穆迪 (MCO) 2007 Q1 法說會逐字稿

Good day, and welcome, ladies and gentlemen, to the Moody's Corporation first quarter 2007 earnings conference call.

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

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

I will now turn the conference over to Lisa Westlake, vice president Investor Relations.

Please go ahead.

Thank you, Audra.

Good morning, everyone, and thanks for joining us on this teleconference to discuss Moody's results for the first quarter of 2007.

This is Lisa Westlake, vice president of Investor Relations.

Moody's released its results for the first quarter of 2007 this morning and the earnings release is available on our website at IR.Moodys.com.

Ray McDaniel, chairman and chief executive officer of Moody's Corporation will lead this morning's conference call.

Also on the call this morning is Linda Huber, she is financial officer of Moody's Corporation.

Before we get started, I 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 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, 2006, 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 members of the media might be on the call this morning in a listen-only mode.

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

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

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

Linda will then take you through the quarter's operating highlights, provide some commentary on revenue and expenses, update you on our share repurchase program, and review several investments we made in the first quarter.

I will then discuss developments in the regulatory area and finish with Moody's outlook for 2007.

After that, we will be happy to respond to your questions.

Moody's reported strong results for the first quarter of 2007.

Revenue rose to $583 million and was 32% higher than in the first quarter of 2006.

All major business units in geographic regions delivered double-digit percent revenue growth led by strong gains in both structured finance and corporate finance ratings.

Operating income in the first quarter was $305 million, 28% higher than the first quarter of last year.

Foreign currency translation positively affected revenue and operating income growth, increasing each by approximately 200 basis points.

Diluted earnings per share of $0.62 for the quarter were 27% higher year-over-year.

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 $379 million in the first quarter, up 36% year-over-year.

At Moody's investor service, U.S.

ratings revenue rose 39% year-over-year.

U.S.

corporate finance was the largest contributor to growth on a percentage basis, with revenue increasing 52% compared with the prior year period.

U.S.

corporate finance benefited from significant growth in revenue related to syndicated bank loans and high yield bonds.

U.S.

structured finance was the largest contributor to revenue growth on a dollar basis, increasing $55 million, or 45% versus the first quarter of 2006.

Strong results from rating commercial mortgage-backed securities and exceptional growth from rating credit derivatives ratings were the primary drivers of U.S.

structured finance performance in the quarter.

U.S.

financial institutions ratings revenue rose 13% compared with the prior year period, due to strong issuance by insurance companies and good growth in the finance and securities sectors, somewhat offset by weaker issuance in the real estate sector.

U.S.

public finance revenue increased 15% compared with the first quarter of 2006, reflecting higher-than-expected refundings and strong new money issuance fueled by an unanticipated increase in issuance by state and local government.

Finally, U.S.

research revenue rose 22% from the prior year period, including strong revenue growth from new data and analytic products.

Turning now to our international operations, Moody's total international revenue of $204 million in the first quarter was 27% higher than in the prior year period and included approximately 590 basis points of positive impact from foreign currency.

The very strong performance of the U.S.

business meant that international revenue accounted for 35% of Moody's total in the quarter, compared with 37% in the prior year period.

Focusing first on Moody's investor service, international revenue increased 29% year-over-year.

International structured finance ratings revenue was 43% higher than in the prior year period, benefiting from broad based growth across all asset classes, particularly from credit derivatives and residential mortgage back securities ratings.

International financial institutions revenue rose 19%, reflecting solid growth in the European banking and insurance sectors, due to strong issuance, as well as good growth in new ratings relationships, offset by a modest decline in revenue from rating local government debt.

International corporate finance revenue also grew 19%, primarily due to increases in non-issuance-related fees.

Turning now to Moody's KMV, on a global basis, the business generated $36 million of revenue, up 10% compared to the first quarter of 2006.

Revenue from risk product subscriptions grew 13% and revenue from professional services grew 20%.

Revenue from licensing of credit processing software and the related software maintenance fees was essentially flat versus the prior year period.

Operating profit at Moody's KMV increased 12%.

Moving on to operating expenses, Moody's operating expense for the quarter totaled $278 million and was 38% higher than in the prior year period.

As anticipated, expenses grew at a faster pace than revenue, largely due to higher personnel costs, including bonus accruals associated with the above-planned revenue performance, incremental technology investments and additional lease expense, primarily related to Moody's headquarters move later this year.

The quarter's operating margin was 52.3%, 180 basis points lower than the same period last year, and 30 basis points below our full year guidance of down 150 basis points.

However, absent certain non-compensation expenses, including real estate expense associated with our headquarters move, operating margin would have been only approximately 30 basis points lower than the first quarter of 2006.

I'll 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, by making selective acquisitions in related businesses, by repurchasing our stock and by paying a modest dividend.

During the first quarter of 2007, Moody's repurchased 6.8 million shares at a total cost of $443 million and issued 2.2 million shares under employee stock compensation plans.

First quarter share repurchases were funded using a combination of excess free cash and $80 million financed by Moody's revolving credit facility.

