Though home sales wilt when interest rates rise, investors have stuck by the market's two largest mortgage stocks-Fannie Mae and Freddie Mac.
The Standard & Poor's bank index has plunged more than 10% since the Federal Reserve raised a key short-term rate March 25, but Fannie Mae has lost only 4% of its value, and Freddie Mac has dropped 8.5%. The government-sponsored enterprises invest in more than half of all new-home loans.
Analysts say the two stocks haven't suffered as much as other interest rate-sensitive issues because Fannie and Freddie have shown they can post strong earnings even when rising rates eat into loan volume and profit margins.
"There is some sensitivity of margins, and therefore earnings, to changes in interest rates," said analyst Jonathan Gray of Sanford C. Bernstein & Co., but "it's well-managed, it's moderate, (and) the market perceives that."
When rates rise, the volume of fixed-rate loans favored by the agencies falls as homebuyers turn to the cheaper adjustable-rate mortgages. Fannie and Freddie dominate the fixed-rate portion of the mortgage market, snapping up as much as 85% of new loans, Mr. Gray estimated. By contrast, they buy only 10% of new adjustables; the rest end up in bank and thrift portfolios.
In addition, profit margins on the available loans shrink, and finally, a "modest" mismatch emerges in the durations of assets and liabilities, Mr. Gray said.
How do the agencies counter these effects?
In the past, they have made up for skimpy mortgage production by buying up their own securities that are backed by older mortgages, often at bargain prices.
Moreover, both agencies, particularly Fannie Mae, are adept at managing their balance sheets to fatten reported earnings.
This time around, Mr. Gray said, he expects that Fannie Mae, which has surplus loan-loss reserves, could reduce loan-loss provisions or even raid previous provisions in order to strengthen reported earnings.
Thomas O'Donnell of Smith, Barney & Co. is banking on the agencies' stock buyback plans to support their stock prices. Fannie plans to buy back as much as 6% of its outstanding shares, and Freddie can buy back up to $1 billion worth of shares, or about 5% of those outstanding, at Thursday's closing price.
That means "they don't have to chase portfolio growth" with their excess capital, Mr. O'Donnell said. "That's a new weapon in their arsenal."
His 12-month target price for Fannie Mae, which closed Thursday at $39.25 a share, is $49. Freddie Mac, which closed at $28.125 Thursday, should reach $37 within 12 months, according to his estimate.
Of course, many banking analysts say that banks, too, are better protected against rising rates than investors believe.
But as Michael L. Mayo of Credit Suisse First Boston observed, "At the end of the day, these stocks are called interest-rate-sensitive stocks, and old perceptions die hard."