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DOJ Charges Standard & Poor’s: What About Moody’s?

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DOJ lawsuits don’t come bigger than today’s. The Department of Justice sued The McGraw-Hill Companies, Inc. (NYSE:MHP) subsidiary Standard & Poor’s for inflating the value of mortgage bonds artificially in the years leading up to the 2008 financial crisis. The real question is whether or not the DOJ is ready to go after Moody’s Corporation (NYSE:MCO) next.

DOJ Charges Standard & Poor's: What About Moody's?

The market is clearly readying itself for that eventuality. Moody’s Corporation (NYSE:MCO) shares have fallen by more than 8% in trading today, as the knock on effect from the DOJ lawsuit on Standard & Poor’s hit the company, and investor confidence was shaking. Shares in The McGraw-Hill Companies, Inc. (NYSE:MHP), which was actually sued today, fell by more than 10% today.

It seems likely that Moody’s Corporation (NYSE:MCO) will be hit with a similar suit after the DOJ announcement today. During the financial crisis, both firms were involved in similar ratings businesses, and both of them overvalued the mortgage bonds that eventually led to the financial crisis in 2008. The DOJ has not given any indication that a suit is forthcoming, but the market is already pricing it in.

Both Moody’s Corporation (NYSE:MCO) and The McGraw-Hill Companies were the subject of similar lawsuits from private companies in the last four years, owing to losses in the financial crisis. There is evidence tying the practices of both firms together, though the DOJ may be trying to concentrate on one case at a time, rather than have them run simultaneously.

Despite the worries, analysts from Piper Jaffray see this as an opportunity rather than a problem. That opportunity is a direct result of the volatility in the shares of both of these companies, which will almost certainly continue as litigation pressure mounts up. The author of the report, Peter P. Appert, believes Moody’s Corporation (NYSE:MCO) and The McGraw-Hill Companies, Inc. (NYSE:MHP) are experienced enough to deal with litigation pressures.

Apart from the DOJ lawsuit, the Piper Jaffray report expects growth in both rating agencies to be robust in the first quarter of 2013. Bond issuance is expected to be high in the first quarter, and as the chart below demonstrates, Moody’s Corporation (NYSE:MCO) revenue is linked very strongly to bond issuance.

Moody's Revenue Bond Issuance

Secular growth in the bond ratings business will be good in the year ahead, according to the Piper Jaffray report. The outcome of the lawsuit, which will probably take a very long time to arrive, will not effect the company’s bottom line for a long long time to come.

If the market is anything to go by, Moody’s Corporation is very likely to be the next target of a DOJ investigation. The company’s investors have already fled from the stock on fears of such an occurrence. When the DOJ will announce an operation like that will be the question on the minds of many investors going forward. If the DOJ leaves it for a long time, the market may become more confident, bringing new declines if a suit is announced.

One thing is certain, Moody’s Corporation (NYSE:MCO) investors will not rest easy until the suit is announced, they might still be waiting for it in four years time.

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