穆迪 (MCO) 2006 Q2 法說會逐字稿

Good morning and welcome, ladies and gentlemen, to the Moody's Corporation second quarter 2006 earnings conference call. [OPERATOR INSTRUCTIONS] I will now turn the conference over to Michael Courtian, Vice President, 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 second quarter of 2006.

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

Moody's released its results for the second quarter of 2006 this morning and the earnings release is available on our Web site at IR.moody's.com.

Ray McDaniel, Chairman and Chief Executive Officer of Moody's Corporation will be leading this morning's conference call.

Also on the call this morning is Linda Huber, Chief Financial Officer of Moody's Corporation.

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

Certain statements my colleagues and I make today may be forward-looking within the spirit of the Private Securities Litigation Reform Act of 1995.

This act provides the Safe Harbor for such forward-looking statements.

I would like to direct your attention to the management's discussion and analysis section and the risk factors discussed in our annual report on Form 10-K for the year ended December 31, 2005, and 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 this morning in a listen-only mode.

I'm pleased to turn the call over to Ray McDaniel.

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

I'll begin our prepared remarks this morning with a brief summary of Moody's' second quarter results.

Linda will take you through the quarter's operating highlights, providing some commentary on revenue and expenses and update you on our share repurchase program.

I will then review developments in the legislative and regulatory area and finish with Moody's' outlook for 2006.

After that, we'll be happy to respond to your questions.

Moody's' second quarter revenue rose to $511 million, 14% higher than in the second quarter of 2005 and included healthy double digit revenue growth in most of our major lines of business despite rising interest rates.

Operating income in the second quarter was $289 million and also grew 14% year-over-year.

Foreign currency translation exerted a modest negative impact on operating results, mainly due to the strength of the U.S. dollar relative to the euro, reducing revenue growth by approximately 40 basis points and operating income growth by approximately 60 basis points.

Diluted earnings per share of $0.59 for the quarter were 26% higher than in the prior-year period.

Results for the second quarter of 2006 included $0.04 of expense related to stock-based compensation compared with $0.03 of similar expense a year ago.

Based on Moody's strong results for the first half of 2006 we now believe the results for the full-year 2006 will modestly exceed our prior forecast.

Our earnings release includes tables showing non-GAAP financial measures that are derived after excluding adjustments for our legacy tax matters and stock compensation expense.

At this point, I'll turn the call over to Linda who will start with some detail on revenue and expenses.

Thanks, Ray.

I'll provide details for the quarter, starting with our U.S. businesses.

Moody's U.S. revenue was 328 million for the quarter, up 16% year-over-year.

For Moody's investor service, U.S. ratings revenue rose 16% year-over-year.

The quarter's growth was led by the U.S. corporate finance business where revenues grossed 20 million increasing 39% from the prior-year period.

Moody's benefited from robust activity across the investment grade, high yield, and bank loan segments of the market.

U.S. structured finance again generated solid growth with revenue rising $19 million, an increase of 14% compared with a very strong prior year period.

Particularly strong revenue growth from rating credit derivative driven by record breaking issuance more than offset a year-over-year decline from residential mortgage-backed securities.

U.S. financial institutions rating revenue rose 19% compared with the prior year period, including particularly robust growth from the insurance sector.

However, as we had expected, U.S. public finance was the one major line of business by to experience a year-over-year decline.

Revenue declined 19% compared with the second quarter of 2005 as an increase in new money issuance was more than offset by a sharp decrease in refunding.

Finally, U.S. research revenue rose 24% from the prior year period reflecting good growth from selling Moody's narrative credit research, licensing Moody's data to third parties, selling data and analytic tools and providing credit training.

Turning now to our international operation, Moody's continues to generate good growth outside the U.S.

Total international revenue was 183 million in the second quarter, 11% higher than the very strong prior year period, where revenue grew more than 30%.

Growth in the quarter also reflected an unfavorable foreign currency impact which reduced the growth rate by about 1%.

International revenue accounted for 36% of Moody's total in the quarter compared with 37% in the year-ago period.

For Moody's investor service issues international revenue increased 10% year-over-year.

Corporate finance ratings revenue was 30% higher than in the prior year period, primarily due to strong issuance and growth in new rating mandates, particularly in Europe.

International structured finance revenue were 12% and benefited from strength in the asset backed securities, residential mortgage-backed securities, and credit derivative segment of the business.

All these more than offset a decline versus a very strong second quarter in 2005 from commercial mortgage-backed securities.

International financial institutions revenue declined 11% on weaker issuance compared to the very strong prior-year period.

On a global basis, Moody's KMV generated 35 million of revenue, 16% more than in the second quarter of 2005.

This included growth in each of the Company's major product areas, subscriptions for risk products, licensing of credit processing software and fees for related software maintenance and fees for professional services.

Moody's KMV produced about 3 million in operating contribution for the quarter compared with a loss of several hundred thousand dollars a year ago.

