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Bull/Bear Report -- Would you bank on Fannie Mae?
The credit crisis is over. No, check the credit crisis is not over. Wait, the Federal Reserve says the financial system is secure. Hold that, Lehman (LEH) searches for capital.
So is it over or isn’t it?
Obviously it is an important question especially as it relates to the financial sector. Frankly, without a strong financial group, it is hard to see how the market and the economy recover from the current malaise.
During Round 1 of the Strategy Lab Open, we raised the question of Fannie Mae (FNM). The responses then were quite accurate in suggesting that investors stay away from this company in the center of the housing storm.
“Don’t buy,” you said, with some going so far as to suggest that that FNM be sold outright. Sage advice indeed, but what about FNM today?
Is the company a buy or a sell?
Read on to see if our bloggers are bullish or bearish on Fannie Mae (FNM).
As a value manager at heart, FNM is intriguing to me on many levels. The dividend and the implied government guarantee are two very good reasons to own the stock. At above 5% dividend yield investors get paid to wait for the storm to pass.
But, what if the storm does not pass? Could it get worse before it gets better?
The answer is absolutely “yes”. FNM is not out of danger by any stretch of the imagination. There have been far too many calls for the bottom, that I’m starting to think that there may be one or two more legs down before this is all over.
And, what happens with a new administration. Some of the ideas floated about to help the homeowner may delay the pain, but they will not prevent it.
As for the government guarantee, such a backstop has done little to prevent the deterioration that we have seen to date. In other words there may be more downside on FNM and the government may not be able to do anything about it.
As tempting as it may be to dip your toes into FNM, it may be best to wait or avoid it all together. You all seem to agree. Here are two very good posts on the subject – both are bearish.
What do our bloggers think?
To some there is a major benefit to quant analysis, in that it avoids personal biases.
To others, a major complaint of quant analysis, is that it avoids qualitative analysis.
I'm a quant.
I love being a quant, and although I'll try to respect the ideas of non-quants, I'm still a quant.
So, I'll look at FNM as a quant.
I know there are qualitative stories that can be told about all sorts of mortgage backed securities.
But I'm a quant, and so I'll still give you a quant opinion.
My blogs are short as my thoughts are quickly made, and you can certainly disagree with me. But even in the world of quant analysis, FNM might be a tricky one to analyze.
Nevertheless, here is my quick quant opinion.
Smart money funds - FNM has a high short interest. SHORT.
Value funds - FNM has a nice low price/book and price/cash flow, but it also has a poor PE. Mixed result = SHORT.
Growth funds - FNM has some positive growth, but poor earnings growth. Mixed result = SHORT.
Quality funds - FNM has low accruals and a low F-Score. LONG.
Econ thought - I'm long on Financials, but short on 'thrifts/mortgage finance'. Mixed result = SHORT.
My valuation - $41. LONG.
My Opinion - SHORT FNM, but some 'value' or 'quality' funds might want to buy FNM.
The Bear Case: Don Barrett
Fannie Mae was created back in 1938 by then President Franklin D. Roosevelt to provide liquidity for all the people, all the time, and wherever they may be. FNM is a secondary buyer of mortgages and does not originate home loans. FNM is a GSE or government sponsored enterprise which means FNM can borrow funds from the government at less than the going rate to lower the costs of the loan, but are not guaranteed nor funded by the U.S. government. FNM was originally a government agency in 1938, but became a publicly traded company in 1968 and is funded by investors from around the world. In theory FNM takes a bite of the spread between the government loan rate and what FNM actually charges the borrower. FNM also in theory takes about 1/2 per cent of all the secondary mortgages they purchase on the market as a guarantor of principal and interest.
FNM is under a cloud lately and I'm not sure when the sky will clear. As FNM strives to put low income or subprime borrowers into a residence of their own, the risk and losses for FNM are escalating. They are ignoring the basis of any sensible loan-can you pay it back? The mortgages FNM are sorted into pools of subprime and other sectors such as non-verified income pools. Also, the art of leverage is becoming a serious factor for FNM. A bank can originate a loan without regard to the borrower’s means to pay it back, sell it to FNM, and then buy another mortgage and sell it to FNM, and so on. But, FNM bundles these questionable loans into MBS’s, or mortgage backed securities, and sells these to banks or brokerages and you then have the "subprime meltdown". And guess who will be left holding the bag? You and the other tax payers in America.
FNM has guaranteed the payment of principal and interest to the loan originator, and though not actually guaranteed by the Fed. No one thinks FNM will be allowed to collapse.
I was getting to FNMs current quarterly report and just read what I thought would happen soon- FNM is cutting their dividend. FNM lost $2.2 billion for 1st quarter 2008. They actually cut the dividend in December and are cutting it again from .35 cents to .25 cennts, and will be raising $6 billion for future writedowns as they expect the housing downturn to continue. FNM’s fair value of net assets was down 66% to $12.8 billion due to falling housing prices. And FNM’s exposure is deepening as Congress has lowered the amount of required down payment and raised the maximum loan FNM can make, and as the housing market falls, FNM and the other government housing loan agencies are taking on a bigger percentage of the mortgage market.
While I think it is a very noble idea for FNM and the other agencies to put everyone in a house, I wish they would add one stipulation: you have to make the payments. Since the beginning of time, man has had to have a place to live. And in the last 3 or 4 centuries you were expected to buy and pay for the home. This program has some successes and people do indeed make their house payments, but an ever widening number don't.
I think there are much better and safer investments available. The dividend will most likely be cut out completely and the share price I would guess is no where near bottom yet.
In my opinion, I would wait one or two more quarters before buying FNM. It is tempting, but I think we still have more downside here.
Jamie Dlugosch
Executive Editor, InvestorPlaceBlogs
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