Moody's made several investments during the first quarter that I would like to review briefly.

In March, we entered into an agreement to purchase South Africa-based CA-Ratings, and on Monday of this week we closed the transaction.

CA-Ratings, established in 1993, is the larger of two domestic credit rating agencies in South Africa and is the market leader in municipal ratings.

The agency also provides credit rating services in the structured finance, financial institutions and corporate finance markets.

The firm will now become part of Moody's investor service South Africa, which provides domestic market ratings in South Africa and globally comparable ratings for cross-border financing.

Earlier this month we celebrated the official opening of Moody's new office in Dubai.

Middle Eastern market participants are increasingly turning to the global capital markets to serve their financing needs, and Moody's Dubai office will further enable us to address the growing demand for in-depth, locally comparable credit analysis and ratings, as well as to ensure high quality service to Middle Eastern issuers and investors.

On April 13, Icra Limited, our affiliate in India, successfully completed an initial public offering on the Bombay stock exchange.

Moody's is Icra's largest shareholder, with current ownership stake of just under 29%.

We also have an outsourcing arrangement with the firm.

Established in 1991, Icra is one of the primary credit rating agencies in India.

In January we acquired 99% of PT Kasnic Credit Rating Indonesia, which is the second largest rating agency in Indonesia.

The firm will operate as Moody's Indonesia based in Jakarta.

We continue to see good long-term growth opportunities in a number of developing markets around the world, including southeast Asia.

Moody's Indonesia will allow us to provide enhanced customer service to both domestic and cross-border Indonesian issuers, and to offer high quality credit ratings, research, analysis and training to local market investors.

Before I turn the call back over to Ray, I would like to mention that Moody's will hold its second annual Investor Day on Tuesday, June 5, in New York City.

Hold the date notifications were sent out earlier in the month.

If you didn't receive one and you would like to attend, please contact Lisa Westlake at the e-mail address listed at the top of Moody's first quarter earnings release.

The event will be webcast for anyone who cannot attend in person.

Details will be posted next month on our website at IR.Moodys.com.

With that, I'll turn the call back to Ray.

Thanks, Linda.

Before I turn to our full year outlook, I'll briefly summarize a few regulatory developments.

In the U.S., Moody's has provided the Securities and Exchange Commission with comments on its proposed rules related to registration and oversight of nationally recognized statistical rating organizations, or NRSROs, which were published in early February.

We have been working constructively with the SEC commissioners and staff, as the commission completes its rule-making process.

We expect that the final rules will be effective by the end of June, consistent with the timeframe provided in the Credit Rating Agency Reform Act of 2006.

A copy of Moody's comments to the SEC is available on our website at www.Moodys.com, by clicking on regulatory affairs at the bottom of our home page.

Separately, as you're undoubtably aware, developments in the subprime mortgage market have received attention in Washington.

Over the past few weeks, Congress has held hearings on the subprime mortgage market, and on April 17, Moody's participated as a witness at a hearing conducted by the Senate banking committee's subcommittee on securities, insurance and investment.

At the hearing we explained the role of rating agencies in the residential mortgage securitization process.

Internationally, IOSCO, the International Organization of Securities Commissions, recently issued a press release summarizing topics discussed at its annual meeting.

In the release IOSCO indicated that it plans to initiate a review of rating agency's role in the development of structured finance products, including how rating agencies manage potential conflicts of interest in the structured finance rating process.

We look forward to working constructively with IOSCO as it pursues this review.

I'll conclude this morning's prepared remarks by discussing Moody's outlook for 2007.

Moody's outlook for 2007 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's 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.

For Moody's overall we project low-teens percent revenue growth for the full year of 2007.

This growth assumes foreign currency translation in 2007 at current exchange rates.

We continue to expect the full-year operating margin, excluding the one-time gain on the sale of Moody's 99 Church Street building from our 2006 results, to decline by approximately 150 basis points in 2007 compared with 2006.

This reflects investments to sustain business growth including, international expansion, improving our analytical processes, pursuing ratings transparency and compliance initiatives, introducing new products, improving our technology infrastructure, and relocating Moody's headquarters in New York City.

We expect our quarterly spending pattern to differ from previous years, which could result in quarterly operating margins that differ materially from our full year expectations.

On a GAAP basis, diluted earnings per share in 2007 are still projected to be modestly lower compared to 2006.

However, excluding the one-time gain on the building sale from 2006 results, we continue to project low double-digit percent growth in 2007 diluted earnings per share.

In the U.S., we still project low double-digit percent revenue growth for the Moody's investor service ratings and research business for the full year of 2007.

In the U.S.

structured finance business, we now expect revenue for the year to rise in the high single-digit percent range, including solid double-digit year-over-year percent growth in revenue from credit derivatives and commercial mortgage-backed securities ratings, partially offset by a decline in rating from residential mortgage back securities ratings, including home equity securitization, in the low-teens percent range, which is a greater decline than the mid-single digit percent decline originally forecast.

