The Truth About Fannie The mortgage giant has slumped as investors fret about rising interest rates and political threats. Are the fears justified?
(MONEY Magazine) – The list of Fannie Mae's (FNM) admirers reads like a who's who of value investing: Clipper fund's Jim Gipson, Legg Mason's Bill Miller, Oakmark's Bill Nygren and Scudder's David Dreman. Fannie is the second-largest U.S. financial company behind Citigroup, and it pumps out solid earnings. Even better, its shares typically trade at a low price-to-earnings ratio. But since December 2001, the stock has gone from $83 to a recent $71, splattering egg on the faces of everyone--including MONEY--who thought Fannie was cheap 2 1/2 years ago. Is this stock really a value at nine times its expected 2004 earnings? Or is it deservedly unpopular?
On paper, Fannie's business is hard to beat. The company buys home mortgages from banks with money it raises from the bond market. Thanks to Fannie's loose government ties, it has terrific credit. So it can sell bonds at below-market interest rates and then profit from the difference between its own low costs and the higher yield of the mortgages it holds. Since 1994, Fannie has increased its earnings at an 18% annualized rate, faster than Wal-Mart. With demographics pointing to ever-higher home ownership, business should be great for years to come.
But lately the market has been worried that rising interest rates will cool the housing market and wreak havoc on Fannie's complex financial hedging strategies. It's an overblown anxiety. In 1994, when rates rose a point and a half, Fannie's profits rose 14%.
The bigger threat is political. Conservative critics in Washington complain that taxpayers could be on the hook should Fannie fail. They're gunning for Fannie: They want Congress to sever the company's (never tapped) government line of credit. If that happens, Fannie's bonds wouldn't be as safe a bet, and its borrowing costs could soar.
Given Fannie's status as financier of the American dream, it's unlikely that Congress would ever accede to such demands. Barney Frank, the ranking Democrat on the House financial services committee, tells MONEY that even with Republicans controlling Congress, Fannie appears safe. A less partisan observer, Bernstein Research analyst Jonathan Gray, shares this assessment.
There's an opportunity here: A win by Democratic presidential candidate John Kerry would be a win for Fannie Mae. Fannie has always been more popular with Democrats than with Republicans. Throw in the fact that former Fannie CEO James Johnson is one of Kerry's top advisers, and Scudder's Dreman is convinced that "if Kerry wins, you could see a 50% rise in the stock price."
And if Bush is re-elected? Fannie could keep its single-digit P/E and still produce annual returns in the low teens, thanks to its earnings growth and 2.9% dividend yield. As downsides go, that's not bad. We think this stock is still a buy. --JON BIRGER