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A first look at first-quarter earnings
SNL Financial (April 14, 2003)

The financial services industry begins its parade of earnings reports this week with a hodge-podge of specialty lenders and securities brokers. Investors shouldn't be shocked to find more of the "same old story" - mortgage finance will be strong, with retail and institutional brokerage weak.

That's not to say there won't be a smattering of good and bad news.

The good news first:

Fannie Mae likely will be among the best performers of the quarter. The yield curve remained steep throughout the first quarter of 2002, which should lift Fannie Mae's net interest margin from already respectable levels. Fannie reported NIM of 1.15% in 2002 and 1.26% for January and February 2003.

Fannie Mae also should report accelerated portfolio growth thanks to a lingering real estate boom, if nothing else. But analyst Robert Napoli at U.S. Bancorp Piper Jaffray has written that the company could see annualized portfolio growth at more than 20% this quarter, thanks to the company's improved position in the sector. According to Napoli's April 10 report, Fannie has seen "significant" loan volume from Bank of America since the bank ceased selling exclusively to Fannie competitor, Freddie Mac. Market-share gains by Fannie Mae ally Countrywide Financial Corp. and the fixed-income market's recent improved pricing of Fannie's mortgage-backed securities relative to Freddie's issues suggest Fannie has gained market share, according to Napoli, who considers Fannie Mae one of the best investments in financial services.

Should Fannie's earnings report provide evidence of the strong growth that analysts are expecting, the company could see a sizeable bounce. At $69.01 the company trades at a modest 15x its last-12-months earnings. But analysts are predicting earnings to jump by nearly 60% in 2003 and another 10% in 2004. Given that growth, Fannie is trading well short of 8x anticipated earnings. Another certain beneficiary of today's favorable real estate and interest rate-climate remains New Century Financial Corp. The company consistently has beaten analysts' estimates over the past year and appears poised to do so again when it reports April 16. On April 4, the company announced loan production of $4.7 billion for the first quarter of 2003, topping year-prior figures by nearly 80% and putting the company in line to meet its 2003 guidance of $18 billion in originations. A statement by CEO Robert Cole indicated the company would blow by analysts' consensus first-quarter earnings estimate of $1.62 per share.

Nevertheless, New Century stock has actually slipped 5.29% since its upbeat pre-earnings announcement. That sell-off is consistent with previous dives as the stock approaches a ceiling of about $35 per share. Though most sell-side analysts (and even one prominent short-seller consultant) agree the company is undervalued, the company bears a 33% short interest on its shares, a burden the company has long tried to shake. Unfortunately, that probably won't happen this earnings season as most of New Century's current good news has already greeted the marketplace.

Whereas most lenders recently have suffered from increased delinquencies, defaults and deteriorating collateral, SLM Corp. ("Sallie Mae") and its smaller, more specialized colleague Student Loan Corp. are basking in sunny demographic projections and secure up-market clientele. As such, both stocks have capitalized from investors' flight to quality over the past 12 months, rising 17.2% and 6.1%, respectively.

When both companies report April 17, there shouldn't be many surprises. Sallie Mae will speak to analysts' sadistic interest in the aircraft-leasing business that SLM's former management team acquired two decades ago. The company could well take impairment charges this quarter related to seven outstanding leases with AMR Corp. unit American Airlines, similar to last quarter's $51-million after-tax writedown tied to the UAL Corp.-United Airlines bankruptcy. But that loss didn't stem stock growth then, and it likely won't now. Unless the company announces some unprecedented, unexpected MBNA Corp.-like collapse in credit quality, the company will remain popular.

Not, necessarily, that it should. The company expects long-term growth at 15%, a potentially conservative estimate. But with a price of 23x earnings and a 1.5 PEG ratio, this otherwise safe stock seems pricey. Nonetheless, investors and six out of eight sell-side researchers love SLM shares these days.

A few lingering broker/dealers also will detail their takes on the first quarter of 2003 this week, but in most cases their stories have already been told.

Merrill Lynch & Co. is scheduled to report April 16, but with most other Wall Street investment banks having already reported, the Bull may find itself the victim of excessive market expectations. Since Goldman Sachs Group Inc., Lehman Brothers Holdings Inc. and Morgan Stanley all announced handedly positive earnings surprises on March 20, the SNL National Broker/Dealer Index has climbed 4.2% versus the S&P 500 Index's 0.3% loss. Merrill, too, has gained 4.8%. Unfortunately, this week Merrill approaches earnings unarmed with the same fixed-income focus as its peers. In past quarters, Merrill drove much of earnings gains through cost cutting and layoffs - it must be close to tapping out those reserves.

Institutional brokers LaBranche & Co., Knight Trading Group Inc. and Investment Technology Group also announce earnings on April 15 and 16. But where Merrill could suffer from overoptimism, these market makers won't likely offer earnings reports any worse than the warnings the market has already digested.

ITG on April 7 announced that, at 12 cents to 14 cents per share, first quarter earnings would be only half of what analysts had expected. ITG added it plans to cut 175 jobs, or 12% of its workforce, to reduce costs. The stock lost 10.8% on the announcement and has yet to regain significant ground.

LaBranche reported March 31 that first-quarter earnings should reach just 6 cents to 8 cents per share compared to analysts' expectations of 21 cents to 30 cents per share. It tumbled 5.4% following its announcement, but has since regained much of those losses.

And Knight warned the same day that it expects a loss of 9 cents to 13 cents per share, which includes a 10-cent-per-share loss related to severance costs and writedowns of investments. Analysts hadn't previously expected much better performance, so NITE shares were spared the losses of its peers. The company fell 3.3% on the news, but has gained 6.7% since then.

The broker/dealers suffered an institutional trading freeze amid pre-war and economic uncertainty in the first quarter. As LaBranche wrote, "Geopolitical uncertainty and continued pressure on equity prices have resulted in both lower dollar volumes on the NYSE and lower dollar volumes traded by LaBranche as principal." Some high-pitched, last-minute trading in late March and April broke the traders' calm, but failed to make-up for lost time and money. If any management teams can provide evidence this week that the above-average trading associated with the war could linger post-Saddam, expect investors to regain limited optimism and buyback deeply discounted stock.



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