穆迪 (MCO) 2005 Q1 法說會逐字稿

Good morning and welcome, ladies and gentlemen, to the Moody's Corporation First Quarter 2005 Results Conference Call.

At this time, I would like to inform you that this conference is being recorded, and that all participants are on 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 ever to Michael Courtian, Vice President of Investor Relations and Corporate Finance.

Please go ahead, sir.

Thank you.

Good morning, everyone, and thanks for joining us on this teleconference to discuss Moody's results for the first quarter of 2005.

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

Moody's released its results for the first quarter of 2005 this morning, and the earnings release is available on our website at IR.Moodys.com.

As many of you know, John Rutherfurd retired from Moody's following our Annual Shareholder meeting yesterday.

We are all grateful to John for his leadership and wish him the best in his retirement.

At its meeting yesterday, the Board of Directors selected Ray McDaniel to succeed John as Moody's Chairman and Chief Executive Officer.

And, Ray will be leading this morning's conference call.

As in the past, we also have Jeanne Dering, Moody's Chief Financial Officer participating on the call.

Before we get started, I would like to call your attention to the cautionary language setout 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's discussion and analysis section and the risk factors discussed in our annual report on Form 10-K for the year ended December 31st, 2004, and in other filings made by the company from time to time with the SEC.

I would 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 this morning in a listen-only mode.

At this point, I am pleased to turn the call over to Ray McDaniel.

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

As Michael said, John Rutherfurd retired yesterday as Chairman and Chief Executive Officer of Moody's.

John's guidance and leadership were instrumental to Moody's outstanding financial performance since the company went public in October 2000.

And, on behalf of Moody's shareholders and employees I join Michael in thanking John for his exceptional leadership and record of achievement.

I'll begin by providing a summary of Moody's first quarter results and operating highlights.

Jeanne will then discuss expenses for the quarter including a charge related to acceleration of stock compensation expense for employees at or near retirement eligibility, provide some detail on our legacy tax provision we made in the quarter, review several developments in the regulatory environment and update you on our share repurchase program.

I will finish our prepared comments with Moody's outlook for 2005, after that we will be happy to respond to your questions.

Moody's had a good start to the year with first quarter revenue and EPS modestly above our expectations in all business lines contributing to growth.

Revenue in the quarter rose to $390 million and was 18% higher than in the first quarter of 2004.

We benefited from continued favorable issuance conditions in a number of markets and from continued strength in our research business.

Together, these more than offset lower than expected issuance in a few market segments.

Operating income in the first quarter was $213 million and grew 16% year-over-year.

Foreign currency translation contributed approximately 200 basis points to the quarter's revenue growth and had a similar impact on operating profit.

Diluted earnings per share for the quarter was $0.78, 15% higher than in the prior year period.

As noted in our press release, diluted earnings per share in the quarter included charges of $0.02 per share related to legacy income tax exposures that Moody's assumed in connection with its separation from Dun & Bradstreet in 2000, and $0.07 per share related to stock-based compensation.

The latter included $0.04 related to the expense acceleration that I mentioned previously.

First quarter 2004 diluted EPS of $0.68 per share included $0.02 related to stock-based compensation and no legacy tax provisions.

Our earnings release included tables showing the non-GAAP financial measures that are derived after excluding the legacy tax provisions, and the stock compensation expense from our results.

Now, I will provide some details for the quarter, starting with operating highlights for our US businesses.

Moody's US revenue was $242 million in the first quarter, up 14% year-over-year.

At Moody's Investor Service, US ratings revenue rose 15% year-over-year and research revenue continued to grow faster at 19%.

US structured finance contributed most of the growth on a dollar basis, as revenue rose in the high 20% range compared with the prior year.

Moody's benefited from continued robust activity in the residential mortgage and home equity sectors, reflecting a gain in coverage versus the prior year period and continued strength in housing markets.

The US credit derivative sector also performed well.

US corporate finance revenue was essentially unchanged from the prior year period, reflecting flat revenue from investment- grade bond ratings and a significant decline in high-yield ratings revenues, largely offset by strong growth in revenue from bank loan ratings.

US financial institutions ratings revenue rose in the mid-single-digit percent range compared with the prior year period, based on strong revenue from insurance companies partially offset by declines in revenue from banks and other financial institutions.

Finally, US public finance revenue grew at a mid-teens percent rate compared with first quarter of 2004, reflecting good growth in new money issuance and a large year-over-year increase in refundings as interest rates remain more favorable than expected.

Moody's KMV reported a modest increase in US revenue with growth from both new credit risk assessments subscriptions and credit processing software revenues, partially offset by client attrition in credit risk subscription products due primarily to bank mergers.

Moody's also continues to generate good revenue growth in international markets, strongly aided by the favorable impact of currency translations.

Total international revenue of $148 million in the first quarter was 24% higher than in the prior year period, with foreign exchange rates accounting for almost 5% of the growth.

International revenue accounted for 38% of Moody's total in the quarter, up from 36% in the year-ago period.

