5. Two-Faced Fannie
Hand to God,
faithful. We've been crafting this column for more than a decade and never before have we encountered a research report as bafflingly bi-polar as
Sunday note on
Seriously, how else can we describe the analyst's overwhelmingly bullish outlook for two stocks he persuasively argues are going to zero?
Before ultimately concluding the shares are entirely without value, KBW analyst Bose George first highlights the recent earnings power at the government sponsored entities (GSEs). Fannie, for instance, reported a first-quarter profit of $8.1 billion last month, up from $7.6 billion in Q4, before preferred stock dividends and the release of $50.6 billion of its valuation allowance. Meanwhile, Freddie posted a Q1 profit of $4.6 billion, up slightly from $4.5 billion last quarter.
On a per-share basis, Bose trumpeted the fact that Fannie Mae's operating earnings of $1.41 smashed his own $0.81 estimate. Likewise, Freddie Mac's $1.41 crushed his Q1 forecast by 16 cents as a result of improving credit fundamentals and a housing rebound.
Pretty rocking results right? Heck, based on those numbers, it's hard to argue with the daytraders that have been running up those stocks. Common shares of Fannie Mae traded at $1.83 Thursday afternoon, returning 620% since the end of 2012, when the shares closed at 26 cents. Freddie Mac's shares closed at $1.70 Thursday, returning 546% since the end of last year, when they also closed at 26 cents.
Of course, the fact that Fannie and Freddie can drum up normalized annual earnings of around $2 really should really mean
to common shareholders. It's not like the GSEs pay a dividend or anything.
The GSEs' renewed cash generating ability does, however, offer a beautiful bounty for a covetous Congress. And as Bose rightly points out, the real story here is about political idiocy, not earnings per share.
"Lawmakers are becoming addicted to the regular source of revenues in a tough budget environment," writes Bose. "Reliance on these revenues in the current budget environment makes it tougher to unwind the GSEs and transition to a new mortgage finance system. In Washington, budget politics often trumps other policy considerations."
Booyah, Bose! We wholeheartedly agree that inertia will keep Uncle Sam on the GSE gravy train for a long time to come. In fact, we expect Congress to keep hoovering up GSE cash well past the end of this year when Fannie and Freddie are expected to have finished repaying the $189 billion the government spent to bail them out.
Think about it. Do you really think our friends in Washington are going to quit using Fannie and Freddie profits as knee-pads just when sequestration is knee-capping their approval ratings?
Slapping a zero price target and an underperform rating on a profitable stock may seem totally ridiculous at first pass. A total brain-buster even if you know the full story.
Congress exploiting a ready source of cash for as long as it can, on the other hand, well, that's a no-brainer.