Fannie Mae and Freddie Mac

[Non_Comformist]

Is there any other reason besides a fear of rising interest rates causing Fannie Mae and Freddie Mac to what appears to be overwhelmingly undervalued right now.

Fannie Forward P/E 8.45; PEG .7 ;3 year earnings growth 16.43, annual dividend 1.94 Projected EPS growth 12.10 next year PEG .63

Freddue forward P/E 8.75. PEG .66 ; 3yr earnings growth 69.47; dividend 1.04, projected eps growth 13.26; next year PEG .54

It seems that there are strong concerns about future home purchases given increased interest rates. However certainly a grwoing economy would help increase home purchases. Additionally aren't we really looking ar a return to normal interest rates of 2% or so from an unsustainable 1%. I didn't really follow the market too closely then but I don't remember a collaspe in the real estate market the last time the Fed raised interest rates, given it was during the dot-com bubble.

It seems like this would be the time to buy here, instead of being behind the curve.

What am I missing?

[BadBoyBenny]

NEW YORK, May 07, 2004 (United Press International via COMTEX) -- Fannie Mae, the mortgage finance giant, improperly accounted for losses on part of its portfolio, federal regulators say. The move could force Fannie Mae to restate its earnings, according to the Financial Times.

The Office of Federal Housing Enterprise Oversight has been reviewing Fannie Mae accounts following the revelation last year that Freddie Mac, Fannie Mae's smaller sibling, had understated earnings by $5 billion.

Questions were also raised over Fannie Mae's accounting last year after the company revised some figures in its third-quarter earnings statement, blaming "computational" errors.

On Thursday OFHEO questioned Fannie Mae's accounting procedure on mobile homes and aircraft lease securities, arguing that the agency had not fully recognized the fall in the value of its portfolio.

The regulator added that Fannie Mae may have to undertake further "financial analysis" as a result of other findings from its examination. Fannie Mae said it would submit the information OFHEO requested by the regulator's deadline of May 14.

Copyright 2004 by United Press International.


Today the SEC said that Fannie will not have to restate past results but will have to change accounting methods in a way that will result in more frequent write downs. I'm not familiar enough with the story to know how much that will affect earnings. I also seriously doubt it will be any trouble to their ability to keep up and increase the dividend as it doesn't affect cash. It may cause a price drop tomorrow though.

[Non_Comformist]

Yeah I would say that might be what I was missing. I used to work for a large accounting firm so I somewhat get the gist of what is going on.

Thanks, it will be interesting to see what happens this week.

[BadBoyBenny]

Interesting that Freddies shenanigans actually understated their earnings by 5 billion. I think people are still a little wary of the company. Obviously if they were sandbagging they must think earnings will need a boost down the road. I think they are a much better value than Fannie right now if I had to pick.

[Non_Comformist]

[ QUOTE ]
I think they are a much better value than Fannie right now if I had to pick.

[/ QUOTE ]

The numbers certainly echo that. Interestingly enough I ran a screener with the following criteria

Forward P/E (Curr. Yr.) < 10
PEG Ratio (Curr. Yr.) < 1
3-Yr. Earnings Growth (%) > 9
Annual Dividend ($) > 0
Proj. Long-Term EPS Growth (%) Display only
PEG Ratio (Next Yr.) Display only

It returned 48 stocks the overwhemling majority of which were financials, specifically the housing market. It appears that this may be one of the buying opportunities that Graham talks about in the intelliegent investor.

[BadBoyBenny]

It's hard to say, I think that same screen last year would have given you just as high of a percentage of housing and mortgage stocks.

It's hard to use Graham's standards today because in his heyday he was able to buy great companies for less than their net current assets. It's hard for someone young like me to believe that those prices will ever come around again too.

I don't think they are necessarily a bad value, but I would be careful about getting something without a strong balance sheet and shareholder friendly management in case rates rise and times get tougher.

I remember having a love affair with NVR and their ridiculous ROE and growth with a low PE for a long time. But a look at their stock option policy made me decide I could never own the company. It was something like 8-10% dilution a year... Still would have made a killing on the stock if I had the balls to buy it.

Point is be safe, like all other investments, I have a feeling when rates rise the stronger businesses in the industry will do well and the others will crash as revenues decline. That's a pretty safe and non committed statement but I'm drunk and not capable of deep thought right now

[bob2007]

I've been following fannie mae quite a bit. Another thing to note is that GSE change in regulation which will effect its business if approved.

[adios]

Freddie and Fannie are highly leveraged companies making extensive use of derivates along with the utilization of the carry trade (borrowing short and lending long) to generate profits. I'm more familiar with Fannie than Freddie. Fannie attempts to match the funding of their loans with the duration of the loans so that the rate they borrow at is lower than the rate they lend at. They use derivatives to match the durations. The complaints against Fannie are that their derivative strategy isn't all that transparent, that they shouldn't have the implicit government guarantee behind their assets and that they're too highly leveraged. If they de-leverage some their earnings should drop accordingly. The Fannie web site explains their business model much better than I can.

[DVO]

Some pretty good value managers like these two stocks, but many are wary of the tremendous leverage (debt vs assets)built into these two companies. Worse, the derivatives exposure is massive.

Buffett mentioned this issue at Berkshire's annual meeting last week. Bottom line, it's so difficult to assess the real risk here, I would stay away. My 2 cents.