穆迪 (MCO) 2002 Q3 法說會逐字稿

Good morning and welcome to the Moody's corporate third quarter results conference call.

At this time all parties will be placed on a listen-only mode.

I would like to advice all parties today's call is being recorded at the request of Moody's Corporation.

If anybody does have any objections please disconnect at this time.

I would now like to turn the call over to Mr. Michael Cortian, Vice President - Investor Relations and Corporate Finance.

Sir you may begin.

Thank you.

Good morning everyone and thanks for joining us on this teleconference to discuss Moody's results for the their quarter 2002.

This is Michael Cortian, Vice President - Investor Relations and Corporate Finance.

Moody's released its results for the third quarter 2002 after the market closed yesterday and the earnings release is available on our website at ir.moodys.com.

John Rutherford, Jr., President and CEO of Moody's Corporation will be leading this morning's conference call.

Also on the call this morning are Ray McDaniel, President of Moody's Investor Service and Jeanne Derring CFO of Moody's Corporation.

They will be available to answer your questions following John's remarks.

Before we get started I would like to call your attention to the cautionary language set out at the end of our earnings release.

Certain statements my colleagues and I make today may be forward-looking within the spirit of the private securities litigation reform act of 1995.

This act provides the safe harbor for such forward-looking statements.

I would like to direct your attention to the management discussion and analysis section and the risk factor s discussed in our annual report on form 10- k for the year ended December 31, 2001.

I would also like to point out the safe harbor statements under the private securities litigation reform act of 1995 contained in our press release issued yesterday evening.

These set forth important factors that could cause actual results to differ materially from those contained in any such forward-looking statements.

I should point out that some members of the media might be on this call in a listen-only mode and I'm pleased to turn the call over right now to John Rutherford.

Thank you Michael and thank you all for joining us on today's call.On this call I'm going to discuss the highlights of our results for the third quarter of 2002.

Next Ray McDaniel will review our international results.

We'll also talk about the S.E.C.'s current study of rating agencies.

Finally we're able to discuss some of the enhancements to our rating process that Moody's is implementing.

Following Ray's comments, I will give you an up down on our share repurchase program and conclude by discussing Moody's outlook for the remainder 2002 and for 2003.

After the prepared comments, my colleagues and I will respond to questions.

Moody's reported robust results for the third quarter of 2002.

Revenues rose to $248 million in the third quarter.

An increase of 30 percent from 190 million from the same period of 2001.

Reported results included 14 million revenues related to K.M.V. which Moody's acquired in April.

Excluding K.M.V.'s revenues, third quarter 2002 revenue would have been $234 million up 23% year over year.

Third quarter operating income of $127 million rose 36% from 94 million in the third quarter 2001.

Net income for the quarter was 68 million.

An increase of 36% from 50 million last year.

Diluted earnings per share were 43 cents, growth of 39% over third quarter.

Moody's third quarter revenue reflected broad gains in the rating business compared to the prior year period.

Where issuance flowed in the weeks following the September 11 terrorist attacks.

We also saw strong revenue growth in our research at M.K. and V. businesses.

Moody's U.S. revenue totaled %165 million for the third quarter 2002 increase of 23% from 135 million in the third quarter of 2001 .

Structured finance was the largest contributor to growth in the United States.

In fact it accounted for almost two-thirds of the year to year increase in our global ratings revenue.

In the U.S. double digit growth was achieved in all sectors except commercial mortgaged backed securities reflecting volume growth, market share gains and growth in complex instruments which generate higher rating fees.

The residential house housing sector including new mortgages, re-financings and home equity loans showed the greatest growths as mortgage rates fell to 30-year lows in the quarter.

The U.S. corporate finance sector declined reflecting very weak issuance levels as refinancing activities slowed and business investment remained weak.

We don't expect to return to strength in the U.S. corporate finance ratings until business investment and M and A spending picks up.

Financial institutions revenue grew over 27% year on year as the number of new issues and new issuer level ratings remain strong despite volume declines.

Public finance continued its strong performance as low rates and declining state and municipal tax receipts supported issuance.

Our U.S. research business grew at greater than 30% over the same period last year reflecting increased investor focus on credit risks as well as revenues from new products and licensing Moody's information to other distributors.

In our Moody's K.M.V. quantitative ratings and risk management business also did very well.

