Freddie Mac And Fannie Mae Report Excellent Earnings

 |  Includes: FMCC, FNMA
by: David Sims

The housing market seems to have really turned a corner this time. Not only are property prices rising, but loan losses are starting to turn a corner too. The Government Sponsored Entities, Fannie Mae (OTCQB:FNMA) and Freddie Mac (OTCQB:FMCC) announced the best collective quarterly earnings in years.

Fannie Mae reported (pdf) earnings of $5.1 billion for the 2nd Quarter. Loan loss provisions actually reversed, reflecting a turnaround in housing prices and delinquencies that have remained steady, or dropped for many months. Fannie was also able to send a dividend of $2.9 billion to the Treasury.

For the 2nd Quarter of 2012, Freddie Mac responded positively to good housing news, reporting a $3 billion profit. The company was able to recognize lower credit losses on its portfolio and pay the government a massive dividend of $1.8 billion.

This also marks the first quarter of increased guarantee fees under the payroll tax compromise, which included about a 10 basis point increase in fees charged on mortgages starting April 1st. The Federal Reserve has been stimulating demand for mortgages by lowering the effective 30-year fixed mortgage rate by buying longer duration Treasury securities. The effect is a record low mortgage rate, which touched 3.49% just a few weeks ago. The result for housing consumers is that rates are still very attractive despite the increased fees placed on newly underwritten mortgages.

Notable in both Fannie and Freddie reports is the loss from derivatives. Both of these companies use a hedging strategy to prevent losses from increased interest rates. Over the past few quarters, the companies are losing money on this hedge, as rates decline. Operationally, they are still able to make a profit, which is good news to taxpayers and shareholders alike. Better news is that these hedges may turn around when rates finally rise.

Immediately after Freddie Mac reported a profit on Tuesday, the stock of both companies began to climb. Freddie Mac's stock price ended the day up over 20% versus the previous close. On Wednesday, similar gains started early with both stocks.

For traders, another notable fact is the level of short interest on both securities. Reports from July 13th show that 17 million shares were short on Freddie Mac, which means that the days to cover on a short squeeze stood at close to 37 days. Fannie also had similar short interest data. For those that remember trading in August 2009, there is a genuine interest in the common stock after years of stagnant trading. After the 2nd Quarter report in August 2009 showed a surprise profit for Freddie Mac, the common stock soared from low of 59 cents to a high of $2.50. Fannie's stock rose from a low of 51 cents to a high of $2.13 in the same period.

If the government decides to adopt a proposal similar to Jim Millstein's plan, then there is a potential for common shareholders to have a seat at the table, and that is enough to send these stocks higher for weeks to come.

Disclosure: I am long OTCQB:FNMA, OTCQB:FMCC.

Additional disclosure: Currently, holding GSE preferred stock.