At Fannie Mae, Mind the Fair Value, not the GAAP: Jonathan Weil
Commentary by Jonathan Weil
Feb. 28 (Bloomberg) — Fannie Mae, the government-sponsored
mortgage company, yesterday reported a net loss of $3.55 billion
for the fourth quarter and a $2.05 billion net loss for 2007. As
horrible as those results are, they dont even begin to tell how
bad last year was.
The better gauge of Fannies performance is the amount by
which the companys net assets declined in value. Viewed this
way, Fannie lost $13.4 billion last year, according to the
annual report it filed yesterday. That figure excludes the
effect of capital transactions, such as the $7.5 billion of
preferred stock Fannie issued last quarter when it needed to
raise capital to stay above its regulatory minimums.
Fair-value changes for Washington-based Fannie are more
informative than its results under generally accepted accounting
principles, or GAAP, because almost all the things on the
companys balance sheet are financial assets or liabilities.
While Fannie discloses fair values for all these items each
quarter, it still carries many of them on its official balance
sheet at historical cost — sometimes out of choice, and other
times because the accounting rules require it to.
Think of how a hedge fund or mutual fund reports its
results, or even how you might tally your own investment
portfolios performance. If the value of your portfolio rose
last year to $5 million from $1 million, then you made $4
million, at least on paper. It makes no difference what the
accounting rules say. The economics dont change.
Fannie estimated that the fair value of its net assets was
$35.8 billion at Dec. 31, down from $43.7 billion a year
earlier. About $6.5 billion of that slide came from declines in
the net value of mortgage guarantees on Fannies books.
By contrast, Fannies net assets under GAAP were $44
billion. Meanwhile, its “core capital as defined by federal
statute was $45.4 billion, about 9 percent more than the
governments current minimum requirement.
Taking a Dive
The company said it had experienced “a significant
decrease in the fair value of our net assets since the end of
2007, though it did not say how much. If current conditions in
the mortgage and credit markets persist, Fannie said, it expects
“the fair value of our net assets will decline in 2008.
If they do decline, Fannies stock should, too. Theres
really no good reason why a portfolio of financial instruments
like Fannies should sell for significantly more than fair
value. For instance, back to the example of the investment
portfolio: If the fair value is $5 million, it makes little
sense for someone else to buy it for $6 million or more.
By some measures, Fannies common stock still trades at a
premium, even after losing half its value during the past year.
Yesterday, the companys shares closed at $27.27, up 30 cents,
giving Fannie a $26.7 billion market capitalization. Based on
Fannies latest fair-value balance sheet, thats 30 percent more
than the portion of the companys book value thats available to
common shareholders.
Losing Control
The $35.8 billion of shareholder equity at fair value
consisted of $20.5 billion of common shareholder equity and
$15.3 billion of preferred shareholder equity. A year earlier,
by comparison, the fair value of Fannies common equity was
$34.7 billion, while the fair value of the preferred was $9
billion. This is a fancy way of saying that the common
shareholders are losing control of the company, fast.
Fannies chief executive officer, Daniel Mudd, yesterday
said the company has “no current plans to go back to the market
for capital. Still, the annual report makes clear that Fannie
shareholders should brace for even more dilution of their
stakes.
“If the current challenging market conditions continue or
worsen, Fannie said in its annual report, “we may have to
take further actions to meet our regulatory capital
requirements, including issuing additional preferred or common
stock.
Make Sense
Yesterday, at least for a few hours, Fannie investors
appeared to be all smiles on news that the Office of Federal
Housing Enterprise Oversight will remove the growth caps on the
portfolios at both Fannie and its government-sponsored cousin
Freddie Mac.
The agency had imposed the restriction in response to the
accounting scandals at Fannie and Freddie a few years ago. Both
companies stocks initially soared on the news. Fannie at one
point touched $31.58, up 17 percent from Tuesdays close.
It was as if the market seemed to think that Fannie might
keep losing gobs of money, but make it all up on volume.
Investors quickly came to their senses.
(Jonathan Weil is a Bloomberg News columnist. The opinions
expressed are his own.)
To contact the writer of this column:
Jonathan Weil in Boulder, Colorado, at