Moody's Investor Service reported mid-20s percent growth in international revenue with high teens percent growth in local currency.

International financial institutions ratings revenue was the largest contributor to this growth on a dollar basis, an increase over 45% year-over-year.

The most important driver of this growth was very strong issuance by European banks as they took advantage of continuing low-interest rates and as German Landesbanks issued bonds ahead of the removal of government guarantees that will occur in July of this year.

International corporate finance revenue rose more than 30%, led by robust year-over-year growth in the European and Asian high yield sectors, which more than offset weaker than expected issuance in the European investment-grade sector.

In addition, European results benefited from a number of other factors, including growth in bank loan and commercial paper revenue, as well as favorable currency translation.

International structured finance revenue grew in the single-digit percent range compared with the first quarter of 2004.

Strong growth in asset-backed commercial paper and commercial mortgage-backed securities in Europe, more than offset weakness in parts of the credit derivatives market.

Moody's research business continued its very strong international performance with revenue rising 30% year-over-year including currency gains.

Finally, MKMV generated $17 million of international revenue, 23% more than in the first quarter of 2004, with little foreign exchange impact.

Revenue included good growth from credit risk assessment subscription products.

At this point, I will ask Jeanne to pick up with a discussion of Moody's expenses for the quarter.

Thank you, Ray.

Moody's expenses for the first quarter totaled $178 million and rose 20% over the prior year period.

The operating margin for the quarter was 54%, compared with 55% a year ago.

As we noted in our earnings release, first quarter expenses included $16.9 million for stock-based compensation compared with $5.2 million in the 2004 period.

The first quarter 2005 amount included a charge of $9.1 million to accelerate the expensing of equity grants for employees who are at or near retirement eligibility as defined in Moody's stock plan.

This charge reflects recognition of compensation expense over the period from the grant date to the date of retirement eligibility, which is shorter than the normal four-year vesting term for these employees.

Excluding stock-based compensation expense in both years, first quarter 2005 expense growth with 13%, which was below the rate of revenue growth.

Also, as we noted in our earnings release, Moody's results for the first quarter included a charge of $2.7 million or $0.02 per diluted share related to legacy income tax exposures that Moody's assumed in connection with our separation from Dun & Bradstreet in October 2000.

In the fourth quarter of 2004, D&B and the IRS reached a settlement in the matter referred to in our securities filings as the utilization of capital losses.

At the end of last year, Moody's had a reserve of approximately $14 million for our estimated share of the settlement cost.

The first quarter 2005 charge reflects an increase in our estimate of Moody's share of the cost of that settlement.

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

And, I would like to remind you that as our securities filings state, the estimated maximum exposure on our legacy tax matters is greater than the sum of the estimated probable exposures for which we have reserved.

Now, I would like to make a few comments on the ongoing regulatory review of the credit ratings industry both internationally and in the US.

Many of you who have been following this issue know that IOSCO, the International Organization of Securities Commissions, published a code of conduct fundamentals for credit rating agencies late last year.

Last month, the Committee of European Securities Regulators, known as CESR, released its advice to the European Commission on whether and how the EC should regulate credit rating agencies.

CESR advised that the IOSCO code of conduct appropriately addresses issues and standards for the credit ratings industry, and that as a result, the EC should adopt a wait-and-see approach where the effects of the IOSCO code are given time to work.

We do not know whether the EC will take this advice or whether it will determine that additional regulation is needed at this time.

In addition, IOSCO held its annual meeting earlier this month in Sri Lanka.

The credit ratings industry was one topic addressed at the meeting and John Rutherfurd presented Moody's perspective during a panel discussion.

In his comments, John reiterated Moody's global support for the IOSCO code of conduct.

John's comments are posted on our website.

Turning to regulatory activity in the US, in March and April, senior SEC representatives, including Chairman Donaldson, spoke before committees in the Senate and House of Representatives.

In those hearings, the SEC confirmed that it is working with the credit ratings industry to devise a voluntary compliance framework, but that the Commission is not certain that this work will produce a satisfactory conclusion.

The Commission left open the possibility that it may need to ask Congress for specific authority to regulate the credit ratings industry.

Finally, last week, the SEC published for comment, a proposed rule regarding the definition of nationally recognized statistical rating organization or NRSRO.

The SEC has proposed a definition containing three components that each must be met in order for a credit rating agency to be recognized as an NRSRO for purposes of federal securities laws and Commission rules and regulations.

Broadly, the components would require first, that a credit rating agency issue credit ratings that are publicly available on a widespread basis.

Second, that it is generally accepted as an issuer of credible and reliable ratings.

And third, that it uses systematic procedures designed to manage important aspects of good professional practice.

The SEC has posed numerous questions and set a deadline of June 9 for comments.

Moody's believes that the SEC has proposed a balanced approach to addressing areas of market concern such as the credibility and reliability of NSRSO ratings, management of conflicts of interest, and the avoidance of potential barriers to entry for new market entrants.

We are in the process of further developing our comments and views on the SEC proposal.

Now, I would like to turn to capital allocation and stock buyback.

