There is upside to buying Fannie Mae shares for "patient" investors but the next few years look difficult, a Goldman Sachs Group Inc. analyst said in reinitiating coverage of Fannie with an "in-line" rating.
Separately, Fannie Mae floated $1 billion of five-year subordinated bonds Tuesday, its second issue of such debt this year.
In a report issued Monday, Goldman's Robert G. Hottensen wrote that though Fannie Mae "has built one of the financial service sector's most consistent 'earnings machines,' reinforced by one of the nation's strongest managements, we believe the 'sweet spot' is passing."
Goldman stopped covering Fannie on Feb. 26, when it dismissed financial services analyst Howard Shapiro (who rated the stock "outperform") and five other analysts and suspended research on a number of other blue-chip companies, including AOL Time Warner Inc. and Walt Disney Co.
Mr. Hottensen said he expects the mortgage financing giant to have per-share earnings of $7.15 this year, which would be a 13% improvement, and $7.85 in 2004, which would be up 10%.
The consensus of analysts surveyed by Thomson First Call has Fannie posting earnings per share of $7.20 this year and $8.01 next. In the past month 16 of the 21 analysts covering Fannie have revised their second-half earnings forecasts downward.
Mr. Hottensen wrote that Fannie shares are worth $80 according to his "economic profit model" but that they "might remain well below 'economic value' as the market transitions and rotates to cyclical beneficiaries of a more robust economic recovery." (Fannie shares fell about 1% Tuesday, to $63.65.)
With home price appreciation slowing and the popularity of cash-out refinancing waning, "mortgage debt growth overall [will] be in the range of 6%-7% over the next five years at least," his report said.
On other hand, Mr. Hottensen touted Fannie's market-share gains over rival Freddie Mac and low price-earnings ratio as positives, and wrote that he does not expect "drastic" regulatory changes.
Fannie's $1 billion subordinated-debt issue was priced Tuesday to yield 75 basis points more than the five-year Treasury and 37.5 basis points more than the company's senior debt.
In late April, Fannie issued $1.5 billion in subordinated bonds maturing in May 2013. Before Tuesday's sale it had $10 billion of subordinated debt outstanding, according to Mukul Chadda, an agency strategist at Lehman Brothers.
In the fall of 2000 Fannie and Freddie agreed to issue subordinated debt for the first time the following year. The move was intended to impose more discipline on the government-sponsored enterprises and provide markets with "a canary in a cold mine" indicator of the GSEs' financial health, said Nancy Vanden Houten, an analyst at Stone & McCarthy Research.
But spreads between the GSEs' senior and subordinated debt never widened until Freddie's accounting mess surfaced, Ms. Vanden Houten said, and that may have undercut the idea that holders of the debt would give the companies more scrutiny.
Interest payments to subordinated bondholders would be suspended if certain triggers are hit - if core capital were to fall below a certain threshold, for instance, or the U.S. Treasury were to exercise its discretionary authority under the GSEs' charters and buy their debt.
Fannie must keep its combined core capital and subordinated debt above 4% of on-balance-sheet assets, after adjustments for capital required for off-balance-sheet mortgage securities, it said in a press release Monday. For the last two years it has pledged to issue subordinated debt at least twice a year.
When it started issuing this debt, Fannie said it expected to float $13 billion to $15 billion by the end of 2003. But earlier this year it revised that to $10 billion to $13 billion, which analysts said implied that it expected asset growth to taper off.
