The Wall Street Journal (subscription required) has obtained a draft version of the SEC's report on bond-rating firms and their role in the credit bubble, and some of the stuff is pretty scary.
In one e-mail, a staffer at Standard & Poor's, which is own by McGraw-Hill (NYSE: MHP) told another that "we rate every deal," and that "it could be structured by cows and we would rate it."
Another wrote that "rating agencies continue to create" an "even bigger monster -- the CDO market. Let's hope we are all wealthy and retired by the time this house of cards falters. ;O)"
Yes -- complete with the smiley face. If this seems reminiscent of disgraced analyst Henry Blodget's e-mails bashing stocks he was publicly pumping during the dot-com bubble, that's because it's exactly the same. The lesson here, once again, is this: e-mails ever really get deleted permanently and, if you're being shady or doing something unethical, make a phone call, talk with the person in a dark alley, or send them a letter that they can promptly discard. Don't send an e-mail!
Of course, S&P's investment-grade ratings on CDOs stuffed with dodgy loans turned out to be wildly optimistic, and the house of cards has done more than falter -- it's brought down Bear Stearns and wreaked havoc on the economy.
The roots of Reed Elsevier go back to the late 1800s. And since then, it has become a publishing empire. And a big part of the growth has come from M&A.
Well, now the company is engaged in another key deal. That is, Reed Elsevier is engaged in an auction to sell its Reed Business Information (RBI) division.
It's an attractive asset. For example, RBI has such publications like Variety and New Scientist. In all, there are about 80 publications and annual revenues come to about $2 billion.
Now, RBI's goal is to get $2 billion to $2.5 billion. However, in light of the tough economic situation, this could be optimistic. Keep in mind that RBI may provide some financing help to potential buyers.
Then again, there may be a way to get a stronger valuation: it looks like The McGraw Hill Companies (NYSE: MHP) is interested. All in all, RBI would be a nice fit for the firm, with some revenue and cost synergies.
McGraw-Hill (NYSE: MHP) shares opened lower today, but have rebounded as the day moved on after the European Union Internal Market Commissioner announced that bond and credit rating agencies, including MHP's Standard & Poor's, will face mandatory new European Union regulation as a result of these agencies' roles in the U.S. sub-prime mortgage crisis. If you think this stock won't be rising too far in the coming months, then it could be a good time to look at a bearish hedged play on MHP.
After hitting a one-year high of $71.97 last June, the stock hit a one-year low of $33.91 in March. This morning, MHP opened at $42.87. So far today the stock has hit a low of $42.10 and a high of $43.65. As of 12:00, MHP is trading at $43.60, down $0.13 (-0.3%). The chart for MHPlooks bullish and steady.
For a bearish hedged play on this stock, I would consider an August bear-call credit spread above the $50 range. A bear-call credit spread is an options position that combines the purchase and sale of call options to hedge risk in case the stock doesn't do what you think but still leverage nice returns. This particular trade will make an 11.1% return in two months as long as MHP is below $50 at August expiration. McGraw-Hill would have to rise by more than 14% before we would start to lose money.
MHP hasn't been above $50 since October and has shown resistance around $45 recently. This trade could be risky if the company's earnings (due out in late-July) are a positive surprise, but even if that happens, this position could be protected by resistance MHP might find at its 200 day moving average, which is currently around $44 and falling. Brent Archer is an options analyst and writer at Investors Observer. At publication time, Brent neither owns nor controls positions in MHP.
MOST NOTEWORTHY: McGraw-Hill, Curis and Azure Dynamics were today's noteworthy initiations:
Jefferies initiated McGraw-Hill (NYSE: MHP) with a Buy rating and $49 target. The firm believes the downturn in credit markets has already been fully priced into shares and expects the stock to gain momentum throughout 2008 in anticipation of liquidity returning to credit markets.
RBC Capital initiated Curis (NASDAQ: CRIS) with an Outperform rating and $2.50 target based on the company's partnership with Genentech (NYSE: DNA) and potential upside from its pipeline.
Merriman started Azure Dynamics (OTC: AZDDF) with a Buy rating. The firm believes the company's focus is where customers see the most benefit from a medium-duty hybrid or market-appropriate solutions and finds the stock attractively valued.
MOST NOTEWORTHY: IberiaBank, Dynamic Materials and Barr Pharmaceuticals were today's noteworthy upgrades:
Keefe Bruyette upgraded shares of IberiaBank (NASDAQ: IBKC) to Market Perform from Underperform after the company announced that Pulaski has assumed the insured deposits of ANB Financial of Bentonville, Arkansas.
KeyBanc upgraded Dynamic Materials (NASDAQ: BOOM) to Buy from Hold citing stability in base business, valuation, and the added benefit associated with a European competitor being acquired.
Cowen raised Barr Pharma (NYSE: BRL) to Outperform from Neutral citing the recent pullback.
OTHER UPGRADES:
Goldman added McGraw-Hill (NASDAQ: MHP) to its Conviction Buy List.
RBC Capital raised RadioShack (NYSE: RSH) to Sector Perform from Underperform.
