Do People Believe In Ratings After the Recession?: The McGraw-Hill Companies, Inc. (MHP) and More

Recently, shares of The McGraw-Hill Companies, Inc. (NYSE:MHP) fell by 11% on Tuesday after the US Department of Justice (DOJ) announced that it is filing a lawsuit against its Standard & Poor’s rating service unit. McGraw Hill has lost $3.7 billion in market capitalization in last two days and the US government is seeking $5 billion in compensation.

What Went Wrong?

The US government believes that S&P mislead investors in between 2004 and 2007 and gave a high rating to securities to promote the interest of the firm and that of the investment banks. The company ignored the high credit risk associated with the securities and influenced investors to buy these securities on the basis of their good ratings. This ultimately led to the financial breakdown in the United States. The DOJ said – “The Justice Department alleges that S&P knew the housing market was collapsing but was intentionally slow to downgrade hundreds of securities because of concerns that such a move would cut off the pipeline of deals and anger issuer clients.”

However, McGraw Hill said “S&P analysts worked diligently to keep up with an unprecedented, rapidly changing and increasingly volatile environment, while acting to ensure changes to their ratings reflected robust analysis and deliberation. In fact, throughout this time, S&P included in its analysis the possibility that a rise in mortgage delinquencies would result in bondholder losses and, as a result, required substantially more RMBS collateral as protection against such potential losses to support AAA CDO ratings.”

Financials & Future Strategy

McGraw Hill’s results for the third quarter of 2012 were above analysts’ expectations. The company posted adjusted quarterly earnings of $1.33 per share – a year-over-year growth of 10%. The major growth came from the company’s financial business. However, the company’s education business saw a decrease of 11% in revenue and 15% in adjusted operating profit during the third quarter. The company has a current dividend yield of 1.9% and long term earning growth projections of 14.8%.

McGraw Hill is focusing on changing its business model and is seeking to expand into business sectors capable of delivering high growth. It has recently sold off its education division for $2.5 billion. The company is planning to change its name to McGraw Hill Financial and will mainly concentrate on capital and commodity markets.

Competition Scenario

S&P largest competitor is the Moody’s Corporation (NYSE:MCO). The company reported third quarter revenue of $688.5 million – year-over-year growth of 30%. Expenses also saw an increase of 25% as compared to last year. It achieved double digit revenue growth in all its business segments during the third quarter. These results suggest that the company is performing very well and future growth prospects are very high.