Moody’s Corp. (MCO:US) shares may drop as the market’s indifference to its downgrades prods bond issuers to stop paying for ratings, according to Mark Palmer, an analyst for BTIG LLC, a trading firm in New York.
As Moody’s cut its ratings on banks worldwide, the company was fired by Denmark’s Nykredit Realkredit A/S and the mortgage unit of Danske Bank A/S (DANSKE), the country’s biggest bank. Investors continued to buy the lenders’ bonds after the decisions, which may show other issuers that they can stop paying fees to the New York-based company, Palmer wrote in a report today.
“The Danish banks’ firing of Moody’s is not likely to be an isolated incident, but could presage a trend in which frustrated issuers end their dealings with the rating agency,” Palmer said. “If the market continues to yawn in response to these firings, as we expect, this will encourage even more issuers to follow suit.”
Moody’s also faces the risk that investors will win lawsuits over its inflated ratings for mortgage bonds that were blamed for fueling the housing bubble, Palmer said. The report was his first on the ratings company. He said investors should sell the stock and that it could fall to $28, which is 24 percent below Moody’s stock price of $36.94 at 11 a.m. in New York.
Michael Adler, a spokesman for Moody’s, had no immediate response to the report. The company’s ratings unit, the second- largest in the world behind Standard & Poor’s, generated 86 percent of its $888.4 million of operating income (MCO:US) last year, according to data compiled by Bloomberg.
Last month, the cost of protecting financial debt declined following Moody’s downgrades of 15 global investment banks, showing the ratings company has little credibility with investors, Palmer said. The company’s “ruined brand” is starting to put its continued relevance in doubt, he said.
“The reasons for that recalibration may have more to do with politics and the existential threat to the company than what’s really going on with the companies being analyzed,” Palmer said today in a telephone interview.
Palmer said he hadn’t spoken with Moody’s management about the report. “That’s going to be an interesting conversation,” he said.
Moody’s has gained power over the century since John Moody published his first ratings in 1909 as regulators and funds around the world embedded its scores in rules, Palmer said. After the 2010 Dodd-Frank Act mandated the removal of references to ratings in financial regulation, pension managers may follow suit, reducing Moody’s influence, Palmer said.
Moody’s net income (MCO:US) rose 13 percent to $571.4 million last year, according to data compiled by Bloomberg. Earnings may increase another 6 percent to $605.3 million this year, the average estimate of four other analysts surveyed by Bloomberg. The regulatory and litigation risks to the ratings industry are fading, Peter Appert, an analyst at Piper Jaffray & Co. in San Francisco, wrote in a report today.
Appert has the equivalent of a “buy” rating on Moody’s and says its stock may climb to $47 as it maintains its market share amid rising worldwide bond issuance.
David Einhorn, who runs the New York-based Greenlight Capital Inc. hedge fund and is known for betting against Lehman Brothers Holdings Inc. before the investment bank’s 2008 collapse, said in a May 2009 speech that he was shorting Moody’s because ratings were “shunned” by investors. The stock has climbed 37 percent since then.
Warren Buffett’s Berkshire Hathaway Inc. is Moody’s biggest shareholder (MCO:US) with a 13 percent stake valued about $1 billion. Buffett told the Financial Crisis Inquiry Commission in 2010 that Moody’s sales are unaffected by investors’ opinions about ratings, calling the business a “natural duopoly.”
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