Moving on to operating expenses, Moody's operating expenses for the quarter totaled 222 million, 15% higher than in the prior year period.

This increase was driven primarily by higher personnel costs and various technology investments.

The quarter's operating margin was 57%, essentially unchanged from the same period last year.

I'd like to turn now to an update on capital allocation and stock buybacks.

Moody's remains committed to using its strong cash flow to create value for shareholders by investing in growing areas of our business, making selective acquisitions in related businesses, repurchasing our own stock, and paying a modest dividend.

During the second quarter of 2006, Moody's repurchased 9.7 million shares at a total cost of 574 million and an average price of just under $59 per share.

Partially offsetting these buybacks, we issued approximately 1 million shares under employee stock compensation plan.

At quarter end, we had roughly 2.1 billion of share repurchase authority remaining.

Before I turn the call back over to Ray, I'd like to briefly discuss a final item.

Moody's headquarters building in downtown Manhattan has served the Company well for more than 50 years, but we've outgrown its capacity.

We've been carefully weighing options to address this issue for several months and at its meeting yesterday, Moody's Board of Directors approved plans to relocate the Company's headquarters.

We've found suitable space at a nearby building and we are in lease discussions with the building's owner, but we have not yet signed a definitive agreement.

If we secure space that we're looking at, we plan to move next year and to be completely in the new location by the third quarter of 2007.

We're still at a fairly early stage in this process, so we're not in a position right now to provide details of the financial implications of the relocation.

Based on our current assessment, we estimate that this relocation will have a modest impact on our 2007 margin, but will not cause us to adjust our overall long-term margin outlook.

Moody's owns the building we're in now and we expect to use the proceeds from selling our building to fund moving expenses and to outfit our new space.

We'll keep you updated as we reach significant milestones and will share more details with you on future conference calls.

With that, I'll I turn it back over to Ray.

Thanks, Linda.

Turning to the regulatory front, in mid-July, the U.S.

House of Representatives passed HR2990, a bill that aims to improve ratings quality by fostering competition, transparency, and accountability in the credit ratings business.

As we've said before, Moody's is supportive of these goals.

Key elements of the bill were amended during consideration by the house, including some portions of the build that could have had unintended industry or market consequences.

Last Friday, the Senate Banking Committee introduced its own bill, the Credit Rating Agency Reform Act of 2006.

There are many similarities between the House and Senate bills and we are in the process of evaluating the Senate bill in more detail.

We understand the Senate bill is scheduled for review and markup by the Banking Committee today, so additional information may be available very shortly.

As I'm sure you know, the House vote and the introduction of the Senate bill are two steps in a process that may or may not lead to final legislation.

For any legislation to become effective, a bill must be passed in both the House and the Senate, a reconciled bill must be agreed to and that bill must then go to the White House.

As a result it's difficult to gauge exactly what any final legislation might look like and whether and when it might ultimately be enacted.

Our focus is to ensure that any oversight approach from credit rating agencies, whether legislative, regulatory, or otherwise avoids unintended consequences for the industry and market participants and enables Moody's and other rating agencies to continue to strive to achieve high standards of quality and independence in credit ratings and research.

If legislation is eventually enacted, we remain confident that Moody's business model will be respected and that we will be able to continue to serve financial markets effectively.

Moody's will continue to communicate with lawmakers as the legislative process proceeds and we'll keep you informed of any significant progress.

In Europe, CESR, the Committee of European Securities Regulators is expected in October to deliver its first annual report about rating agency compliance with a code of conduct published by the IOSCO the International Organization of Securities Commissions.

Those of you who have been following Moody's for a while are aware that we enacted our own code of professional conduct in June of 2005 consistent with the IOSCO codes requirements.

I'd like to conclude this morning's prepared comments by discussing Moody's assumptions and outlook for the remainder of 2006.

Moody's outlook for 2006 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 borrowing, and refinancing activity, and securitization levels.

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

Based on Moody's stronger than expected results for the first half of 2006 we have made a number of revisions to our outlook for the full year.

For Moody's overall, we now project revenue growth in the low double digit percent range for the full year 2006.

This assumes foreign currency translation for the remainder of the year at current exchange rates, which would result in no material full-year impact from currency translation.

We now expect the operating margin before the impact of expensing stock-based compensation to be flat in 2006 compared with 2005.

Among other things, this reflects our increased revenue and a delay in some expenses related to real estate expansion of our New York headquarters.

The margin outlook continues to reflect investments we are making to expand internationally, improve our analytical processes, pursue ratings, transparency and compliance initiatives, introduce new products, and improve our technology infrastructure.

For 2006 we project year-over-year growth in non-GAAP diluted earnings per share to the mid- to high teens percent range.

This forecast excludes the impact of adjustments elated to legacy tax matters in 2005 and 2006 and the expensing of stock-based compensation in 2005 and 2006.

This year represents the final year of phasing in of expense related to stock-based compensation, which we began in 2003.

