穆迪 (MCO) 2004 Q3 法說會逐字稿

Good morning, and welcome, ladies and gentlemen, to the Moody's Corporation third quarter results conference call.

At this time I'd like to inform you that this conference is being recorded and that all participants are in a listen-only mode.

At the request of the company we will open the conference up for questions and answers following the presentation.

I will now turn the conference over to Michael Courtian vice-president investor relations and corporate finance.

Please go ahead, sir.

Thank you, Audra.

Good morning, everyone, and thanks for joining us on this conference to discuss Moody's results for the third quarter of 2004.

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

Moody's released its result for the third quarter of 2004 this morning and the earning release is available on our website at IR.Moodys.com.

John Rutherfurd, Junior, Chairman and Chief Executive Officer of Moody's Corporation will be leading this morning's conference call.

Also on the call this morning are Ray McDaniel, President and Chief Operating Officer of Moody's Corporation and President of Moody's Investor Service, and Jeanne Dering, Chief Financial Officer of Moody's Corporation.

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

Before we get started I'd like to call your attention to the cautionary language set out at end of our earning's 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'd like to direct your attention to the management discussion and analysis section and the risk factors discussed in our annual report on Form 10-K for the year-ended December 31st, 2003 and in our other filings made by the company from time to time with the SEC.

I'd also like to point out the Safe Harbor Statement under the Private Securities Litigation Reform Act of 1995 contained in our press release issued this morning.

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 the call morning in a listen-only mode, and at this point I'm pleased to turn the call over to John Rutherfurd.

Thank you, Michael, and thank you all for joining us on today's call.

I'd like to start by commenting that we are continuing our process of orderly management succession at Moody's.

Yesterday the board of directors elected Ray McDaniel President and Chief Operating Officer of Moody's Corporation and decided that Ray would be Chairman and Chief Executive Officer of Moody's Corporation when I retire at age 65 at the annual shareholders meeting next April.

Many of you know that for the last few years Ray has been leading the team which has produced the extraordinary operating results at Moody's.

Ray's promotion and designation as my successor has been well-earned and well-deserved, I congratulate him.

On this call, I'll provide a summary of Moody's third-quarter results and Ray will discuss our operating highlights for the quarter.

Following Ray's comments I will provide some detail on a Legacy tax provision we made in the quarter, give you an update on the regulatory environment, and discuss our share repurchase program.

I will conclude with Moody's outlook for 2004.

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

Moody's reported good results for the third quarter of 2004.

Revenue rose to $358 million in the quarter, 17 percent higher than in the same period of 2003.

Our revenue was much stronger than we had projected at the end of the second quarter mainly because of the continued surprising strength of the U.S. residential mortgage and home equity securitization markets.

Operating income of $198 million grew at faster pace than revenue reflecting the impact of higher than expected revenue.

Foreign currency exchange contributed about 200 basis points to the quarter's revenue growth and had a small positive impact on operating income.

Diluted earnings-per-share for the quarter were 63 cents, an increase of 13 percent over the third quarter of last year.

Third quarter EPS included a charge of $18.4 million, equivalent to 12 cents per diluted share related to Legacy income tax exposures that Moody's assumed in connection with its separation from Dunn and Bradstreet in 2000.

In addition earnings for the quarter included 6.7 million of pretax expense related to stock options and other stock-based compensation plans equivalent to three cents per diluted share.

This compares with $3 million of similar expense or one cent per diluted share in the third quarter of 2003.

In light of the strong third-quarter results we have raised our outlook for the full year.

I'll talk more about our current outlook in a few minutes.

Now I'd like to ask Ray to provide a review of Moody's operating results for the quarter.

Thank you, John.

I'll begin by discussing operating highlights for our U.S. businesses.

Moody's U.S. revenue reached $228 million in the third-quarter, growth of almost 20 percent year-over-year.

At Moody's Investor Service growth in U.S. ratings and research revenue was 19 percent.

Ratings revenue grew in the high teens and research revenue continued to rise at a very strong pace growing more than 30 percent.

In the ratings business U.S. structured finance was the largest contributor to growth on a dollar basis with revenue rising in the high 20s percent range compared with the prior year.

Moody's benefited from continued exceptionally strong activity in the residential mortgage and home equity sectors supported by low interest rates, a strong housing market, and gains in ratings coverage.

The commercial mortgage backed securities and credit derivative sectors also performed well.

U.S. financial institutions ratings revenue rose in the mid-20s percent range from the prior-year period.

Significant contributors to this increase included strong issuance by real estate companies and by banks which refinanced opportunistically as spreads tightened.

U.S. corporate finance revenue grew in the high single digit percent range reflecting a strong year-over-year increase in bank loan ratings partially offset by declines in the investment grade and high yield and corporate debt issuance.

Prime republic finance revenue declined six percent in the quarter versus the prior year period as both new money and refinancing issuance declined from the prior year.

The decline reflected higher interest rates as well as lower borrowing needs due to improving tax receipts.

Moody's KMV reported double digit percent growth in U.S. revenue.

Moody's also continued to generate good revenue growth in international markets.

Total international revenue of $130 million in the third quarter was 15 percent higher than in the prior-year period and accounted for 36 percent of Moody's total in the quarter, roughly in line with the year-ago period.

Strong issuance -- strong revenue growth in some segments of the international business were again aided by the favorable impact of foreign currency translation.

Moody's Investor Service reported mid-teens percent growth in international revenue.

