Fannie Mae is getting a lot of mileage out of a plan to restructure its capital.
The plan has already drawn the highest form of praise from investors: a jump in the stock price. Securities analysts have also endorsed the plan, and some say they are expecting the shares to push even higher in coming months.
And Fannie says the program, announced last week, even has something to offer lenders. Frank Raines, executive vice president, said, "We've now funded our affordable-housing outreach past the turn of the century. The efforts are no longer subject to annual appropriations within the company.
"It gives lenders the additional comfort to know that these efforts are what we say they are, and not an attempt to get into direct lending."
The restructuring involves a number of steps that the market believes will enable Fannie to continue expanding its earnings at a rate of about 15% per year. A flattening to perhaps 12% had been predicted by some observers.
Fannie Mae, formally the Federal National Mortgage Association, will issue $1 billion of preferred stock and use the proceeds to repurchase its common shares.
About $350 million of the shares will be contributed to the company's charitable foundation, which promotes affordable housing. Fannie will report a writedown because of the gift for the fourth quarter of 1995, and the market has already taken that news in stride.
On the plus side, Mr. Raines says the company will shift about $20 million a year of advertising expenses for its outreach program to the foundation, as well as $20 million of annual funding. Thus, earnings should benefit to the tune of $40 million a year before taxes.
The contacts with consumers generated by the outreach program will now be insulated completely from Fannie Mae itself, Mr. Raines said. Lenders had feared Fannie's direct contact with consumers could be a prelude to direct lending.
Lenders had little reaction to the plan because it was announced between the Christmas and New Year's holidays, when many of them were away.
The company is also splitting its shares four for one, a step that could lure more investors into the stock.
Aida Alvarez, director of the Office of Federal Housing Enterprise Oversight, said the plan would not affect Fannie's compliance with capital requirements as long as any common stock withdrawn is replaced by an acceptable preferred.
Thomas O'Donnell, a Smith Barney analyst, responded warmly to the program. "We believe the restructuring is a sign that Fannie Mae's political risk is low," he wrote. He says the company can now sustain a long-term growth rate of 14% to 15%.
Mr. O'Donnell raised his 1996 earnings estimate to $10 a share on the present shares, from $9.85. He is expecting $11.40 a share next year.
Another analyst, Jonathan Gray of Sanford C. Bernstein & Co., also raised his earnings estimates on the basis of the restructuring. He is now expecting $9.85 a share next year, up from $9.70, and $11.15 next year, up from $10.90. He said he expects long-term growth in earnings per share to be 13% or higher. Mr. Gray had earlier predicted the company would do a share repurchase. He said in a Dec. 8 report that both Fannie Mae and Freddie Mac have surplus capital. "Assuming Fannie Mae maintained a 7% to 8% capital cushion, we believe the company could effect a share repurchase of $700 million to $1.5 billion by the end of 1996," he wrote.
Fannie Mae's rival, Freddie Mac, has already instituted a capital restructuring and is "quite happy" with the results, said John Gibbons, senior vice president. He said no further changes were planned.
The company fine-tuned its capital structure in 1992 and 1993, Mr. Gibbons said. During that time, Freddie issued preferred stock, repurchased shares, and completed a 3-for-1 stock split, he said. The repurchase program is still open.
Preferred shares now make up $837 million of Freddie Mac's $5.6 billion of total equity. The company is also structured to produce a 20% return on equity, Mr. Gibbons said.
Freddie Mac has made it a practice to pay out 20% of earnings in the form of dividends and to put 80% back into the business to fuel further growth.
One common criticism of stock repurchases is that they signal limited investment opportunities. But Mr. Raines said this view was not applicable because the common stock was simply being replaced by preferred with no change in total capitalization.
"The preferred is cheaper for us than common if you look at the cost of capital," Mr. Raines said. "Even though the dividend is higher, issuing the preferred improves the earnings per share of the remaining common."
Mr. Raines said the package would be completed this year, but there was no specific timetable. "We'll issue the preferred according to what we think the market can absorb," he said. "We don't expect to do the whole billion at once."