In the U.S.

corporate finance business, we now expect revenue growth in the mid-20s percent range for the year, up from our previous expectation of low double-digit percent growth, largely due to a higher volume of leverage transactions than previously anticipated.

In the U.S.

financial institution sector, we continue to expect revenue to grow in the low-teens percent range.

For the U.S.

public finance sector, we continue to forecast revenue for 2007 to grow only modestly, despite better performance in the first quarter due to a softening of issuance in certain sectors, including healthcare, higher education and infrastructure.

We continue to expect growth in the U.S.

research business to be about 20%.

Outside the U.S., we still expect ratings revenue to grow in the high-teens percent range with high teens percent growth across all major ratings business lines, led by corporate finance revenue growth in Europe and Asia, financial institutions growth in Europe, and growth in international structured finance.

We also now project growth in the low-20s percent range for international research revenue.

For Moody's KMV globally, we continue to expect growth in sales and revenue from credit risk assessment subscription products, credit decision processing software, and professional services.

This should result in low-double-digit percent growth in revenue and greater growth in profitability.

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

Thank you.

(OPERATOR INSTRUCTIONS)

We'll go first to Karl Choi at Merrill Lynch.

Hi, a couple questions.

One, Ray, I wonder if you can break down the performance within structured finance globally a little bit more in detail into the different categories.

The global structured finance business, Karl, for the first quarter, we had double-digit growth in all of our major business lines, except for our ABS term business, which grew in at high-single-digit percent rate.

It was led by derivatives which had very strong growth, both in the United States and in Europe, and we also had very strong growth in commercial mortgage-backed securities in the U.S.

and Europe and residential mortgage-backed securities, particularly in Europe.

Okay.

And within corporate finance, do you mind breaking down into the components of bank loans versus high yield versus investment grade?

Sure.

The largest growth we saw was in the syndicated bank loan area.

That growth was over 100% year-on-year, and that really drove the overall high yield sector of the business.

So high yield, including bank loans, was really the sole contributor to growth in the corporate finance area.

We had very modest growth coming from transaction-based issuance in the investment grade sector.

Do you have the percentage of revenues from the different categories for the quarter within corporate finance?

I can do that, Ray, if you want.

Sure, yes.

I think Linda has the numbers.

Karl, for Q1 2007, percentage of global corporate finance revenues high yield was 18%; investment grade was 15%.

Bank credit facilities, which includes the bank loans that Ray was speaking of, is 26%.

And other accounts, which include medium term notes, shelves, commercial paper, et cetera, is 41%, to total 100.

Great.

And there has been some sort of observations, and I think [inaudible] talked about it yesterday as well, regarding some deals, especially within the structured finance area, being pushed into the first quarter.

Just wonder if that's what you saw and if there's a way to sort of quantify the impact, and related question on the pipeline in the corporate finance area.

Okay.

Let me start with the corporate finance pipeline.

That remains robust, again, particularly in the high yield sector.

So we continue to see strength related to M&A activity and LBO activity.

So the pipeline looks good there early in the second quarter.

With respect to the acceleration of structured finance transactions in the first quarter, I think we do believe we saw that in the CDO market as warehouse facilities were being cleared out.

And so business that we normally would have expected perhaps to be spread over the first and second quarters, some of that business did go into the first quarter, and I think it's certainly fair to say we don't expect to see growth rates in the CDO market for the rest of the year at the levels that we saw in the first quarter of this year.

That being said, there are some important differences of opinion about what the outlook will be for the CDO market as we've spoken to market participants.

The more bearish view is that as the warehouses have been reduced, that is going to have an impact on overall CDO issuance going forward that is more material.

The more bullish view is that with the warehouses having reduced their stocks and with some stability returning to the market, there will be an ability to increase warehouse stocks, again, going forward, and that that will support CDO issuance for the second half of the year.

At this point, I think it's just too early to tell how much of the warehouse facilities that have been reduced in the first quarter are going to be replenished.

And the more difficult issue in the CDO area, which we always have, is looking at the component of CDOs that represent new assets or new structures, which have not been prominent previously and how much they are going to fill in for any gap that might occur, for example, from a reduction in CDO-related, or housing-related CDOs.

Last question, then.

Behind your full year outlook, what are you assuming for CDO?

Are you taking a more bearish view or taking a more bullish view in your outlook?

Well, I think we're somewhere in between, but we are -- it is early in the year, so I think it's fair to say we are being cautious.

That being said, the current pipeline in the CDO business is good.

And the pipeline, unfortunately, really provides only a good view for the relatively near-term, and we would not expect to see pipeline activity yet for the second half of the year.

Great, thank you.

We'll go next to Fred Searby at J.P.

Morgan.

Thank you.

Hello, everybody.

Just following up on the CDO question and the pipeline question.

Obviously, your objection for the second half, like everyone else, is subject to a lot of vagaries, but the near-term outlook in terms of CDO issuance.

McGraw Hill said 60% CDO issuance, which is clearly deceleration but still a great number, looking into the second quarter.

Can you give us some sense of what your thoughts are, where you have more visibility for CDO issuance for the second quarter, what your forecast is?

