Equity Research and Investment Analysis

The point of this post is not to pass judgment on the major ratings firms, as we all know plenty has been written and said about their short comings. Rather, the point is to highlight an intriguing trend in debt instruments; a trend that has been used by firms such as Highland Capital Management, Heineken NV, Gruppo Campari and Credit Suisse (CS). The credit rating firms provide a service that many investors cannot do without, and the evolution of unrated bonds should motivate them to improve and not repeat mistakes that have harmed their credibility. However, the emergence of independent research and due diligence is what is more interesting to us at Ockham.

The latest data out of Moody's suggests that investors should remain wary of company's heavily tied to consumer debt. More jobs are being lost each month and even with the pace of those losses slowing, it must be a concern to creditors. Given the run that each of the previously mentioned stocks, we would seriously wonder if the market has prematurely assumed that the family balance sheet has improved substantially. Furthermore, the earning power of these companies could be diminished going forward if consumers are more spend-thrift going forward. A climbing savings rate suggests that consumers may be less likely to turn to the plastic for any unnecessary purchases.

Today Moody's cut JC Penny's debt down to junk level. The problem is that JC Penny is experiencing significant sales weakness and Moody's does not expect that to improve in the near term. We have to agree with them and barring a major turnaround it is only a matter of time before the company cuts their dividend.

Genworth has seen significant appreciation well in advance of the fundamentals justifying such gains. Analysts are expecting fiscal 2010 earnings of $1.10 which would make the valuation look attractive, but that seems to expect quite a bit out of Genworth’s other units if the mortgage unit will see its peak losses in that year. As capital markets have healed this year, GNW has raised capital through asset sales, a debt offering, and a secondary offering of stock in order to provide a cushion for any future losses.

There is significantly less risk in this bank than probably any other major bank, and their CEO believes that the conventional wisdom regarding New York City is probably too bearish. With a multiple below 13x and a dividend yield around 4.5%, we firmly believe this investment will start to attract some attention as quality becomes more of a premium.

Cramer talked about enormous upside on this deal with Colonial, as their mortgage unit, which had come under DoJ investigation, posses no liability to BB&T. The offering went on sale Tuesday, and so far in morning trading the stock is up more than 2 percent. Clearly, BB&T is having no trouble raising money in the open market.

Clearly, the relaxation of mark to market has served the purpose of giving banks a breather from book value destroying write-downs. However, as Weil exposed, book value is really simply accounting fiction. Many of the credit issues that caused this mess are still yet to be worked out, and at Ockham we remain very wary of bank stocks.

As today's earnings release demonstrates, credit concerns still necessitate fortification of their balance sheet. We will continue advising investors to steer clear of Deutsche Bank for the time being because the recent economic improvements are still vulnerable and the actions of the company do not inspire a lot of confidence in the immediate future.

There were a couple of very interesting pieces of news from the this morning that I believe are important. One, a study by the WSJ, has shown that banks thus far are lending less than before they received the TARP funding. The second comes from a newsletter from John Mauldin that warns of the possibility of more TARP programs headed our way.