Moody's Corporation (NYSE:MCO) has received a 'strong buy' rating and a $55 price target from analysts at Raymond James. The move comes after the 18.5% pullback in stock price ($2.3 billion market cap loss) after the 2/4/13 announcement that the U.S. Department of Justice (DoJ) will bring charges against its peer,McGraw-Hill Companies, Inc. (NYSE:MHP)’s Standard & Poor’s credit rating business, for alleged wrongdoing in the rating of mortgage bonds prior to 2008.
Possible Outcomes: No Litigation—If Moody's Corporation (NYSE:MCO) is not named in a similar suit, investors who use the current price as an entry point are getting a free option on a recovery of the stock’s multiple. To date, the credit ratings agencies have succeeded in having the majority of legal cases related to 2005-2007 U.S. residential mortgage-backed and similar securities dismissed, withdrawn or dramatically reduced in scope. Over the years The McGraw-Hill Companies, Inc. (NYSE:MHP) has been successful in defending against lawsuits. In 2012, 30 cases were dismissed, with 10 voluntarily withdrawn.
Litigation—If Moody’s is named as a defendant in a similar case, then Raymond James analysts believe that:
(1) the $2.3 billion loss in market cap already reflects this risk
(2) the case would not impact Moody’s ongoing operations since the claims in the DoJ’s lawsuit vs. MHP are based on events prior to the U.S. government imposing significant regulations on the rating agencies following the 2008-2009 Recession
(3) investors would likely recognize a damages/settlement payment as a one-time event that would likely not have an impact on forward business and
(4) Moody’s has sufficient liquidity to handle potential expenses related to such litigation; at 9/30/12, the company had $1.7 billion in cash and equivalents, no amounts outstanding on its $1.0 billion senior unsecured revolving credit facility, and the ability to generate in excess of $500 million in annual free cash flow. However, a word of caution from Raymond James. They note (the obvious) that being named in a DoJ lawsuit would likely prolong the time period of Moody’s elevated litigation expenses.
Some other positive factors for Moody's Corporation (NYSE:MCO) and Syandard & Poor's, which were not noted by Raymond James.
In its lawsuit, the Justice Department alleges fraud related to about 30 CDO’s in 2007. Several states may join the DOJ lawsuit. S&P has stated the lawsuits are without merit as its ratings reflected its current best judgment at the time about the CDOs in question.
Also, every CDO cited by the DOJ independently received the same rating from another rating agency. It is expected that it could take up to three years for the lawsuit to come to trial and that a settlement could be reached as the trial date draws near.
The Abu Dhabi case, set to come to trial on May 6, 2013 was filed four and half years ago on August 25, 2008. Some believe that a settlement of the case sooner than that would probably be viewed as a positive by investors because it would remove the litigation overhang sooner.
With a continuing low interest rate environment, corporations should continue to issue new debt for capital expenditures, share repurchases, mergers and acquisitions, and refinancing. Investment grade corporate bond issuance was up 55% y/y in 4Q12, according to industry sources, with high yield bond issuance up 215% y/y. Mortgage related issuance also picked up, increasing 20% y/y for October and November, with asset backed up 38% and municipal flat. Strong demand for covered bonds boosted issuance in Europe. This is good news for both of the large rating agencies.
There remains a substantial amount of debt to be refinanced that ought to drive debt issuance through 2015. S&P estimates more than $1 trillion will be financed each year for the next several years.