And then secondly, I assume, are you still differentiate somewhat between international and domestic, where obviously the housing-related RNBS is probably having more vivid impact in contrast to the international strength we're still seeing.

And then secondly, can you give us some sense -- I mean, obviously you had a tremendous quarter from revenue perspective and costs went up a lot, but historically you've given us stock option expense and it sounds like bonus accruals are up a lot.

And kind of giving us, Linda, some breakout of how much was the lease for bonus accruals in personnel and how that should trend throughout the year in stock option?

Thanks.

Sure.

Let me talk to the CDO component.

We still expect to see double-digit growth year-on-year in CDOs for the second quarter.

In particular, although the housing market and the availability of housing product for contribution in CDOs will be constrained for at least for the subprime product, we continue to see a lot of strength coming out of the CLO market And that's a result of, in part, the high-yield activity that we're seeing in the corporate finance area, particularly the bank loan activity.

And we also are seeing CDO transactions backed by housing product that is related to alt A and non-subprime assets, and so we think that that's going provide some support in the second quarter.

As far as the U.S.

versus international breakout, I think we probably still expect to see greater growth in the U.S.

in Q2 than we do internationally.

Linda, do you want --

Ray, not to pin you down, but the 60% that McGraw Hill talked about.

I mean, your double-digit growth is nice but can you give us some more just specific, I mean around what your thoughts are in the second quarter heading in, whether as you see it right now in your pipeline of business, whether that's a reasonable number for the second quarter?

I don't think we're going to see 60% growth in CDOs in the second quarter, and by saying I don't think we're going to see that, I mean I think it will be lower, not higher.

And by what dimension or by what --

Well, I think that's as much as I can reasonably give you at this point without just being completely speculative.

Fred, let me try to see if we can give you a bit more specificity here on our comp expenses.

You're right, comp expenses were up, but we want to absolutely frame that from the backdrop of having a pretty terrific quarter here, so we have to accrue compensation in line with the revenue growth.

Last year, our total compensation expense for the quarter was $141.8 million and this year it's $196.8, and that is a 20% increase.

And the main reason for that -- you're asking about stock-based compensation -- this year stock compensation is, for the first quarter, $21.2 million, up from $13.8 last year.

Now, the reason for that is a couple of things.

First of all, we do the stock-based compensation, including our option compensation, based on Black-Scholes valuation, and as our stock price has gone up, that has increased.

Also, quarter-over-quarter, we're looking at about a 14% head count increase, excluding Moody's Wall Street Analytics year-over-year.

So the compensation expense here is driven, again, by the strong quarter and the accruals that we've made.

Now, how that will trend for the rest of the year depends on how we do, but obviously that's a big compensation number that we've put up for this quarter.

So suffice it to say if we slow down, that rate of compensation accrual of course would commensurately slow down.

So it's a high point basically, in essence, for--

Yes.

Okay.

Unless we have --

We hope not!

Yes, we hope not.

I think it would be fair to say if -- we are usually asked the question, if everything unfortunately becomes worse, how much comp flexibility do we have?

I think our answer to that would be at least $20 million on the bonus line and, again, when we have great revenue we have to put up larger compensation expense.

Just the way it works.

Okay.

We're happy about the great revenue.

Thank you.

Sure.

Thank you, Fred.

We'll move next to Michael Meltz at Bear Stearns.

Thank you.

Two follow-ups on Fred's questions there.

Linda, your point on expenses, did you say, what were you actually accruing bonuses at, the percentage in the quarter?

Hang on just a second, Michael.

I think we can find that.

Do you have another one for us?

Yes, and then the CDO question another way.

Implicit in your guidance for the rest of the year, in U.S.

structured, Ray, I understand what you're saying, less than 60%.

In the back half of the year, though, is your guidance assuming CDO revenue growth in second half?

It is assuming CDO revenue growth in the second half, but, again, decelerating Q1 to Q2 and then Q2 to the second half of the year.

So we expect growth, but decelerating growth for the global CDO business.

I was actually referring to U.S.

specifically.

Yes, we would -- I think for the second half of the year, we would expect it to be essentially flat.

Okay.

And then, Linda, one other question for you.

You made a comment at the beginning about non -- I missed what you said but it was, essentially, you took out the real estate costs.

Can you repeat what you said there?

I guess you were isolating the impact on the quarter.

Let me go back to your question on the components of comp expense if that's okay, Michael.

I think what we wanted to say for this quarter, we wanted to -- it's probably best to say that incentive compensation is 20% of total compensation, and comp expenses as a percent of total expenses is 71% versus the 70 at this point last year.

The incentive compensation piece is $38.4 million for the first quarter of this year.

That's up over -- as compared to $19.3 million for the first quarter of last year.

So hope that helps you to dimensionalize what's going on with comp.

If you have further questions on this, I think maybe next week after we release the Q, Mike, we would probably have a more fulsome discussion.

And I think what we're trying to say is that if you had taken out certain costs that were related to compensation and also the move, our margins come down 37 basis points without those quarter-over-quarter.