Moody's is committed to using a strong cash flow to create value for shareholders through acquisitions or other investments and strong franchises or products in growing capital markets and to returning excess cash to shareholders.

Our approach to the latter continues to be to pay a modest dividend and to buyback shares opportunistically using a discounted cash flow model with conservative assumptions to determine a range of fair values for the shares.

Our goal is to return capital to shareholders in a way that serves their long-term interests.

As a result, the share repurchase activity will vary from quarter-to-quarter.

As we've said, we regularly assess our policy and the mix between dividends and share repurchase to ensure that it will produce a good long-term outcome for our shareholders.

Accordingly, in February we announced an increase in our quarterly dividend from 7.5 cents per share to $0.11 per share and a proposed 2 for 1 stock split that became official when our shareholders approved an increase in our authorized shares.

The split will take effect for shareholders of record on May 4th and the new dividend, which will be 5.5 cents per share post-split, will be effective for shareholders of record on May 27th.

During the first quarter of 2005, we did not repurchase any shares, although we issued 1.2 million shares under employees stock compensation plans.

However, said becoming public in September 2000 and through the end of March 2005, Moody's has repurchased 26.4 million shares at a total cost of $1.1 billion, including 14.2 million shares to offset issuance under employee stock plans.

At the end of the first quarter, Moody's had more than $750 million of cash on its balance sheet.

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

At quarter end, we had $548 million remaining in our current $600 million share repurchase authorization.

At this point, I will turn the call back over to Ray.

Thanks, Jeanne.

I'll conclude this morning's prepared comments, by discussing Moody's outlook for 2005.

While Moody's revenue and earnings growth rates for the first quarter of 2005 were above the full-year growth rate guidance we provided when we reported our 2004 results in February, our overall outlook for 2005 remains substantially unchanged from our previous guidance.

We still believe that our overall revenue growth rates will slow throughout the year and the full year revenue will decline in several important businesses in the US, namely the residential mortgage-backed and home equity sectors, public finance, and high-yield corporate.

Our outlook is based on assumptions about many macroeconomic and capital market factors, including interest rates, corporate profitability, and business investment spending, merger and acquisition activity, consumer spending, residential mortgage refinancing activity, securitization levels and capital markets issuance.

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

In the US, we expect mid-single-digit percent revenue growth for the ratings and research business for the full year 2005.

In the US structured finance market, we expect that revenue from rating residential mortgage and home equity securities will decline by high teens to 20% in 2005, from the record level of 2004.

This is modestly less than the decline of 20% or more that we originally anticipated.

We continue to expect good year-over-year growth in several other sectors of US structured finance, including asset-backed securities and credit derivatives, and flat revenue performance in asset-backed commercial paper.

In addition, we have increased our revenue growth outlook for mortgage-backed securities from mid single-digit percent growth to high single-digit to low double-digit percent growth on the strength of the first quarter.

Accordingly, for the full year 2005 we continue to expect a slight year-to-year decline in the US structured finance revenue.

In the US corporate finance business, given lower than expected issuance in the first quarter, we now expect that both investment-grade and speculative-grade bond issuance will be somewhat weaker than we anticipated at the beginning of the year.

We expect this weakness to be offset by stronger than expected growth in bank loan ratings and by revenue related to our enhanced analysis initiatives, resulting in mid single-digit percent growth in revenue.

In the US financial institution sector, we continue to expect that the impact of flat issuance volume will be offset by revenue related to our enhanced analysis initiative and from new rating relationships, providing low double-digit percent growth in this sector in 2005.

Despite a strong first quarter in US public finance, we still expect a second consecutive year of modest year-to-year revenue decline in this sector, as we believe that issuance was accelerated into the first quarter to take advantage of continuing low interest rates.

We also continue to forecast strong growth in the US research business.

Outside the US we still expect growth in ratings and research revenue and area of 20% with double-digit percent growth in all major business lines and regions, assisted by favorable foreign currency impacts.

Our projection assumes improved corporate issuance in Europe after a relatively weak 2004, modest issuance growth and good growth in new rating relationships in the financial institution sector and good growth in most sectors of structured finance in Europe and Japan.

In addition, we expect continued strong growth in international research revenue.

Finally, we continue to expect global revenue to rise in the mid-teens percent range at Moody's KMV, projecting good growth in both credit risk assessment subscription products and credits processing software products.

For Moody's overall, we expect revenue growth in the 7% to 10% range for the full year 2005 including positive impact of currency translation.

We expect the operating margin before the impact of expensing stock-based compensation to be down approximately 100 basis points in 2005 compared with 2004.

This reflects slower expected revenue growth in 2004 than in 2004 and investments we are continuing to make to expand geographically, improve our analytic processes, pursue ratings transparency and compliance initiatives in the Moody's Investors Service business, introduce new products and improve our technology infrastructure.

For 2005 we expect a year-over- year growth in pro forma diluted earnings per share will be in the 7% to 10% range.

This expected growth excludes the impact of legacy tax provisions and the expensing of stock based compensation in both 2005 and 2004.