Increased market acceptance of quantitative risk assessment tools and broader adoption within existing clients were the most significant forces behind the solid performance .

International revenues of 83 million in the third quarter of 2002 were 49 % higher than the prior year period on a reported basis and 39% higher excluding the results of K.M.V.

Non U.S. revenues account for 34 percent of Moody's total in the quarter up from 29% in the third quarter of 2002.

Revenue in the third quarter was about 23 million dollars lower than the second quarter.

The third quarter decline was about evenly split between the United States and international.

U.S. structured finance revenues decline versus the record second quarter reflecting weaker commercial mortgage activity, after a very strong second quarter.

A sequential decline but still exceptionally strong quarter in residential mortgages and some weakness in term asset backed issuance.

I've already commented on weakness of the U.S. corporate finance business.

The quarter to quarter decline in international revenue reflected lower results in corporate finance, and financial institutions.

Many investors are interested in the stability of Moody's revenues.

We break our revenues down into transaction based and relationship based ratings revenues and non-ratings revenues.

Globally during the third quarter we had 50% transaction based revenues, 31 percent relationship based and 19% non-ratings.

Transaction based revenues are generally based on the volume of issuance of credit -sensitive fixed income securities.

Relationship based revenues are generally based on annual contracts with issuance and non rating revues are a research and risk management revenues which are based on subscriptions or software sales.

Non-ratings revenues have become a larger percentage of our total revenues because of the acquisition of K.M.V.

About three quarters of our transaction-based revenues in the quarter were derived from structured and public finance.

Which are predominately transaction based.

Only approximately six percent of Moody's total global revenues in the quarter were U.S. corporate finance transaction-based revenues.

This explains why Moody's was able to deliver strong financial results in the third quarter of 2002, based on strong volumes in the sectors that are predominantly transaction based, structured and public finance, and good growth in subscription based sectors.

Research and quantitative ratings and risk management despite weak issuance volumes in U.S. and European corporate finance.

Now I would like to ask Ray to talk about our international business.

The status of the S.E.C.'s rating agency review and some enhancements to our rating process .

Thank you, John .

Moody's continued to achieve strong results in international markets during the quarter.

While Moody's United States revenue grew 23% year over year in the third quarter, international revenue continued to grow much faster.

Moody's non U.S. revenue for the third quarter 2002 totaled $83 million, rising an impressive 49% from the year earlier period.

In the aggregate business outside the U.S. rose to 34% of Moody's total revenue from 29% a year ago.

When we look at markets outside the U.S. from a strategic perspective when see two [secular] courses which we think will continue to drive strong growth .

Broader use of the public debt markets by companies that have traditionally relied on banks for all their financings should enlarge the universe of companies issuing securities Moody's can rate.

At the same time increased utilization of structured finance both in the range of assets contributed to securitization transactions and in expansion to new jurisdictions should create additional opportunities for Moody's.

Our research and quantitative ratings and risk management businesses are also showing strong growth internationally as companies adopt and refine tools for evaluating credit risk measurement and management.

During the third quarter of 2002 structured finance remained the fastest growing areas of Moody's non-U.S. business.

International structured finance revenue rose 65 % in the third quarter of 2002 compared with the same period of 2001.

Driven primarily by ratings of more complex instruments which generate higher rating fees, continued growth in European credit derivatives and robust double digit growth in the Japanese commercial mortgage backed and asset backed securities sectors.

Revenue from corporate and financial institution ratings outside the U.S. was up double digits in the third quarter 2002 compared with 2001.

International research revenue grew over 40% to approximately 10 million dollars reflecting new customers and products.

We believe growing acceptance of structured finance by European and Japanese issuers will continue to create opportunities for Moody's.

In the European corporate and financial institutions markets near term issuance remains difficult to forecast.

As many issuers wait for more favorable interest rates spreads but the medium and longer term picture remains positive .

We receive a number of questions from investors about the status of the S.E.C.'s studies of ratings agencies.

So I will provide some brief comments.

Pursuant to congressional request and as required under the [Sarvain Oxley] act, the S.E.C. commissioners have directed the staff to review the role and function of credit rating agencies to determine whether the S.E.C. should adopt or amend rules governing rating agencies and whether more licensed rating agencies should be designated. [Sarvain Oxley] requires the S.E.C. to report its findings to Congress within 180 days of the act's July 30th effective date .