The impact of expensing stock-based compensation is expected to be in the range of $0.15 to $0.17 per diluted share in 2006 compared to $0.10 per diluted share in 2005.

In the U.S., we forecast high-single to double-digit percent revenue growth for the Moody's investor service rating and research business for the full-year 2006.

In the U.S. structured finance business, we expect revenue for the year to rise in the mid- to high single digit percent range from the record level of 2005.

We project a midteens percent decline in revenue from residential mortgage-backed securities ratings, including home equity securitization, offset by strong year-over-year revenue growth from rating credit derivatives and commercial mortgage backed securities.

In the U.S. corporate finance business, we expect revenue growth in the mid- to high teens percent range for the year, up from our previous expectation of high single digit percent growth, largely due to higher expected transaction volume in rated bonds and bank loans.

In the U.S. financial institution sector we expect revenue to grow in the low double digit percent range for the year as new ratings mandates and fee increases partly related to our enhanced analysis initiative should more than offset the impact of lower revenue related to issuance volumes.

For the U.S. public finance sector, we expect revenue for 2006 to decline in the double digit percent range as rising interest rates should continue to slow refinancing activity.

We continue to expect strong growth in the U.S. research business at better than 20%.

Outside the U.S., we expect ratings revenue to grow this the low teens percent range.

This forecast assumes that foreign currency translation will have no material impact on revenue growth for the year.

Our outlook assumes mid- to high teens percent growth in international revenue for all major business lines, except financial institutions where is we expect international revenue to grow in the mid-single digit percent range.

Our outlook for Moody's KMV globally anticipates growth in net sales and revenue, from credit risk assessment subscription products, credit decision processing software and professional services.

We now expect this will result in a high single digit percent growth in revenue with greater growth in profitability.

That concludes our prepared remarks today and if the operator would please open the call for questions, we're happy to take them.

Thank you. [OPERATOR INSTRUCTIONS] We'll take our first question from Steven Barlow, a Prudential Equity Group.

Linda, was there any revenue smoothing in this quarter?

That was one of the factors that upset people last quarter.

And secondly, can you give us an idea of the percent of revenues from real estate mortgage back in the U.S. and overseas?

Thank you.

Ray will answer the mortgage back question for you first, Steve.

Steve, the percent of U.S. residential mortgage-backed securities revenue as a percent of Moody's Corporation overall revenue in the quarter was about 13.5%.

And for global residential mortgage-backed securities, and both of these include home equity securitization, the percentage of Moody's Corporation overall revenue was about 11%.

And Steve, we had a bit of follow-on effects in our corporate finance area regarding that small change that we had put into effect last quarter, but it's not particularly material, so not something that will require a lot of change.

And lastly, last quarter you had talked about your cash balance being higher than you wanted it.

Is this the right comfort level for your cash balance?

Well, I feel much better at 223 than I did over 0.5 billion and we think we were able to put that to pretty good use, as we said that we would.

Thanks.

We'll go next to Fred Searby, at JP.

Morgan.

Thank you.

A couple questions.

One, I wondered if you could comment on July trends and specifically with respect to credit derivatives, if you could just address whether you've seen the exceptional strength you saw in the second quarter?

And then secondly, can you comment on how much of this growth you're seeing in high grade and some of the resurgence you've seen there is related to M&A activity and what your thoughts are and what you've incorporated into the guidance with respect to merger and acquisition?

Thank you.

Sure, Fred.

With respect to the CDO business in July, it does continue to be robust and we expect to have a good growth in CDOs through the rest of the year.

Just one other area that I will highlight for the second half of the year is that we, in the residential mortgage area, we are seeing some weakening in parts of the residential mortgage market as as it relates to securitization volume.

And that's for the prime mortgage sector.

We have not seen as much of a decline in the subprime sector and the home equity sector yet.

We're still expecting it, but most of the decline we've seen has been with respect to the prime portion of the the residential mortgage sector.

As far as high grade issuance, yes, we had a very strong quarter for high grade issuance.

Actually, in corporate finance, we had a strong second quarter really across the board.

High-grade bonds, spec-grade bonds and loans, all three.

As you note, that was in part driven by strong M&A activity, leveraged buyout activity, and the pipeline for M&A activity continues to be strong as well.

Although whether it's going to keep up at the pace we saw in the second quarter, I think is questionable at this point.

Thank you very much.

We'll go next to Lisa Monaco, Morgan Stanley.

Hi, yes, Ray, if you could just give us some color or specifics on the individual subsegments within structure finance and within U.S. and international and then I have a couple follow-ups.

Sure.

In the U.S. structured finance business, as I think you know from the prepared comments, we had a very strong quarter in credit derivatives.

That was by far the largest percent growth contributor for the quarter in the U.S. structured finance market.

We had a decline in the residential mortgage-backed area, and a very slight decline, essentially flat for the term asset-backed or consumer receivable sector.

Breaking that out a little bit further, there was weakness in the vehicle securitization sector and we saw strength in the student loan and what we call other sector, which includes things like equipment leasing.

