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  Stock Picks: FNM, FRE Down; MOT Up (Market Movers)
Reported by SmartMoney.com on Monday, 19 October 2009 (on October 19, 2009)
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FNM, FRE Down
A damning downgrade hit the battered shares of Fannie Mae (FNM) and Freddie Mac (FRE) Monday, prompting large selloffs of both mortgage finance companies.
Shares of Fannie Mae were down about 17% in midday trading, and shares of Freddie Mac were down 14% after Keefe, Bruyette & Woods analysts Bose George and Frederick Cannon wrote a report warning that a much-needed government recapitalization plan would cut the 12-month price target to $0. The two companies have a critical role in the secondary mortgage market, buying mortgages from lenders, then creating securities to resell, and guaranteeing payment.
"Fannie Mae and Freddie Mac have been at the heart of the U.S. housing boom, bust and recovery," the report said. "As the mortgage market moves away from crisis mode, the future of the government-sponsored enterprises (GSEs) has to be addressed. In order for the GSEs to survive going forward, we believe they need to be recapitalized through investments from the banks that benefit from their role in the secondary market."
Since the government placed Fannie and Freddie in receivership last year, the two companies have gotten $98 billion of capital and taken a more explicit stance to guarantee their mortgage loans. At the same time, private lenders have cut back mortgage originations, to the point where Fannie Mae and Freddie Mac accounted for 68% of all originations this year to date.
Neither company returned calls for comment on Monday morning.
Following government intervention, "Fannie Mae and Freddie Mac today are acting as a direct arm of the federal government providing massive federal aid to support and revive the U.S. housing market in the midst of a crisis," George and Cannon wrote. "At the same time, their operating structure is as private companies operating under the conservatorship of the U.S. government. This is not a sustainable structure," they said, citing a recent report from the Government Accountability Office.
"What the GAO report is missing, in our view, is addressing the most crucial issue regarding the agencies: how to recapitalize them," which is a vital step.
Operating under conservatorship, the report said that Fannie and Freddie create an unlimited government liability. They also pointed to accounting changes that will balloon the balance sheets of the two companies to approximately $5.5 trillion in 2010 from under $2 trillion today; the authors then noted that large banks are generating large amounts of mortgage banking income as a result of the government operations in the mortgage business. Wells Fargo (WFC), now the nation's largest mortgage lenders, had mortgage banking income of over $3.5 billion in the first half of 2009.
The decks need to be cleared, the analysts said.
"In our view, the only viable option to limit taxpayer expense and recapitalize Fannie Mae and Freddie Mac is to set up a Bad Fannie and Bad Freddie with the existing portfolios, and a new Fannie Mae and Freddie Mac as cooperatives of bank mortgage lenders, along the lines of the other GSEs," the report said.
Bottom Line: Sell
The very idea that small investors are still involved in these rolling disasters at the heart of the worst financial crisis in decades is astonishing. These are speculative plays with no long-term horizons.
MOT Up
Shares of Motorola (MOT) climbed Monday as competitors' weakness and growing buzz behind its new iPhone-challenger, the Droid, combined to spark investor enthusiasm. Shares were up 8% in midday trading.
Last week, rival Nokia (NOK) reported disappointing earnings results and lost market share, giving Motorola more clout and credibility as traditional wireless handset makers battle Apple (AAPL) in the high-end market.
Tero Kuittenen, an analyst at MKM Partners, foresees a pricing battle in the key Chinese and emerging European markets that will pressure Motorola shares. In a Thursday report, he said Motorola's Cliq model may be priced too high as Nokia engages in price cuts.
At the same time, investors have taken note of positive press for the Droid, a smart phone running the 2.0 version of Google's (GOOG) Android operating system. Verizon (VZ) recently launched a web site devoted to the phone, even though it won't launch until next month. And Tech Blog BoyGeniusReport also gave the device a favorable evaluation. "It’s the Android device to beat, and easily the most impressive," a recent entry said. "From what we’ve been told, Google had a direct hand in the Motorola Droid. Something to the point of almost dictating every move Motorola made when designing and making the phone."
Bottom Line: Hold
Investors with a high risk tolerance may want to load up, but it's very early in the smart phone battle and probably better to wait and see how the initial clashes are seen on the Street.
SMARTMONEY ® Layout and look and feel of SmartMoney.com are trademarks of SmartMoney, a joint venture between Dow Jones & Company, Inc. and Hearst SM Partnership. © 1995 - 2009 SmartMoney. All Rights Reserved.
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