Moody's has provided information to the S.E.C. staff as requested.

The S.E.C. is expected to hold hearings as part of its study and Moody's expects to participate in such hearings.

I believe that we'll know more about the S.E.C.'s views towards the end of the year.

I would also like to spend a few moments bringing you up to date on some enhancements we're making to Moody's professional rating process.

We seek to improve our ratings process on a continuous basis as delivering a better product to all users of our ratings is both good business and supports market confidence.

Important improvements have included our census of issuers contingent obligations including obligations dependent upon rating levels which we call rating triggers.

Through this census we achieved a better understanding of the important contingent obligations of issuers, many of which were not and are not reported in public regulatory files and which can have a significant effect on credit worthiness.

We also published more than 550 assessments of companies short-term liquidity.

We believe this will assist the market in evaluating the credit worthiness of companies.

In many companies financial difficulties have arisen from their lack of access to credit market or liquidity.

In June Moody's announced plans to supplement our currents credit analysis practice with new analyst teams with expertise in three areas, accounting, derivatives and corporate governance.

The first members of these specialist teams have now joined Moody's.

These experts will contribute topical research and commentary in their areas of specialization, participate with analysts in meetings with issuers and in ratings committees and assist in technical training, for example, to better understand the credit consequences of alternative accounting principals.

Most recently we hired Kenneth Burch to direct our corporate governance efforts.

Before coming to Moody's, Ken worked at [T.

I. A. A. Krep] where he was responsible for coordinating reviews of the governance structures and practices of U.S. companies.

Taken as a whole we're confident these new initiatives will improve Moody's analytic capabilities, enable us to meet the evolving needs of issuers and investors and debt capital markets.

Now I'll turn the call back to John.

Thank you, Ray.

Let me now give you an update on our share repurchase program.

Moody's is committed to returning its excess cash to shareholders in the form of share repurchase.

Moody's took advantage of periods of relative weakness in the price of its stock during the third quarter and recently in October and is now completed the $300 million share repurchase program that had been authorized by the board of directors in October 2001.

That brought our cumulative stock buy backs since becoming a public company in September 2000 to 17 million shares at a cost of 600 million dollars.

This includes 5.6 million shares that we have repurchased to offset stock issuance on our employee stock plan.

At a meeting yesterday our board of directors authorized an additional 450 million dollar share repurchase program.

Which Moody's expects to complete by the middle of 2004 .

I would like to conclude my comments this morning by discussing our outlook for the full year 2002 and offer offering some comments about 2003 .

We expect the revenue trends that Moody's experienced in the third quarter of 2002 to continue into the fourth quarter.

With continued strength in global structured finance, U.S. public finance and global research and risk management services and relative weakness in U.S. corporate finance.

In structured finance we anticipate a continuation of strong issuance related to the U.S. residential mortgage sector including new mortgages refinancing some home equity loans.

We expect low single digit growth in consumer spending and continued strength in the international segments of our business.

Particularly in Europe and Japan.

Public finance volumes are likely to remain robust reflecting the confluence of low interest rates and weak public finance tax receipts.

Finally we expect the good growth we have seen in our research and M.K.V. businesses to continue.

In our corporate finance business U.S. debt issuance will likely slow as the volume of outstanding debts still to be refinanced declines and the need for new borrowings to fund investments and mergers and acquisitions remains weak.

Our current range of expectations for 2002 is year to year percent revenue growth in the mid 20's including K.M.V. with higher growth in operating income and with 2002 diluted E.P.S. close to or above $1.78.

The high range of our previous range of estimates for the full-year.

For 2003 we expect year over year revenue growth to be substantially less than the very strong growth we achieved in 2001 and 2002.

Nevertheless, we expect margins to decline only slightly and to achieve low double digit percentage growth in diluted E.P.S. now my colleagues and I will be happy to take any questions you may have.

Our first question comes from Lauren Fine.

Merrill Lynch.

Congratulations on a very good quarter.

Just a couple of very quick questions.

I'm wondering, on the shareholder purchases, if you could break out what portions took place during Q-3 versus during what took place in October.

And then I'm wondering, if you could just breakdown structured finance into the U.S. and the international pieces.

And then a third question, if you could review again what portion of your costs we should view as variable or maybe just focus on the incentive compensation portion so that if revenues do flow we have a sense of what you can do on the cost side.