We also had modest growth in the commercial mortgage-backed security sector, but that was a growth off an extremely strong second quarter in 2005.

So we actually count it as a good quarter even though the growth was modest.

Internationally, I think those comments largely hold.

We saw a little bit more growth in international asset-backed securities as opposed to a very slight decline in the U.S. and less of a decline -- or, I'm sorry, growth in international residential morning-backed securities is compared to a decline in the U.S.

The commercial mortgage-backed security sector was up in Europe.

It was down in some of our other international sectors.

And again, the derivatives was up in Europe and again down in some of the other international sectors.

Our next question comes from Geoffrey Dunn, KBW.

Good morning.

On the corporate side, can you give us a sense of how much of the activity came from the refinancing side?

And do you get the sense that some of that was the last-ditch effort to lock in low rates?

I'm sorry, this is for the corporate finance sector?

Please.

Yes.

In corporate finance, really a lot of things contributed to the very strong growth in the second quarter.

We did see high volume activity including both refinancing and new money issuance.

Growth in mandates or new rating requests from new issuers and importantly the mix in that business was more favorable for us in the second quarter.

And by that, I mean the growth in issuers that request ratings on a per transaction basis.

Those are primarily the speculative grade bond issuers and rated loan issuers.

We had a tight spread environment, we had a low default environment and that encouraged a lot of activity at the lower end of the credit spectrum.

Add to that some price increases associated with our enhanced analysis initiative and also relatively weak comparison for the second quarter 2005.

We were working off of a relatively weak quarter.

All of these were contributors to the strong growth.

I wouldn't associate the growth's particularly with refinancing.

It was broad based within corporate finance.

I didn't mean to imply it was all refi.

Are you able to give us a rough breakdown of investment grade, high yield, refi, and bank line, or is that pouring in too much?

The revenue we regenerated from the spec grade sector, including bonds and loans, was a bit higher than the revenue we generated from investment-grade issuance.

But as you know, the issuance in the investment grade sector doesn't track as closely in terms of our revenue growth because we have more frequent issuer pricing programs for the investment grade issuers.

Thank you.

I -- I was going to offer a bit more detail.

For the percentage of global corporates revenue, high yield for the second quarter was 17%, investment grade, 20%; bank loans which is really quite a fast growing part of our business is 22%; and then other, which is credit facilities, MTN, shelves, things like that was 41%.

We'll take our next question from Megan Talbott, at Lehman Brothers.

Hi, good morning.

Just trying to get a sense of how much your raised guidance for the year is based off of better 1H performance versus different expectations for the back half of the year.

So if you could maybe give some color on if any of your assumptions for the second half of the year have changed, given what you've seen this quarter?

And as a related question, it looks like you're looking for a little bit of an acceleration in international revenues in the back half of the year, so if you could talk about what's driving that as well.

Sure.

The guidance for the full year, most of the basis for the increased guidance is the result of our strong first half.

We have, however, upgraded our expectations modestly for revenue in the second half of the year, and that is primarily coming out the structured finance area.

Several different components of the structured finance area.

So the majority is based on strong first half performance, but there is some contribution from the upgraded forecast in structured finance in the second half of the year.

And as for the international picture, really what -- two things I think were contributing to the lower growth in international in the second quarter than we have seen in some other quarters.

One, being the fact that we had negative impact from foreign currency translation and we expect that that impact is not going to be negative in the second half of the year.

And also, we had a decline in growth in the financial institution segment in second quarter and that is partly related -- well, partly related to a weaker issuance environment for financial institutions, but also to the revenue deferral that Linda mentioned a few minutes ago and that will not have the same kind of negative impact in the second half of the year that it did in the first.

Okay, great.

Just one quick follow-up on the expense side.

Linda, at your analyst day, you mentioned that you were going to try to maybe smooth out expenses a little more this year and not have as heavily loaded fourth quarter.

Did that happen this quarter, should we expect it to continue?

We did make the effort to smooth out the expenses as we had said.

And it's flat -- we read with great interest this morning the variety in the views of the analysts in terms of how they were looking at our expense, clearly some of you adjusted expense and some of you did less of that.

So directionally, as a trend, we have increased our expenses in terms of technology and also spend on people.

For the second quarter, our expenses are still about 70% compensation and the majority of the increase in the expense line, more than 70% of it is related to our greater head count and our compensation numbers.

So those trends kind of continue and we would expect that the quarters would be more even, though, the fourth quarter still will be a bit heavier than the proceeding three.

Okay, great.

Thank you very much.

We'll go next to Karl Choi, Merrill Lynch.

Just a follow-up.

Can you give us the head count increase year-over-year for the quarter?

On the regulatory side, Ray, can you talk more about the unintended consequences you discussed in your prepared remarks?

Sure, Karl.

The head count right now stands at about 3,000 people for the Corporation, that's 18% head count growth year-over-year, but that also includes the addition of Moodyseconomy.com, which we did not have at this time last year, so if you take that out, we're at 14% year-over-year head count growth.

