Q. I’m very concerned about my shares of Fannie Mae. What are the prospects?
C.J., via the Internet
A. The largest U.S. buyer of home mortgages is trying to get its house in order. To accomplish this it must overcome its recent scandalous history of allegations of shoddy accounting and earnings manipulation, unbridled growth and ousted management.
Shares of Fannie Mae (FNM) are down 29 percent this year, following last year’s 5 percent decline. Fannie Mae is in the business of buying mortgage loans from banks, packaging them into securities and selling them into the market.
Regulators ordered this government-sponsored company to restate its earnings back to 2001, a correction that could run as high as $11 billion. It recently said it won’t release 2004 financials until the second half of 2006.
As it works toward a government-imposed Sept. 30 deadline to increase its capital reserves by 30 percent, Fannie Mae is reducing its mortgage loan portfolio and raising new capital through issuance of $5 billion in stock.
Federal Reserve Chairman Alan Greenspan has testified before Congress that Fannie Mae’s acquisition of mortgage securities for its own portfolio adds “significant risk to the American financial system.” Proposed legislation in Congress would overhaul the housing agency regulation governing Fannie Mae and Freddie Mac, as well as reduce their mortgage portfolios.
Change has begun. After accounting problems came to light, Fannie Mae Chairman and Chief Executive Franklin Raines was forced into retirement and Chief Financial Officer Timothy Howard resigned.
Daniel Mudd has been upgraded from interim status to Fannie Mae President and CEO. He was president and CEO of GE Capital, Japan, before joining Fannie Mae. Experienced outside executive S. Jean Hinrichs was named senior vice president for internal audit.
Even though its accounting records remain a quagmire and looming legislation seems likely to reduce its autonomy to some degree, Fannie Mae nonetheless performs a crucial financial function in the important housing market. So while opinions are mixed, most investment analysts don’t expect it to be dismantled.
Based on its reduced stock price, stock of Fannie Mae receives a consensus “buy” rating from analysts who track it, according to Thomson Financial. That consists of two “strong buys,” 10 “buys,” six “holds,” one “sell” and one “strong sell.”
Fannie Mae earnings are expected to decline 10 percent this year, versus an 11 percent increase projected for the credit-services industry. A decline of 1 percent is forecast for next year compared with a 9 percent increase expected industrywide. The projected five-year annualized Fannie Mae growth rate of 9 percent trails the 12 percent gain expected industrywide.
Q. I’m considering investing in Vanguard Morgan Growth Fund, which was recommended to me. Is it worth considering?
J.T., via the Internet
A. It is definitely worth a look. This unique fund is divided among three portfolio managers operating independently.
All three are talented and experienced:
– Vanguard Group’s George Sauter manages 30 percent of the portfolio by employing a quantitative index-style approach to invest in large-capitalization stocks.
– John Cone of Franklin Portfolio Associates runs 30 percent with a similar index strategy aimed at mid-cap stocks.
– Robert Rands of Wellington Management, focusing on fundamentals, has free rein with 40 percent of assets to seek growth at reasonable prices.
The 5.5 billion Vanguard Morgan Growth Fund (VMRGX) had a total return of about 17.5 percent over the past 12 months and had a three-year annualized return of roughly 13 percent. Both results rank in the top one-fourth of all large growth funds.
“This is one of my favorite large growth funds in Vanguard’s lineup, in part because it digs down a little lower in market capitalization than some competitors,” said Sonya Morris, analyst with Morningstar in Chicago. “Its mid-cap stocks have given its performance a tailwind, though that won’t last forever, and some managers believe large-cap growth stocks are about to revive.”
This solid fund should do well over time as a core holding in an individual’s portfolio, she believes, though it will lag in markets dominated by giant stocks. Due to its portfolio structure, it is unlikely to ever top the performance charts.
Twenty percent of the fund’s stocks were recently in health care. Hardware, consumer services and business services are other significant concentrations. Its largest stock holdings are Yahoo Inc., Microsoft Corp., Dell Inc., Cisco Systems Inc., Aetna Inc., AstraZeneca PLC, Medtronic Inc., Pixar, American International Group Inc. and Vanguard Growth VIPERs exchange traded funds.
This “no-load” (no sales charge) fund requires a $3,000 minimum initial investment. A real plus is its low annual expense ratio of 0.44 percent.
Long recognized for its low-cost funds and fine communication with shareholders, Vanguard has not been disciplined by any regulatory or legal authority in the past decade.
Q. How does the government know when inflation is occurring and why do interest rates go up when it happens?
H.R., via the Internet
A. Solid economic growth accompanied by slow and stable price increases is the ideal sought by the Federal Reserve.
Mostly due to higher gasoline and other energy costs, inflation has been accelerating the past two years. It is measured by the consumer price index, or CPI, the monthly survey of a wide range of goods and services measured by the Bureau of Labor Statistics.
While core inflation excluding energy remains modest, the Fed has cautiously continued to click short-term rates higher this year to remain vigilant against rising prices.
“Raising interest rates slows economic growth because it becomes harder for businesses and individuals to borrow, which limits spending and investment,” explained Mark Zandi, chief economist for Economy.com in West Chester, Pa. “In addition, they must shell out more money to service their previous debt and have less to spend on everything else.”
The current expectation is that the Fed’s monetary policy committee will increase short-term interest rates another quarter of a percentage point at its next meeting on Sept. 20 and again on Nov. 1.
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Andrew Leckey is a Tribune Media Services columnist. E-mail him at yourmoney@tribune.com.