Sure, Lauren.

Jeanne, do you want to comments on share repurchase.

Sure.

Lauren, during the third quarter and to date in the fourth quarter we repurchased a total much about 4.7 million shares .

And those repurchases have been roughly equally split between the third quarter and the fourth quarter to date.

OK and then the breakdown of structured finance between the U. S. and international piece?

One minute.

One other comment on the share repurchase.

At the end of the third quarter our average diluted shares outstanding for the third quarter were about 159 million.

So I don't know if that helps you in terms of understanding --

I want to know what the actual shares outstanding were versus the average for the quarter.

What was it as the actual share count at the end of the quarter and what is it now?

The actual share count at the end of the quarter I believe was about 150 million.

And since then we have repurchased about another 2.3 million shares.

Some of those repurchases in October will be applied to offset issuance under our -- to offset issuance upon the exercise of option s so not all of the 2 .4 million will reduce our shares outstanding.

Do you have any balance sheets available in terms of cash and debt at the end of the quarter?

At the end of the third quarter we had cash of roughly 70 million dollars.

And have at this point a little bit of debt outstanding on our balance sheet but didn't have any at the end of the third quarter.

If we can go back to the structural finance question now?

Obviously we still have the 3 00 million of bank debt outstanding.

Jean was referring -- of private placement outstanding.

Jean was referring to the bank debt.

Yes, I'm sorry, Lauren.

I knew that.

I knew that didn't go away.

Borrowings understood our bank credit line, we borrowed during the fourth quarter but we do still have the 300 million of debt.

Just one correction, I'm sorry to what I said before, the shares outstanding at the end of the third quarter were 153 million.

I think I said 150.

Which would seem too low so I'm glad you corrected that.

OK Ray, do you want to talk about International structured?

Lauren, for the third quarter the U.S. structured business was twice the international structured business for us.

That is broadly consistent with the pattern we have seen though in the second quarter the U.S. business was particularly strong.

That's helpful.

Then I wanted -- -- what I'm trying to understand on the cost side is [sequentially] when I looked at your costs in the third quarter there was a bit of an up tick and I suspect that some of that could relate to maybe additional staff but it could be bonus accrual, but what I'm trying to understand, when we look at a fourth quarter where revenue could flow or next year where you are anticipating slower growth what kind of leverage you have on the cost side understanding that you even are anticipating margins go down but sort of what leverage you have at your disposal on the cost side of the equation.

Surely.

The main leverage that we have to manage the cost side of the equation is the effect of our compensation program for managing directs and above which is based on our normative targets of 12.5 % growth for most of the managing directors and a combination of that plus 15% earnings per share growth for a few senior managers.

As we have stated that we expect our growth next year to be only a low double digits, we would expect substantially less bonus expense.

That would be the main area of reduced expenses.

Thank you very much.

Again, great quarter.

Thank you, Lauren.

Our next question comes from Kevin Grinick.

Baer Sterns.

Following up on Lauren's question, I was wondering if you could provide the year to date bonus expenses as a percent of your compensation expense and then I have a follow-up.

Kevin this is Jeanne Derring and I'll address that question for you.

First of all, we talked before about our compensation expense being roughly two-thirds of our total expense.

Being perhaps a bit less than two-thirds in quarters when our growth is lower than our normative targets and being a bit more when that growth is higher.

Clearly the growth was higher this quarter so the compensation expense is a bit more than two-thirds of the total.

For the quarter our incentive compensation expense which includes all of our annual bonus plans as well as bonuses that are paid as a part our profit participation plan based on E.P.S. growth, so this is an all in number, our incentive compensation expense compared with total compensation was roughly 25%.

That's fairly consistent with the year to date number as well.

Thank you.

And the in the Moody's K.M.V. business which seemed like it was going to run about 100 million dollars as an annualized run rate and could get into the mid 80's in terms of revenues for the year, obviously that business is growing fast and it's growing well.

You know on a sequential basis, too, but it seems to be running a little bit under that rate at 23 million plus in Q-3.

I know there is some skew in seasonality in the old Moody's risk management business to q-4.

Is that enough to make up for what looks like light ness here?

Well, Kevin, I think that we expect the Moody's K.M.V. business to come in very, very close to the revenue target that we had had for the full year.