The largest contributor to growth in the quarter was international structured finance where revenue rose over 30 percent.

European structured finance ratings revenue achieved particularly strong growth across many business lines including the credit derivatives, asset backed and commercial and residential mortgage backed sectors.

Japanese structured finance revenue also had strong growth driven by the commercial mortgage backed securities and credit derivatives markets.

International corporate finance revenue declined modestly from the prior-year period as the effective weak issuance and difficult prior year comparisons especially in the European investment grade sector more than offset good activity in some smaller markets.

And Moody's research business continued its very strong international performance with revenue rising more than 40 percent year-over-year.

Internationally Moody's KMV generated $15 million of revenue, five percent more than in the third quarter of 2003.

This included good double-digit growth from credit risk assessment subscription products.

The quarter's revenue growth was in line with expectations which included a negative impact from software sales that had been expected in the second half of the year but, as previously announced, closed in the second quarter instead.

Moody's operating margin for the third quarter was 55 percent compared with 53 percent a year ago.

As we've mentioned in the past a large part of our expense base is related to our people and is relatively fixed in the near term.

Therefore, our margin expanded in the quarter as a result of unexpectedly strong revenue growth.

At this point I will turn the call back to John.

Thank you, Ray.

I'd like to provide some detail now on the charge we record this quarter related to Legacy tax matters.

As we noted in our earnings release Moody's third quarter included a charge of $18.4 million, equivalent to 12 cents per diluted share related to Legacy income tax exposures that Moody's assumed in connection with our separation from Dunn and Bradstreet in October, 2000.

This charge is in addition to the $10 million Legacy tax charge that we took in the second quarter.

In the second quarter, we reported that D and B and the IRS had reached a preliminary non-binding basis for settlement regarding a substantial portion of the matter referred to in our securities filings as royalty expense deductions.

As we noted then this tentative settlement will not be binding unless a final settlement agreement is executed.

Finalization of the settlement is dependent on the agreement the IRS and all D and B related parties who have financial liability for this matter.

Unfortunately to date the parties have not been able to conclude a settlement agreement that is acceptable to all.

Therefore, we have reassessed our exposure for this matter and have increased our Legacy tax reserves by $18.4 million to reflect our current estimate of probable exposure.

Our Form 10-Q for the third quarter will include additional disclosure on the status of this and other Legacy tax matters.

In addition, please note that our securities filings state that the estimated maximum exposure on the three Legacy tax matters is greater than the probable exposure for which we have reserved.

Now I'd like to make a few comments on the ongoing regulatory review of the credit rating agency industry in the United States and abroad.

In the United States the SEC has not provided any public updates about the progress of its review of the role and function of credit rating agencies so there is nothing to report since our last conference call in July.

The SEC has not announced a specific time table for completing its work.

We continue to work with the commission to assist the process in any way we can.

Outside the United States we also continue to speak with authorities who are studying credit rating agencies.

These authorities include national securities regulators and lawmakers and international and regional securities and banking system regulators such as the International Organization of Securities Commissioners, or IOSCO, the Financial Stability Forum, the European commission and the European parliament.

Earlier this month IOSCO released a proposed model code of conduct for credit rating agencies.

Proposed model code generally follows the code of conduct Moody's published last year and we believe that the IOSCO document captures useful guidelines for industry conduct.

IOSCO has put its proposal out for public consultation and will be accepting comments through November 8th.

A final version of the model code is expected after the consultation process is complete.

Although the proposed model code contains several areas that we will continue to focus on we remain hopeful that the final version of IOSCO's code of conduct will merit Moody's full support.

On another front the Community of European Securities Regulators, or CESR, continues to work on a report about the credit rating industry for the European commission.

In early October Moody's together with other credit rating agencies and selected market participants got together at a hearing in Paris organized by CESR.

We understand that CESR is working to complete a draft of their work before the end of this year and to deliver a final report to the EC commission in April, 2005.

Moody's will continue to assist CESR with their work in any way we can.

Moody's senior management continues to conduct open and constructive dialogue with financial and securities regulators around the world.

We believe that it is important to work cooperatively with these authorities as they consider potential international and national standards relating to the credit ratings industry.

Turning to Moody's share repurchase program, we're committed to returning our excess cash to shareholders.

We pay a nominal dividend with the majority of our excess cash being earmarked for share repurchase.

We take an opportunistic approach to share buy-backs and we use a discounted cash flow model with conservative assumptions to determine a range of fair value for the shares.

Our goal is to return capital to shareholders in a way that's -- their long-term interest.

As a result our share repurchase activity will vary from quarter to quarter.

As we've said before we regularly reassess our policy and the mix between dividends and share repurchase to ensure that it will continue to produce the right long-term outcome for our shareholders.

During the third quarter of 2004, Moody's repurchased approximately half a million shares at a total cost of $35 million.

Since becoming a public company in September, 2000, and through the end of September, 2004, Moody's has repurchased over 26 million shares at a total cost of $1.1 billion, including 12 million shares to offset shares issued under employee stock plans.

At the end of the third quarter Moody's had approximately $450 million of cash on its balance sheet.

We are willing to let cash accumulate until we can repurchase shares at prices that we believe benefit our long-term shareholders as well as those that may be interested in selling.

At quarter end we had $548 million of authorization remaining in our current $600 million share repurchase program which was approved by our board of directors in May.