The impact of expecting stock-based compensation including the expense acceleration related to retirement-eligibility is expected to be in the range of 21 to $0.23 per diluted share for 2005, compared to $0.11 per diluted share in 2004.

The estimated 2005 expense excludes the effect of adopting Statement of Accounting Standards No 123 R, Share-Based payment, which Moody's will implement effective as of January 1, 2006, based on the Securities and Exchange Commission's recent rule allowing deferral of the implementation date.

That concludes our prepared remarks we would be pleased to take any questions you might have.

Thank you.

[Operator Instructions]

We will take our first question from Lauren Fine with Merrill Lynch.

Great.

Thank you, Ray.

Couple of questions, one I am just curious if you could, discuss April trends.

McGuire has indicated that the month started out pretty strong.

And then secondly, if you could comment -- in Europe there seems to be a sense from the way you describe that that maybe some of the business got pulled forward in terms of a regulatory change that you talked about in Germany as well as a concern about rates and, so, is there a sense that business could slow their?

Thank you, Lauren.

With respect to April trends, I think it's fair to say that we continue to see strength in areas that we are strong in the first quarter.

In particular in the US, the mortgage market continues to be strong.

The credit derivatives market continues to be strong.

And so we have not seen a slowing of momentum in a couple of the key business areas that really did push our growth in the first quarter.

The corporate sector, particularly the high-yield sector, continues to be weak.

So, that trend continues as well.

Turning from the US to Europe, I think that your comment that business was pulled forward is certainly true in some sectors.

I think that's true for the financial institution sector and, perhaps to some extent in the corporate finance sector.

I think that is offset, though, by some business that we expect to be stronger in the second quarter, and that would include, for example, the credit derivatives area of European structured finance, which did not have a strong first quarter, but does have a good pipeline of business and is sensitive to what happens to credit spreads in that area.

Ray, and one last question, on Jeanne, on the stock option side, so we should expect to see that expense go back to the more normal year-over-year increase starting in the second quarter?

There won't be any additional acceleration then, is that correct?

Yes.

That's correct.

The majority of the first quarter charge represents a one-time charge for the acceleration over expenses of expense for prior equity grants.

And going forward, to the extent that equity grants are made to employees to meet the retirement criteria or close to meeting the criteria in our stock plan, then there would be acceleration of expense for those employees.

You're right, that's certainly for 2005, for the remaining three quarters the expense will be slightly higher due to this acceleration, but not anywhere near the extent you saw in the first quarter.

Right.

And one last one, could you pick out the other net line between interest expense, joint venture currency, anything that's in there?

The non-operating expense line consists of interest income and expense, as you've said in tax from joint ventures, and foreign-exchange gains and losses.

And the main components of that line in the first quarter or the interest expense on the $300 million of debt, which is a little under $6 million per quarter. and interest income on our invested cash, which was I think a bit more than $4 million in the quarter, and then foreign-exchange losses or the remaining largest parts of that line and foreign-exchange gains and losses fluctuate quarter-to-quarter, based on fluctuations in exchange rate within the quarter and based on the non-US dollar or the non-local currency asset and liability positions that we have at a given point in time.

Great.

Thank you.

Thank you, Lauren.

Thank you.

Next we'll hear from Fred Searby with JP Morgan.

Great.

Thanks a lot, and congratulations, Ray, on your position.

Thank you.

Couple of question, one, can you give us some sense of new relationship growth in Europe and International, Asia as well?

How that's tracking?

And two, you know there is a lot of talk given your prodigious cash flow about how you have been returning capital or acquisitions?

In particular, given what's happened in India with Crisil, I mean, is that something that you are exploring?

And just, it is something I have been harping on, but that the market share story, my understanding is in a lot of the international markets on the structured finance side are single ratings.

I mean, is it still pretty much on this deals, 40/40 the traditional split, S&P, Moody's or Fitch kind of breaking in and actually, our garnering a stronger position?

Thank you.

Okay.

Thank you, Fred.

With respect to new relationship growth, I think those of you who have been following us for a while or familiar with the trend growth in international relationships, most of that has been coming from Europe.

And we have been adding approximately 100 new relationships per year in Europe over the last few years.

I think, the interesting part of that story is that the growth in relationships coming out of the corporate sector has not been as strong as we would have anticipated several years ago.

It is going, but not at the pace that we would have expected, and I think that reflects the pace of this in a mediation going on in the corporate sector.

But stronger than expected growth in rating relationships on the financial institution side.

We have been establishing rating relationships with banks in Europe that are not necessarily anticipating being near-term bond issuers, but are interested in ratings as part of their broader banking activities including in the inter-bank market.

And so, if that trend continues, I think we may see a bit of a step-up from our historical pace of new relationships coming out of Europe, and I hope to be able to talk to you later in the year to confirm that that impact happens.

With respect to returning capital to shareholders, generally, in India, and S&P is taking a majority position in the rating agency called Crisil, specifically.

We are certainly interested in looking at acquisitions as one means of using our available capital.