So you are right that in the old Moody's part of that business there software sales at the end of the year and obviously we're hoping that we'll come in at or above the target.

But that is our current forecast.

So that the number for the full year actually is probably slightly closer to 95 million than it is to 100 million.

I understand.

Could you update us on developments in Russian credit ratings with your venture with [Interfacts]?

Well, we believe it's coming along very well.

They have made a number of progress.

We have -- I believe recently had a contract to rate one of the most important presidential regions in Russia which is the euro region and we're pleased with the progress there.

Of course it doesn't have a tremendous amount of impact on our financial statement.

Thank you very much .

Thank you.

Our next question comes from Peter Eppert.

Goldman Sachs.

John, can you remind us give us a background on the relative pricing dynamic of the different ratings categories, how that works?

Are you referring to pricing dynamic in terms of what's transaction based and what is relations based?

No, I was thinking in terms of the relative pricing of the structured deal versus a straight corporate finance deal versus a public finance deal and how the prices vary.

Sure.

As you know we have two types of pricing arrangement.

We have relationship -based pricing and transaction.

I think it's easy to answer the question about transaction -based pricing.

There are normal corporate pricing is 3.3 basis points on the sides of a transaction with both a cap and a collar.

If you change from that to public finance, the main difference is the collar instead of being around 30,000 dollars is around 5,000 dollars.

In structured finance, we have a number of transactions that are either complicated or require a great deal of work to bring them to market.

An example would be a commercial mortgage securitization where we have to review the documents on a large number of properties.

Generally in structure depending upon the complexity of the deal the price can go from three to 10 basis points.

That's helpful.

Thank you.

And how about the relative profitability from your perspective of transaction-based revenues versus relationship-based revenues?

Well, in what we view that transaction-based revenues are a way to catch the wave.

And if we have -- if you have strong issuance, the transaction-based revenues are more profitable , you have to in effect give people a discount to ask them to sign up to bring you all their transactions during a year as would be the case under a relationship- based pricing.

To the extent that you have a lower fee theoretically the profitability is reduced but there is greater visibility around it is the concept?

Exactly.

And the last question, you've talked in the past about a, I think a 48% long-term margin target.

Obviously you are doing substantially better than here on a year term basis given some indication that it will be down a little next year.

Is 48 still the right number or have we seen permanent enhancement in the profitability of the business based on some of the things you have been able to do in the last year or two?

I think in part you are right, but we do not expect -- we do expect strong growth out of the M.K. & V. business in the long term.

Our target for that business would be essentially twice the target for our ratings and research business .

And that is a business that will have lower margins.

Our target margin for that business in 2005 is only 22%.

As that business gets to be a bigger part of the total over the longer term our margins should trend down a bit.

Great.

Thank you, John.

Thank you, sir.

The next question comes from Joe LaMana.

Joe LaMana, William Blair.

Can you give us a little further breakdown on the 11.6 million in structured finance in the quarter in terms of what portion of that we related to the residential mortgage-backed rating business in the U.S.?

Sure.

Let me ask Ray to comment on that, Joe.

Joe, it's Ray McDaniel.

The U. S. residential mortgage business was about 15 million dollars in revenue in the third quarter.

Also related to that can you give us a sense of the lag between -- it's being driven by the residential mortgage by the refinance boom but rates have picked up in the fast few weeks.

What is the lag between people locking in the refinancing versus when it goes deals tend to come to market in terms of you rating the securitizations?

There is some variability based on what the spreads are for the securitized product.

Assuming the spreads remain constant we would expect probably a three- month or four- month lag.

So if the refinancing boom peaked in September that would carry through December, January?

I think we would expect to see that.

We continue to see a good pipeline in the residential mortgage area.

Thank you.

Our next question comes from Brandon Doble.

Credit Suisse First Boston.

A couple questions.

Looking at 2003 if you could give us some idea of what kind of assumptions go into your growth projections in terms of is there some interest rate assumptions, growth in certain markets, new jurisdictions, then turning the page a little bit, looking at the structured business , if you could talk about the relative size of the different asset classes and [securitization] breaking out mortgages versus credit card versus commercial, residential, or other asset classes and give us a sense where the real leverage is the past couple quarters or so would be helpful.

Thanks.

Sure.

Let me try that.

We -- as we mentioned to Joe on the previous question, we do expect volumes in residential mortgage securities to taper off in 2002 but to remain reasonably robust at least in the first quarter .

