Bad Ratings
Share prices of Moody's Corp. fell drastically last week as investigations began into a computer error that caused the
rating service to apply improper ratings to be assigned to European debt securities, known as
constant proportion debt obligations. Shares fell from a high of $46.46 last Monday, to close Friday at just $34.16, on this news.
As financial markets continue to be bashed by the subprime crisis, we certainly did not need another bit of wrongly rated debt instruments to remove even more faith from our financial system. The
Financial Times reported this week that it obtained internal documents showing that the agency has actually been aware of this error since 2007, yet Moody's continued to rate these complex debt securities as
AAA until early this year, when downgrades were seen across almost all debt instruments due to market turmoil.
In a letter to customers sent on Friday, the
CEO of Moody's Raymond McDaniel, said that he will act "quickly and decisively to address any need for changes." McDaniel continued, stating that "it is inconsistent with Moody's analytical standards and company policies to change models and methodologies for any reason other than to improve the accuracy of our ratings."
It is admirable that the CEO would admit an error has occurred and take steps to fix it, rather than trying to pass the buck or cover it up. Reuters reported on Friday that Moody's has hired a law firm for the review of its rating processes. The bottom line is that it appears that something terrible has happened in this situation, and whether it was fraudulent or just simply due to incompetence, it seems that Moody's executive are doing what it takes to find out the truth.
No Bottom YetWith regulatory and legal risk now brought to the forefront of Moody's situation, I am wary of calling a bottom. That said, it has historically been a strong company, and should Moody's come out of this investigation smelling of roses, its share price could be poised to return to its previous highs. Risk of the legal nature, though, is dangerous, and we've all seen legal actions put a company out of business. Moody's could definely be a candidate for this situation, with
revenue growth already hurting from the ongoing turmoil in the financial markets.
Regardless, Moody's sentiment remains high in the
Stock Picking Community with 100% of the members liking its chances going forward. I agree with these members, feeling that when compared to everything that has happened in the financial community these past couple of years, this may be seen as a drop in the bucket. I will, however, wait to see what regulatory action ensues, before calling a bottom on this hurting company. (To learn how to assess which stocks are poised for a turnaround, read
Catching Comeback Stocks For Clients and
Turnaround Stocks: U-Turn To High Returns.)
Add Your Two Cents
What do you think will happen with Moody's going forward? Will the credit rating giant be able to regain it's reputation, and come back to reward it's loyal investors? Be sure to join me (
aytonmm) in the
FREE Stock Picking Community to share your thoughts and see what other investors are saying.
