Wall Street Analysts Bullish on Fannie Mae’s Prospects

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The New York Sun

Despite mounting legal and political trouble over its accounting practices, Fannie Mae has the financial strength to weather its upcoming potentially massive restatement of past earnings, argue Wall Street research analysts.


Moreover, 11 out of the 12 analysts who have posted price targets for Fannie Mae’s stock claim it will bounce back.


Fannie Mae’s shares closed at $66 yesterday, up 29 cents.


The stock is down 13% since September 21, the day Fannie Mae’s regulator – the Office of Federal Housing Enterprise Oversight, or Ofheo – announced that it strongly disagreed with Fannie Mae’s accounting treatment of derivatives and hedges, singling out both Chairman Franklin Raines and CFO Timothy Howard for criticism.


The regulator also announced that a significant restatement of earnings for the past six years is possible, potentially forcing Fannie Mae to raise capital by selling assets or issuing stock to comply with regulatory capital standards.


Chairman Raines is expected to offer a spirited defense of his company’s accounting and risk management practices in testimony before the House Financial Services Committee today, according to analysts.


The $9.38 billion of market value that has been lopped off Fannie Mae’s stock since September 21 hasn’t scared Credit Suisse First Boston analyst Moshe Orenbuch, who recently reiterated his outperform rating and set a $100 price target on the stock.


“To the extent there are real changes at the company or in its regulatory capital position, we will revisit the opinion,” he said.


Mr. Orenbuch said that while the risks of Fannie Mae stock ownership “certainly are greater, we see the risks as being fully disclosed at this point.”


Mr. Orenbuch issued his outperform recommendation when Fannie Mae’s stock was at $80.


He added that he still likes the stock’s fundamentals, such as cash flow and earnings-per-share growth. Now that the stock is at $66, he said, “I see no reason to change my opinion.”


One of Fannie Mae’s biggest boosters, Sanford Bernstein’s Jonathan Gray, a member of the coveted Institutional Investor magazine All-America Research Team since 1974, is recommending clients buy the stock and has a $98 price target.


Mr. Gray dismisses Ofheo’s charges of questionable accounting against Fannie Mae as “implausible” and “unproven.” He said that the most serious charge – that Fannie hid billions in derivative losses in an account that would not affect earnings growth – was due to the extreme complexity of a controversial accounting law called FASB 133. The rule governs the proper valuation of derivatives and hedging instruments.


“This rule has no objective standards for treating derivative valuations,” Mr. Gray said. The results is “a situation where almost every accounting firm is going to interpret this differently,” he said.


Mr. Gray said a mistaken reading of the rule could force “most every major financial firm into regulatory capital problems.”


The only “sell” rating on the stock comes from Portales Partners’ Mark Agah. He initiated his sell rating in late January when the stock was at $75 and has reiterated every quarter since, most recently last week. Mr. Agah, whose firm sells research on financial services companies to institutional clients, said he put the sell rating on because “it was clear from reading the filings that Fannie was playing games with their hedges.”


Mr. Agah said that the wide quarterly swings in the dollar value of Fannie Mae’s Other Comprehensive Income account – an account that is not listed on the income statement and so does not directly affect earnings – clearly indicated, “something was wrong with their hedges,” especially since interest rates remained in a tight range.


Mr. Agah said that once he put a sell on the company, no Fannie officers would return his phone calls.


“The stock will probably stick in a tight range here, but the next 10 point move will be down to $55, not to $75,” said Mr. Agah.


He said that Fannie Mae “probably did not intentionally seek to mislead – unlike Freddie Mac”- but the company’s financial statement’s would take months to recertify. He was also skeptical of Fannie’s ability to issue audited quarterly and capital reports while Ofheo and the Securities and Exchange Commission conduct their inquiries.


Last year, Freddie Mac, Fannie’s smaller competitor, admitted to hiding $4.5 billion in profits using an array of accounting gimmicks, so Wall Street analysts would be convinced the company had less volatile earnings and would bid the stock price up.


Mr. Agah has told clients he expects Mr. Raines and Mr. Howard will be forced to resign and that the re statement of prior earnings will force the recognition of “up to $15 billion in losses.” At that point, he said, “It’s just a point of how much Fannie has to reduce its portfolio by.”


The New York Sun

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