Are Fannie and Freddie Worthless?

According to Bose George analyst at Keefe, Bruyette & Woods, the two government sponsored entities that buy mortgages from banks have zero value to common shareholders. KBW downgraded the shares to Underperform and lowered the price target to zero from $1. The primary concern is that the mortgage giants have been bailed by the government to the tune of nearly $100 billion, and according to George they will still be heavily indebted to the US government even ten years down the road. In addition to the bailouts Fannie Mae (NYSE:FNM) and Freddie Mac (NYSE:FRE) have already received, there is a strong probability that further capitalization will be necessary for them to survive. The CBO has said that the two will require nearly all of the $400 billion in taxpayer aid already pledged by the Treasury.

Interestingly, KBW set its previous $1 price target back in April, a month where neither FRE nor FNM broke above the $1 mark. While it would be difficult to call that a bullish stance on the stocks, they at least believed they had some value at that point. Now, more than six months later, the housing market has not recovered as many had hoped and earnings power for the two GSE’s is still very much in doubt. Few analysts are willing to issue earnings estimates on these entities, and the few that do foresee another ugly year. Over the last two years, the companies have lost a combined $165.3 billion.

The two GSE’s are still responsible for financing 70% of new mortgages, but there is credible doubt whether they will survive in their current form. Even with a substantial improvement in homeowners’ ability to pay their mortgages each month, the debt burden could be enough to wipe out common shareholders. With that being said, we are skeptical that foreclosures will abate in the next few months and we expect the housing market will be soft for some time. These GSE’s are important to the financial system and will not be allowed to fail completely, but that does not mean that their equity has any value. It should come as no surprise that we cannot advise holding these shares, and at this point we think these shares are little more than a tool for speculators.

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Ockham Research is an independent equity research provider based in Atlanta, Georgia. Security analysis at Ockham Research is based upon the principle known as Ockham's Razor, named for the 14th- century Franciscan friar, William of Ockham. The principle states that a useful theory should utilize as few elements as possible, because efficiency is valuable. In this spirit, our goal is to make the investing environment as simple and understandable as possible, yet no simpler than is necessary.

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