I'd like to conclude my comments this morning by discussing our outlook for 2004.

Moody's outlook for the full year 2004 is based on assumptions about many macroeconomic and capital market factors, including interest rates, consumer spending, corporate profitability, and business investment spending in capital market issuance activity.

There is an important degree of uncertainty surrounding these assumptions and if actual conditions differ from our assumptions Moody's results for the year may differ from the outlook presented in this conference.

We expect revenue in the fourth quarter to reflect a resumption of many of the macroeconomic and capital market conditions that we saw at the beginning of the third quarter.

And to be generally the same as revenue in the third quarter.

So with considerable uncertainty, we expect positive seasonality in our revenues to offset less favorable capital market conditions.

We expect that the third quarter declines we saw in the 10-year treasury rate off which many debt securities are priced, were beginning to reverse in the fourth quarter.

We expect that residential mortgage and home equity securitizations will decline versus the third-quarter levels, offsetting seasonal increases in asset backed securities and credit derivatives, and we expect further weakness in public finance issuance and a seasonally strong fourth quarter at MKMV.

Consistent with our expense pattern in 2003, we expect increases in fourth quarter expenses over our third quarter levels.

Areas of likely increased spending in the fourth quarter include improving our technology infrastructure and administrative systems, office relocation and expansion, Sarbanes-Oxley compliance, marketing programs, and a grant to the Moody's foundation.

Our outlook for the full year 2004 reflects these expectations for the fourth quarter.

In the United States we expect low double-digit percent revenue growth for the rating and research business for the full year 2004.

While the federal reserve has increased its target interest rate -- which is the short rate -- three times since June 30, the yield on the ten-year U.S. treasuries has fallen.

Moody's has benefited from stronger than expected issuance in the third quarter in part as a result of this decline, but we expect that the ten-year rate will resume rising as we saw earlier in the year.

We expect that higher borrowing costs combined with sufficient profits from current production to reduce the need for corporations to funds business investment with debt will result in a continued weakness in United States investment grade corporate issuance for the remainder of the year.

We believe that issue in the high yield bond market for the remainder of 2004 will likely continue its downward trend from the very strong levels of the second half of 2003 and the first half of 2004, though this may be partially offset by continuing strong activity in the leveraged loan sector of that market.

For the full year 2004, we expect moderate growth in U.S. corporate finance and good growth in financial institutions revenue versus 2003 including the benefits of new products, particularly our enhanced analysis initiative.

In the United States structured finance market, revenue from rating residential mortgages and home equity securities has been stronger than last year, and much stronger than we anticipated at the start of this year, driven by persistently low interest rates, the strength of real estate prices and increases in coverage.

For the full year 2004 we now expect revenue from rating residential mortgage backed securities and home equity loans to grow approximately 40 percent compared with 2003.

We expect 2004 revenue from rating asset backed securitizations including credit card and vehicle transactions to decline slightly compared to 2003.

Asset backed commercial paper should continue to show flat to modestly negative revenue growth, but we expect good growth in commercial mortgage backed securities and credit derivatives.

Accordingly, for the full year we expect mid-teens percent revenue growth in U.S. structured finance.

We continue to expect a year-to-year revenue decline in U.S. public finance, and we are forecasting continued strong growth in the U.S. research business.

Outside the United States we continue to expect mid-single digit percent revenue growth in the combined corporate and financial institutions rating business.

We're also projecting mid-teens percent year-over-year revenue growth for international structured finance rate, primarily due to strong growth in European and Japanese residential and commercial mortgage backed securities, European asset backed commercial backed paper and Japanese asset backed securities.

We expect strong growth in international research revenue to continue.

These expectations, which include favorable foreign currency impacts, should produce mid-teens percent revenue and research growth in Europe and mid- to high-teens percent revenue growth in other international regions in 2004.

Finally, we continue to expect low-teens percent revenue growth at Moody's KMV on a global basis.

This expectation is lower than the growth rate which MK and V achieved in the first half of 2004 due to factors that include earlier than expected sales of credit process software and longer product development and sales cycles than anticipated for new, more complex, risk analytic products.

For Moody's overall we now expect low-teens percent revenue growth for the full year, up from our high single digit to low double-digit growth expectations at the end of the second quarter.

We expect the operating margin before the impact of expensing stock based compensation to be more than a hundred basis points higher in 2004 compared to 2003.

This reflects the unexpected revenue growth that we have seen in several of our businesses this year, partially offset by investments we are making.

For 2004 we expect that year-over-year growth in diluted earnings-per-share will be in the high teens percent range.

This expected growth excludes the impacts of the insurance gain in 2003, the Legacy tax provisions in 2003 and 2004, and the expensing of stock-based compensation in both years.

The impact of expecting stock-based compensation is expected to be in the range of $26 million pretax in 2004, equivalent to ten to 11 cents per diluted share, compared to $10.8 million or four cents per diluted share in 2003.

That concludes our prepared remarks.

Now my associates and I will be happy to address your questions.

Thank you.

The question-and-answer session will conducted electronically.

If you would like to ask a question today, please do so by pressing the star key followed by the digit 1 on your touch-tone telephone.

If you are using a speaker phone please make sure your mute function is turned off to allow your signal to reach our equipment.

Once again, that is star 1 to ask a question.

We'll go first to Lauren Fine at Merrill Lynch.

Great quarter and congratulations, Ray.

Couple of quick questions on the U.S. corporate.

