In a recent report, Salomon Brothers Inc. analyst Bruce W. Harting recommended that near-term investors hold Freddie Mac stock and that those with a long-term horizon buy it.
His reasoning: The stock has appreciated 31% since Jan. 1 and 39% since the start of 1994.
The long-term fundamentals of the Federal Home Loan Mortgage Corp. are sound, Mr. Harting wrote. Freddie's loan portfolio grew at a 35% annualized rate through April, and credit losses are falling.
Excerpts from his report follow:
Freddie Mac continues to increase earnings at a mid-teens rate through strong top-line growth and tight expense and credit controls.
During the first quarter, net income per share grew by 12%, resulting from 33% year-to-year retained loan growth, or 25% annualized growth. Net interest income increased by 14%, which was less than loan growth because the net interest margin declined.
Interest income growth carried the quarter singlehandedly because guarantee fees have failed to rise for several quarters, a problem shared by Fannie Mae (which reported identical first-quarter guarantee fees of $276 million).
Freddie Mac's ability to generate such strong retained loan growth allows the company to sustain a higher earnings growth rate than that of Fannie Mae. In addition, this higher earnings growth rate is higher quality, as it is fueled by real top-line growth rather than cost cutting, lower provisions, and share repurchase.
Alterations in underwriting standards, combined with better software for mortgage analysis, are providing the mortgage agencies and private mortgage insurance companies with more accurate mortgage statistics and, in turn, greater predictive ability in the underwriting process.
The reams of mortgage portfolio statistics can be cross-sectioned by year of origination and geography.
These data reveal the following three very important points:
*Roughly 80% of current losses are coming from loans originated before 1992, which was when the company's tighter underwriting rules took effect.
*60% of current losses are coming from California loans and 35% from the Midwest, leaving just 5% coming from the balance of the country.
*Early delinquencies, reported one year after loans are originated, were under five basis points for loans originated in 1992-early 1994, compared with 44-45 basis points for loans originated in 1989-1991, an indicator of how strong the 1992-1993 vintage loans should prove to be.
However, early delinquencies on 1994 vintage loans are already trending higher.