We have looked at a number of opportunities.

We have a fairly conservative approach to looking at acquisitions, and we also have a commitment not to diversify for diversification's sake.

We're looking at opportunities that we think are well aligned with where Moody's expertise and brand are going to contribute to the growth through acquisition rather than simply creating a portfolio.

And I would say that the possibility of expanding in India would fit very nicely into how we think about an intelligent use of capital.

I think, you know, we have a minority stake in a rating agency in India known as a ICRA.

We would be interested in increasing our position in ICRA, and especially now that S&P has increased opposition Crisil, that may increase the likelihood of us being able to pursue that kind of opportunity and we're certainly going to be looking at it.

Is ICRA publicly traded as main objective?

No, it's not.

So, that is one difference from Crisil.

And with respect to market share, although I don't have regional market share numbers in front of me, I think it is fair to say that the segmentation of the business between the large rating agencies in Europe and in structured finance, in particular, is broadly reflective of what we see here in United States.

Okay.

Thank you.

Thank you.

Our next question will come from Michael Meltz with Bear Stearns.

Hi, a couple of question for you, Ray.

Just in terms of Europe, last year or even before that, few of the bond insurers were commenting on certain sluggish conditions in European structured finance.

Can you talk about that and discuss if that's an issue that hurting you on the credit derivatives side there?

And secondly, Jeanne, can you give us an update on headcount at quarter-end, as well as the typical question on incentive compensation and comp as a percent of total expenses?

Thank you.

Okay.

Thank you, Michael.

I'll address Europe and then ask a Jeanne, to respond to your second question on headcount and compensation.

The first quarter for European structured finance, overall, was relatively slow.

We had low growth.

We did have good growth in several sectors of the European structured finance business, including the asset-backed market and the commercial mortgage-backed securities market, and especially the commercial paper market, ABS Commercial Paper.

The reason for the overall sluggish performance was really that the derivative markets were slow in Q1, and that is such a large portion of our European structured finance business that it fully, or almost fully, offset the growth that we saw in the other business lines.

The European credit derivative story, I think, really relates to tight credit spreads.

And the effect of tight credit spreads particularly on the synthetic portion of that market where the deals historically had been smaller, and there have not been the same scale economies that come from the larger cash transactions.

So, where we really saw the sluggish activity was in that part of the credit derivatives market, and to the extent that credit spreads widen later in the year in Europe, we would expect to see good growth in that area because we do believe there is a good stock of business to be rated that is dependent on credit spreads and interest rate conditions.

So, that's our view on the structured finance story in Europe.

And we'll obviously keep you posted as we get into the second quarter.

Jeanne?

Okay.

In terms of headcount at the end of the first quarter, we are at a bit over 2400 people, not counting our joint ventures and that's roughly 6% higher than we were at the same time last year.

And the growth and headcount has been principally in the Moody's Investors Service business, percentage growth rise roughly equally split between the US and International.

In terms of compensation expense, compensation as a percent of total expense has remained at about the two-thirds level that has been for some time.

And incentive compensation as a percentage of that was about 18% in the first quarter, which is consistent with the first quarter of 2004, since our revenue and earnings growth rate were quite similar in the two quarters.

Okay.

And Jeanne, one follow-up question.

Just so I'm clear on the accelerated option expense, or the better way ask you, what if will be additional option costs be occur FAS 123 in 2006?

It's difficult to project what the additional expense would be in 2006 because it depends on the equity grants so that will be made to employees who fall into this category.

But, just to give you an idea for the remainder of 2005, our estimate of the effects of accelerating expenses for this group of employees is less than $0.01 per share.

Since, today we have a relatively small group of employees who qualify for this retirement treatment under our stock plan.

Okay.

Thank you.

Thank you.

Our next question comes from Douglas Arthur with Morgan Stanley.

No questions here, but I think Lisa has a question.

Ray, could you just elaborate on or provide some color on in the corporate line?

If you could break out kind of US versus international and then within that, investment grade versus high yield if possible within each of those.

And then if you could speak to the more relationship based type revenues and the frequent each year of the and the revenues from enhanced analysis, given that the 10% growth in the quarter versus the sharp decline in issuance in the US?

Thanks.

Okay.

In terms of the breakout between US International for corporate finance, approximately two-thirds of the business is US based and one-third of the business is international.

For the first quarter of 2005, as a percent of global corporate finance, the high-yield sector was about 20%, and this is in terms of our revenues.

It was about 20% and investment grade was a bit below that.

The bank credit facilities was also about 20%.

And then revenue coming from other accounts, which would include fees for medium-term notes, commercial paper, and (inaudible) based fees, which are largely, but not exclusively coming from the investment grade sector, would be about another 45%.

So, you really have to take a large part of the 45% plus the slightly less than 20% for the investment grade bond issuance and add those together to get a view of the overall investment grade sector.

Okay.

And then just switching to margins, you're expecting margins to decline excluding stock compensation expense, so that would imply, I would think, that expenses are in some of the investments spending in the areas as you cited.

