Please ensure Javascript is enabled for purposes of website accessibility

As They Prepare to Leave Government Conservatorship, Are Fannie Mae and Freddie Mac Attractive Stocks?

By Bram Berkowitz – Jun 25, 2020 at 7:00AM

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

After 12 years, the two government-sponsored entities are preparing to leave government control and launch a new public offering.

Fannie Mae (FNMA 0.70%) and Freddie Mac (FMCC 0.61%) have been in government conservatorship with the Federal Housing Finance Agency (FHFA) since September 2008. As you may recall, both of the government-sponsored entities took on too much exposure to subprime mortgages during the Great Recession while not keeping enough cash on hand to cover the losses. Government control did not sit well with investors, as both stocks have gone from trading north of $60 per share in 2007 to about $2 per share today.

But after 12 years, the two firms finally look to be moving away from conservatorship. The FHFA has set new capital requirements, and last week Fannie and Freddie hired Morgan Stanley and JPMorgan Chase(JPM -1.56%)to advise them on stock issuances that will play a critical role in helping them leave government conservatorship. As they get closer to the release from government control, are Fannie and Freddie attractive stocks? Let's investigate.


Image Source: Getty

Less risky now

An obvious question about the two firms, which essentially got bailed out from insolvency in 2008, is: Could the same thing happen again?

As a refresher, Fannie and Freddie are not in the business of making loans. They are in the secondary market, meaning they buy individual mortgages from banks and other lenders. This provides lenders with the liquidity they need to keep originating mortgages for all those who need and qualify for them. Fannie and Freddie take the mortgages they buy and package them into securities that they guarantee and sell to investors. Investors get the cash flows from the mortgages in the security, while Fannie and Freddie collect a transaction fee. 

In 2008, while home values were plummeting, Fannie and Freddie were packaging too many mortgages from subprime borrowers who were defaulting on their loans. Additionally, in the middle of 2008, the two firms only had combined capital equivalent to 1% of their exposure to mortgage risks, according to the Federal Reserve. As the mortgage losses piled up, the government was forced to step in to protect liquidity in the mortgage market. The Treasury Department injected more than $187 billion in taxpayer funds into the two firms in return for senior preferred stock.

Since then, there is broad consensus that underwriting standards have greatly improved. Also, under new capital requirements that are part of the exit from conservatorship, total capital must now account for at least 8% of risk-weighted assets. That means the new capital rules require Fannie and Freddie to hold a combined $234 billion in capital to guard against unseen loan losses. Fannie and Freddie would also not be allowed to be nearly as leveraged as they were during the Great Recession. This is certainly a huge improvement from 2008, and although nothing is certain, it makes for two much safer institutions.

Owning the mortgage market

Hate them or love them, Fannie and Freddie dominate the secondary residential market. At the end of 2019, Fannie had $3.4 trillion worth of mortgage assets, including those that serve as collateral for guaranteed mortgage-backed securities, mortgage assets in its retained mortgage portfolio, and credit enhancements. As of September 2019, this amounted to 26% of the $12.6 trillion total U.S. residential mortgage debt, according to the company's annual filing. At the end of 2019, Freddie Mac had about $1.9 trillion worth of mortgage assets in its portfolio.

Analysts are uncertain whether Fannie and Freddie can maintain this huge market share or continue to make this business model viable. But what we do know right now is that Fannie and Freddie are the best at providing liquidity to lenders and packaging mortgages into securities for investors. Businesses can succeed by dominating one segment, although the risk is less revenue diversity.

Return of a dividend

Because the Treasury Department took senior preferred stock, once Fannie and Freddie exceed their capital reserves limit, the rest of their profits go to the government, preventing either firm from paying out dividends to shareholders.

But once they leave conservatorship and raise capital, an offering that could be worth tens of billions of dollars, a dividend might be back on the table. Matthew Howlett, an analyst at Nomura, said in May that he could see at least Fannie Mae issuing a dividend by 2024 if the firm can raise $55 billion in an offering by summer 2021.

After all, Fannie has generated more than $14 billion in profits in both 2018 and 2019, and has paid more than $181 billion in dividends to the Treasury Department between 2008 and 2019.

Will they be attractive?

It's uncertain whether Fannie and Freddie can return to their former glory of $60 per share or higher. But at roughly $2 per share now, these stocks are attractive. The main driver will be their new public offering after getting delisted from the New York Stock Exchange in 2010 -- specifically when it will happen and how much interest it will attract. I think the stocks will see renewed interest as leaving conservatorship increasingly becomes a reality, but it's still not a guarantee -- economic conditions and geopolitical factors could still prevent this from happening. However, if you invest now and they do return to the NYSE, I could see these stocks rising due to the excitement, at least for a time.

Bram Berkowitz has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

Invest Smarter with The Motley Fool

Join Over 1 Million Premium Members Receiving…

  • New Stock Picks Each Month
  • Detailed Analysis of Companies
  • Model Portfolios
  • Live Streaming During Market Hours
  • And Much More
Get Started Now

Stocks Mentioned

Federal National Mortgage Association Stock Quote
Federal National Mortgage Association
$0.52 (0.70%) $0.00
Federal Home Loan Mortgage Corporation Stock Quote
Federal Home Loan Mortgage Corporation
$0.52 (0.61%) $0.00
JPMorgan Chase & Co. Stock Quote
JPMorgan Chase & Co.
$104.50 (-1.56%) $-1.66
Morgan Stanley Stock Quote
Morgan Stanley
$79.01 (-1.06%) $0.85

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

Related Articles

Motley Fool Returns

Motley Fool Stock Advisor

Market-beating stocks from our award-winning analyst team.

Stock Advisor Returns
S&P 500 Returns

Calculated by average return of all stock recommendations since inception of the Stock Advisor service in February of 2002. Returns as of 10/01/2022.

Discounted offers are only available to new members. Stock Advisor list price is $199 per year.

Premium Investing Services

Invest better with The Motley Fool. Get stock recommendations, portfolio guidance, and more from The Motley Fool's premium services.