Capital Markets

Credit Raters Feel the Financial Pinch

Results for Moody's and Standard & Poor's nosedive in the wake of the debt-market plunge.
Stephen TaubFebruary 5, 2009

The collapse of the credit markets and the slow recovery in the new-issue market for corporate bonds are heavily impacting the top and bottom lines of the two largest credit rating agencies, Moody’s and Standard & Poor’s.

Moody’s on Thursday reported that 2008 operating earnings fell 34 percent to $748.2 million, while revenue dropped 22 percent, to $1.76 billion. Excluding the positive impact from foreign currency translation, global operating income and revenue declined 36 percent and 23 percent, respectively.In the fourth quarter, operating income plunged 41 on a 22 percent decline in revenue.

“Weak credit market conditions that prevailed throughout most of 2008 were exacerbated in the fourth quarter by the broader downturn in global economic activity,” said Moody’s chairman and CEO Raymond McDaniel.

The picture is not much better at Standard & Poor’s, which is owned by McGraw-Hill Companies. The firm reported that revenue for its Credit Market Services operation, which provides global credit ratings and risk evaluations, declined by 22.5 percent to $1.8 billion in 2008 and by 24.5 percent to $396.3 million in the fourth quarter compared to the same period in 2007.

“We’re in the toughest period right now,” McGraw-Hill CEO Harold McGraw said on a January 27 conference call, according to Bloomberg. “When we look back at some point, I think the fourth quarter of ’08 and the first quarter of ’09 will be the bottom.”

S&P noted that new-issue dollar volume in the United States fell by 53.3 percent in the fourth quarter of 2008 compared to the same period a year earlier, citing its own estimates and reports from Thomson Financial and Harrison Scott Publications.

Corporate new-issue dollar volume was off 39.3 percent, public finance declined by 28.8 percent, mortgage-backed securities fell by 90.8 percent, asset-backed securities were off 85.1 percent, and collateralized debt obligations were down 95.1 percent.

The sharp declines for the two rating firms come as the global demand for credit ratings has plummeted, especially in structured finance such as asset-backed securities, which are widely blamed for touching off the current global economic crisis.

Moody’s and S&P have come under heavy criticism for not warning of impending trouble. They have been accused of engaging in conflicts of interest, since they earn fees from the same companies they are rating, supposedly in an unbiased fashion.

The agencies’ outlook for 2009 remains bleak. Moody’s expects full-year revenue to decline in the low-single-digit percent range. “Although Moody’s has a solid base of recurring revenue, we anticipate issuance-based revenue to reflect generally weak conditions throughout 2009, with any broad improvement in market liquidity and issuance expected to be modest and to occur later in the year,” it said.

Drilling down through the fourth-quarter results for Moody’s, within the ratings business, global structured finance revenue plunged 42 percent, to $92.2 million. U.S. structured finance revenue decreased 57 percent, driven by declines in issuance across all asset classes. Non-U.S. structured finance revenue fell 26 percent, led by declines in European commercial real-estate finance and credit derivatives.

Global corporate finance revenue of $56.6 million in the fourth quarter of 2008 declined 37 percent from the same quarter of 2007. U.S. corporate finance revenue plunged 45 percent in the fourth quarter.

Outside the United States, revenue fell 23 percent, driven by the reduction in issuance of both investment-grade and speculative-grade securities.

Amid all the bad news, there was a bright spot: The company reported that global revenue for Moody’s Analytics for the fourth quarter of 2008 climbed 13 percent, to $149.8 million, from the same quarter of 2007.

Moody’s Analytics provides research, data, analytic tools, and related services to debt-capital markets and credit risk management professionals. The products and services help assess and manage the credit risk of individual exposures as well as portfolios; price and value holdings of debt instruments; analyze macroeconomic trends; and help customers with their risk management.

For 2009, Moody’s said it expects revenue growth at Analytics in the mid-single-digit percent range. “We expect strong revenue growth in the software and consulting businesses to offset a revenue decline in the subscription business in the low-single-digit percent range,” it added.

At S&P Credit Market Services, non-transaction revenue grew by 5.2 percent to $1.3 billion in 2008 compared to 2007. Non-transaction revenue includes surveillance fees, annual contracts, subscriptions, and other services, such as bank loan ratings, that are not reflected in public bond issuance. About 90 percent of the non-transaction revenue stream is recurring, the company noted.

In the fourth quarter of 2008, non-transaction revenue accounted for 79 percent of S&P Credit Market Services revenue.

However, transaction revenue at S&P Credit Market Services plummeted 54.8 percent in 2008 and 57.4 percent in the fourth quarter of 2008 compared to the same period last year.