It's going to accelerate for the balance of the year.

Is that correct assumption?

Thanks.

Yes, it is.

It did include a number of investments that we think are important or necessary over the longer-term.

I think among them being our international expansion, and also we are anticipating an increase in compliance costs with -- so for the rating agency portion of our business, because the IOSCO code of conduct and because of our anticipation that there will be some additional oversight coming out of the SEC here in the US.

We don't know what those costs would be at and we're -- really that is importantly dependent on both the pace and the nature of oversight that comes out of the SEC here in the US.

Okay.

Great.

Thanks.

Now with CS First Boston, Brandon Dobell.

Just a really quick one.

As you look at some of the changes, Sarbanes-Oxley and the insurance investigation, those kinds of things.

Is that having an impact on how people view, perhaps push in the envelope on some of these complex structures or the types of instruments that issuers may be thinking about?

And I guess, if you could talk US versus Europe, and what are the differences there might be?

That would be helpful.

Thanks.

I think in terms of the financial engineering and complex structures that are part of the ratings universe.

I really don't think there is much of an effect.

The structured financing assets securitizations both here in the US and in Europe, I think are well understood by market professionals, and especially in the asset classes that have been an existence for a number of years, are well understood, and the transparency is good.

Now, there may very well be financial engineering techniques that are not the subject of public securities ratings, and are not instruments that come to the rating agencies to be rated.

What the effect on some of that financial engineering might be, I think probably, my guess is no more educated than yours would be.

But, we do not see this as being a risk or an impediment to the growth of the core structured finance business, either here or in Europe.

Okay.

And then kind of one final one would be.

As you look at the M&A environment right now, where do you think that shows up the most for you guys?

Where did it show up in Q1 you think about expectations for the back half of the year?

Where would the sensitivity be, on the revenue line or on the margin line, I guess as well?

In terms of the impact of M&A on our ratings revenue.

Is that your question?

Yes.

Correct.

Well, as you know, we have not -- we had been through quite an extended period where corporate borrowing for the purposes M&A was not an important driver.

Where we do expect to see a gain in revenue, obviously it would come out of the corporate finance, potentially financial institutions area with increased M&A activity.

And, in Q1 we did see more borrowing taking place for mergers and acquisition purposes than we have seen in a number of recent quarters.

So, the offsets are that with mergers and acquisition we lose names and we have to end up with a fewer number of larger institutions that we are rating.

And on the other hand, there is borrowing to accomplish the mergers and acquisition activity.

So, in the short run, I think those are probably going offset each other.

In the long run, as we see consolidation at the high-end, for example, in the bank market, there will be a negative effect on the number of issuers we have to rate among those large institutions.

Okay.

Thanks a lot.

We will take our next question form Geoffrey Dunn with KBW.

Thanks.

Good morning.

Could you talk a little about your expectations with domestic RMBS and HELOCs markets?

Your current projection I think is more pessimistic than some of your origination estimates out there might support.

So, is there a difference in your expectations in terms of timing of securitizations or mix of portfolio reimburse coming to market with securitizations?

I think there is a couple of factors influencing our outlook, Geoffrey.

First of all, this is a very competitive marketplace, and although we have established good market share in this area, it's entirely possible that we will not be able to maintain market share levels at the current numbers.

So, that's one consideration, and that's an industry-based consideration.

More broadly, we have been saying for a couple of years now that we expect a decline in Residential Mortgage Backed Securities activity, and expect the decline to come from both mortgages and the home equity component of the market, which we include in our RMBS numbers.

That continues to be our expectation.

I have seen the same kinds of mixed messages that I am sure everyone else on the call has read in terms of strong mortgage originations continuing, declines in housing starts, and what kind of an outlook does that forecast.

We do expect though that interest rates will rise and in fact, the stubbornness of the long-term rates at their current low levels, at least according to some observers may cause more aggressive tightening and although, as a result we would see a delay in the decline in mortgage securitization.

When the decline comes, it could be more dramatic as rates have been rising slowly throughout they year.

So, we are trying to take that into consideration as well.

Okay.

And, then could you comment a little bit about the cash management strategy, with senior portfolio of cash in the past quite, but to the extent that the stock evaluation remains out of the money for your appetite.

At what point do you do consider may be other direct methods of returning capital to shareholders, possibly through a special dividend?

Well, as we mentioned in our prepared comments, we do continue to assess this.

We are certainly aware that there is -- there are different mechanisms by which we can return value to shareholders.

I think we would like to see how the stock performs in a slower growth environment.

That may importantly inform how we think about share repurchase versus dividends.

We certainly would consider reassessing our current position in that kind of an environment.

I think we are probably less inclined to act through a special dividend, since that would be a one-time event for shareholders as of the specific date and we would rather do something that benefits shareholders on an ongoing basis.

Okay.

Thank you.

Thank you.

We will take our next question is from John Neff with William Blair.

Hi, guys.

I have two questions.

First, I think you touched on this earlier, but I was wondering if you could quantify the contribution from the enhanced analytics initiative and what the growth has been.