Sirius Satellite (NASDAQ: SIRI) was upgraded at Merrill Lynch to Neutral from Sell.
Merrill Lynch upgraded Sirius (NASDAQ: SIRI) to "neutral" from "sell" according toBriefing.com. The news service also reports that Citigroup downgraded EDS (NYSE: EDS) from "outperform" from "market perform".
Goldman Sachs downgraded ITV to "sell" from "neutral," according toMarketWatch.
CNNMoney reports that McGraw-Hill Co.'s (NYSE: MHP) Standard & Poor's (S&P) forecasts the possibility of a $1 trillion bailout of Federal National Mortgage (NYSE: FNM) and Federal Home Loan Mortgage (NYSE: FRE) -- government sponsored purchasers of pools of loans which package them into securities. Specifically, S&P forecasts that a bailout of these two -- known as Fannie Mae and Freddie Mac -- would cost -- in a worst case scenario -- between $420 billion and $1.1 trillion of taxpayer's money. This would represent several times the $250 billion Savings & Loan bailout by the first President Bush.
It's a bit ironic for S&P to be issuing this report. After all, it was among the ratings agencies that contributed to the problem in the first place. As I posted last August, the ratings agencies competed for enormous fees from investment banks to put their AAA ratings on issues of mortgage-backed securities (MBS). Those AAA ratings caused naive MBS buyers to skip the kind of detailed analysis of their purchases that might have stopped the flow of dumb money into the MBS bubble that is now putting Fannie and Freddie at risk.
How did S&P arrive at this scary conclusion? Both companies are forecast to report more losses this year due to declining home prices and rising mortgage defaults. And according to Yale professor, Robert Schiller, "The real fundamental problem is real estate prices have been falling and they might fall substantially more. The Office of Federal Housing Enterprise Oversight (OFHEO) and Fannie and Freddie never considered the possibility of a massive real estate correction."
Given that the big credit rating agencies -- Moody's (NYSE: MCO) and McGraw-Hill's (NYSE: MHP) Standard & Poors -- completely failed in their assessment of risk when it came to mortgage-backed securities, it's no surprise that the SEC is being asked to take a look.
Senator Charles Schumer (D-NY) has met with SEC Chairman Chris Cox to discuss conflicts of interest and disclosure problems. The Wall Street Journalquotes (subscription required) the senator as saying that "There has to be a lot more done about conflicts of interest at the agencies."
Among the worst of the rating agency abusers has been MBIA (NYSE: MBI) which, back in March, had the gall to ask Fitch to drop its coverage of the firm because they didn't like Fitch's opinion. To its credit, Fitch stayed strong and later downgraded the company's credit rating.
But wait, there's more: In a devastating piece on Friday, The Wall Street Journalreported (subscription required) on Moody's efforts to cozy up to issuers in exchange for more business, possibly at the expense of the integrity of their ratings.
This is essentially a replay of the issues involving conflicted analysts like Henry Blodget who, at the height of the internet stock bubble, sacrificed his research to the investment banking arm of his firm. It will take a tough regulator to clean up this mess, and I seriously doubt that Chris Cox is the man for job.
Bloomberg News reports that McGraw Hill Co.'s (NYSE: MHP) Standard & Poor's (S&P) reportedly called the bottom of the subprime meltdown after estimating its toll at $285 billion, up from a previous forecast of $265 billion. It raised its estimate because of increased loss assumptions for collateralized debt obligations (CDOs). And it claims that, "The bulk of writedowns may have already been taken."
Maybe, maybe not. S&P is not exactly objective about this. It was among the ratings agencies that caused the problem in the first place. How so? As I posted, back when the $6.1 trillion MBS market was booming, investment banks would pit rating agencies against each other to see which one would give a AAA rating to the toxic waste they were brewing. If S&P won the contest, it would get the lucrative fee from the investment bank.
S&P and its peers made good money by lending their credibility to the firms they were supposed to rate objectively in exchange for those fees. And when the MBS market began to collapse, the ratings agencies suddenly realized that there was no more new ratings business to be had. So they had to go plan B -- trying to salvage their reputations by downgrading the MBSs that they had previously blessed. This reinforced the collapse of the MBS market.
The active ingredient in Baxter International Inc's (NYSE: BAX) generic version of the anticlotting drug heparin, under investigation for four deaths and hundreds of bad reactions, was made in China, the Wall Street Journal reported.
Mike Zafirovski, CEO of Nortel Networks Corporation (NYSE: NT), said the company would examine possible opportunities to be taken over "when they arise." Mr. Zafirovski did not comment on rumors of a Motorola Inc (NYSE: MOT) merger, Reuters reported.
Standard & Poors, a division of McGraw-Hill (NYSE: MHP), has joined Moody's (NYSE: MCO) and Fitch in announcing reforms in the wake of the criticism for their role in the subprime fiasco.
S&P says it will hire an ombudsman to investigate conflicts of interest and bring in an outside firm to look at compliance and ethics-related issues. Lead analysts will be rotated from time to time and the company will consider a slew of new factors: liquidity, volatility, correlation and recovery, and "worst-case scenarios."
