Thursday, December 01, 2005

Freddie Mac (FRE)

Freddie (FRE) increased its dividend by 34% to $0.47, a surprise since the company generally doesn't increase its dividend until the March quarter. The dividend has increased 81% in the last two years!

My valuation on FRE "dead" that is basically stopping its business and letting its existing portfolio run off is $72. If FRE enjoys a modest amount of growth, say one third of what it had in the last decade, I believe the stock is worth closer to $100.

There remains $12 billion in excess capital above minimum levels and roughly $5 billion above the 30% capital standard. Management appears to be set in returning much of it to shareholders. This will occur when the company has brought its financials up to date and restored its relationship with its regulator. The excess capitalwould allow the company to buyback almost 10% of the outstanding assuming the 30% capital remains.

Remember that Freddie's sins were UNDER-stating of earnings versus Fannie's of OVER-stating earnings. Fannie has had to sell almost $200 billion in assets to meet its capital requirements.

Both GSE's are under considerable scrutiny by Congress as their role is being defined and legislated. In my view, this is not terribly unlike the opportunity that SLM and STU presented during the Clinton attack on student lending under the FFELP program.

It seems to me that FRE in particular should resume its growth quickly sometime in mid-2005 as the Congressional cloud lifts and the company gets current with the SEC filings.

The company has indicated that it will commence a $2 billion buyback and has now cranked up the dividend substantially. Clearly, the company is signalling its shareholder orientation. At 1.4 times book value versus an historical average of closer to 2.7 times, I find the stock quite cheap.


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