With regard to other elements of structured finance next year, we expect low single digit growth in the growth of consumer indebtedness.

That's what drive s a lot of our asset -asset-backed product area, with we usually call the consumer economy.

So we expect lower growth in those elements of structured finance into next year.

Than what we have seen which is a rate of growth of five or six percent.

In public finance we do see a lower public issuance volumes mainly driven by on the assumption of slightly increasing rates at least by the middle of next year.

Public finance is quite sensitive to rates, and we assume that the corporate business will not be strong at least until the very end, say , of next year, mainly because of only a modest recovery in corporate business investment spending.

In the U.S. we do expect that we will have a growth in our research business and in our Moody's K.M.P. business.

Internationally, we see a more robust picture, more growth internationally in structured finance because it won't feel the drag of the reduction in the residential mortgage business in the U.S.

We do expect stronger corporate issuance as well.

So we broadly see a picture of revenues that will be somewhat like 2000 where we had weakness in the U.S. strength out of the U.S. and strength in our research and our quantitative ratings and risk management business.

We expect to add to that in terms of E. P.S. growth because of our lower number of shares outstanding and also because of a somewhat lower tax rate .

So that's a broad statement of where we think we'll be in 2003 and I guess I should ask you whether that responds to your question.

That was very helpful.

Maybe you are looking at it from a different perspective again would be looking at head count.

You made some comments about having to get back with the S.E.C. and it terms of that kind of looking into your business and some additions of certain teams.

I should think about head count for the fourth quarter and going to 2003 do you expect to add people in those kind of areas where there is probably not as much variability in the cost structure where you have to have those guys on your staff regardless of what the volumes do or is the head count additions going to be more in terms of volume driven businesses like structured for public finance for example?

I think we do expect to add some staffing because we do expect continued growth in the structured business and we do have the addition of the specialist teams of the large reason why we do not expect significant growth in expenses beyond growth and revenues is a reduction in bonus expense.

But I have already chatted with Lauren and Kevin about.

Ok, great, thanks a lot.

Very helpful.

Our next question comes from Bessie Anteniel.

Northwestern Mutual.

I just have a question regarding your assumption 2003 margins are expected to go lower and is this is driven by your recent acquisition and its lower margins or is there anything else that you are basing that assumption on?

The main reason that is going lower is that we have increased our staff this year and we are increasing our staff in the specialist teams, and so we both have the full year effect of expenses that we only had a partial year of this year.

Together with some new hires.

Now that's off set largely by the lower bonus expense.

So it's both the two combined.

Thank you.

Our next question comes from Hal Derose.

My question has been answered.

At this time if tough questions you may press star one on your touchdown phone.

Merrill Lynch.

Just a quick one.

Has fluctuations and currency I affected your revenue growth in either direction?

I haven't heard that quantified before and didn't know if that was an issue.

Jeanne can you take that one.

Lauren, fluctuations in currency year to year have small impacts on our results and for the quarter principally due to the strength of the euro we had a small positive impacts on revenue and on operating income, we had an opposite impact on expense so that the effect on operating income was very small.

Can you quantify the impact on revenue, was it as much as a percent?

It was probably a little bit under a percent in terms of points of growth.

Great, thanks.

Our next question comes from Jeff Gates.

Please state your company name.

This is Doug Falasis.

Do you have the cash at end of the quarter?

At the end of the quarter the cash balance was about 70 million dollars.

Thank you.

Our next questions come from Daniel Orlo.

Numero Securities International .

I got on the call late so if this was answered already I'll take it up offline.

But sort of as a general business strategy question my understanding is you are using more and more of some of the K.M.V. tools as part of the central and analytic process for the business.

I was wondering if you can talk about that more specifically if you have covered it already, my apologies and I'll just follow it up off line.

Ray, do you want to answer that?

We haven't talked about that so thank you for asking the question.

Sure, I would be happy to address that.

We are -- our Moody's investor service rating analysts do have access to the estimated default probabilities and quantitative outputs that are produced by the Moody's K.K.M.V. business.

Our analysts and the Moody's K.M.V. professionals, however, do not interact in any way with respect to the information that we receive on a confidential basis or information they may receive from customers as part of their product sales efforts.

