Comparing Online Reports: The Case of Fannie Mae
One of our missions at "A Dash" is helping investors find their way through the maze of online information. In particular, it is often the case that a little knowledge can be a dangerous thing.
Mainstream media sources now have blogs. There are differing standards — both editorial and in making corrections — for blogs and traditional sources. What is a reader to do?
A New Series
To illustrate this issue we will occasionally show how an important story has been covered by several different sources. This allows us to provide information on an important topic, and also to show readers how what they learn depends upon what they read.
The Fannie Mae Story
The strength of Fannie Mae (FNM) is important for several reasons:
- Any improvement in the mortgage market probably includes Fannie Mae as part of the solution. Strength or weakness in the company has implications for the ability of qualified borrowers to get loans, and therefore, for any stability in the housing market.
- Exaggerated moves in any financial stock spread rapidly through the market, if only because of trading in ETF’s.
- Pressure on financial stocks has weakened the market at a time when technical support levels were being challenged.
Because of past accounting problems at Fannie Mae, the company is operating under restrictions in overall lending. As a Government Sponsored Entity (GSE) it is also opposed by many Republicans who dislike the apparent competition with private entities.
Chronology of the Story
November 10: FNM reports earnings, stock declines 80 cents to 49, rebounding from an intra-day loss of over nine percent.
November 15: Fortune writer Peter Eavis writes about Fannie Mae’s Fuzzy Math, arguing as follows:
Lost in the unsurprising news of the mortgage lender’s heavy losses was
a critical change in the way the company discloses its bad loans — a
move that could mask that credit losses that are rising above levels
that the company predicted just three months ago.
Eavis pointed out an apparent change in the way the company calculated the credit loss ratio, a measure of the proportion of bad loans.
Popular blogger Paul Kedrosky highlights the article without additional comment. The stock opens down by three points and closes nearly seven points lower at 43.
November 16: The company holds a conference call to explain the apparent discrepancy between the very large announced write downs and the modest change in the credit risk ratio.
Barry Ritholtz writes that the stock chart was reminiscent of Tyco’s, providing a helpful arrow suggesting a collapse to the twenty-range.
Diana Olick reports on CNBC and later on her blog. She points out that the company was buying back delinquent loans because they could not work out terms unless they did so. She cites outside sources suggesting that many of the loans could be "cured" (80-90%) but many could not. The story is still difficult to understand, but read her post to appreciate her effort on the story.
Peter Eavis fires another salvo, arguing that investors were not satisfied with disclosures.
The stock declines by almost six points, but rebounds a bit to close down 2.35 at 40.69.
After the close, Felix Salmon highlights the Eavis stories and points up the significance of Fannie Mae to the overall mortgage market.
November 17: On this weekend day, Tanta at Calculated Risk asks "Fuzzy Math or Fuzzy Reporter?" In a long and detailed explanation, she writes, in part, as follows (but read the entire article):
The problem is that the market right now does not distinguish between a
scratch & dent loan—one with a problem that could be cured with a
modification—and defaulted nuclear waste that is facing 50% or more
loss severity on imminent foreclosure. Whether it should be making that
distinction or not—whether this is partly irrational panic or not—is
not the point here. The point is that it just isn’t doing so, and so
anyone who takes a loan to portfolio right now and uses a true market
value instead of a fantasy is going to show the same huge write-down
for the scratch & dent as for the nuclear waste. This will continue
to be true until the market decides that everything isn’t nuclear waste
So nobody wants outfits like Fannie Mae to mark to
model; we want them to mark to market. We also want them to work out
loans that can and should be worked out. Remember, we aren’t talking
about horror subprime exploding ARMs here, we’re talking about troubled
loans in typical Fannie Mae MBS. We’re talking about the kind of loans
that would have taken a $60 million write-down in a past quarter, but
that are taking a $600 million write-down in this quarter, solely
because the market price of those loans has deteriorated so badly.
She points out that Fannie Mae had no obligation to take back the loans and reveal the write downs. There was no concealment, since the total amount was revealed. The only question, and the company could do better in discussing this, is the expected recovery from the repurchased loans.
Analyst commentary today supported the Tanta argument. The announced write downs basically take the worst case marks from an illiquid market. Meanwhile, Fannie Mae is not going to sell the loans. Instead, by working out the terms, the company will probably recover much of the projected loss and also serve the public interest by facilitating the market.
We wonder how many investors followed the various sources carefully enough to understand this issue. It involves difficult questions of accounting standards and reporting. Most people hear only a summary from one media source. Whom should one trust?
How should the investor choose from among the various sources of information? This is a story that is likely to be repeated frequently in the coming weeks, at least until trading resumes in mortgage securities.
We have no position in FNM, but find Eddy Elfenbein’s comment (from November 16) intriguing. He compares FNM earnings to Altria’s, at half of the price, but makes no recommendation. The market must be expecting more declines, since the price dropped again today, losing another 2.11 to close at 37.58.
Meanwhile, the GSE regulator, the Office of Federal Housing Enterprise Oversight (OFHEO) published a stale report on compliance right in the middle of the controversy. Bear Stearns noted today the dated nature of the report (Sept. 1st data) and that FNM now appears to be in compliance with OFHEO requirements. This would permit an expansion in new loans and an improvement in earnings.
There is a bottom here somewhere, and this could be a catalyst. Buying FNM now seems like catching the falling anvil, but outsize returns come from better insight into difficult situations. We are taking a hard look.