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Buoyant Moody's


Moody's () is a juggernaut. As one of the two dominant credit-rating agencies in the U.S., it practically mints money, pocketing 35 cents of each dollar it takes in after taxes. With wads of cash, the company can buy back $1 billion worth of its stock in a year. All that has helped boost its shares by more than 200% since 2002.

Yet for all its success—which has propelled it to the No. 29 spot on BusinessWeek's 2007 list of the top 50 corporate performers—Moody's is getting some grief. Amid the subprime mortgage mess, Congress twice this spring summoned Moody's management to testify about its part in the creation of investment pools that included those risky home loans. Now some scholars are adding to the chorus of concern, arguing that Moody's has been too slow to downgrade those same mortgage-backed securities given the rising foreclosures and weak housing prices nationwide.

Such controversy is hardly new for Moody's and the other major ratings agency, Standard & Poor's (MHP), which together issue 80% of debt grades. (Standard & Poor's is a unit of The McGraw-Hill Companies (MHP), as is BusinessWeek (MHP).) Five years ago, Moody's and S&P were roundly criticized for not seeing signs of fraud at Enron and WorldCom before those companies plunged into bankruptcy. Meanwhile, borrowers, who pay Moody's for its services, and investors are constantly quibbling over particular ratings. "I've been here for 20 years, and I've been fussed at for 20 years," says Chairman and CEO Raymond W. McDaniel. "If I'm still here, I'll probably be getting fussed at 20 years from now."

Following on the subprime saga, some critics are questioning whether there are flaws in its methodology for assessing all manner of structured finance products, which also include investment pools backed by other assets, such as credit-card receivables and corporate loans used in private equity deals. The products are big business for Moody's, accounting for 44% of revenues, vs. 32% for traditional corporate bond ratings.

The worriers, such as those at a recent conference hosted by Hudson Institute, a Washington think tank, say such investments are far more complicated and risky than plain old corporate debt. Calculations in the structured-finance arena factor in multiple borrowers, highly technical statistical models, and the arcane legal rules governing such deals. "Risk is getting mixed up, and the ratings agencies can't keep track of it," says Drexel University associate professor Joseph R. Mason. (A spokesman for S&P says: "S&P closely monitors market trends in order to ensure that its models, methodologies, criteria, and analysis are fully informed.")

BUFFETT'S STAKE

Assessing risk is Moody's main strength. While McDaniel concedes that Moody's initially underestimated losses in subprime loans from 2006, the company was quick to see the declining credit quality and adjust its ratings criteria. He stands by Moody's rating standards, asserting that the company has kept up with the increasing complexity of this product over the past two decades.

Certainly, Moody's track record over more than a century is impressive. Founded in 1900, the company has offices in 22 countries, ratings on some 137,000 issues, and reams of studies on its performance over numerous economic cycles. Since international investors crave standard, reliable ratings across the globe, it will be tough to break the grip that Moody's, along with S&P and Fitch Ratings, have on the business—even after a new law designed to open competition is implemented in June. That position is a big reason that legendary investor Warren E. Buffett of Berkshire Hathaway Inc. (BRK) owns 17% of the stock.

McDaniel knows reliable ratings will be key as Moody's expands. In a way, he's looking forward to a downturn to prove naysayers wrong: "The low-water mark for defaults we're experiencing is just part of the cycle. When those defaults occur, you'll [see] how well we did."

By David Henry


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