Can you quantify what percent of the total is the bank loan business and could you give us a better sense of what's driving the demand there and sorts of if it has a seasonal pattern what that might be during the course of a year?

And then a question I know you've been asked before, but I'd love to get an update on it, within U.S. structured finance what percent of the total is the residential and home equity piece?

Okay.

Lauren, it's Ray.

First of all, thank you very much.

Let me start with the U.S. structured finance piece of the business.

For the full year, I think last year we had talked to you that we expected -- that that was between six and seven percent.

For the U.S. business, that looks like it's going to be now closer to perhaps 11 to 12 percent.

Is that total he ever total U.S. or as a percent of structured finance.

As a percent of total U.S.

Okay, great.

Thanks.

Next is Mister Peter Appert with Goldman, Sachs.

Wait a second, Peter.

We haven't finished Lauren's...

Yeah, we also had a question on the bank loans from Lauren.

The bank loan revenue has been about 22 percent of our total corporate finance -- U.S. corporate finance revenue.

And that is higher than it was in 2003 obviously, and with respect to the cyclicality or seasonality of that business, we would expect that bank loans will continue to be a relatively strong part of the overall leveraged portion of our business combined high yield bonds and bank loans for the remainder of the year.

We have not yet completed our preliminary thinking on the split between bank loans and high-yield bond issuance for next year so that will have to come, I think, at a later time.

Lauren, does that respond?

Okay, and we'll go next to Peter Appert with Goldman Sachs.

Yes, that responded for Lauren.

Thanks, very much.

John, did you -- I'm going to ask you a couple things.

I'll get them all in before I get cut off.

Did you say that the fourth quarter revenue growth rate you expect to be similar to the third quarter?

That's question number one.

Question number two, can the fourth quarter margin be sustained flat year to year in the context of your revenue expectations?

And then the last thing, related to that I guess, is there any catch up cost accruals that we have to see here in the fourth quarter in terms of compensation expense?

Let me answer the first question first.

I think what I said was that the fourth quarter revenues -- or not the revenue growth rate -- but the absolute quantity of revenues is expected to be generally similar to the third quarter.

And that's because although we do expect some fall-off in revenues that are interest-rate sensitive, there's usually some favorable fourth quarter seasonality in the business.

So, you know, generally we think that those will offset and we'll have about the same amount of revenues in the fourth quarter.

So that would imply, John, you know, basically, you know, flat to even down slightly revenues on a year to-year basis?

That's how you were thinking about it?

Yes, sir.

Okay.

Thank you.

Your next question dealt with our fourth quarter margin expectation.

Jeanne, do you want to comment on that?

If I understood the question, Peter, I think you asked if it would be possible to maintain the prior year margin at fourth quarter?

Is that --

Correct, that was it.

Okay.

And in 2003, the margin in the fourth quarter declined versus the third quarter, and we're once again expecting a margin decline in the fourth quarter versus the third quarter.

Whether it will represent a decline versus the fourth quarter of 2003 -- it could.

On the other hand, it could be closer to that margin.

It's a little bit difficult to tell now because as you know, the margin is certainly dependent on revenue, since other than the expenses that John talked about, generally most of our expenses are fixed, not sure that specifically answers used question.

Your third question, Peter, was do we have -- do we expect catchup expenses in bonuses and the answer is no.

We take -- we take an estimate of the bonus expense based on our full year growth and we reflect that back in our quarterly numbers.

Okay.

Great, thank you.

Next we'll go to Geoff Dunn with KBW.

Thank you and good morning, and congratulations on a great quarter.

Two questions on the international business.

First, is there any material component that's derived from the Australian real estate market?

And second, is there any material component of your international business that might be tied to British interest rates?

Ray, can you...

With respect to the Australian market, it is a small market for us.

And so the real estate component of the Australian market I think is really not material in looking at our overall numbers.

With respect to interest rates in the U.K., I mean certainly we have an important part of our European corporate finance business represented by U.K. firms issuing in Europe or, for that matter, in the U.S.

And to the extent that that rates provide refinancing opportunities or in a rising rate environment foreclose those opportunities, they would be relevant to our performance in European investment grade corporate finance in particular.

But as with the U.S. there are a number of factors that make it sometimes difficult to forecast issuance activity, including the level of capital expenditure and whether the rising rate environment is coincident with a resumption of business optimism, merger acquisition activity, et cetera.

Just to follow up on that last piece, does your current forecast for potential corporate activity in Europe include a rising rate assumption for '05?

We have not provided any '05 outlook at this point.

Okay, thanks.

We'll take our next question from Douglas Arthur at Morgan Stanley.

Actually I think Lisa has a question.

Yes, John, could you just speak to the impact of foreign currency on structured finance overseas?

And then also if you could just give a little bit more color on the segments within structured finance in the U.S. and overseas?

You quantified derivatives overseas but if you could be a little bit more specific on the different pieces.

And then, secondly, if you could just -- you cited that you expect a slowdown in interest rate sensitive revenues in the fourth quarter.

Have you seen that slowdown so far in the fourth quarter?

Thanks.

Sure.

Our structured business was helped by foreign exchange in the third quarter.

I don't know whether we can this quickly get you a basis point figure.

I'll answer a couple of other questions and maybe we'll get it by then.

In terms of segments European and U.S. structured finance, perhaps I could ask Ray to comment on that.

Sure, be happy to, John.