On the regulatory side, Karl, I think the two primary issues, and I believe we have at least mentioned these in some prior calls.

One is that we're very concerned that any legislation or regulatory initiative would cause imposition of standardized methodologies across the credit rating industry in how we conduct our credit analysis.

And that has been specifically precluded in the Senate bill, so there is specific language in the Senate bill saying that any oversight guidelines or rule making should not go to the content of credit analysis as conducted by the credit rating industry.

The second is the contingent liability issue.

And again, we are pleased to see the recognition of the importance of maintaining our current legal protections for reducing credit opinions being written into the Senate bill.

We think that recognition is extremely important for anyone who's in the business of providing opinions, especially forward-looking opinions, which we are doing.

So those are the two critical factors and we think that they have been addressed in a reasonable way in the Senate bill.

Okay.

Just a quick follow-up.

Could you talk a little bit about from your four-year guidance, what are you expecting for residential mortgage-backed in the second half in terms of either issuance or revenues?

Well, we are -- as Linda mentioned in the prepared comments, we are still expecting a decline in residential mortgage-backed securities for the second half of the year.

Based on current activity and the fact, as I mentioned a minute ago, that we're seeing more of the slowdown coming in the prime sector rather than the subprime home equity sectors, we are anticipating that more of the decline is going to be pushed off into the fourth quarter rather than the third quarter, so we would expect a modest decline in the third quarter, but more of it hitting in the fourth quarter.

When we spoke to you a few months ago, we thought this was really going to be a second half issue rather than a fourth quarter issue.

But presumably, residential was I think down in the second quarter, but overall, probably up for the first half.

So we shouldn't expect the declines to be much more dramatic -- or higher than what you're guiding to for the full year it sounds like?

Yes, I think that's correct.

Next we'll go to Brian Shipman at UBS.

I just want to follow-up, Linda, on the share repurchase that you made in the second quarter and given your two-pronged approach.

It seems you're certainly more opportunistic in the second quarter.

Do you plan to abandon the methodical approach you had historically utilized prior to the second quarter.

Should we assume the pace of share repurchases going forward from here will decelerate from what you did in the second quarter?

Thank you.

Just to review where we are, we spent $776 million this year on share repurchase and 202 of that was in the first quarter. 574 million was in the second quarter.

So we feel we've been pretty aggressive with the repurchasing activities given what happened with the change in the stock price after the first quarter earnings call.

And putting that in context, the amount we've spent on share repurchase through the second quarter is 12% higher than the 692 million we spent in all of 2005, so we feel we've been pretty aggressive opportunistically, as you had noted.

We are not going to abandon our systematic share repurchase program.

We like it because it allows us to stay in the market through all the black out periods.

Which if you look at all the four quarters of the year we would be out of the market approximately four months out of the year if we didn't have a systemic repurchase program.

We intend to continue both.

But on an opportunistic basis, we've got to look at where the stock settles out and how our multiple compares to where it's traded historically and will make a decision about our balance between systematic and opportunistic.

But we're very pleased with the progress that we made and we're pleased with where our cash balance is and so we'll take it from here and see where the stock price goes.

We'll go next to Peter Appert, Goldman Sachs.

Two questions please.

Ray, I'm wondering, or Linda, if yo have a specific estimate of any incremental costs that might hit you as a result of the bills currently proposed in the House and Senate.

And secondly, maybe more importantly, it certainly feels like this cycle is different from past cycles for you guys.

In the context of despite the sharp increase or meaningful increase in rates, you've been able to sustain very impressive revenue growth and I'm wondering, Ray, if this causes you to rethink the cyclicality of your business and perhaps suggest that the secular growth rates are perhaps higher than you've talked about in the past.

Well, let me address the second question first, .

No, I don't think the expectations are higher than we have forecast.

While interest rates have moved up significantly, it has really -- the most significant move as you obviously know has been at the short end.

We have had increases at the long end, but we have not had the kind of increase that we saw, for example, back in the mid 1990s and the '93, '94 period on the benchmark ten-year treasury and the effect that that would have on bond issuance.

That being said, yes, we do have a more diversified business now that than we have had in previous cycles.

Our international business is a larger contributor, our nonratings business both in research and at Moody's KMV is much more significant contributor.

So there are reasons to believe that we are not going to be as influenced by issuance activity, but the issuance activity itself, while I think we can say that it follows or tracks interest rates, there are a lot of other factors going into issuance activity as well.

For example, a rising interest rate environment associated with very strong economic activity is a better scenario for us than a stag inflation environment where interest rates are being pushed up but they're being pushed up against a backdrop of weak economic activity.

I still think that continues to be the realistic worst case scenario for us if we are facing a stag inflation environment.

As for incremental costs associated with regulation, yes, I think there will be some.

We have been anticipating that for a while, though, and we have already been building out our regulatory and compliance infrastructure, both personnel and systems to accommodate that.

