RD's Picks

One of our SLO1 questions of the week was Fannie Mae and we've been asked to take another look. When the SLO1 question hit, FNM was trading in the mid-to-high 40's. Most opinions were decidedly negative (and correct) as the stock now trades at about 27.

Since Nov, FNM has cut the quarterly dividend from 50 cents to 35 cents and issued new common and preferred stock to raise about $6 billion in new capital. The dividend will be cut again to 25 cents beginning in the third quarter. According to the most recent monthly summary 1.15% of loans are seriously delinquent and that rate doesn't appear to have leveled off yet.

The most recent quarterly report is for their Q1 FY08 ending 31 March and shows losses of $2.57 per share. That was prior to the dilution from raising new capital. That was an improvement from the $3.80 per share loss from the prior quarter, however charge-offs were higher than Q4 FY07. The report states "We expect home prices to decline 7 to 9% on a national basis in 2008..." and that credit losses are expected to increase in 2009.

It's tempting to point to an implied government credit guarantee for FNM, but that only protects bond holders. While getting wiped out in a bankruptcy is highly unlikely, there's still plenty of room on the downside for the share price.

According to the Yahoo Finance page, analysts are estimating losses for the remainder of 2008, but predict FNM will earn 1.97 a share in '09. That puts the stock trading at 13.7 times 2009 earnings and a dividend yield of 3.7% based on the 25 cent a share dividend.

The stock is certainly a better buy than last fall, but you need to believe the mortgage business is going to improve substantially over the next year to make it a good deal. If you believe that, I think Washington Mutual offers more leverage (and risk) to an improving housing market. While we may have seen the worst of foreclosures and credit gridlock, I'm very skeptical of forecasts for improving mortgage markets in the near term. In their last quarterly report, WaMu was forecasting future home price declines of 13-30 percent.

Based on the forward PE, FNM is trading at a 25+% premium to my two favorite financials, Wells Fargo and JP Morgan. Both of those banks offer a much more diversified business model than FNM and I see no reason FNM should trade at a premium to them.

FNM is cheaper than it was last fall, but not much else has changed. I'd still rather own a stronger, more diversified financial or the BTO bank closed-end fund that Tom recommended a while back. FNM would need to trade at a discount to those investments to get interesting.

If I wanted to bet on an improving housing and credit market (and I don't), it would make sense to get a little more leverage (and risk) with WaMu, Citi or one of the other troubled lenders.

Disclosure: At time of posting I'm long Wells Fargo; the dividend helps ease the pain. No position in any other company mentioned.

Comments: View Comments |  Tuesday June 3, 2008  |  Stocks: C, FNM, JPM, WFC, WM,