As I think we've discussed on calls previously, the percentage of our structured business outside the U.S. that's represented by the credit derivatives market is relatively larger than it is in the U.S.

Internationally, as far as a component of our international business, the credit derivatives is, oh, probably about a third -- that's an estimate -- and in the U.S., it's a bit less than that.

Where we've seen the highest growth recently outside the U.S. though in addition to the strong creditor's market has been both residential mortgage and commercial mortgage-backed securities activity and that phenomenon has been growth.

We've seen strength in the U.S. certainly in the mortgage sector but that has been replicated in most geographies outside the U.S.

I don't have a percent breakdown of all the lines for all of the geographies right at hand.

Back to your first question, I think Jeanne has figured out the answer.

Well, I figured out an estimate for you, Lisa.

International structured finance revenue growth on a reported basis was in the range of 30 percent and roughly 500 basis points of that reported growth was due to the favorable impact of currencies inflation.

And can you just talk about activities so far in the fourth quarter?

Oh, sure.

And, you know, activity was pretty good in the first month of the fourth quarter.

And, you know, we wouldn't have the sort of outlook that we did if credit market conditions had strongly deteriorated this far in the quarter.

Yeah, I would just add in the part of the business, the residential mortgage and home equity sector -- which I know we've talked about for a while is anticipating a decline -- it is not at the high water mark in terms of our pipeline that we had a bit earlier in the year, but it is still a relatively strong pipeline of activity.

Great, thanks.

We'll go next to Michael Mel[ph] with Bear Stearns.

Hi, couple of questions for you for.

Following up on Peter's question, can you quantify that percentage that you're accruing incentive compensation?

Secondly, given the comments you just made on Q4 trends, can you put 2005 in a context for us in terms of the type of growth we may expect to see on the top line for you?

And thirdly, can you just discuss your research business, the growth has been excellent for a long time now, several years, can you tell us how many seats or licenses or subscribers you have there?

Thank you,.

Surely, Michael.

On the incentive compensation, I think we are at a -- we have two pieces of it.

We have a piece for our professional staff which we are accruing at close to its maximum percentage, which is -- we've been accruing around 200 percent of target.

It caps out at 210 percent.

For our other staff, our senior managers, we are expecting something around a little over 100 percent of target which is substantially reduced from last year due to the reduction in growth rate.

So overall, I think that our accruals for incentive compensation this year are less than they were last year.

Okay, and I understand that but in terms of the context of the numbers you've given in the past of 20 percent or 15 percent in a normal year, where are you in the third quarter?

Well, let me ask Jeanne if she knows the answer to that.

Michael, in the third quarter, the combination of what John described resulted in incentive comp expense being roughly 20 percent of aggregate compensation. and as we've said in the past, that can range from roughly 15 percent up to 25 or more percent, so we're sort of in the middle that have range in this quarter.

With regard to 2005 we, frankly, do not have a well-developed outlook.

I think that we do our strategic plan in July.

We have a revised but that suggested that probably 2005 would be below the 12 and a half percent long-term target for operating income and revenue growth that we have.

And I don't think we're really -- frankly have a very tight ball park on this number.

Better than -- John, better than 2000?

Well, 2000, we had around seven or eight percent growth.

I don't, I don't know that -- whether it's going to be better or worse or -- frankly, how it's going to relate to 2000.

I wouldn't -- I would say that, you know, 2000 is probably an interesting year to pick for comparison.

Okay.

You asked about our research business.

There has been growth in number of products.

We have some new products that come out of our credit research area which enable customers to compute default likelihoods and transition likelihoods for groups of companies that they may be interested in.

We have some products that make it easier for customers to use our website.

We have products in structured finance which have been quite successful, which essentially allow investors to look at various segments of structured finance in the way that our analysts do.

We've also had good growth in customers, particularly in Europe and in Asia.

And the growth of those customers come from a lot of -- a lot more cross-border investing in Europe based on European monetary union.

We also have had a successful program to license our information for in-house installation by financial institutions and to allow other types of redistributors to distribute our information.

So all of that adds up at the moment to around to 3,000 institutions using our research at the moment and about 20,000 users within those institutions.

So we've had good growth, both on the product and on the customer side.

Okay.

Thank you.

We'll go next to Joe Lamanna with William Blair.

Yeah, thank you.

First is in the press release you mentioned the growth in the quarter being due in part to market-share gains and real estate securitizations.

Can you elaborate on that comment?

Sure, Ray will handle that comment.

Yeah, Joe, we have historically had a coverage, paid coverage in the residential mortgage-backed securities market of about two-thirds of issuance.

This year we're up year-to-date over 80 percent in coverage for the residential mortgage sector.

And so that has certainly been a contributor to our revenue growth.

I would add that in looking at this, we are -- I'm talking specifically about the mortgage portion of the -- what we call the residential mortgage securities sector -- rather than the home equity sector where we have traditionally had very high coverage and continue to.

And is that market share at expense of one of your competitors or is that people just signing three ratings instead of two ratings?

It's probably a combination of both.

I have not looked at the comparative market share statistics for all of the competitors in this market which not only includes the large competitors but also some of the new entrants.

Okay.

Shifting to the expense side, I notice a number of bounces around quarter-to-quarter and you don't talk about it much in the press release but the nonoperating income which is usually usually an expense being down to around 3 and a half million this quarter, versus 7.4 million a year ago.

Is there any further elaboration you could make on that decline and especially relative to looking forward where that number might be?

