The Lunacy In Fannie Mae

Includes: FNMA
by: Paulo Santos

Fannie Mae, or Federal National Mortgage Association (OTCQB:FNMA), illustrates just the kind of utterly massive lunacy which the Federal Reserve has launched upon the markets.

The reason is not so much whether it can one day be worth the price it trades at, after all even today FNMA carries a book value of $62.4 billion, and the market value of its equity now stands at "just" around $22.4 billion. The reason is that for the equity to have any value at all, a political decision would have to be made to grant it such value.

Fannie Mae was put into conservatorship and neither its common equity nor its preferred equity carries any value at this point (other than the value that can be gotten in the market by selling both the common shares and the preferreds). Indeed, the preferred stock isn't even paying dividends. Before the common stock could have any value, the preferred would have to resume paying dividends.

Not only that, but even with the entire value being held on a political decision which might never come, the common stock is already trading at a value of nearly 40% of what it was worth without any problems at the tail end of a giant real estate bubble.

At the end of 2006, Fannie Mae carried a market capitalization of $57.7 billion. Sure, it then traded at $59 and now it seems "cheap" at just $3.90, but the fact is that there were only 972 million shares outstanding back then, to the 5.76 billion right now. And not only that, but there's also a sea of public preferreds now standing between the common stock, preferred stock and any kind of value.

On top of that, Fannie Mae was having income of $3.5-$5.5 billion in its best bubble years. Such "cruise" income would already value the equity at 4-6.4 times earnings. It might seem cheap, but again remember, there's total uncertainty regarding getting ANY earnings without a political decision bringing them towards the common shareholder. And even if such political decision was made, it would probably entail massive dilution for the present common shareholder, thus making the effective earnings multiple much higher.

In short, the best case scenario would attribute value to the common shareholder that would be equal, or less, to what the shares already trade for.

An alternative

Is there an alternative to this madness? Actually there is. If anyone wants to speculate on Fannie Mae regaining any kind of value, it can choose to buy one of many Fannie Mae quoted preferred shares (FMNAS)(FMNAK)(FMNAH)(FMNAI)(FMNAM)(FMNAN)(FMNAG)(FMNAL)(FMNAP)(FMNAJ)(FMNAT) which are not paying dividends right now. All of them still trade wildly below par (usually the par is $50, for stocks trading for $11 or so and with 5% yields at par if they ever pay again!).

These shares have a higher potential for upside (to $50 or even better, whereas common stock can't trade at 4.5 times the present value without FNMA becoming an unrealistic $100 billion market cap) while also having the potential to earn a large yield if the speculation on the common has any grounds to it.


The lunacy taking place in the common shares of Fannie Mae makes no sense. Were someone to speculate on these shares regaining any value, he'd do much better to buy the preferreds. The upside would be larger and the yield, if they were to ever pay dividends again, would be massive (23% or so, depending on the issue).

It should however be said that even buying the preferreds is highly speculative - just better than buying the common stock, which makes no sense.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.