreet) -- Fannie Mae ( FNMA) and Freddie Mac ( FMCC) were the big losers among major U.S. financial names on Tuesday, as President Obama prepared to deliver a speech calling for the end of both mortgage giants.

Fannie Mae's common shares were down 16% to close at $1.51, while Freddie Mac was down 15% to close at $1.40.

The broad indices ended with 1% declines after Dennis Lockhart, the president of the Federal Reserve Bank of Atlanta, said in a speech that the Federal Reserve could slow its bond-buying as soon as next month. The Fed has been making monthly purchases of $85 billion in long-term securities in an effort to hold-down long-term interest rates. Investors have anticipated this move by the Fed by pushing the market rate on 10-year U.S. Treasury bonds to 2.65% from 1.70% at the end of April.

The KBW Bank Index ( I:BKX) was down 1% to close at 66.02, with all but two of the 24 index components showing afternoon declines. Shares of Bank of America ( BAC) were down over 1% to close at $14.64, after the Department of Justice in the final hour of trading announced a lawsuit accusing the bank of mortgage fraud.

Fannie and Freddie

The two companies -- known as the government-sponsored enterprises, or GSEs -- hold about $5.2 trillion in assets, mainly consisting of mortgage loans and mortgage-backed securities. They were taken under government conservatorship in September 2008. The government's preferred stake in Fannie and Freddie came to a combined $189.4 billion as of March 31. Following GSE dividends paid to the government in June, Fannie and Freddie paid a combined $131.6 billion in dividends to the Treasury.

Institutional and individual investors holding common shares and junior preferred shares of Fannie and Freddie have filed multiple lawsuits against the government, with the aim of recovering some value. Under their modified bailout agreements, Fannie and Freddie are required to pay all profits to the government, in excess of minimal capital buffers of $3 billion apiece. The GSEs are not allowed to redeem any government-held preferred shares.

Non-government shareholders of the GSEs have been taken on a wilde ride this year. Fannie's shares traded for 26 cents at the end of last year, and rose to an intraday high of $5.44 on May 29.

The companies' junior preferred shares have also been quite volatile, with investors hoping that their senior position to the common may make them a decent long-term investment because of their great discounts to par value.

Fannie's preferred Series S shares (FNMAS), with a face value of $25, were down 4.5% to close t $4.87. The shares closed at just $1.67 on Dec. 31. Freddie Mac's preferred Series Z shares (FMCKJ), with a face value of $25, were down 3% to close at $4.95. Freddie's preferred Z shares closed at $1.75 at the end of 2012.

Senators Mark Warner (D. Va.) and Bob Corker (R., Tenn.) in June introduced legislation to wind-down Fannie and Freddie over five years, privatize most of the U.S. mortgage market, while putting in place a limited government backstop in the form of a "Federal Mortgage Insurance Corporation (FMIC), modeled in part after the FDIC." The Federal Deposit Insurance Corp. insures bank deposits by charging premiums to all U.S. banks and savings and loan associations.

FBR analyst Edward Mills, in a note on Tuesday, said the president's speech was likely to be "all but an endorsement of the Corker-Warner GSE reform proposal and would make any efforts at a recap of Fannie Mae and/or Freddie Mac even more unlikely."

But investors' battle with the government over Fannie and Freddie is far from over. The lawsuits challenge the legality not only of the revised bailout agreement, but of many aspects of the bailout, including its timing in 2008.

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-- 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 TheStreet.com 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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