In other words, we're down that much for the first quarter of this year.

So we can also give you some more detail on that, but basically what we're trying to do is correct for the real estate costs and the comp expenses.

Okay, but --

I'm sorry.

I actually misspoke.

It's 30 basis points.

I apologize.

I guess this isn't that important, but I don't really understand.

Why would I be taking out compensation costs?

I understand why I want to look at the real estate number.

Can you just elaborate a little bit the point of that metric?

Yes, let me -- I'm sorry.

We may have a little bit of confusion here.

The comment that we made with respect to a 30-basis point move does relate to non-compensation expense.

Linda was previously, I think, trying to explain the compensation component, but that's not part of the 30 basis point analysis that we gave you.

Okay.

I'm sorry, Mike.

I was trying to answer your two different questions and I didn't mean to link them.

That's okay.

Thank you for your time.

Next we'll move to William Bird at Citigroup.

Yes, I was wondering if you could just elaborate a little bit more on how the pipeline looks in high yield in syndicated bank loans, and also just what your expected pattern of investment spending is this year.

Thank you.

Okay.

With respect to the high yield, again, right now it's robust and we expect activity to remain strong in the second quarter.

We do expect it to tail off in the second half of the year, but not by as much as we were originally forecasting back in February.

So we are expecting more strength throughout the year in the corporate sector, particularly in the U.S., than we had been expecting previously.

And that's really what informed the upgrade in our outlook for the global corporate finance business.

And commenting on your question, what we expect for investment spend for the rest of the year, what we're shooting toward is to move into our new building by the September timeframe.

So by the second and third quarter, we hope that we are completed with most of those expenses.

I think we're looking to keep our levels relatively flat at this point, but we're very cautious, of course, about what's happening with the margin.

As you note, we are looking to guide the margin down 150 basis points this year to 52.4% for a total of 2007.

So we will watch our expenses in investment spending carefully going through the rest of the year.

And it generally tends to be a little heavier in the fourth quarter.

Hope that's helpful.

Yes.

Thank you.

Also, by the way, I was wondering if you could call out what the redundant lease number was this quarter and what you expect it to be in the coming quarters.

Sure.

It's not particularly material.

It's $3 million per quarter for the redundant costs of occupying both 99 Church and also 7 World Trade Center.

Thank you.

We'll go next to Steven Barlow at Prudential.

Thanks.

Based on, Linda, what you just said about the lease things and your margin with the investment spending, I'm just trying to figure out how we should look at the margin in the fourth quarter when you talk about all this Sawtooth action happening in the year.

Should the fourth quarter be traditionally about the lowest margin of the year with all the noise taken out?

Actually, Steve, I think our fourth quarter is traditionally stronger, if you look at that, because generally we have better revenue performance in the fourth quarter if we hold true to our pattern.

A little bit tough at this point, I think, to project where we are going to go with the fourth quarter.

We would see some benefit as we move into the new building, but as we said, we don't think that's going to be particularly material with the rolloff.

So think it's probably worth looking at the trends from the previous years and we'll talk to you some more about where we see the fourth quarter going as we get closer to it.

And I would just add to Linda's comment that, to the extent that our outlook is accurate, with the strong first quarter and the compensation, the incentive compensations accrual that we had in the first quarter, that should weight the accruals for this year into Q1, as opposed to a number of our previous years where it was weighted more heavily into Q4.

Fair enough.

And then on the Indian IPO, with your operation there, is there any particular gain or loss or something we should be looking at in the financial statements?

No.

There would not be, not with our 29% stake.

So, in theory, the value of that has gone up based on how the Indian market stock performs.

But it's just a market to market thing that we would do it sort of a hidden asset.

We are holding an investment that is much more valuable than what we paid for it, but that's the extent of it.

That's not going to flow through to the operating numbers.

And what is the amount of that change?

To tell you the truth, I don't have that off the top of my head.

We've made a number of investments, incremental investments in that business going back to the late '90s, with our initial investment for a 10% stake being very modest, and we've been buying up to the current 20% stake.

So it has increased very materially, but I just don't have the number for you.

That's fair.

And are there any parts of the world that you still need to make investments in that you think are growing and you don't have a presence yet?

I know you are doing quite a bit in China right now.

In terms of planting more flags, I think we feel that we are pretty well positioned around the world at this point.

We may find some additional opportunities, particularly in Southeast Asia, but I think more of the investment at this point is going to be going into increasing our personnel and, as a result, our real estate in the locations that we're already at.

The nice thing about that is we can match that investment to the growth of the markets and the growth our revenues in those markets.

So I think a lot of the prepositioning has been taken care of at this point.

Thanks very much.

We'll take our next question from Lisa Monaco at Morgan Stanley.

Hi.

I was wondering if you could quantify what percent, percentage of the structured finance segment was derived from derivatives.

And then, Ray, if you could just elaborate on international.

I'm surprised that the growth -- I think you said outside the U.S.

ratings revenue will be up high teens -- I'm surprised that's not a little higher.

