The business stories that matter, by Fortune's Colin Barr
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March 5, 2008, 11:37 am

Fannie falls despite upgrade

Fannie Mae (FNM) fell 4% in midday trading in spite of a modestly encouraging analyst note out this morning. Analysts at Morgan Stanley upgraded Fannie’s stock to equal-weight from underweight, saying their weak outlook for last week’s fourth-quarter numbers is now reflected in the stock. Morgan Stanley said it continues to like rival mortgage investor Freddie Mac (FRE) better, but is taking off most of its short position on Fannie.

The firm says the risks of a further decline in Fannie stock are evenly matched with the prospect that investors who don’t own it will miss out on a rally based on its modest multiple - the stock is trading below regulatory book value - and its earnings power going several years out. But how the company handles the next year remains an open question, Morgan Stanley says. “On the negative side, we cannot yet bracket a reasonable worst-case scenario for credit losses,” the firm writes. “Prime mortgage delinquencies are accelerating, and the full impact of labor market deterioration has yet to be felt.”

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Colin Barr covers business and finance for Fortune.com. Previously he was an editor at TheStreet.com and author of the weekly Five Dumbest Things on Wall Street column, and an editor at Dow Jones Newswires.
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