But New York Attorney General Andrew Cuomo isn't buying it: "The supposed reforms announced today by Standard & Poor's and by Moody's on Tuesday are too little, too late. Both S.&P. and Moody's are attempting to make piecemeal change that seem more like public relations window-dressing than systemic reform."
From an investor's standpoint, I'm inclined to agree with Mr. Cuomo. Moody's carries a market cap of nearly $10 billion, but its entire business depends on the willingness of investors to take its ratings and analysis seriously.
But over the past year or so, the "work" of the ratings agencies has been exposed as pretty much a joke. It will take a lot more than this to recover the company's reputation.
Stock futures were positive this morning, indicating U.S. stocks could be poised for a rebound today after suddenly plunging in late session trading Tuesday into correction. However, futures are now mixed, looking for direction. With no economic data on the docket, investors will focus on the start of earnings season and how a slowing U.S. economy could affect corporate profits. The market is very sensitive these days, though, and could react negatively to a number of news, including increasing oil prices.
On Tuesday, a late-day sell-off was caused by fears that Countrywide Financial (NYSE: CFC) would file for bankruptcy (these were denied by CFC and this morning CFC shares are up over 10% in premarket trading), and AT&T (NYSE: T)'s pessimistic outlook about consumer spending. The Dow industrials fell 238 points, or 1.86%, the Nasdaq Composite dropped nearly 59 points, or 2.35% -- this was the Nasdaq's eighth consecutive drop -- and the S&P 500 lost nearly 26 points, or 1.84%.
Oil prices rose to mid $96 a barrel Wednesday ahead of the weekly crude inventories report due out today at 10:30 a.m. EST. Analysts are expecting the report will show crude oil stockpiles fell last week.
The New York Times reports that McGraw-Hill Co.'s (NYSE: MHP) Standard & Poor's (S&P) has downgraded bond insurer ACA Financial Guaranty Corporation from A to CCC, a sub-investment grade. S&P is saying that ACA's financial guarantee is worthless and thus bond holders must write-down the assets ACA insured.
As of September, ACA insured $7 billion in municipal and $43 billion in corporate debt. S&P's downgrade could cost Merrill Lynch & Co. (NYSE: MER) $3 billion and Canadian Imperial Bank of Commerce (NYSE: CM) estimates it will take a $2 billion write-down.
A few decades from now when economic historians look back on the current financial market implosion, there will be books written about the role that ratings agencies played in blowing up the bubble and then bursting it. That's because the ratings agencies competed with each other to offer the highest ratings to bundles of loans such as Collateralized Debt Obligations (CDOs). Now that this market has collapsed, the ratings agencies see no profit in rating new CDOs so they're trying to salvage their reputations by bending over backwards to downgrade those same debt instruments.
For 25 years, Steven Halpern, editor of TheStockAdvisors.com, has surveyed the leading financial newsletter advisors asking for their favorite stocks for the coming year. This article is one of 100+ ideas in the Best Stocks for 2008 report.
"McGraw-Hill (NYSE: MHP) is my top conservative pick for 2008," says Nathan Slaughter, editor of Half-Priced Stocks. "If you want to beat the market in 2008, then you might start with the one company that actually owns the market, or at least the S&P 500 Index; McGraw holds the keys to the widely used stock barometer, as well as other benchmarks from the ubiquitous Standard & Poor's family.
"From futures contracts to ETFs, there is a staggering $5 trillion of investable assets linked to these indices -- which generate piles of recurring royalty and licensing revenues.
"Elsewhere, the firm is also a leading provider of textbooks and other supplemental learning materials. There are roughly 55 million students enrolled in grades K-12, and state governments currently spend more than $8,500 per student each year -- a total that is forecast to hit $11,000 within the next seven years.
Bloomberg News reports that Connecticut's attorney general has subpoenaed McGraw Hill (NYSE: MHP)'s Standard & Poor's related to an investigation into credit rating.
The legal question is whether S&P issued overly rosy credit ratings on subprime mortgage-backed securities (MBSs) that later lost more than half their value. S&P and its peers were competing for the lucrative ratings fees paid by the investment banks that underwrote the MBSs. And it has been alleged that the winning firms offered the highest ratings.
If the MBSs were indeed the financial equivalent of toxic waste -- then the AAA ratings that S&P and its peers awarded to the MBSs could be thought of as golden wrapping paper. This gold wrap was particularly useful to the investment banks when they visited MBS customers in Europe and Australia.
Rather than get into the details of what was inside the gold-wrapped boxes, these customers simply relied on the assurances of the MBS sales people that the "investment" had been blessed by S&P. No need to dirty themselves with unwrapping the box and exposing the toxic waste within.
The Wall Street Journal (subscription required) has obtained a draft version of the SEC's report on bond-rating firms and their role in the credit bubble, and some of the stuff is pretty scary.
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Stock futures were positive this morning, indicating U.S. stocks could be poised for a rebound today after suddenly plunging in late session trading Tuesday into correction. However, futures are now mixed, looking for direction. With no economic data on the docket, investors will focus on the start of earnings season and how a slowing U.S. economy could affect corporate profits. The market is very sensitive these days, though, and could react negatively to a number of news, including increasing oil prices.
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