The Irony of Write-Downs: Could Moody’s (MCO) Be Next?
November 6th, 2007 by 
James Cullen
This question from Eric Fox about the language in Moody’s (MCO) recent 10-Q filing caught my eye. The text Eric is wondering about reads:
“Based on its review of the latest information available, in the opinion of management, the ultimate liability of the Company for the unresolved matters referred to above is not likely to have a material adverse effect on the Company’s consolidated financial condition, although it is possible that the effect would be material to the Company’s consolidated results of operations for an individual reporting period.”
What is the company referencing? “[C]laims and litigation that are incidental to the Company’s business, including claims based on ratings assigned by Moody’s” - in short, legal liabilities likely resulting from the rounds of subpeonas and lawsuits flying in connection with the company’s ratings on structured debt deals. As to clarifying the meaning, I think this from footnote 10 does a better job:
“Based on its review of the latest information available… in the opinion of management, the ultimate liability of the Company in connection with pending legal and tax proceedings, claims and litigation is not likely to have a material adverse effect on the Company’s consolidated financial position, results of operations or cash flows, although it is possible that the effect would be material to the Company’s consolidated results of operations for an individual reporting period.”
So, if there won’t be an impact on financial position, management is ruling out any sort of significant cash award to parties filing suit against it - I think this is a good sign, and consistent with my prior interpretation of the (minimal) legal liabilities Moody’s has from its credit rating business.
Also, if management is ruling out the possibility of a hit to operating cash flow, what does it leave? Try accrual earnings - net income, for an individual quarter. In my mind, this most likely means a non-cash charge to write-down some of the combined $239 million in goodwill and intangibles Moody’s keeps on its balance sheet. How are those broken down?
Goodwill:
Moody’s Investors Service - $55.6M
Moody’s KMV - $124.1M
Any size write-down there is open to speculation, but I think the high-probability source here is the $21.6M in intangibles carried by Moody’s KMV as “trade secrets.” Moody’s KMV division “develops and distributes quantitative credit risk assessment products and services,” so any court case would likely involve them being pressed to reveal the methodology used to rate these structured finance instruments that have caused so much trouble.
Whether or not any of this is material is difficult to say; I don’t see all sorts of new credit rating agencies springing up even if Moody’s methods are revealed - just as I don’t see the firm being harmed by a non-cash charge. I still like MCO, write-down or not…
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November 7th, 2007 at 8:36 am
Good point. They are probably preparing the street for a write off and don’t want a Citigroup type of reaction.
November 7th, 2007 at 11:37 am
I see the situation with Moody’s is different from Citigroup (or just about any other big bank) because Moody’s would be writing down intangibles, whereas Citi et al. are marking down the value of real assets.
November 7th, 2007 at 1:22 pm
Unlikely a write down of intangibles. More likely a significant amount paid in legal fees or costs associated with some change in process.
Changing the value of intangiles would be suggesting a permenant loss in value for its franchise and I don’t think managers are prepared to make such a statement at this time.
More interesting will be the reaction of the market if and when Radian and or ACA are downgraded or default. The ripple impact could be significant unless company gets out infront of these downgrades.