I don't expect any big surprises on the cost side coming from the legislative process currently underway or the subsequent rule making.

Thank you.

Just to follow-up on that for a minute, you had spoken about the increase in interest rates, but one of the things that influences us heavily here at Moody's is the absolute rate on the ten-year, which has not moved dramatically, though the short end of the curve has moved up.

And we would like to offer to point out that the spread environment tends to be relatively reasonable right now for us.

We noticed that this morning as well.

But given the overall view in terms of where the ten-year's been in spreads, the situation has remained relatively reasonable.

Linda, on the head count issue, you've obviously stepped up hiring pretty dramatically this year.

Can you talk about sort of a reasonable expectation on a go-forward basis in terms of what you would be targeting in terms of FTE increases?

Sure.

We've been trying to catch up in structured area and also in some of the staff areas as well, Peter.

Technology and some of our compliance and frankly some of our finance areas related to stocks and things like that.

We would hope to get this down to probably a high single digit rate relatively soon we're done with the catchup period, but as Ray has indicated the business conditions through the second quarter have been relatively good and we've got to make sure thatwe're adding people appropriately to support the growth in the business so we don't fall behind.

As for the balance of the year, we'll see how that goes.

We have to support, as we said, the infrastructure improvements and we'll see how the tone goes in the lines of business as to where we go with hiring.

Great.

Thank you.

We'll go next to Brandon Dobell, Credit Suisse.

Hi, Ray.

I wondered if you could address your thoughts on how the European or the Asian markets would look relative to the U.S.

CDO space?

Just trying to get an idea for the appetite of the different slices and dices of the risk spectrum that investors might have outside this.

And from a structural perspective, do you think there are any major barriers in the near term that might go away or longer term that might make, especially, Europe look a little bit different from the CDO market perspective?

CDO growth -- let me start with the U.S.

The CDO growth that we've seen this year and particularly in the second quarter has been broad-based within the credit derivatives area, and by that I mean it has been the collateralized loan obligations, the resecuritization of asset-backed securities and growth in synthetic CDOs.

In Europe, interestingly, we have seen similar growth in the collateralized loan obligation area.

That has been very strong for us as well.

But we have not seen the growth in the synthetic side of the market in the second quarter.

And that's really the result of two things.

One the tight spreads, but spreads have been tight in both the U.S. and Europe.

So I think the real story there goes to what is driving the synthetic market?

And we are seeing, in Europe, synthetics being built off of underlying corporate obligation.

Where as in the U.S. we've seen more of the synthetic market being built off of or issued off of asset backed securiities where spreads are a bit wider.

So it's a difference between creating synthetic securities out of corporate obligations versus synthetic securities out of asset-backed securities obligations.

That is one difference in Europe.

Over time, I think we'd probably expect to see more convergence between these two markets.

And I would also point out that in both the U.S. and Europe, growth in the CDO sector is also coming from an increase in our monitoring and surveillance fees for our outstanding CDO.

Which is a good news story.

Because the larger that stock of outstanding rated securities becomes, he more we are monitoring and conducting surveillance activities on so there are associated fees with that on an annual basis.

Okay.

As you look at the structured finance segment, with the growth in CDO and CMBS the last couple of years or so, has it changed the mix of transaction versus nontransaction revenues there?

And from a different perspective, frequent issuer versus kind of nonfrequent issuer, trying to get a feel for what the profitability mix has looked like or how that's changed the last couple of years.

Well, both the CDO and commercial real estate businesses, which include some CDOs of commercial real estate continue to be transaction-driven businesses.

As I've said, we are seeing growth and I would expect the growth to continue in surveillance fees, but the majority of the revenue comes from new issuance activity and that is transaction-based fees.

I think it's also probably worth noting that the credit derivatives market is itself a channel through which to push an increasingly broad scope of assets, underlying assets, whether they be corporate loans or asset-backed securities or single name corporate credit risk.

And so the more assets that are being used, becoming acceptable classes of assets for use in CDOs helps grow that market.

So that market is in part reliant on underlying capital market activity and then the acceptance of the different sectors of that capital market activity for use in credit derivative transactions.

Okay, thanks a lot.

We'll go next to Ashley Hatfield, William Blair.

I was wondering if you could just give us an update in terms of the effective tax rate and if we're still looking at about 41% for the remainder of the year?

And then I was wondering if you could also give us an update on the frequent issuer program, and any impact it might have had on the quarter or what you're looking at year-to-date?

Sure, Ashley.

It's Linda.

The second quarter effective tax rate, we've got that on page 3 of the press release, is 40.6, so I think it's a pretty safe bet to look to continue to model 41 going forward.

We have items which bounce around on the margin quarter to quarter and they're very hard to predict, so 41%, I think, would be a safe bet.

Okay.

And I'm sorry, you had a second question, I think, Ashley?

Yes.

In terms of the frequent issuer program, and I know you had discussed it last quarter.