And also can you possibly comment on the CapEx implications of the regulatory scrutiny?

What your CapEx expectation might be in '05 relative to historical levels?

Okay.

With respect to the enhanced analysis initiative, I think we commented last year that we expected about $11 million in incremental revenue in '04 from the enhanced analysis initiative, and we achieved that.

We continue to believe that we are going to realize about $50 million incremental by 2007 from this initiative.

We are on track in 2005 to meet that long-term target.

So, we still feel very good about the effort and how it is working with customers.

I am sorry.

Could you repeat the second question just, I didn't jotted down?

Sure, just the CapEx implications of all the regulatory scrutiny and possible increase in regulations and transparency, what that might mean for your CapEx relative to history?

I think the fairest answer is that it is uncertain right now.

We do not have a very good understanding of what the final conclusions coming out of the SEC, or potentially the Congress, could be here in the US.

We certainly expect, though, that it is going to increase.

Both our technology costs in terms of technology investment for monitoring our compliance with commitments that we make both in the US and Europe, and it's probably going to have a modest impact on staffing costs as well.

But, I think both of those impacts on the grand scheme of things are going to be relatively small and would not cause an important change in our expense base.

Great.

Thank you.

Thank you.

And now from Neuberger Berman we have Jim Baker.

Yes.

I had a couple of questions.

One is on the other income, I know this question was asked, I am not sure that Jeanne, I got the full answer on this, what exactly was the net interest expense for the quarter?

As you said net interest expense you had in the interest income, I am sure you specify?

Okay.

Jim, the net interest expense for the quarter was roughly $1 million.

Roughly 1 million?

Yes.

It's good.

Isn't there something like 5 million a quarter of interest expense?

You're saying the net interest income was actually $4 million?

Right, the interest expense is on the $300 million of debt is a little under 6 million a quarter, and then the interest income on the invested cash was about $4.5 million in the first three quarter.

So, if you look at this number for the year, it seems like you're suggesting that the Fed keeps raising rates and so on and your cash keeps piling up, you're not raising your dividend, you're not buying back much stock these days, so is it possible and also given the fact that you're going to repay, I believe, in September or October those high interest notes.

Is it possible that net interest could actually be break-even or positive for the year?

I guess, it's certainly possible, although you are right if we repay the notes that had a relatively high rate at this point in time, we'll get some benefits on that in the fourth quarter.

It's certainly possible, but we haven't put together forecasts scenarios that would give us specifics on that.

You could certainly create scenarios where the interest income might offset interest expense if we didn't do any share repurchases.

Okay.

The other thing, I'm going to ask my usual question about the segment breakdowns just between Moody's KMV and the rest of the business.

And if you could give that on a sort of before and after stock option expense bases, I would appreciate that.

Okay.

For Moody's KMV and I assume you're referring to operating income.

That is correct.

The operating income for Moody's KMV on a reported basis was about $3 million in the quarter and roughly that included roughly 1 million of expense related to stock compensation.

So that excluding the stock compensation, is a little under 4 million of operating income.

Well, that strikes me as a very strong performance for a first quarter, which I don't recall being seasonally strong, could you comment on that all?

Well I think that MKMV had a relatively good quarter in corporate sales, which incrementally are a high margin product and also I think you've seen the benefit of leverage that they're starting to get on the employee base that has been built up over the last couple of years.

So, you're starting to see some margin expansion in the business.

I would just add that outside the US, the risk subscription business also had a strong quarter.

Inside the US, it was impacted somewhat by mergers and acquisitions which reduced growth.

I see.

I guess I would just ask, is there a sense you get that software will sort of as you said you make your full year projection there were software continue to be somewhat of a higher percent of the mix maybe what you see in the past?

No, I think and this is -- looking at what caused the split as we saw on the first quarter, I think excluding the loss of revenue from M&A activity, we would have seen a more typical split between software sales and risk subscriptions and I would expect it to refer to that.

Okay.

And then I guess I just wanted to comment in general on maybe your revenue guidance, because basically you're really saying with your revenue guidance for the rest of the year -- and I know you guys always hasten to ask, that why you have not been great forecasters.

You're sort of saying 3.7 to 7.6% revenue growth for the rest of the year, and you really haven't scaled-down your estimate for research growth that much, and that alone is about I think 12% of the base which is growing at 20%.

So, it seems to me like you're short of saying, and pleasantly you are saying, that ratings revenue really you would see growing in the low single digit range for the rest of the year.

Isn't that the application to your guidance?

Is that what you need to say?

Yes.

I think that we, as we mentioned, we continue to expect long-term rates to rise and we continue to expect that that is going to hit the mortgage home equity, public finance and high yield corporate sectors.

And that the strength in the other businesses, while they are going to offset that, or not going to offset that by much so I think your comments overall is a fair one.

Okay, and Ray, I just wanted to clarify me.

I think you always sort of state what assumptions are implicit in your forecast, and I think surely one thing that has happened so far this year is that mortgage rates this 10 year notes have increased a heck of a lot less than probably most of us would have imagined four months ago or perhaps even a month or two ago.

