Fannie Mae, Freddie Mac Continue to Rally. They’re ‘Not for the Risk-Averse,’ This Analyst Says.

Freddie Mac and Fannie Mae buy, package, and guarantee mortgages from loan originators. (Kevin Dietsch/Getty Images)

Key Points

About This Summary

• Deutsche Bank sees further upside for Fannie Mae and Freddie Mac, but investors should proceed carefully.
• The analyst’s price targets are $20 for Fannie Mae and $25 for Freddie Mac, implying upside.
• Outstanding questions about the conservatorship need to be resolved because of potential dilution.

Share prices of Freddie Mac and Fannie Mae have more than tripled this year on hopes that Donald Trump’s administration would resolve longstanding questions about the companies’ government conservatorship.

They could have further to climb, Deutsche Bank analyst Mark DeVries wrote in a Sept. 10 note initiating coverage of the two secondary mortgage market giants—but investors should proceed carefully.

“Despite already rallying ~300% year to date, we still see attractive upside for both stocks as the companies near a likely recap & release, though with meaningful downside if the recapitalization process brings greater-than expected-dilution,” the analyst wrote.

His price targets—$20 for Fannie Mae and $25 for Freddie Mac —implied about 38% and 87% upside at the time of publication respectively, according to the report.

Fannie Mae and Freddie Mac, which trade on OTC Markets, are up a respective 9.6% and 11.7% on Thursday.

The shares in recent weeks have climbed in part on discussion from government officials about selling part of the company to the public. Bill Pulte, the director of the Federal Housing Finance Agency, said earlier this month that the administration could sell 5% of the companies. Commerce Secretary Howard Lutnick said in a Thursday CNBC interview that the administration could sell “a small percentage of these companies” as soon as this year.

But a number of outstanding questions about the mortgages giants’ conservatorship and long-term future still need to be resolved. The two companies, which buy, package, and guarantee mortgages from loan originators, have been overseen by FHFA since the housing-led financial crisis in 2008. Freddie Mac and Fannie Mae common shares are up 333% and 365% so far this year, respectively, according to Dow Jones Market Data.

It seems likely that the companies will be recapitalized and released from their government conservatorship, DeVries wrote. But “the value of the outstanding common [shares] is less clear because it will hinge on several key issues that have yet to be clearly resolved,” he wrote.

Among the issues: the Treasury’s stake via its senior preferred shares. Converting the government’s senior preferred shares into common stock, which the Trump administration considered during his first presidency, would dilute existing common shares, Barron’s wrote previously.

“If the government ultimately acknowledges that it has been repaid, which we believe it has, then the common has significant upside potential from here,” DeVries wrote. “If the government refuses to recognize that it has been repaid, however, then any path forward likely
involves significant dilution to the existing common that leaves it with limited value.”

The FHFA, Treasury department, Fannie Mae, and Freddie Mac didn’t immediately respond to requests for comment.

Other issues that require resolution include whether the government changes the amount of capital the companies are required to hold, and the method for ensuring future government backing of the companies mortgages, which is currently inferred through the conservatorship but not formalized.

His price targets are based on four scenarios weighted by how likely they are to happen “given the significant impacts to the common from these unresolved questions,” he wrote. In the analyst’s worst-case scenario for the shares, in which the senior preferred stock is converted in the common shares, he estimates Fannie Mae and Freddie Mac stock would be valued at $1.50, implying nearly 90% downside for both stocks, according to the report.

Because of the potential for dilution, “buying the outstanding common shares is not for the risk-averse,” the analyst wrote.

Write to Shaina Mishkin at shaina.mishkin@dowjones.com