The recent news that Fannie Mae (FNM) will raise the fees that it charges mortgage originators to assume the liabilities related to their loans will significantly help the company going forward. In raising the fee that it collects for buying and guaranteeing mortgages from .25% to .50% of the loan value, Fannie Mae has successfully expanded its fee generation possibilities. If the company can survive its current predicament, which is still very questionable, the company may just be able to drive earnings – excluding loan loss provisions and other charges – that will allow the company to create an asset and fee structure capable of supporting all of the dilution that has taken place over the last year.
In looking at the company’s May summary of its financial situation, we can see that the company purchased $182 billion dollars in mortgages for its portfolio during all of 2007. In addition to these purchases, the company also guaranteed the issuance of $629 billion dollars in mortgage backed securities for other institutions. What is probably an all too simple calculation reveals that these $800B dollars of additions to the balance sheet (which are cancelled out to a degree by runoffs) generated somewhere near $2B dollars in fees for the company in 2007. It should be noted that the annual premium payments put forth towards keeping Fannie Mae as the guarantor of the securities is not included in this figure. In the quarter ended 3/31/08 the company took in $1.752B in guaranty fee revenue.
The $800B in securities that passed through Fannie Mae last year is likely a good number to use for future years as the company, with what is now nearly an explicit guarantee of support by the federal government, has managed to monopolize the market in which it participates. While this has exposed the company to a greater deal to less healthy business segments within the mortgage market it could potentially allow shareholders, if they are not diluted to nothing, to reap substantial rewards should we begin to see a bottom in the housing market fairly soon. Going forward from October 1, when the fee increase is set to go into effect, we should expect to see Fannie Mae’s fee income related to its handling of mortgages that pass through its door’s to double from $2B to $4B. Management will welcome this extra $2 billion dollars as it will help to relieve some of the pressures being put forth by the company’s high levels of leverage. The elimination of the company’s dividend would add another $1.3B dollars to the company’s capital base over the course of the year, something the company desperately needs. These two steps could allow for significant internal capital creation over time.
The federal government’s near explicit guarantee put forth recently by the Paulson bailout plan will prevent Fannie Mae from blowing up on the financial community overnight because the debt investors of the company have been reassured that their principal will be taken care of by the federal government in the event of a liquidity inspired insolvency at the company. Such a belief has bought management time to pray that the housing market bottoms and to scrape together internal sources of capital in the forms of increased fees and savings from a potential dividend elimination to help smooth out the losses caused by defaults in the company’s portfolio.
While I would certainly not want to own Fannie Mae at this point in time, I am watching the situation closely as there is a small possibility in my opinion that an investment in Fannie Mae could be just as successful as an investment in Chrysler could have been immediately following its bailout. If Fannie Mae has not been nationalized by the end of the year and if interest rates are still at 2% then I believe that it may just be appropriate to enter into a position in Fannie Mae. Internal capital generation coupled with an expansion of net interest margin (a result of low rates and inefficient credit markets) could create significant upside potential in the stock of this beleaguered company. While an expansion of auxiliary revenue sources will be key, strong net interest margins will be incredibly important and it something I first talked about in regards to Fannie Mae back in May. Another bullish indicator for the company would be the company’s announcement of a significant increase in the premiums that it charges other financial institutions to guarantee the mortgages that they have originated. Fannie Mae is still a wait and see story but the point is clearly coming when ultra deep contrarian investors must decide whether or not an equity position in Fannie Mae makes partial sense.
For Further Review:
May Financial Update Provided by Fannie Mae
Bloomberg Article on Fannie Mae's Rate Increases
Disclosure: None
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