The Federal Home Loan Corporation (NASDAQ – FMCC) and Federal National Mortgage Association (NASDAQ – FNMA), better known as Freddie Mac and Fannie Mae, respectively, have had traded in a wide range over the past year. Fannie Mae had a 52 week low of $0.25 and high of $5.44. It currently trades at $1.34 and has traded between $1.20 and $1.75 over the past three months, also an incredibly wide range. The share price movements are closely tied the legislative agenda and what Congress decides to do with the two GSEs. Will government receive all the value from them or will shareholders receive something if they are wound down over time? This is the key question behind buying or shorting the shares.
Recent History That Has Driven The Volatility
The ownership and news flow over the past year is important to understanding these two stocks. First, they are in government conservatorship. The government – the US Treasury Department in this case – put $189 billion into the firms in order to bail them out during the mortgage and economic crisis that started over five years ago. As a result, the US Treasury department owns 80% of the equity in each of the firms, in the form of preferred stock, and receives all of the profits in order to repay debt. Shareholders have no claim on profits until after the Treasury department is paid off. This has weighed on the share prices for some time. At the same time, this is big money for the Government. In August, Freddie Mac paid $4.4 billion in dividends to the Federal Government.
However, accelerated profitability and improved ability to repay the bailout money moved the timeframe forward for repayment and, more importantly, when shareholders could start to share in profits. In mid-March of this year, the two firms announced that a change in their deferred tax valuation allowances were significantly larger than expected. For Fannie and Freddie, the new valuation for deferred tax was $61 billion and $31 billion, respectively. This, along with some news that Congress may make some changes that would benefit shareholders, drove the share prices of both Freddie Mac and Fannie Mae to highs in late May. However, the shares overshot their mark and started to retreat back to levels around $1.75.
Also, Republicans in Congress announced a bill that was a further catalyst for declines in share value. It showed the intent to wind down the two mortgage giants over a five year period.
Another Solid Quarter in 2Q13
Both firms delivered better than expected 2Q13 financial results. Fannie Mae and Freddie Mac had profits of $10.1 billion and $5 billion, respectively, and up from $8.1 billion and $4.6 billion in 1Q13. This is before repayment of preferred dividends to the US Treasury. After the quarter the US Treasury still held $189 billion in the two GSEs with the firms having paid $146 billion in preferred dividends to the government. By the end of 2013, the two firms total dividends will exceed the $189 billion they received in bailout money. That said, they have not repaid any principal.
What Happens to the GSEs? Legislative Overhang on Shares
The value and catalyst for both stocks at this point is more tied up in legislative action than in quarterly earnings reports. The opinions vary on potential legislation, its impact on Fannie and Freddie, and most importantly what each shareholder would receive. Some analysts believe the government will wind them down and see all the benefit leaving shareholders with nothing, while others believe shareholders will profit. One thing is consistent – most agree there is value in Fannie and Freddie portfolios, it’s just a case of who benefits from it, the government or shareholders, and when.
There are two pieces of legislation that are in Congress, although action prior to year end is unlikely. The Protection of American Taxpayers and Homeowners (PATH) Act, introduced by House Republicans in July 2013, and calls for the complete wind down of Fannie and Freddie and a move towards a totally private home mortgage market. This bill would also make many more changes, including some to the FHA. Shareholders would more than likely get hurt by this bill.
The Corker-Warner Bill – aka Housing Finance Reform and Taxpayer Protection Act 2013 – was introduced in late June of this year by Mark Warner, Democrat, and Bob Corker, Republican. A version of this bill is seen by some as the most likely template for solution to the GSE. This bill still has a place for the government to back the secondary mortgage market, but would shift the first 10% of credit loss to the private sector. More importantly, this bill also winds down Fannie and Freddie and transfers their operations to the Federal Mortgage Insurance Corporation, an independent Federal agency.
The problem with buying either Fannie or Freddie right now is timing and valuation. Making a call on how Congress intends to treat shareholders is a game of guessing the political probabilities. Essentially, these are options where you will receive either nothing if legislation moves in one direction or some X dollar value if it goes another way. Every time there is news that legislation will move in one direction or another, the shares may move. While earnings releases could cause some movement, it cannot change the major legislative overhang. At this point in time, making a call on these stocks is tied to making a call on politics. With legislation unlikely this year, it is tough to make a definitive call on the political will of US Congress. Unless investors feel they have an edge making the political call, it is hard to make a case to buy or sell the stocks.
What are your thoughts on Fannie Mae and Freddie Mac? Are you interested in buying the gamble?