Shares of The McGraw-Hill Companies, Inc. plunged 23% in the last two days as investor sentiment wavered following the news of a civil lawsuit filed by the United States Department of Justice against its subsidiary, Standard & Poor's Rating Services (S&P) for deliberately providing high ratings in 2007 to U.S. collateralized debt obligations (CDOs) and residential mortgage backed securities (RMBS) that underperformed and fueled the collapse of the housing market.
S&P has strongly denied the allegations of the Department of Justice, which is seeking approximately $5 billion in the lawsuit, Reuters reported. The U.S. Government stated that S&P did not properly highlight the credit risks related to the mortgage securities issued by the investment banks in order to get more business from them.
However, S&P stated that the ratings were provided on the basis of subprime mortgage data that was accessible to others as well as government officials, who in 2007 claimed that subprime woes have limited impact.
The lawsuit filed by the government is the first legal action undertaken against a rating firm. The two other industry bellwethers, Moody's Corp. (MCO - Analyst Report) and Fitch Ratings are still not on the radar. Rating companies have been facing criticism for the procedure by which they had assigned a grade to the mortgage securities since the financial crisis. S&P provided credit ratings on over $2.8 trillion of RMBS and approximately $1.2 trillion of CDOs between Sep 2004 and Oct 2007.
Earlier, the discussion between S&P and the government officials failed, when the latter demanded a penalty of above $1 billion, reported by The New York Times, the flagship newspaper of The New York Times Company (NYT - Analyst Report). S&P said that it employed approximately $400 million in the last 5 years to strengthen the reliability, objectivity, independence and performance of ratings. Moreover, it has now set tough criteria for the securities to attain AAA ratings, considering the challenging global economy.
McGraw-Hill, which holds a Zacks Rank #3 (Hold), is slated to report its fourth-quarter 2012 results on Feb 12, 2013. The company previously entered into an agreement with Apollo Global Management, LLC (APO - Snapshot Report) to divest its education division for $2.5 billion.
The move is a strategic attempt on the company’s behalf to restructure its portfolio of businesses and concentrate more on high growth operations, thereby enhancing shareholder value through proper capital allocation.