Shares in credit rating agency Moody's Corp (MCO.N) slid 6 percent on Friday as the prospect of a federal fraud lawsuit over its pre-crisis debt ratings overshadowed a 66 percent rise in quarterly earnings and a strong 2013 outlook.
The U.S. Justice Department and several states are discussing suing Moody's for defrauding investors, people familiar with the matter told Reuters, but any such move will likely wait until the lawsuit against rival Standard & Poor's is tested in the courts.
The U.S. government launched a $5 billion civil suit last week against S&P and its parent, McGraw-Hill Companies Inc MHP.N, over mortgage bond ratings.
"If the question has become when, and not if, a lawsuit will be filed against Moody's, then the shares are simply unbuyable, in our view," BTIG analyst Mark Palmer said.
Moody's and S&P have faced criticism from investors, politicians and regulators for assigning high ratings to thousands of subprime and other mortgage securities that turned sour.
On a post-earnings conference call, Moody's Chief Executive Raymond McDaniel said the company had not been named in the S&P lawsuit and routinely receives requests for information from state attorneys general.
"We don't have any knowledge of any pending complaint by the Department of Justice raising similar claims against Moody's," McDaniel added.
Moody's already faces fraud claims filed from private investors. Abu Dhabi Commercial Bank, King County in Washington state and other investors are suing the company over losses in Cheyne, a structured investment vehicle.
Moody's shares slid to $43.89 on Friday morning, before bouncing back to $44.02 on the New York Stock Exchange. They have fallen around 20 percent since news of the S&P investigation.
"I don't know how a portfolio manager can explain why he was holding the stock when this legal sword of Damocles is hanging over Moody's," Palmer said.
SEES STRONG 2013 PROFIT
On its conference call, Moody's focused on its forecast of a strong year ahead. Moody's and S&P have benefited as firms refinance debt to take advantage of rock-bottom interest rates to access cheap funding.
Revenue in Moody's corporate finance business rose 73 percent to $244.9 million in the quarter.
The company said it expects full-year earnings in the range of $3.45 to $3.55 per share and revenue growth in the high single digits percent range.
Analysts on average were expecting earnings of $3.18 per share, excluding items, according to Thomson Reuters I/B/E/S.
"The legal fears are overshadowing what is a stellar 2013 outlook. I think the fears are overblown, but that's my opinion," Benchmark Co analyst Edward Atorino said.
Moody's did signal that growth in its Investors Service unit, which houses the bond rating business, is set to slow.
The company's forecast of full-year revenue growth in the high-single digit percent range for the unit compared with a 20 percent rise in 2012.
Revenue from structured finance -- the rating of complex bonds such as collateralized loan obligations and commercial mortgage-backed securities -- is expected to grow in the mid-single digit percent range for the full year.
The complicated debt structures were blamed for magnifying the chaos caused by the souring subprime mortgages and issuance fell after the crisis.
But as the consumer and auto loans are increasingly being bundled into securities in the United States, the fortunes at the business are turning around.
U.S. structured finance revenue grew 50 percent in the fourth quarter. Revenue rose 33 percent to $754.2 million.
Net income in the quarter rose to $160.1 million, or 70 cents per share, in the fourth quarter, from $96.2 million, or 43 cents per share, a year earlier.
(Editing by Rodney Joyce, Supriya Kurane and Ted Kerr)