In terms of how we use the Moody's K.M.V. tools, it is one of a number of different indicators or filters that we would ask our analysts to look at in terms of helping guide where they think there may be credit stresses or improvements in credit worthiness .

The analysts are not guided to follow either the Moody's K. M. V. default probability estimates nor any other quantitative metric.

And in fact our ratings diverge from the K.M.V. ratings more in 2002 than they did in either 2001 or in 2000.

So we have our analysts making forecasts and predicting credit ratings within the Moody's investors service ratings business independent.

We'll continue to do so.

I just had one other note that before we purchased K.M.V. the Moody's analysts had access to the Moody's risk management services quantitative tools and made similar use of those tools.

Putting it slightly differently, Moody's offers two different rating systems.

And our strategic objective is for each those rating systems over time to find their natural customers and have their own costs as a business.

The Moody's traditional rating system is based on fundamental credit analysis and has an objective to deliver stable and accurate ratings over a credit cycle.

Whereas the Moody's K.M.V. rating system delivers point in time ratings and also ones that are more volatile over a credit cycle.

Is that helpful?

It is.

That's a good follow-up.

Is it appropriate to think about the traditional system as being appropriate to benchmark that performance against the K.M.V. performance or does it make sense to think about K.M.V. as essentially because much of the analytic work deals around equity volatility versus bond ratings is essentially gaining the production of the traditional ratings analysts?

Well, I think that we do have a document which we can get to you which is Moody's view as to how one assesses in a somewhat abstract way the values of a ratings system.

And we do that using various statistical techniques and we can provide you with that document.

I'll follow-up with that off line, congratulations on a great quarter.

Thank you, sir.

Our next question comes from John Ness.

William Blair.

If I heard right earlier on the call you said in the third quarter that about 50 percent of revenues were transaction based as you look ahead to 2003 how that proportion might change as a percentage of revenues .

Well, I think what we have said is that broadly speaking we expect corporate finance and public finance to be relatively weaker .

One of which has more transaction-based revenues than public finance, but a smaller than corporate finance.

And we expect more growth in structured which is generally more transaction-based.

So my off the top of the head without doing a spread sheet answer to your question is that we would expect the transaction-based revenues to slightly increase as a percentage next year.

Thank you.

The next question comes from John Britten.

Select Equity.

John, I was wondering if you could give us a operating profitability statistics in the third quarter for the research and K.M.V. and if there is longer- term guidance for 2003 and 2004 for those segments you could provide.

Let's start off with the K.M.V., Moody's K.M.V.

Jeanne, can you provide any information on profitability of K.M.V. in the quarter?

Well, I can comment generally on the Moody's K.M.V. profitability when in 2001 we made a net operating income investment in the Moody's risk management service services business and when we acquired K.M.V. it had operating margins in the range of 10%.

And as a part of the benefit of this acquisition to us was eliminating some of the investment spending we were making at the Moody's risk management services level.

So we anticipated that the combination of the two companies would enable us to improve the combined operating margin.

And at this point you asked about the quarter?

In the quarter including the purchase accounting amortization, the combined companies did generate a small profit.

And as John said, over time, we expect the operating margins for the combined company to grow to 20% or higher.

We would expect to get there by about 2005.

And we would expect a progression in margin growth from now until 2005.

Ok.

What about on the research?

Well, the research, frankly unfortunately John, we don't compute that separately for a reason .

Which is that the research is -- can be thought of as somewhat of a byproduct of the rating business.

So after the analysts have done ratings they tend to write research on companies at least annually.

We do not attribute any of the costs of those analysts to the research business.

So I'm not sure that the -- that the number that we think about which is just the sales costs and the technology costs is really very useful.

Fair enough.

One other follow-up for Jeanne related to the -- can you give us a sense of what the fully diluted number of shares should be roughly for the fourth quarter?

Well, the calculation of fully diluted shares is dependent not only on the number of shares that we retire during the quarter but also dependent on the diluted impact of options that are outstanding.

So it requires a forecast of the average share price for the quarter and you may be better at thinking about that than I am.

It's a difficult question to answer because of that aspect of it.

But as John mentioned, we, our board of directors did approve a new share repurchase program and we would certainly intend to repurchase shares during the fourth quarter if conditions would enable us to do that.

So that we're -- our attention to be to further reduce our basic shares out standing during the fourth quarter.

The diluted shares outstanding does require projections of average share price which are difficult for me to comment on.

