It hasn't been the best of times for ratings agencies like Moody's (NYSE: MCO ) or rival Standard & Poor's, a unit of McGraw-Hill (NYSE: MHP ) . The once-lucrative business of rating batches of collateralized debt obligations has begun to sour amid a near-comatose debt market.
On Thursday, New York-based Moody's reported a 54% decline in net income to $127 million, or $0.49 per share, compared to $278 million, or $0.97 a share, in the fourth quarter of 2006.
Moody's has lost nearly 50% of its value since last summer. In addition to anemic demand for new bond ratings, the company's dealing with allegations that it and other ratings agencies contributed to the now-infamous subprime fallout. Investors and regulators have wondered whether agencies like Moody's awarded unjustified prime ratings to CDOs destined to plunge in value as real estate prices softened.
In a bid last year to regain any lost reputation, Moody's separated its ratings unit from its sales and marketing division, attempting to highlight the independence of each area. With the fate of bond insurers Ambac (NYSE: ABK ) and MBIA (NYSE: MBI ) essentially riding on whether the ratings agencies continue to grant those firms a prime AAA rating, the validity of credit ratings has become more critical than ever.
Bond ratings currently account for 80% of revenue, but Moody's is trying to branch out into other realms of the bond world. It purchased BQuotes in January; the firm provides pricing and data information for "over the counter" products, which are typically less transparent than heavier-traded investments.
Since Moody's never issued or held the debt it rated, it won't be pinched nearly as badly as others in the market. Nonetheless, 2008 will pose its fair share of challenges for the company. As everyone from regulators to investors seeks a culprit for the subprime mess, the spotlight may turn toward the ratings agencies on which investors relied.
As Berkshire Hathaway (NYSE: BRK-A ) (NYSE: BRK-B ) chief Warren Buffett quipped in the past, "It takes a lifetime to build a reputation and five minutes to destroy it." Going forward, the changes Moody's and others make to their business practices will determine just how much of that reputation they can salvage.
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