Could you elaborate on that?

I'm sorry.

I missed the second part of your question, Lisa.

I apologize.

International revenue growth.

The ratings revenue growth guidance, you gave us high teens for the year.

Correct.

I'm surprised it's not higher.

If you could just drill down on that.

Okay, sure.

Let me take the second component of that first.

We do expect to have, as I mentioned in our prepared comments, high teens growth in all of our ratings businesses internationally.

That is, again, assuming that we are not going to see the same pace of growth in either structured finance or corporate finance in particular, that we saw in the first quarter of the year.

I hope that that proves to be a cautious estimate, but we just don't have a lot of visibility at this point around the pipeline for our European business and structured finance in the second half of the year.

And, again, we are not expecting that the growth in certain areas of corporate finance will keep pace with what they did in the first quarter either.

So we will have to see.

There's not a tremendous amount of visibility around this in terms of being able to look at an existing pipeline going into half two.

And then the percentage of structured finance revenues that were derived from derivatives in the quarter?

Sure.

The derivatives business -- I'm sorry, give me one second.

The derivatives component of the U.S.

structured finance business was about 42% in the first quarter.

Do you have it for international?

For international, it was -- give me just a second.

It was about -- it was about 35%.

And just following up on that, what percentage of U.S.

structured finance -- what percentage of structured finance was derived from the U.S.

in the quarter?

What percent?

Well, structured finance was about 47% of our total Moody's U.S.

business in the first quarter.

Okay.

Thanks.

And then two follow-ups.

I'm not sure if you commented on what the pipeline for ABS specifically was looking like.

And then lastly, can you just elaborate on IOSCO and why they are revisiting the credit rating market?

Thanks.

Sure.

On the ABS side, right now we see the pipeline being modestly higher for the credit card and student lone sector than it was this time last year.

The weak part of the ABS sector has been the vehicle sector and that looks like it's going to continue to be a bit weak.

So it's not materially different when you look at ABS as a whole, but the strength is coming from credit cards and student loans and weakness is coming from the vehicle sector.

With respect to IOSCO, I think this is -- I think the IOSCO study is related to interests about how the structured finance business operates.

I think those interests particularly are coming from authorities in continental Europe as they try to understand the dynamics of this business.

And I believe that the working group that is going to be looking at this is headed up by Commissioner Roel Campos from the U.S.

SEC, which I think is a positive signal because the SEC is reasonably sophisticated in thinking about our business and our markets.

Great.

Thank you.

Next we'll move to Megan Talbot at Lehman Brothers.

Hi, there.

Couple of questions.

First, it looks like your outlook in the back half of the year, admittedly, you don't know a lot yet, but it's for generally slowing growth markets.

So just wondering from a broader perspective, does this change your thoughts around increasing your hiring in certain areas now that the growth is slowing?

And maybe you could provide a little bit more detail around where the head count growth is coming from.

Sure.

I think to the extent that our revenue outlook, again, proves to be accurate, the hiring that we would plan to do is consistent with the 150-basis point decline in margin.

We did expect to have slowing growth later in the year at the beginning of this year when we were doing our budgeting, and so we have been more aggressive in hiring early in the year to accommodate issuance volumes in Q1 and what we expect will continue somewhat into Q2.

And so that should mean that our hiring profile, at least compared to previous years, would be more weighted toward the first quarter and the first half of the year.

And, of course, if we prove to be wrong one way or the other, we are going to react to that in terms of our hiring.

Okay, great.

And a couple of quick questions.

For the ABS, I think you gave a high single-digit growth number for the first quarter.

Was that U.S.-specific or global?

The ABS business grew at a high single-digit rate globally.

It was low single digits in the U.S.

alone.

And that's term ABS.

That does not include asset-backed commercial paper.

The asset-backed commercial paper did grow at a double-digit rate, low double-digit rate in the U.S.

in the first quarter.

Okay, thanks.

And finally, Linda, you mentioned that you used your revolver to buy back shares during the quarter.

Any thoughts on doing that moving forward?

Our capacity is $500 million on the revolver total, and we do have good overall available repurchase authority, as you know.

So we'll watch the stock price and see what happens, and it depends on market conditions and depends on the price.

Great.

Thanks a lot.

We'll go next to John Neff at William Blair.

Hi.

And I'm sorry to beat up on this point.

I just want to make sure I'm completely clear.

The 30-basis point adjusted decline in operating margin year-over-year, does that take into effect only the increase in real estate expenses?

No, it's got a couple other pieces to it, including some system things and a couple of other things that we did, and maybe we can probably best catch up with you on that after the call.

Okay, great.

And then just if we can get a little bit more color on your current thoughts on the subprime mortgage market fallout.

I think I saw something to the effect that you recently increased your thoughts as to what the possible loss expectancy might be in that sector, but I just want to get your feeling on current thoughts on how contained you think it is relative to prior expectations.

Sure.

You're correct.

We did put out, in our monthly update piece, some revised estimates for cumulative losses in the subprime sector with particular focus on the 2006 vintage.

