NEW YORK (
) -- With the House and Senate reaching agreement on sweeping financial reform legislation, investors are watching for the impact on the big Wall Street bank stocks, but it's
Moody's Investor Service
that is popping on Friday morning.
Moody's shares were recently trading up 4% on Friday morning after the news from Washington, D.C.
Moody's stock hasn't just been under pressure from financial reform, but from a general dip in bond issuance in May and early June. Yet the financial reform overhang on Moody's reached its zenith a few weeks back when its top brass were sent to Washington to testify alongside
CEO Warren Buffett about the role of the credit-rating agencies in the financial crisis. Buffett is among the largest investors in Moody's shares, but over the past year and a half has been a net seller of his Moody's stake.
The worst fear was about an amendment to the financial reform package proposed by Sen. Al Franken (D., Minn.) that would have required a pool of rating agencies to be formed and overseen by the
Securities and Exchange Commission
. It was an an idea that Buffett downplayed in his testimony before the congressional commission at which he and Moody's officials testified, and it didn't make the final cut of negotiations between the House and Senate over financial reform.
Edward Atorino, an analyst at Benchmark Capital, said there were two main outcomes in the financial regulation bill that can be viewed as positives for the rating agencies. First and foremost, the rating agencies won the battle to keep the Franken amendment from making it into the final package of reforms.
Furthermore, while the rating agencies lost the battle to keep out of the reform package legal liability related to ratings, the language was not as bad as some had feared it might be in providing room for lawsuits against rating agencies.
"They lost that battle," Atorino said, but it's not the type of regulation that will significantly change the business model of the rating agencies, or lead to "frivolous lawsuits," the analyst said.
The analyst noted that Moody's management has previously indicated that additional layers of management and reporting required by financial reform might result in $15 million to $20 million in annual costs.
"Reform was part of the overhang, and there were rumors that there would be horrendous regulatory developments coming out of the final bill," Atorino said. The fact that the final bill is no worse than it was before removes that overhang and can be judged a positive, even though the rating agencies will be subject to more legal liability for their ratings. "Maybe it stops the negative drumbeat," the analyst added.
Peter Appert, analyst at Piper Jaffray, took much the same view in a note released ahead of the final financial reform package this week. "While burdensome to implement, we believe it is increasingly clear that the new regulatory standards to be imposed by the financial reform bill will not be 'game changers' for the rating agencies. Improved regulatory clarity should ultimately be a driver of P/E upside for the stocks."
Piper Jaffray said in the note that the most significant component of the bill for the rating agencies makes it easier to sue them in the future. "The wording is somewhat vague (a risk factor), but we believe the rating agencies can adjust their business practices and operations to minimize the risk of suits."
The Piper Jaffray analyst predicted that the long period of uncertainty for Moody's and for Standard & Poor's parent company
would come to an end, however, it was only Moody's seeing gains on Friday morning.
McGraw-Hill was recently trading down 2.5%.
The Benchmark Capital analyst Atorino said that one factor that complicates the outlook for McGraw-Hill is its education publishing business, with state budgets under pressure to cut costs, including the profitable textbook business. The overhang from the state budget pressure may still affect McGraw-Hill, while Moody's outlook brightens more acutely with the financial reform uncertainty eliminated.
Both analysts pointed to the fact that the rating agencies are trading at 10 times 2011 earnings, and at these levels there is room for the stocks to rally on positive catalysts, based on historic trading multiples.
Even amid the developments in Washington, D.C., the rating agency analysts stressed that the current outlook for bond ratings in Europe will continue to be an overhang on the stocks. The drop in bond issuance in May and early June took a toll on the outlook for the rating agencies. However, issuance surged last week, and coupled with financial reform, the events contributed to the Moody's rally Friday.
-Reported by Eric Rosenbaum in New York.
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