OK.

But if the amount -- if the share price is roughly in the high 40's, didn't change that much we would expect a reduction of approximately five million shares roughly on a fully diluted basis from what it was in the third quarter?

At this point we retired about 2.5 million shares of so far in the fourth quarter.

So if we didn't do anymore share repurchase that number would be lower because we're assuming that options will be exercised during the quarter.

So that's what we have done so far.

Very good, thank you.

Just to make a corrective comment on one thing we said before.

As between transaction and relationship-based revenues, we expect transaction -based revenues to grow slightly next year for the reasons I stated.

What I forgot to state is that we expect non -ratings revenue, that percentage also to grow next year because we don't expect the growth of our research business to be affected by a slowdowns in issuance by volumes and we also expect our Moody's K.M.V. business to grow nicely next year.

And both of those businesses generate non- ratings revenue.

That's a clarification I think to John's previous question .

Our next question comes from Grinick.

John, in passing you mentioned market share gains and I was wonder if you could speak to your estimate of market share maybe sequentially , Q-3 versus Q-2 then your year over year and I think you did allude to structured finance where you were gaining market share.

I was wondering if there were other areas where you feel you are gaining share.

Well, we felt we had gained share after the second quarter and generally after the second quarter that our share was very comparable with that of S. & P. We have not had a chance to analyze the third quarter because as you know S. & P. doesn't conveniently report revenues from their rating business.

But let me ask Ray to comment on some areas where we do think we have gained market share at least from an episodic perspective.

Kevin, it's Ray.

Year over year I think the two most important areas where we gain share were residential mortgage backed securities in commercial mortgage backed securities.

And this is in the U.S.

I don't think that we have material gains in either sector sequentially versus Q-2.

So it's more of a year over year trend.

We have been able to largely hold onto share gains that we have gotten particularly in the residential mortgage area since 2000.

So it's been a longer-term trend rather than a Q-2 to Q-3.

The only other thing I would say on the market share is that outside the U.S. we continue to have some regions where we feel we are stronger in terms of our coverage compared to competitors and some areas where we're not as strong.

And I again sequentially since Q-2 I don't think we have seen material changes in that relative market share position.

Importantly also for structured finance internationally, a large part of the growth has come first of all in Japan where we had continued to maintain a very strong market share.

And have because of the growth in asset backed and commercial mortgage backed securities in Japan that broad coverage that we have has generated material revenue increases.

In Europe, the credit derivatives market has been a large driver of growth and that is not a listed market.

So being able to compare ourselves against other rating agencies is quite difficult in that area, but we have had substantial revenue growth.

Thank you.

That was helpful.

Our next question comes from Chris Walters.

First Manhattan.

John, I was hoping you could be a little more specific about the margin expectation for 2003.

I guess your long-term target for the ratings business is 48%.

And I was wondering under what circumstances would your business generate the ratings business generate that type of margin?

Well, what I meant to say was that we thought that the margin next year would be just a smidgen under the margin this year.

So then under what circumstances then does the ratings business go back to your long- term target of 48% or should we really raise that long term target closer to a 50% rate?

We sort of -- you are right that the real experience that we have has been that it's fluctuated above the 48% target with some quarters where we have had strong revenue growth, and if that's combined with trying to be careful with expense management in the beginning of the year of producing higher numbers, I think it's -- the way we're thinking about it now is that it will get more to the 48% level as the M.K. and V. business grow s as a percentage of the total.

So then if I hear you, correctly, I thought the 48% target was specific to the ratings business but it sound like the overall company target is 48%?

Long-term target.

For the overall company including the contribution from K.M.V., being a lower margin business?

Well, we haven't formally thought about it but certainly that's more the way the facts would suggest.

The total company margin target is 48% rather than ratings alone?

All I'm saying is that it's the target, Chris, but I will say it is consistent with the empirical evidence.

Fair enough.

Thanks very much.

Our next question comes from Robert Whalen.

Bluebird News.

Just curious.

There is a lot of positive news in your report last night and yet this morning your stock is down $3.72 right now.

Any idea why the market is reacting to your report this way? )) I don't think it's appropriate for me to comment on short-term stock performance so I'll decline to answer that.

At this time I'm showing no further questions.

Thank you very much for joining us on the call and we very much appreciate your interest in support of Moody's.

Thank you.