Jeanne?

Joe, this is Jeanne Dering, I'll try to address that for you.

The main components of nonoperating income and expense are interest expense on our long-term debt, interest income on our invested cash and foreign exchange gains and losses on assets and liability positions we have at given points in time that are in foreign currencies.

The interest expense component has remained the same for some time because that respect relates to our $300 million of debt.

That debt is coming due in September -- or October of 2005 and what we do with that debt and the way of refunding it could affect that component of the nonoperating income and expense.

So the variance that you've seen year-to-year and quarter-to-quarter really relates to interest income and foreign exchange gains and losses.

We've had more interest income this the third quarter than we did in the same quarter of the prior year because of the much higher excess cash balance that we have at this point in time.

And the foreign exchange area in the third quarter of last year was a loss, and this year it's a gain; and that just depends as I said in the asset and liability positions and then on quarter-to-quarter changes in exchange rates.

Great; one more even more detailed question on the depreciation and amortization, Jeanne, that typically sequentially goes up and in this quarter went down from the second quarter level of 8.8 to 8.3.

Is there anything going on there?

There is nothing, Joe, that I can think of offhand going on there other than -- I think the depreciation and amortization, there are several components of that.

One being software products at MKMV develops and capitalizes and amortizes.

And if one of those products has reached the end of its amortization period it would fall off of the list and create a variance of that sort.

So there's nothing...

Nothing unusual?

...unusual that's going on in that line that I'm aware of.

Okay.

Thank you.

We'll take our next question from John Neff at William Blair.

Hi it's a tag team here.

A couple of questions for you.

First off, I was wondering if you could comment on the status and the contribution of the enhanced analytics initiative.

I think last quarter you said you were expecting about $11 million in 2004 revenue.

Yeah, John, this is Ray McDaniel and that is still our estimated 2004 revenues.

Okay, great.

And second, related to the charge rented to the Legacy tax exposures, did your estimate of the total exposure, has that gone up, or is it more related to the probability of a payment at some point?

Jeanne, do you want to comment on that?

I'm sorry, could you just repeat the question for me?

Sure.

As related to the tax-related charge, has your estimate of the total exposure, the maximum potential exposure, gone up, or is it a reflection of a probability of having to pay that drove the increase -- that drove the charge this quarter?

We -- I'll answer that in two parts.

First the increase in the reserve is really the estimate of the probability of what we think the final outcome will be, so it's more the probability what have we'll have to pay.

But certainly our estimate of the aggregate exposure can change from time to time also as either new assessments are received from the IRS on various matters or as settlement discussions and other activities continue.

But the charged in the quarter is to reflect what we think is the best estimate of the most likely payment that will be made.

Can I simplify that, Jeanne, by saying that as far as I know the only thing that caused the maximum exposure to go up this quarter was interest.

Okay.

No, I'm not sure if that's right, John.

We have to assess the maximum exposure every quarter as these matters work their way through the various discussions that are being held.

So we continue to assess that and we update that on a quarterly basis in our 10-Q.

Okay.

And then the -- I'm sorry, John mentioned earlier what the cash balance was but I didn't get that -- at the end of the quarter?

It's -- the cash balance was approximately $450 million.

Okay.

And final question, kind of theoretical, you're assuming that long-term rates are to move back up but could you just speak theoretically about the implications for your business of a flattening yield curve?

Sure, I'll start and then I'm sure John will want to offer a couple of comments.

I think the -- well, first of all, obviously it may be important as to whether it flattens low or flattens high, but that being said what we would normally expect would be refinancing activity associated with the opportunity to go long for not much higher interest rate than going short.

With all of the refinancing activity that has occurred in the last two years though, I would expect that any effect we would get there would be dampened and so what might be a normal cyclical catalyst to revenue growth in the business coming from refinancing is probably not something -- we cannot expect to see a big increase from in '05 whether it's absolute low rates or just a flattening of the curve.

I guess the only thing I'd add to that is that the normal Leaman index -- refinancing index -- has been for some time in good territory in regard to medium-term refinancing but not in particularly positive territory with regard to long-term financing.

Thank you.

We'll go next to Brandon Dobell at Credit Suisse First Boston.

Good morning.

A couple questions on the pricing environment in both ratings and MKMV.

Maybe you could talk a little bit about what the current environment looks like in the context of where prices were in the early part of this year and then maybe relative to what '03 looked like as well.

Then on the employee side I want to get a little more color, maybe you could give us some detail on kind of how the employee count is dispersed among the different ratings functions.

And then a related question would be that given that we've heard -- heard but not have seen that it's more competitive in terms of the Wall Street investment banks maybe not so much in research but certainly on banking are you seeing any heightened levels of attribution or competition for some of your analysts?

Okay.

This is Ray.

Let me start with the employee question before the numbers slip out of my head.

The -- roughly speaking, if you -- if you take our, what we call our fundamental ratings business, the corporate and financial institutions side of our ratings business, and line that up against the structured finance portion of our ratings business, we have roughly equal numbers of professional staff between those two businesses, for roughly equal numbers of revenue.

We -- in periods of strength on Wall Street, we -- our turnover as you can imagine rises, and it has risen in both areas historically although we have tended to have more trouble keeping our structured finance people because of the market value of those people in a robust Wall Street environment.

I realize you may have been asking that question on the employees at a more granular level but I don't have more specific numbers for you on that.

