Bond Raters Turn Stock Favorites With S&P, Moody’s RallyMatt Robinson
The worst financial crisis since the Great Depression is becoming little more than a fading memory for investors in McGraw Hill Financial Inc. and Moody’s Corp., which have risen about three times faster than the broader stock market in the last year.
McGraw Hill, the owner of Standard & Poor’s, the world’s biggest ratings company, gained 67 percent to $80.27, while Moody’s, has rallied 60 percent to $81.68. The returns outpaced the 21.6 percent jump in the S&P 500 Index as both companies reported record ratings revenue last year, when corporate borrowers issued the most dollar-denominated bonds ever, according to data compiled by Bloomberg.
S&P, Moody’s and Fitch Ratings, the largest debt graders before the crisis, have maintained their market position even after regulations were enacted to curb their influence following congressional reports that their inflated ratings contributed to the crisis. The companies are among beneficiaries of Federal Reserve stimulus that pumped more than $3 trillion into the financial system to spur economic growth.
“The core business is extremely healthy,” Peter Appert, a San Francisco-based analyst for Piper Jaffray & Co. who recommends buying the companies’ stocks, said in a telephone interview. “The underlying trends in the business have gotten better. Bond issuance volumes have been very strong for the last several years because rates have come down and international markets are growing.”
The credit raters have benefited from interest rates near zero, spurring issuers to lock in record-low borrowing costs. The amount of debt globally has soared more than 40 percent to $100 trillion since the first signs of the financial crisis, according to the Bank for International Settlements. The jump in debt as measured by the Basel, Switzerland-based BIS in its quarterly review is almost twice the U.S. economy.
Companies have raised $19.2 trillion since the start of 2009, Bloomberg data show. Yields on corporate bonds globally have fallen to 3.46 percent, below the 5.03 percent average over the last decade, according to the Bank of America Merrill Lynch Global Corporate & High Yield Index.
While most of those sales refinanced debt, there’s “much more refinancing need coming,” Moody’s Chief Financial Officer Linda Huber said March 4 at an investor conference. Issuers have extended their average maturities to 7.1 years in 2013 from 6.5 in 2009, according to data from New York-based Moody’s.
Our focus is on driving “strong growth and shareholder value” that have been supported by “trends in the capital and commodity markets,” Jason Feuchtwanger, a McGraw Hill spokesman, wrote in an e-mailed statement. The company announced today that it’s seeking revenue growth at a percentage rate in the mid to high single digits for the next three years and at least $100 million in savings. The company also said it’s exploring alternatives for its McGraw Hill Construction data and information business.
Michael Adler, a Moody’s spokesman, last week declined to comment beyond the company’s quarterly financial guidance.
McGraw Hill is contesting a federal fraud lawsuit filed in February last year that contends its opinions were swayed by business interests, while Moody’s said about 40 of the 60 lawsuits filed against it and tied to crisis-era ratings have been dismissed or withdrawn.
“Courts have found consistently in the raters’ favor,” said Appert of Piper Jaffray. “It doesn’t mean you can’t be surprised,” he said, “but you have to conclude they have fairly strong defenses.”
Relying on Bonds
European companies are relying more on bond financing than bank loans as new regulations following the financial crisis shrink banks’ balance sheets. Non-financial companies in the region raised 23 percent of their cash in the capital markets, up from 20 percent in 2012, according to data from Moody’s.
If the current trends hold, the increased bond sales represent an additional $600 million of revenue for Moody’s over the next 10 years, Huber said.
The two companies are looking to Asia for growth. Moody’s is seeking to expand its 28.5 percent stake in Indian grader ICRA Ltd. McGraw Hill increased its holding in Indian competitor Crisil Ltd. to 68 percent last year from 53 percent. Indian debt sales increased 21 percent to 2.3 trillion rupees ($37.6 billion) last year from 1.9 trillion in 2010.
“The Indian market is a substantial bond market,” Raymond McDaniel, the chief executive officer at Moody’s, said at an investor conference March 11. “Hopefully, the tender offer will be successful and we’ll get to a majority position with ICRA.”
McGraw Hill and Moody’s research and data businesses are also growing. Revenue for S&P’s financial services division, which includes analytics provider Capital IQ and S&P Indices, rallied 10 percent to $1.7 billion. Sales at Moody’s Analytics rose 8.1 percent to $924.7 million last year.
Shares may ease from record highs once investors receive more clarity on potential legal repercussions, Edward Atorino, a New York-based analyst at Benchmark Co., said in a telephone interview. “The market is behaving as if there isn’t anything to worry about,” he said.
Ratings companies were blamed for helping trigger the financial crisis by awarding top grades on bonds backed by subprime mortgages to win business from Wall Street banks, according to a Senate investigation.
The credit-grading business was targeted by lawmakers in the 2010 Dodd-Frank Act after the collapse of mortgage-backed securities contributed to $2.1 trillion in writedowns and losses at financial firms globally. Ratings cuts on top-rated bonds tied to subprime debt helped wipe out almost $11 trillion of household wealth, the Financial Crisis Inquiry Commission said in its 2011 report.
The Justice Department sued McGraw Hill on Feb. 4, 2013, seeking as much as $5 billion in damages, and sending shares down 13.8 percent to $50.30, the biggest drop since the stock market crash of 1987. The company said in a statement the next day that the lawsuit was “meritless” and that it would fight the claims “vigorously.”
Moody’s, founded by credit-ratings pioneer John Moody in 1909, dropped 10.7 percent to $49.45 the same day. It wasn’t included in the lawsuit.
The government and S&P are in the evidence discovery phase of the Justice Department suit, for which a trial date has yet to be set. The outcome of pending legal actions, proceedings and investigations “should not have a material, adverse effect on our consolidated financial condition,” McGraw Hill said in its annual report.
Prior to the Justice Department lawsuit, both companies’ price-to-earnings ratios, or the amount investors pay for each dollar of earnings, traded above the average in the S&P 500. The probe sent their shares tumbling to trade at a discount to the index before they recaptured the premium by July.
The ratio for Moody’s has risen to 22 times, above its 10-year average of about 20, while the measure for McGraw Hill has climbed to 23 times, exceeding its average of 18 times in the same period. The ratio for the S&P 500 is 17.2 times.
Both companies took advantage of the fall in prices with stock repurchases. McGraw Hill returned $1.3 billion in share buybacks and dividends last year and Moody’s sent shareholders $1.1 billion. Investors have slowly priced the shares higher.
While the U.S. Securities and Exchange Commission works to reduce the influence of credit ratings such as removing references to bank capital standards, their grades are still woven into financial regulation. Of the 19 states and the District of Columbia that have sued New York-based S&P for fraud, six require use of or have references to its rankings or those of Moody’s and Fitch.
The rules have helped insulate the companies from competition. The top three raters’ grades made up 96.5 percent of all rankings provided in 2012, down from 98.8 percent in 2007, according to an annual report from the SEC.
“Once the shock of the DOJ lawsuit wore off, and people realized that this would be a long legal tangle for many years, the investment world has gotten more relaxed about the near-term implications,” Douglas Arthur, an analyst with Evercore Partners Inc. in New York., said in a telephone interview. “The market believes that the lawsuit is an irritant, but it’s not going to be significant at the end of the day.”