The most recent information we put out I think guides to 6 to 8% cumulative losses for the loans and the subprime sector, as opposed to our original estimate of 5 to 6%.

So we have increased our expectations for loss as that market has deteriorated.

I would just add, though, that the coverage levels available for subprime securitizations, particularly the A and above, remain multiples above our cumulative loss expectations.

So, for example, for single A tranches, we would expect to see protection in the mid-teens range, for AA tranches up near 20%, and AAA up near 30% to high 20s.

So there is deterioration in that market.

The 2006 vintage is performing more poorly than the other vintages, but the coverage levels, the credit enhancement levels, as represented by excess collateral, are very robust for this area.

Great.

Thank you.

Next we'll go to Brandon Dobell at Credit Suisse.

Thanks.

A couple of quick ones.

Just so I have the impact of foreign exchange straight, how do you-- how is guidance embedding that?

Is it now based on current spot rates or still based on what you guys had used when you started the year for guidance?

Yes, I think we are incorporating current spot rates, Brandon, but we're assuming that those hold for the rest of the year, in the absence of better information.

Okay.

And then in terms of the CDO segment, is it fair to assume that I think about 20% of those volumes are CLO's?

Is that about right?

I don't have that number in front of me, Brandon.

As an order of magnitude, I think that's probably correct.

Okay.

And then over in the corporate finance segment, maybe if you could give a little color around who the -- not just customer concentration, but type of customers and how that breaks out, and if those customers are typically on some sort of frequent issuer or a transaction-based model.

Just trying to gauge the potential impact for strong growth relative to frequent issuer caps and things like that.

It's a good question.

The frequent issuer pricing program and the caps associated with that are largely associated with our investment grade issuers.

So when we move into the high yield sector, whether it's bonds or loans, we are looking at per-issue transaction fees and largely an absence of frequent issuer pricing agreements.

Okay.

Brandon, to give you specifics, for corporate finance we're looking at about 70% transaction and 30% relationship breakdown in revenues for this quarter, Q1 2007.

Okay.

If that helps you.

That's perfect.

Thank you.

Then finally, again within CDOs, the resecuritization component of the CDO, is it the same customers you would find in other parts of the CDO world, or is there specific type of customer you see there?

I'm just trying to understand that part of the CDOs better.

Well, when you say "customer," are you talking about the sponsors of the CDOs?

Yes.

Yes, those would largely be-- well, it's going to be a mix of sponsors, but it certainly includes investors in the underlying assets.

But is more heavily weighted towards investors that are looking to buy in the secondary market with a specific view to resecuritization, and that includes a broad range of financial institutions and alternative investment vehicles.

Great.

Thanks a lot.

(OPERATOR INSTRUCTIONS) We'll go next to Jim Bakker at Neuberger Berman.

Yes, good afternoon.

I had a few questions.

One, I wanted to know, historically your stock-based comp has been very, very low in the first quarter compared-- much less than 25% of the year.

Is that, although I note the number you talked about, Linda, is very similar to the numbers you've had for stock-based comp in the past three quarters before this one.

So are we leveling off at this kind of 21, 22 level for the rest of the year, or make this jump again in the second quarter and be much higher at least in the remaining quarters of the year?

Jim, we would hope that it would level off.

The question is how the more recent years come on per Black-Scholes valuation calculations and so on.

So we would think that it would probably level off somewhere around here, but we can't say exactly until we do each quarter's calculation.

Okay, and I think you mentioned it was somewhat contingent on the stock price, obviously, as that goes up, that expense.

But, really, the stock price has not gone up much in the last year, for the first time in a long time.

So that's why I would surmise, assuming it doesn't-- if it stayed around this level, presumably the stock-based comp would level off.

Would you agree with that?

That's right.

And our utilization has also remained quite constant.

So, yes, that's correct.

Okay.

I also wanted to know -- I have a couple of my usual questions on the breakout of segment profits between KMV and Moody's ratings and research.

I wonder if you have that.

Okay, we have that and we also have components of other income if you want that.

Perfect.

Yes, absolutely.

Okay.

Since I've got my book there, I'll give you that one first.

Okay.

For the quarter, interest income was $5.4 million, interest expense was $7.5 million.

Net income from equity investments was negative $100,000, minority interest negative $1.1 million, for a total of negative $3.3 million on other income, which is in fact expense.

There's no forex impact there?

We've got that separately, but, yes, it all nets to zero.

Okay.

On the forex line.

And KMV, the operating income for KMV for the first quarter was $3.7 million.

Okay, that's great.

And then I also wanted to know if you could tell us what the increase in deferred revenue is in this quarter.

I know you've changed your accounting a little bit, starting the first quarter of last year.

And for example, when you publish your first quarter cash flow statement, it will show an increase in deferred revenue as a component of working capital.

I wonder if you just happen to know what that is.

Well, we probably will, but we'll talk to you about that next week when the Q is out I think on Wednesday, next Wednesday.

Okay, fair enough.