I was just wondering if you could update on any impact the ratable recognition it had in terms of the second quarter, or what you're looking at?

It was a fairly large number, not as large as we had in the first quarter, a midseven figure number.

Okay, great, thank you.

We'll go next to Michael Meltz, Bear Stearns.

Just a couple quick questions for you.

Linda, on the comment on the real estate costs, can you at least quantify for us what's being shifted out of '06 and how that's impacting your guidance?

I also -- maybe I misread this or am making it up, I thought you had already signed a lease at the trade center -- or, I'm sorry, downtown, can you just talk about--.

You're been reading the New York Post, Michael.

The Observer, maybe.

Can you just talk about where you are there and what roughly -- the facility you have now is 300,000 square feet, what you think the proceeds could be from that?

And then I have one follow-up.

Sure.

Let me tackle where we are with that.

It's very difficult to talk about the shift from '06 to '07 because the clock doesn't start on anything until we actually sign a lease and the Board just approved our process yesterday and we're negotiating and we have a letter of intent, which is what you saw in the newspaper of record, the New York Post.

So, in fact, while we do have good intentions, we're not there yet in terms of the lease and we need the actual signing of that to be the accounting event to move forward.

So depending on when that happens, we'll start and we'll give you more details on that.

Basically, we're looking to sell this building and use the proceeds from the sale to fit out the new building.

We'll be looking to move about this time next year, sort of second to third quarter next year over into the new building if everything goes as planned.

Roughly the proceeds from this building, roughly, will fund the fit out of the new building and we may have some carryover over year end, but basically that's how we're looking to do it.

So the margin impact next year, as we said should be modest.

Right.

But I was looking for some quantification.

If you're saying there is some shift this year is that a couple million bucks, is that 20 million bucks, what roughly are those number?

Well, Michael, it's going to be hard for me to tell you because I'm not sure if we're going to sign the lease in a few weeks or longer than that, so it depends on how much time we have to deal with the flow of the project this year.

I can probably give you better details on that as we go into the call for next quarter.

And then implicit in your guidance where you're saying margins are now flattish before options, what does that imply expenses will be up in the second half?

Let me check on that a little bit and we'll come right back to you.

Okay.

One last question.

You gave us the compensation was 70% of expenses in the quarter, what were you accruing incentive at?

The incentive comp as a percentage of total comp is 16% and then compensation expense as a percent of total expense is actually 71% for the second quarter.

And actually, on that real estate question, you didn't -- you said you think the proceeds will fund the move.

Are you not -- you're not ready to give a sense of what those proceeds will be?

We've talked to four different brokers and have gotten a range of answers.

It's a little bit dicey to guess what proceeds will be for the sale of this building.

We're looking to put it on the market relatively soon, if we do get the lease signing, that would be the first step.

And we're relatively optimistic.

And downtown market looks good.

There are a number of uses to which this building could be put, office, residential, hotel with retail.

So we're optimistic, but we don't know quite yet.

I'll be sure to keep my eye on page 6.

We'll go next to James Baker, Neuberger, Berman.

A lot of the questions have been asked, but I still have a few.

I wanted to ask about something that I haven't really heard you talk about much.

Deferred revenue is an item that you're showing on your cash flow statements and it's a stream of revenue that's actually been growing as a source of cash flow.

I think it was around $80 million or so in the last 12 months.

It was up sharply in the first quarter.

Could you talk about what is the origin of that and maybe how much it was in this quarter and why it's growing?

Yes, I can start, Jim, and Linda may want to supplement my comments.

A lot of our deferred revenue comes from the nonratings components of the business.

And this is our research business and the Moody's KMV business.

Those are largely subscription-based businesses and as subscription-based businesses, we are recognizing the revenue over the subscription period.

There are, I think, some other smaller components to that, but those are the primary drivers.

And the growth that we've had, particularly in our research area has been a major contributor to the growth in deferred revenue.

Jim, basically those subscription revenues which are part of the relationship revenues, we sign those up in the first quarter.

So we have to look at how they're going to run over the rest of the year.

So basically as the amount of subscription stock that we sell moves up, that's why the deferral has moved up.

Okay.

Do you happen to know what that figure was for the first six months of '06, the deferred revenue figure?

I know you'll publish it in the Q, but?

I've got 334.9 million.

That's the balance sheet number, do you know the cash flow generated by the increase in deferred revenue?

Yes, we've got 46.4 million.

Do you know how that compares to last year?

This is six months ended 2005 is 33.7, so, you're right, it is up about $13 million.

That's very helpful.

Could you break down the other income between interest income, foreign exchange, and so on, usually give that break down.

Sure.

The gain on FX is $0.5 million, interest income is 4.7, interest expense is 3.8 million, and other expense is 0.7 million totaling nonoperating income of 0.7 million.

And I guess the interest income, it's reasonable to assume will drop off.

I don't know if you could give us a sense of the months in which those shares were repurchased.

You did 9.7 million, my sense is that was fairly front end loaded in the quarter.

