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Rater vs. Rater? Fitch Cuts S&P Parent on Lawsuit Worry

The Exchange

In a case of one ratings agency cutting a set of ratings because it's fretting about another ratings agency, Fitch has downgraded McGraw-Hill (MHP), citing the legal threats its Standard & Poor's division is facing.

Standard & Poor's Sign: Credit AP

Late Thursday, Fitch lowered McGraw-Hill's issuer default rating to BBB+ from A- and put a negative Rating Watch tag on the debt, meaning another downgrade could come in the future. The decision was driven by the news that S&P is being sued by the Justice Department and some U.S. states over ratings it maintained on a group of debt securities that were central to the 2008 financial crisis.

Fitch said that while the financial risk attached to McGraw-Hill historically has been reflected in the ratings it assigns, "recent events have heightened this risk. The increased uncertainties are no longer consistent with an 'A-' rating," it said. However, Fitch isn't declaring these end times around S&P and its parent, saying it "believes that the company maintains significant financial flexibility to absorb a material negative financial outcome from the DOJ suit or from other suits and maintain investment grade ratings."

Shareholders haven't been quite as willing to look on the bright side. Following word of the lawsuits, McGraw-Hill has lost almost 27% this week from last Friday's close. Recently, the stock was at $42.73.

Ever since the financial crisis, the ratings agencies have been vilified, and they're much more likely to have detractors who appreciate the irony of one knocking the other than they are to find defenders. Still, they do maintain an important role in the financial markets, and their opinions on creditworthiness can be influential when it comes to judging a corporation or a country's risk -- S&P was further etched into the minds of casual finance-news readers in August 2011 when it downgraded the U.S., removing its AAA rating. Fitch, along with S&P and Moody's (MCO), are the most broadly known big credit raters. Fitch is owned by Fimalac S.A. of France and Hearst Corp.

One ratings agency acting on another is unusual, but it's not unheard of. For example, Fitch has previously lowered McGraw-Hill's issuer default rating, and S&P has had downbeat comments on Moody's.

The ratings agencies have made changes to certain practices in the wake of the financial meltdown, but this week the pressure was turned up dramatically, specifically on S&P. The DOJ has filed a suit against the agency, saying it wants in excess of $5 billion because of its pre-crisis top ratings on questionable housing-related debt securities. S&P responded by calling the legal actions "meritless." The U.S. didn't name Moody's and Fitch in the lawsuit.

Ratings are big business for their parent companies. On Friday, Moody's reported that for 2012, its overall revenue rose 20% from the prior year to $2.73 billion. Sales for Moody's Investors Service, which includes the credit ratings component, accounted for about two-thirds of that. McGraw-Hill said its S&P Ratings unit had revenue of $1.8 billion in 2011, not quite 30% of the corporate total of $6.2 billion.

The latest development on the credit group involves a report that the New York attorney general, Eric Schneiderman, wants explanations from all three of the large agencies on mortgage-backed securities, sending a subpoena to S&P and formal information requests to Moody's and Fitch.

American and global investors have been dealing with the financial crisis fallout for nearing half a decade. For the raters, the fallout might have only begun.