McGraw-Hill Cos., the owner of the world’s largest ratings company, was downgraded by its biggest rival after the U.S. government filed a lawsuit that seeks as much as $5 billion in damages.
Moody’s Investors Service cut the debt rating on the New York-based parent of Standard & Poor’s by two levels to Baa2 from A3, and said it may reduce the grade again. The new ranking, two steps above speculative grade, takes into account the sale of McGraw-Hill’s education unit and the lawsuit filed Feb. 4 by the Justice Department, Moody’s said yesterday in a statement after the close of trading in New York.
The government accused S&P of deliberately misstating the risks of mortgage bonds, whose collapse helped trigger the credit crisis. McGraw-Hill climbed for a third day, rising 0.2% to $44.95 in New York trading. The stock had lost as much as 27% this month, wiping out $4.4 billion of market value. Yields on its $800 million of outstanding bonds rose as much as 0.9 percentage point since the lawsuit.
“Rating agencies damaged their brands in 2008 and now it is having consequences,” said Mat McCrum, investment director at Melbourne-based Omega Global Investors Pty, which manages A$3 billion ($3.1 billion). “They tried to get as much cash flow from their brand at the long-term expense of the value of the brand.”
‘Touch of Irony’
Jason Feuchtwanger, a spokesman for the McGraw-Hill, said in an e-mail: “We are focused on standing up McGraw-Hill Financial, a high-growth, high-margin company that produces solid free cash flow. Overall, we have a strong balance sheet and we intend to maintain it going forward.”
The company said in a Feb. 5 statement that the U.S. lawsuit is without merit.
Moody’s downgrade of McGraw-Hill is “a touch of irony,” Jim Reid, a strategist at Deutsche Bank AG in London, said in a client note.
The rating cut follows the U.S. seeking fines from McGraw- Hill of the equivalent of more than five years of profit.
McGraw-Hill agreed to sell the education unit to Apollo Global Management LLC for $2.5 billion in November. After the divestiture, adjusted earnings at the remaining division, to be named McGraw Hill Financial, will be $3.10 to $3.20 a share this year, the firm forecast Feb. 12, an increase of at least 13% from 2012. McGraw-Hill plans to retire about $457 million of short-term debt with the $1.9 billion it gets from the sale.
McGraw-Hill is focusing on higher-margin businesses including its S&P bond-rating unit while repurchasing stock to raise earnings per share, according to a company statement on Feb. 12. It will swing to a net cash position from about $495 million of debt, according to data compiled by Bloomberg.
“The company’s liquidity position will improve meaningfully” on completion of the education unit’s sale as McGraw-Hill repays commercial paper borrowings with the net proceeds and maintains a “sizable” cash balance, Moody’s analysts John E. Puchalla and John Diaz said in the statement.
Lawmakers targeted the credit-grading business in the 2010 Dodd-Frank Act after the collapse of top-ranked mortgage-backed securities contributed to $2.1 trillion in losses at the world’s largest banks. Reports from the U.S. Senate Permanent Subcommittee on Investigations and the Financial Crisis Inquiry Commission cited failures by S&P, Moody’s and Fitch Ratings as a cause of the financial crisis, which began in August 2007.
S&P rated more than $2.8 trillion of residential mortgage- backed securities and about $1.2 trillion of collateralized-debt obligations from September 2004 through October 2007, according to the complaint filed in federal court in Los Angeles.
The collapse in value of securities that packaged home loans from the riskiest borrowers led to a credit seizure starting in 2007 that sent the world’s largest economy into its longest recession since 1933 as defaults soared and home values plummeted.
Bond and credit-default swap prices for McGraw-Hill imply a Baa3 rating for the company, one step lower than the new grade, according to Moody’s Corp.’s capital markets research group. The New York-based company is the parent of the second-largest ratings business.
Fitch downgraded McGraw-Hill’s debt rating one level to BBB+ from A- on Feb. 7, citing the lawsuit filed by the Justice Department and the potential for more suits against the company as well as the potential impact they may have on S&P’s operations. S&P ranks Moody’s at BBB+, three levels above speculative grade.
“It’s like the ratings companies are eating each other,” said Ayako Sera, a market strategist at Sumitomo Mitsui Trust Bank Ltd., which manages about $163 billion in assets. “What’s being questioned now is the very reason for the existence of these agencies.”