Maybe you can give us a sense for that.

Well, you can get some more details on that from looking at the Q. Most of it was a balance of May and June, but we did have some activity in April as well.

Okay.

And then the other thing I wanted to understand, I think you mentioned the KMV profit was about $3 million.

I don't know if you have a more accurate figure on that, because I think it was only about $2.4 last year, which is a smaller gain, but maybe you've rounded.

The staff is showing me that the number is in fact $3.0 million.

Do you happen to know what that would have been before stock option expense before that division?

No, we don't have that in front of us, Jim, I'm sorry.

We'll dig that one up and we can get back to you.

I'll make a guess on that one.

And then the other thing I wanted to understand, if what do you think the actual pretax stock option expense will be for '07?

It seems like this number keeps creeping a little bit higher?

There's a bit of a change this quarter.

We've had to implement 123R, which is obviously highly technical new accounting regulation and it impacts how we basically expense restricted stock, so given that we're doing relatively well and we have to make some assumptions that that number went up just a bit and that's really what that change is about, so nothing particularly exciting going on there.

The MKV stock comp, going back to your previous question, I'm told it was 1.7 million for the quarter.

That explains a lot.

Then do you have sort of an estimate, you mentioned the $0.14 to $10.16 a share, I don't know what tax rate is being applied to the stock comp expense, do you have a expense of the pretax number there?

We're looking at it more in terms of cents per share, Jim, if that's okay.

We're looking at $0.15 to $0.17 per share.

Okay, I guess I can--.

Go backwards with that.

Exactly.

The other thing I wanted to get a handle on, is what do you foresee that stock comp number doing for '07.

Given this is the last year of the phase-in, one might expect sort of a leveling off or a very small increase in that next year.

What is your sense in that right now?

I think that's probably fair.

Some of this is based on how our performance goes, Jim, so it's a little bit difficult to make a prediction on it.

But you're right, this is the last year of our phase-in and I think we would expect all things being equal given the performance that we're expecting, it should be about the same for next year.

Jim, maybe underneath your question and I should try and address explicitly, I don't anticipate at this point any major changes in the utilization rate of stock compensation to outstanding stock.

So I don't think we're going to have any big swings there.

Okay, that's very helpful.

Have you been continuing to buy shares in the month of July or through today since June 30, could you comment on that?

We have our systematic program and of course, opportunistically, we can't buy back because we're blocked out of the market as we were getting ready to present earnings to you.

But we do have our systematic program and we do continue with that.

Is it reasonable to assume, Linda, that you had bought some during the month of July?

As I said, we did buy some during the month of July, but during much of the month, we were not able to do that because of the pending earnings release.

Okay.

That's understandable.

And I think I have one final one and this is maybe just to clarify an answer to an earlier question.

I think I heard Ray say that the deferral of revenue under the new accounting, where you're deferring some of the things that were capped and so on, that was about $6 million, I believe, in the first quarter and did he say it was $7.5 million year-to-date, did I hear that right?

I said it was a mid-seven figure number.

Okay, so more like 5 million this quarter.

Mid seven figures okay?

Okay.

Mid seven figures and less than the first quarter.

Okay, that's fair.

Okay, that's really all I've got.

Okay, thanks, Jim.

We'll move next to William Bird, Citigroup.

Was wondering if you can just touch on emerging markets and whether you're seeing any increased traction in that part of the world?

And also, within structured was just wondering if you could give us some sense of just the stratification of margins in that group given the growing composition of credit derivatives?

Thank you.

With respect to the emerging markets, we have seen good growth coming out of the emerging markets.

It is still a relatively small portion of our overall revenue base, but it is growing at a higher rate than overall corporate revenue.

And that is -- I think the good news story there not only is the growth rate, but that it is spread across all of our rating and research lines.

It's not growth coming out of any single area or any single jurisdiction in the emerging markets.

I don't have the specific numbers in front of me but the growth rates have been good and they have been diversified.

You had a second question also and I apologize, it just -- structured finance margin.

I don't think you should anticipate a change in margin for the structured finance group or certainly any material change in margin for Moody's overall resulting from a change in the mix in the business.

We do have the opportunity to earn some higher fees in the more complex securitization areas such as credit derivatives and commercial real estate.

But those are also more analytically intensative, so we have more expenses associated with that.

I think the overall margin in that business as a result would look broadly similar to the other areas of structured finance.

Thank you.

Our next question is from Edward Atorino, Benchmark Company.

Mine were mostly answered.

On the tax rate, looking ahead to '07, would we plug in a 41% next year just to be safe?

Ed, it's Linda.

I think that's probably a good plan.

Okay.

Thanks very much.

Thank you, Ed.

At this time, we have no further questions.

I'll turn the conference back over to management for any closing remarks.

Okay.

Just want to thank you all for joining us and we look forward to speaking with you at the end of the third quarter.

Thank you.

That does conclude today's conference.

Thank you for your participation.