We're still sitting in the 4.25% on the 10 year.

If that persisted, in other words if the Federal Reserve increases and the inflation outlook is still basically didn't really drive those rates much higher, could you give us some notion of how that would affect your outlook for the US structured business this year?

Well, I think -- the low rate environments certainly would, or likely would encourage the continuation of both the residential mortgage and home equity boom that we've seen.

I mean we do know that market has been increasingly moving to mortgages that are negative amortization and arms and interest only mortgages.

Those are indications historically the market towards the end of its bull run.

He are also cognizant of the fact that on the home equity side, there is an offset built in between increased home equity activity and a decrease in credit card activity.

We've seen a lot of borrowing in the home equity sector, at the same time we've seen a slowdown in the credit-card sector and the probable conclusions of that is that the home equity market is being used to pay down credit cards.

Right.

So, the lower rate environment would continue in our opinion to support more robust growth in residential mortgages than we've expected.

If that low rate environment, though, persists because the Fed, for example, does not continue to increase the short-term rates as aggressively as has been anticipated, that might indicate a less favorable economic conditions in the US, which would have an implication for consumer borrowing more generally to credit-card sector, the auto sector.

So, the offsets and the factors that affect our outlook are hard to isolate.

And that may be an excuse for one reason why we are not very good at forecasting, but the interplay is somewhat complex, and I don't think we're being cautious in our outlook, but I also, as you point out, acknowledge that our track record has not been great.

Well, it's been very good in terms of performance may be not forecasting, so we will take that.

I just wanted to ask one final question, and that is, the GSE legislation, the government sponsored entities, there seems to be a movement obviously in Washington to curb their rate of portfolio growth.

And, I just want to understand if there any implications for your RMBS business, given that?

I think in terms of near term implications we would say no.

To the extent that there are limits on overall portfolio sizes though, that could have a positive impact.

In the longer run, how material that impact would be, I don't have a guess for you right now.

Thank you very much.

[Operator Instructions] We will take our next question from Peter Appert with Goldman Sacks.

Ray, you've had Dominion in the market, I think, for about a year now roughly and best more recently.

And, I am wondering if you see them at all from a competitive standpoint, what their presence in market has meant?

Whether there is any implications from their presence from a pricing standpoint?

The entrance of Dominion Bond Rating Service into the US market and I guess, more specifically, its recognition as a nationally recognized statistical rating organization a couple of years ago.

It really has not had much of an impact on our business.

We know that they have been increasing staffing in some areas including, for example, the residential mortgage securities area.

But we are not seeing substitution of Moody's ratings for Dominion bond ratings.

I think probably what's more likely happening is that they're being added as a third agency on transactions and that's what part of -- that's what supporting their business as opposed to substitution.

Is your sense of their pricing is identical to yours?

I have no idea what their pricing is.

Okay.

Jeanne, The 18% incentive comp, can you give us a range that we should expect that would fall in under normalized circumstances?

Sure Peter.

I think in years when we, the company, met its plan and performed close to its normative targets, 12.5% operating income growth and 15% EPS growth, we would expect that relationship to be roughly 15%.

We have seen it go as high as 25% or a little more than that in Europe where we had very strong growth, say, in 2001 and 2002, when our growth rates were a lot higher than the normative targets.

So, that's the range that we think about, certainly there could be variation there but I think that is a good guideline.

How about on the low end then, say, you underperformed the 15% EPS then what's the sensitivity there?

Well, it's a little difficult for me to answer of the top of my head, but I would say that the main sensitivity is in the bonus plan for senior management, since that one is -- it's based on performance, growth rate versus the prior year compared with our normative target and the funding structure of the plan is more leveraged then the plan that we had for our professional staff.

And, so the senior management bonus plan is the one that would be the most affected.

If we think of that the bonus expense for the senior management plan versus the staff plan and the MKMV plan in terms of sort of the bonus target, you might -- may be it's roughly 40% or a bit less of the aggregate bonus target.

Okay.

And then what I was really trying to get was trying to understand the 13% expense growth ex-options in the first quarter, the extent to which we should just think about that as a full year number as well.

Well, I think that in the first quarter we didn't add a lot to total staffing.

And I think that that certainly had an impact on year-over-year expense growth.

We certainly have plans to add to staffing as the year goes on.

So, I am not sure that I would necessarily look at the first quarter run rate as being indicative of the rest of the year.

And as Ray mentioned, we do have investments plans that we hope to implement as the year goes on that would also add incremental expense growth.

Got it.

Great.

Thank you.

It appears that we have no other questions at this time.

Mr. McDaniel, I would like to turn it back to you for any additional or closing remarks.

Okay.

Thank you very much.

I thank everyone for joining the call today.

We appreciate the questions and the attention and the support for Moody's and we look forward to speaking with you next quarter.

So thanks all, and talk to you soon.

Thank you.

That does conclude our conference today.

We would like to thank everybody for their participation.

Have a nice day.