With respect to pricing '04 versus '03, it's actually quite a mixed bag.

We have some portions of the business where we have made relatively significant investments and we believe that we have added to the value of the ratings service that we're providing and this would particularly be with respect to the enhanced analysis initiative which is largely focused on U.S. corporate and U.S. financial institutions and the ratings on those.

In other areas of the business, for example, structured finance, we have had price increases in some areas and we have had price reductions in other areas.

Again, really I think shifting according to how much value we can provide based on new technologies that are being developed or the fact that some business may not be going through a period of new technological development and our value added may be reduced.

So it seems like the pricing is more driven by additive technology or additive data that goes into the ratings versus any kind of volume factor in a particular category or perhaps a competitive factor.

Is that a fair statement?

Well, no.

I mean -- we do -- the competition and the ratings business has as one of the tools with which to compete, price.

There are other bases to compete but price is certainly one of them.

And the -- I think it is fair to say that where we are providing additional scope or depth of analysis or where there are areas of more rapid financial engineering occurring, where the importance of having a third -- a credible third-party opinion on new structures and new asset classes particularly in structured finance again, I think that is where we have pricing opportunities and, you know, those are -- those shift from year to year in terms of where the financial engineering is really concentrating development.

Okay, very helpful, thanks.

Our next question comes from Fred Searby at J.P. Morgan.

Thank you.

I'll make it very brief.

Basel II, heard some chatter that things are getting done there.

In the past we've seen that has not pertained to you.

Can you update us on that?

After that I'm going out for lunch, good results.

Sure, Fred, we have never felt that Basel II was a major opportunity for the traditional rating agency business simply because the corporate groups that we cover, which is say 6,000, is a lot less than the number of companies that large banks typically lend to.

So we didn't -- we did not think that it was a major opportunity there.

We have believed that it is a important opportunity for MKMV because -- because we believe that they will be able to supply a number of the systems that will be used by banks to address Basel II.

We also have been strongly encouraged by European authorities to consider extending our ratings more easily to small and medium-sized enterprises.

That's very important in Europe and we have not yet developed a strategy, a product, so forth, but it's certainly something that we need -- we know that we need to do.

Finally if credit rating agencies are to be recognized under Basel II, no matter how small the effect may be, it certainly could lead to some regulation and potentially creeping regulation in that area and that's something that we're paying close attention to.

Thank you very much --

Our next question comes from Peter Appert of Goldman Sachs.

John, it seals like there might be a little dichotomy in terms of your expectations of sort of flattish fourth quarter revenues versus the third quarter and the statement that the October pipeline -- I think I heard sounded like it was relatively strong.

So the question is, I guess, does it suggest that you're seeing something in November, December, that would suggest a slowing pace of business?

Well, the main -- we don't think so.

I mean, the third quarter was really quite extraordinarily good.

Yeah.

This is -- Peter, this is Ray.

I just add that, I mean, really the normal seasonality that we see and declining revenue -- sequential revenue from Q2 to Q3 didn't happen this year.

And we associate a portion of that with the fact that interest rates in the U.S. -- benchmark rates dropped again which we did not expect, and spreads tightened; both.

And so we believe that that led to some opportunistic refinancing, some opportunistic issuance.

If those rates stay low, we still think that opportunistic issuance will have largely already occurred and if they start moving up the affect will be that much greater.

So -- I think this is just really echoing John's comment, but if we have a flat Q4 that would actually be quite a good quarter because of Q3.

Thank you.

Next we'll go to Jim Baker at Neuberger Berman.

Yes, good afternoon, everyone.

I just had a few questions I wanted to ask.

One, in the tax reserves, you mentioned that the amount you've reserved so far is, you know, less than the maximum.

Can you give us, you know, the differential there?

I mean, what's the maximum amount you could reserve in addition to what you already have, to get to -- have you done say 180 out of the 300 or what do the numbers look like there?

Jim, this is Jeanne Dering.

I think that unfortunately we can't answer that specifically until we finalize and file our 10-Q since we continue to assess the exposures.

But I think if you looked at our prior 10-Q filings to use as a gauge, you would see I think, for example, that last quarter, at the end of the second quarter we had reserves on the balance sheet of about $112 million and that was compared with an aggregate exposure of about 200, I know it was $275 million, I think the quarter before that our reserves were a bit lower but our estimate of the exposure was higher.

So that the exposure estimates change from time to time as we consider all of the developments that occur on these matters.

So at the moment the reserve that we have on our balance sheet is substantially less than the potential maximum exposure.

Okay.

So it's reasonable to say you could take the 112, add the 18.

I think you had this quarter so that would be about 130 that you've accrued so far?

Well, the other item that gets accrued each quarter is interest on -- on the amounts that are reserved so there are places for that as well.

Okay.

Now another question I had was that do you have the segment results for the quarter between risk management and ratings and research?

Yeah, I think that in the earnings release table...

I'm referring to the profit portion not the...

Oh, I'm sorry.

It would, I think take me a minute to get that, but we can certainly find it for you.

Okay.

While you're doing I have one other question maybe you or somebody else could answer, and that was the contribution to the Moody's Foundation in the fourth quarter, are you contemplating something larger than the $6 million or so you've done in the past?

No.

And that contribution will obviously have to be approved by the board of directors at that time.

We're just signaling that that is the amount included in our forecast.

Okay.

And then the only other thing, John, I wanted to maybe you or Jeanne or Ray could address this.

