Fannie Mae last week released earning results for the fourth quarter, as well as its December monthly summary. The GSE reported fourth quarter core business earnings of $1.77 per share, which is up 6.6% from one year ago.

The GSE's net outstanding MBS grew 29.4% annualized to $1.3 trillion. This was led by declines in Fannie MBS repurchases and liquidations. The firm's G-fee came in at 19.5 basis points in the fourth quarter. This is down slightly from 20 basis points in the third quarter. A report by Credit Suisse First Boston attributes this decline to the drop in prepayment activity.

Meanwhile, Fox-Pitt, Kelton said that the balance of Fannie's retained portfolio fell compared to last Sept. 30. The retained portfolio balance slid by 2% to $898 billion at year-end 2003.

Fox-Pitt added that with mortgage origination volume decreasing and other investors remaining active buyers of mortgage-backeds, analysts expect mortgage-to-debt spreads to remain narrow in the first half of 2004. The firm added that other investors, such as banks and thrifts, will be less active in 2004 as loan demand accelerates in light of the growing economy. Due to this phenomenon, Fox-Pitt thinks that Fannie's retained portfolio has the potential to increase, particularly in the second half of the year.

"As other investors reduce their appetite for newly created MBS or liquidate their existing MBS holdings, Fannie Mae's mortgage-to-debt spread may widen,"wrote analysts from Fox-Pitt. "As such, after projected shrinkage in the first quarter, we expect the balance of the retained portfolio to grow at an increasing pace as the year progresses."

The analysts added that with mortgage-to-debt spreads staying narrow, and with only $8.1 billion of commitments outstanding to purchase mortgages for Fannie's portfolio at the end of last year, they believe that the GSE's retained portfolio balance should decline by 2.1% in the first quarter of 2004. Any jump in Fannie's retained portfolio growth attributed to the liquidation of MBS holdings by other investors will probably result in a slower growth rate or even an absolute drop in the balance of MBS held by others.

Sandler O'Neill & Partners said that although Fannie's portfolio dropped in the fourth quarter of last year, and may even decrease in the first quarter of this year, banks and other nontraditional long-term mortgage investors will not only sell mortgages but will also stop aggressively bidding once there is a growing consensus that the Federal Reserve is going to increase rates.

"Once this happens, we expect mortgage-to-debt spreads to widen and investment returns to improve for FNM," wrote analysts from Sandler. "The only question is when the great mortgage selloff will occur, not if it will occur."

In terms of headline risk, CSFB said that the current regulatory environment and possible legislation in 2004 would not have a significant effect on the GSEs. Analysts added that recent comments by congressional leaders highlight the fact that the legislative process would probably not reduce the GSEs' ability to carry out their mission as well as grow their books of business.

Fannie also reported its December monthly summary stating that its balance sheet maintained a negative one-month effective duration gap in December, unchanged from November. CSFB also mentioned that Fannie's capital cushion rose considerably in the quarter. The report said that while portfolio investment is still the top priority for capital deployment, with the lackluster near-term investment opportunities, analysts expect an acceleration in share repurchase activity.

Copyright 2004 Thomson Media Inc. All Rights Reserved.

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