How Fannie Mae Soared 990% in 2013

Government-sponsored mortgage enterprise Fannie Mae (FNMA -0.67%) has had an amazing year, with its stock having soared 990% so far in 2013. As recently as February, most investors had given up Fannie Mae and sister mortgage GSE Freddie Mac (FMCC -1.09%) as casualties of the financial crisis, with the government having given massive bailouts to both of the companies in order to protect the American mortgage market and the extensive network of mortgage-backed securities that the two agencies have fostered during their histories. Yet now, Fannie Mae has become immensely profitable, and institutional investors believe that shares that were once believed to be worthless should actually have a claim to some of those profits. Will they succeed? Let's take a closer look at why Fannie Mae has done so well and whether those institutional investors will be proven right in 2014.

Fannie Mae headquarters in Washington, D.C.  Photo: Flickr/Future Atlas.

What sent Fannie Mae stock soaring?
Coming into 2013, most investors had written off Fannie Mae's prospects for ever producing any return for shareholders. With the U.S. government having provided $188 billion in bailouts to Fannie Mae and Freddie Mac in exchange for preferred shares in the enterprises, it seemed like a long shot that the companies would ever be able to repay the government.

But early this year, Fannie Mae started showing signs of life, raising the possibility that it might just survive after all. In April, Fannie Mae reported a $17 billion profit for 2012, reversing its roughly $17 billion loss in 2011 coming largely from settlements with Bank of America (BAC -1.52%) and a reversal of loan-loss provisions. With the housing market having turned around and Fannie Mae enjoying rock-bottom borrowing rates, profit potential looked stronger than ever. Moreover, the prospect for potential recapturing tens of billions of dollars in deferred tax assets pointed to even greater chances for Fannie Mae to get back above water.

The biggest gains for Fannie Mae and Freddie Mac came in May, when Fannie Mae said that it had posted a gargantuan $58 billion profit in its first quarter. That profit heightened the chances for a much-sooner complete payback of bailout funds than most investors had expected, and as a result, hedge funds and private-equity companies accelerated their buying of preferred and common shares of the two government-sponsored enterprises. With well-known names like Paulson & Co., Perry Capital, and Fairholme Capital Management stepping into the ring in search of profits, shares soared above $4 briefly.

Fannie Mae/Freddie Mac Total Return Price data by YCharts.

The problem, though, is that the government has asserted its right to all future profits from Fannie Mae, regardless of the status of paying off the bailout. What's become known as the Sweep Amendment in 2012 essentially diverted all profits to the government, with investors getting no chance to participate in those profits or even have them credited against the government's preferred-share position. The institutional investors that have bought shares in Fannie Mae have filed lawsuits arguing that the Sweep Amendment was an illegal taking of their property without compensation, but most believe a court victory is unlikely.

Still, November marked a milestone month for the entities, with Freddie Mac announcing an expected payment this month that would completely return all bailout money. Fannie Mae's smaller payment leaves it just short of the milestone mark, but it has just $2.2 billion left to repay.

Stats on Fannie Mae

Source: S&P Capital IQ.

What's next for Fannie Mae?
Most recently, Fannie Mae now faces the prospect of a buyout attempt by private investors. The proposal from Fairholme's Bruce Berkowitz [opens PDF] suggests having investors put up about $52 billion in private capital to support a leveraged model covering $1 trillion in mortgage loans, arguing that no subsidy or support from the government would be necessary. Yet Berkowitz also points to potential measures from Congress, such as a reinsurance program, that could help reduce overall risk in the mortgage market and potentially prevent a future systemic collapse akin to what nearly happened during the financial crisis.

At this point, the best chance that Fannie Mae shareholders have to earn profits comes from lobbying efforts. One course involves trying to reverse the Sweep Amendment to allow for an eventual payoff of the government's preferred-stock position. Other ideas involve an alternative to the winding down of Fannie Mae and Freddie Mac. Success could result in further explosive moves upward for Fannie Mae shares, but failure could lead shareholders to lose every penny of their gains in 2013.

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