June 6, 2007Fannie Mae and Freddie Mac enrich shareholders in subprime's shakeout
By Jody Shenn and James Tyson
Bloomberg NewsNEW YORK: Fannie Mae and Freddie Mac, once derided as white elephants of the mortgage market, are benefiting from the subprime-lending debacle and trampling just about anything in their way.
Fannie Mae and Freddie Mac, which are U.S. government-chartered companies and the biggest source of money for Americans buying houses, accounted for 46.9 percent of all mortgage bonds sold through April, according to Inside Mortgage Finance, a newsletter. Their share rose from a record low 37.3 percent in last year's second quarter.
The biggest slump in U.S. home prices since 1991 is reviving Fannie Mae and Freddie Mac after $11.3 billion of accounting errors led to the ousters of their chief executives and the threat of tighter government regulation.
Now, the companies are getting praise in Congress after promising to spend at least $20 billion to keep the mortgage market afloat by purchasing loans made to people with poor credit histories or high debt burdens.
"The political tide is definitely running in their favor," said David Dreman, who manages investments including 12.8 million Freddie Mac shares at Dreman Value Management in Jersey City, New Jersey. The companies "are re-establishing their credibility," he said.
Fannie Mae and Freddie Mac, which together own or guarantee about $4.5 trillion of residential mortgage assets, are offering the capital after foreclosures increased 62 percent in April from a year earlier, according to a recent report by RealtyTrac, which sells information on defaults.
Home prices dropped last quarter for the first time in almost 16 years. More than 50 mortgage companies have halted operations, gone bankrupt or sought buyers since the start of 2006.
While subprime mortgages got battered, the fixed-rate loans that Fannie Mae and Freddie Mac prefer to package into bonds and guarantee increased to 82 percent of new mortgages from 63 percent in mid-2005. The amount of mortgage bonds sold or guaranteed by the companies rose by a net $93 billion this year, up 38 percent from the same period in 2006, according to estimates by Credit Suisse.
Fannie Mae is "confident" about increasing its share of bond sales, Thomas Lund, senior vice president for single-family mortgages, said in an interview last month.
Shareholders are reaping the benefits. Fannie Mae rose 19 percent since the end of March and Freddie Mac gained 14 percent, beating the 8.1 percent increase in the Standard & Poor's 500 index.
"The fact they did not get mired in the subprime market and are now able to pick up the pieces is positive for Fannie and Freddie," said Marshall Front, whose Chicago money management firm, Front Barnett Associates, owns 337,000 Fannie Mae shares.
The subprime turmoil, Front said, "is one of the few opportunities in recent memory when they have been able to demonstrate to the media and to members of Congress that they are going to help with a problem as opposed to being the cause of a problem."
Fannie Mae was created in 1938 as part of the New Deal, the economic recovery and social welfare program of the 1930s. The government took Fannie Mae public in 1968 and Congress created Freddie Mac in 1970.
The companies buy mortgages from financial institutions, providing money for new loans. They profit by holding mortgages and mortgage bonds as investments, and by charging a fee to guarantee securities backed by packages of home loans.
Fannie Mae and Freddie Mac finance about 40 percent of the $10.9 trillion of U.S. residential mortgages. More than $6 trillion of mortgage bonds are outstanding, making it the largest debt market in the world and about 50 percent more than the amount of U.S. Treasury securities. The prices that investors pay for the bonds help determine the rates lenders charge consumers.
The companies' shares also got a boost after Fannie Mae and Freddie Mac told Congress in April that they had committed to provide money to subprime lenders as home prices weakened. The Joint Center for Housing Studies, based at Harvard, estimates residential real estate accounts for 23 percent of the economy.
A month later, the U.S. House of Representatives watered down legislation creating a new regulator for the companies. The bill allows the government to require Fannie Mae and Freddie Mac to sell investments only if they threaten their own financial health.
Kenneth Posner, an analyst with Morgan Stanley in New York, raised his 12-month target price for Fannie Mae shares to $81 from $69 while maintaining an "overweight/attractive" rating on last week.
Fannie Mae and Freddie Mac lost market share starting in 2002 as the housing boom began and the companies became mired in accounting scandals.