The other thing, I just noticed in your discussion of compensation expense you talked about, you broke out the incentive comp element and you sort of indicated the comp expense is up around 38.4% in total, but would have been up 29.3%, even without the additional, the incremental accrual for incentive comp.

So the 29.3 strikes me as very high.

I know the revenue is up 32, but those aren't always directly related.

One might have expected a little more operating leverage on that metric ex the incentive comp.

So I'm just wondering if you could-- was there, in your mind, a lot of extra hiring and stuff that really had nothing to do with the amount of revenue simply because the thought process was just to front-load that this year?

No.

I think what we probably should do is talk to you a bit about this offline.

But I think to sort of review what I had said, head count's up 14% year-over-year, first quarter versus first quarter last year, without Moody's Wall Street Analytics.

Okay.

The percentage of our incentive comp as a percentage of total comp is 20%.

And then going to the absolute numbers, which is where I think you might have misheard me, the absolute dollar numbers for incentive compensation is $38.4 million.

That's a dollar number, not a percentage number, versus last year's $19.3 million, which is, again, the absolute number.

It might be best if we just run through this afterward offline.

Okay.

All I had done with it was subtract those two numbers from the total number you gave for comp expense.

Right.

And so I got an expense of 158.4 versus 122.5 which would be a 29.3% increase.

That just struck me as a very large number, apart from incentive comp.

I'm just wondering if you can comment on that.

I think Linda has another comment to make, but I want to add into the thinking here, Jim, that what we've got in the first quarter is, a large part of it is the annualization of hiring we did in Q2 through Q4 last year.

I see.

That's a good point.

That's an excellent point, Ray.

I guess the other question, and this is my last one I promise, is just that in terms of your business model, sort of what are you trying to do longer-term in terms of your operating margin?

I notice, for example, your first quarter '07 operating margin is a good 440 basis points below what it was two years ago, even if you exclude the effect of stock option expensing, which has had a big impact.

It would be down more like 280 basis points or something like that since first quarter of '05.

So I guess my thinking is, do you sort of see this as a trough level, and if you look at calendar '07, as a trough level for operating margin in terms of your goals for the next few years?

Because we are seeing really just the opposite happening at your major competitor, Standard & Poor's, with their financial services segment actually achieving excellent incremental margins and a steady rise in operating margins You're going the opposite direction.

I think some of your investors would be disappointed if you don't turn that around at some point.

Right, Jim, I think we hear you on that.

We would point out that our competitor still has a long way to go to get anywhere near the margins that we have.

It's very important that we are able to invest in a fast-growing business with a 32% revenue increase this quarter over last quarter.

It does take some investment to feed that kind of growth.

And we have guided margin down 150 basis points this year to, we're shooting for around 52.4%.

We've explained what we're doing; we're catching up on head count.

And we'll watch very carefully as to where our revenue growth goes as to what we do with our hiring for the rest of the year.

We watch the margin very carefully.

What we said about the extended outlook is we're going to stabilize at 50% or above, and we will be very careful to tell you where we're going with the margin.

But again, we've had some years of extraordinary revenue growth.

We're catching up on some of our hot areas.

We're moving our headquarters, and we're making appropriate investments for the international business.

One can't support 32% top line growth without appropriate investment, and that's what we're trying to do.

And maybe Ray has some further thoughts on that.

Yes, the main point I would just want to underscore is that our guidance with respect to long-term margins of 50-plus percent is something that we have been talking about for several years now.

We knew that with the revenue surprises we had in previous years and the way we approached some of the larger components of expense, particularly personnel, that we had a lag effect built in.

And we have tried to communicate that as clearly as we can, but that being said, if you're looking for the trough, our guidance is still 50-plus percent as a trough.

Thank you.

And we'll take a follow-up from Lisa Monaco of Morgan Stanley.

Hi.

Just quickly, Ray, I'm wondering if you could comment on your competitive position in the marketplace.

It looks like S&P, while we don't know the exact revenue performance for their credit ratings business, but it looks like it underperformed your performance in the quarter.

Is that market share shift, or could that be just a composition of revenues which is more geared towards relationship-based revenue?

Thanks.

I think it's probably both.

We do continue to believe that our overweighting of transaction-based revenue is the right way for us to think about pricing and fee structures in the business, as long as our outlook for global fixed income markets is that they will continue to grow and that there will continue to be increases in new issuance activity.

That discourages us from moving towards relationship pricing because inherent in having relationship-based pricing is some discounting that is associated with that.

So that's one part of it.

The other part is that we did have some gains in important areas in our market coverage, our paid market share, including, for example, our commercial mortgage-backed securities area and our residential mortgage-backed securities area and structured finance.

I don't know what the market share numbers are for our chief competitor on those particular lines, but I know that we had gains.

Thank you.

And that does conclude the question and answer session.

At this time, I'll turn the conference back over to Mr.

McDaniel for any closing remarks.

Okay.

We thank you all for joining us, and hope that most of you can join for us for Investor Day on June 5 as well.

Thank you very much.

And that does conclude today's conference.

Again, thank you for your participation.