It's the -- last year in the fourth quarter you had a very large sequential increase in your operating and SG&A expenses even though as you point out there tends to be a fixity of those in the short term.

So I'm wondering if you remind us with a caused that in last year's fourth quarter and whether you might see perhaps a less sequential increase this year.

I think we are expecting a sequential increase.

We have a number of projects underway to improve our technology infrastructure and we expect expenses for those projects to come through in the fourth quarter.

We have a number of expenses for office moves that we expect to hit in the fourth quarter.

Okay, last year it was about a $29 million sequential increase and I'm talking about all the expenses apart from stock options and D&A which is about 22 percent increase sequentially.

I mean my question is are you foreseeing something on that order of magnitude, either absolutely or on a percentage basis or might it be maybe only a ten percent increase or 15 percent increase this year sequentially?

Jim, I'll try to address for you.

Sequentially we could see an increase that is higher than the ten percent level, and some of that -- some of the increase last year was based on differential exchange rates, so a portion of this year's increase compared with that could depend on where exchange rates are for the Pound and the Euro.

Because the Pound effects a lot of our non-U.S. expenses.

And KMV typically has more expense in the fourth quarter in part because the fourth quarter tends to have a lot of their software sales and the sales expenses that go with that.

And as John mentioned the foundation contribution, if it grant is made along the same lines as last year, that has an important effect on quarter-to-quarter expense.

So I think whether it's a ten percent increase or 20 percent increase sequentially depends on -- certainly foreign exchange rates would have an affect on that as well as the amount of spending that we accomplish on some our discretionary projects.

The sequential increase could be as high but it may not.

Okay I it's fair to say where you fall in that range may depend on how revenue develops in the quarter, as well. obviously there's some discretion as to what to do.

Yeah, and where revenue falls in the quarter also would affect incentive compensation expense in the quarter.

So that that could have an effect on the sequential variance as well.

That's right.

Okay.

If you have the segment numbers, Jeanne, I don't know if you have them yet.

Yeah, on the MKMV, the operating income and this includes option expense for the quarter was roughly half a million dollars.

Half a million, did you say?

Yeah.

And that included option expenses, then?

Yeah, I would say the option expense was a few hundred, maybe seven or $800,000 of option expense.

So that excluding that expense would be at roughly $1.3 million of operating income for that business.

Okay.

That's very helpful.

Thank you very much.

I think that answers all my questions.

We'll go next to Jeff Rapport at BRC Partners.

Hi, I know that you don't -- can we get some more granularity in terms of the structured finance revenue?

I know you don't give us the breakdowns of the percentage of the businesses but can you tell us the year-over-year growth in those businesses?

Yeah, this is Ray.

I can -- I think I can give you at least some broad numbers.

The year-over-year growth -- and then I'll tackle this at a global level.

For the ABS sector, including both commercial paper and term asset backed, we would expect growth to be flat to perhaps low single digit.

We expect growth for the year to be much more substantial for both the residential mortgage and commercial mortgage sectors.

High 30 percent growth for residential and mid-20 percent growth for commercial mortgage-backed securities and then growth for derivatives of about 12 percent, again on a global basis.

And going forward next year, when you look at residential mortgage and you look at commercial, what are you figuring in your internal budgets in terms of growth?

Or down 10 percent, down 5 percent, down 20 percent?

We have not completed that work yet and so I don't want to put out a number that turns out out to be a bad number.

I'd rather wait and give you something I feel I can stand behind later in the year.

Have you going back and looked at a peak to trough movement within a mortgage cycle and seen what the declines were from the top to the bottom or the increase from the bottom to the top?

Short answer is yes, we have done that.

The longer answer is but I don't have all that have in front of me.

There is one thing to keep in mind, though, which because we include in our residential mortgage sector the home equity sector, some of the historical analysis is going to be importantly influenced by the secular growth of that part of the business, compared to earlier interest rate cycles.

Well, what do you think is your organic growth of that market?

Normal organic growth of that market?

Basically the answer to that is that there's long-term growth in residential mortgages because of adoption of residential mortgages in many areas of the world where they were not previously adopted.

So there should be substantial long-term growth in residential mortgage -- in Europe and in Asia probably for the next decade or more.

Is there a chance now, when -- when someone does an issuance, does the issuer disclose the fee that is paid to Moody's?

The issuer certainly could disclose the fee that is paid to Moody's but I don't believe they do.

Is there any chance of the consequence of the SEC's investigation results in more transparency of your fees since the issuer is paying for the fee and it's coming out of the investor's pocket?

Is there a chance that they would mandate or legislate that or push for legislation at some point that would have a disclosure of what Moody's -- what the rating service fee is?

Well, the most extensive regulatory initiative to date has been the IOSCO initiative that I mentioned and that initiative would not disclose such disclosure.

I was just wondering, it might have been moved to greater transparency.

No, my answer was correct.

Right, okay, so there's -- and you don't expect a change in that.

I didn't say that.

I said that the current regulatory environment didn't contemplate that.

Right, okay.

Thank you.

We'll take our last question from Evan Berrens at BRC Partners.

Mr. Berrens, your line is open -- and it looks like he hung up.

Mr. Rutherfurd, I'll take turn the conference back over to you.

Thank you all for joining us.

I appreciate your spending the time to be with us today and I certainly appreciate your continued interest in Moody's.

That does conclude today's conference.

Again, thank you for your participation.