The government's takeover of embattled mortgage giants Fannie Mae and Freddie Mac drove shares of nearly all financial services companies and the broader market higher Monday.
Every sector from banks to real estate investment trusts to insurers climbed. The bailout, to the tune of up to $200 billion, was aimed at stabilizing the year-old credit crisis and curbing problems in the mortgage and real estate markets.
Currently, Fannie and Freddie own or back about half of all U.S. mortgages. But with the role of Fannie and Freddie likely to change in the coming years, some financial services firms are poised to get a boost from filling portions of the market where the mortgage giants long dominated. Companies trading heavily in mortgage-backed securities will likely see strong short-term benefits as pricing for those investments stabilizes.
Investment banks and large national banks will be in the best position to take advantage of the government seizure of the mortgage giants, said Ladenburg Thalmann analyst Richard Bove in a note to investors Monday. Financial stocks also could benefit if the government's move decreases investors' perception of risk in the financial markets, and those investors resume stock purchases.
"This is particularly important if foreign buyers of dollars expand their purchases to include financial instruments," he wrote, adding, "I would buy a bank stock today."
News of the government's plan initially sent the Dow Jones Industrials average up a whopping 350 points, in sharp contrast to last week's pessimistic plunge. Stocks pared some of their gains, but the Financial Select Sector exchange-traded fund, which has holdings in a broad range of financial services firms, still rose 94 cents, or 4.3 percent, to close at $22.68. That's greater than the 290-point, 2.6 percent uptick in the Dow Jones Industrials average and 2.1 percent increase in the Standard & Poor's 500 index.
The KBW Bank Index, an index of large national and regional banks, rose 6.9 percent to 73.60, also rising higher than broader market indices. Including Monday's gains, the index is still down nearly 17 percent since the beginning of the year.
Fannie Mae and Freddie Mac were among the few financial companies whose stock tumbled Monday. The government's plan will likely wipe out the companies' equity stockholders.
Fannie Mae shares fell more than 89 percent to 73 cents. Freddie Mac shares tumbled more than 82 percent to 88 cents. Shares of each company hit a new trading low of 65 cents earlier in the session.
Many classes of both companies' preferred stock also plunged around 80 percent, which could pose problems for banks and other financial firms that held the preferred shares. Banks hold the preferred stock as part of their core capital and will likely have to write off those losses.
Keefe, Bruyette & Woods analyst Fred Cannon said in an interview those losses are likely to be recorded in the third quarter, though most large national banks are unlikely to take a significant hit from the losses.
Some smaller banks could take larger losses as Fannie and Freddie shares account for a higher proportion of their capital holdings, Cannon said.
Under the government's control, Fannie and Freddie will be able to expand their support for the mortgage market by boosting their holdings in mortgage securities to as much as $1.7 trillion. But, starting in 2010, they are required to drop their holdings by 10 percent annually until they reach a combined $500 billion.
This eventual reduction in their role in the mortgage market is likely to provide big opportunities for banks to step in and fill the void, analysts say.
"The single-largest beneficiary of these events is clearly Bank of America (Corp.)," Bove wrote.
Earlier this year, Bank of America acquired Countrywide Financial Corp., the nation's largest mortgage lender. That acquisition gives Bank of America the infrastructure to package and sell loans it originates into the secondary market. Fannie and Freddie were the largest players in that market, buying mortgages from originators and then pooling them together to sell to investors.
Shares of Bank of America climbed $2.50, or 7.8 percent, to $34.73, the biggest rise among Dow stocks.
The government's stabilization of the mortgage market, including the secondary market where mortgage-backed securities are sold, will also benefit Citigroup Inc., JPMorgan Chase & Co. and Wachovia Corp., Bove said. That trio have been hit hard by the declining value of bonds backed by mortgages.
As mortgages have increasingly defaulted since last year, the value of bonds backed by those troubled loans have declined. That has forced banks to cut the value of those investments, leading to more than $300 billion in write-downs among financial services firms.
Citigroup shares rose $1.25, or 6.6 percent, to $20.32. JPMorgan shares rose $1.95, or 4.9 percent, to $41.55. Shares of Wachovia jumped $2.24, or 13.4 percent, to $18.99.
Real estate investment trusts that purchase mortgage-backed securities issued by Fannie Mae and Freddie Mac are got a boost Monday.
The government's ability to now purchase these securities should provide pricing support and stability to the securities market, KBW analyst Bose George wrote in a research note. That support should improve pricing and help REITs that invest in the securities.
George affirmed an "Outperform" rating on five REITs specializing in purchasing mortgage-backed securities _ Anworth Mortgage Asset Corp., Capstead Mortgage Corp., MFA Mortgage Investments Inc., Annaly Capital Management and Hatteras Financial.
Shares of all five companies closed up more than 5 percent Monday. Capstead Mortgage shares rose the most among the group, climbing $1.38, or 12 percent, to close at $12.86.
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