Attractive Lenders

If I were a chartist, which I'm not, I'm sure I would consider the chart of KKR Financial to be surpassingly ugly. But I had lunch today with Brian McMahon, the CEO and CIO of Thornburg Investment Management, and he's much more constructive on the company, which essentially is a lender.

McMahon said that the interest rate on the loans that KKR Financial makes has gone up well over 200bp since the summer, in some cases as much as 300bp, even as KKR Financial's own cost of funds has only gone up about 75bp. Result: higher earnings! So if you consider the value of the company to be the discounted value of future earnings, that value should in theory be higher than it was when the crunch hit last summer.

Of course, the discount rate you use to value the company will probably have risen too - and, crucially, the expected default rate on KKR Financial's assets is likely to have gone up substantially, given how property-centric its portfolio is. But is that enough to justify the fact that KKR Financial is trading at less than half the price it was at a year ago?

And McMahon's bigger point is well taken: lending is a good business right now, as credit spreads have widened and banks start being reintermediated in the wake of the bond markets largely closing down for many issuers. There are bound to be banks out there, and other lenders, who have been battered by the credit crunch but whose loan portfolio is actually reasonably solid. Those stocks could prove to be very attractive over the medium to long term, especially if you think that any recession in the US is likely to be relatively mild and overall default rates are likely to remain subdued.