穆迪 (MCO) 2010 Q3 法說會逐字稿

Good day and welcome, ladies and gentlemen, to the Moody's Corporation third quarter 2010 earnings conference call.

At this time, I would like to inform you that this conference is being recorded and that all participants are in 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 Ms.

Liz Zale, Vice President, Investor Relations.

Please go ahead.

Thank you.

Good morning, everyone, and thanks for joining us on this teleconference to discuss Moody's results for the third quarter of 2010.

I am Liz Dale, Vice President of Investor Relations.

Moody's released its results this morning for the third quarter of 2010.

The earnings press release and a presentation to accompany this teleconference are both 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 making prepared remarks on the call, is Linda Huber, Chief Financial Officer of Moody's Corporation.

Before we begin, I call your attention to the Safe Harbor language, which can be found toward the end of our earnings release.

Today's remarks may contain forward-looking statements within the meaning of the private Securities and Litigation Reform Act of 1995.

In accordance with the Act, I also direct your attention to the Management's discussion and analysis section and the risk factors discussed in our annual report on Form 10K for the year ended December 31, 2009, our Form 10Q for the period ended June 30, 2010, and in other SEC filings made by the Company, which are available on our website and on the Securities and Exchange Commission's website.

These, together with the Safe Harbor statement, set forth important factors that could cause actual results to differ materially from those contained in any such forward-looking statement.

I would also like to point out that members of the media may be on the call this morning in a listen-only mode.

I will now turn the call over to Ray McDaniel.

Thank you, Liz.

Good morning, and thanks to everyone for joining today's call.

I'll begin our remarks by summarizing Moody's third quarter and year-to-date 2010 results.

Linda will follow with additional financial detail and operating highlights.

I'll then speak to recent developments in the legislative and regulatory area, and finish with comments on Moody's business initiatives and outlook for 2010.

After our prepared remarks, we'll be happy to respond to your questions.

Moody's results in the third quarter reflected strong performance at Moody's Investors Service associated with robust capital market issuance as well as steady growth for Moody's Analytics.

Total revenue was $513 million, up 14% from the third quarter of 2009.

Operating income for the third quarter was $189 million, an increase of 10% year-over-year.

Diluted earnings per share for the quarter of $0.58 included a one-time tax benefit of $0.07 associated with foreign earnings.

Excluding minor restructuring related adjustments in both years, diluted EPS for the quarter of $0.58 grew by 35% year-over-year.

Turning to year-to-date performance, revenue for the first nine months of 2010 totaled $1.45 billion, a 12% increase over the same period in 2009.

Expenses were $892 million, up 11% from the prior year period.

And operating income of $576 million increased 13%.

Revenue at Moody's Investors Service for the first nine months of 2010 was $1 billion, an increase of 15% from the prior year period.

Moody's Analytics revenue was $445 million, 5% higher than the prior year period.

Based on year-to-date performance and our expectations for the remainder of the year, we're raising our full year 2010 EPS guidance to a range of $1.90 to $1.96 from the prior range of $175 to $1.85.

I'll now turn the call over to Linda to provide further commentary on our results and other updates.

Thanks, Ray.

Good morning, everyone.

I'll begin with revenue at the corporate level.

As Ray mentioned, Moody's total revenue for the quarter was up 14% year-over-year.

For the third quarter, US revenue increased 21%, to $278 million, while revenue outside the US increased 6%, to $235 million, representing 46% of Moody's total revenue.

Recurring revenue of $283 million represented 55% of total revenue, compared to 63% in the prior year period.

Looking now at each of our businesses, starting with Moody's Investors Service, revenue for the quarter was $358 million, a 17% increase year-over-year.

US revenue was up 26% over the prior year period.

Outside the US, revenue grew 7% and represented 42% of total ratings revenue.

Global Corporate Finance revenue in the third quarter increased 43% from a year ago, to $145 million.

Revenue grew 51% in the US, primarily driven by strong high-yield bank loan and bond origination for refinancing, and increased merger and acquisition activity.

Outside the US, revenue increased 29% from the prior year period, with strong, high-yield bond issuance in Europe and improved activity in Asia and Latin America.

Global Structured Finance revenue for the third quarter was $70 million, 11% below the prior year period.

In the US, revenue declined 8% year-over-year with less derivative activity, partially offset by improved commercial real estate finance issuance.

Non-US structured finance revenue was down 15%, with reduced European derivatives and securitization activity.

The decline was partially offset by growth in covered bond activity.

Global Financial Institutions revenue of $74 million increased 17% from the third quarter of 2009, primarily due to higher levels of insurance sector issuance in the US and greater activity in the banking sector internationally.

US Financial Institutions revenue grew 14%, while outside of the US, revenue was up 19%.

Global revenue for Public Project and Infrastructure Finance grew by 13% year-over-year to $70 million.

Revenue increased 24% in the US, with higher volumes in the Public Finance and Infrastructure sectors.

Non-US revenue declined 7%, primarily due to lower issuance volume in European Infrastructure Finance.

Turning now to Moody's Analytics, global revenue from Moody's Analytics of $155 million was up 6% from the third quarter of 2009.

US revenue grew by 10% year-over-year, to $71 million.

Non-US revenue increased by 3%, to $84 million, and represented 54% of total Analytics revenue.

Growth was primarily led by the delivery of risk-management software projects and improving demand for research and data.

Globally, revenue from Research Data and Analytics of $106 million increased by 3% from the prior year period, and represented about 68% of total MA revenue.

The return to growth for this business reflects further stabilization among our capital markets customers, as financial industry conditions improve.

Revenue from Risk Management Software of $43 million grew 16%, while revenue from Professional Services of $6 million was flat with the prior year period.

Growth rates in both of these business units are subject to significant quarter-to-quarter volatility due to the variable nature of project timing and the concentration of revenue in a relatively small number of engagements.

Turning now to expenses,Moody's third quarter expenses were $324 million, an increase of 16% compared to the third quarter of 2009.

The increase was primarily due to greater headcount, higher accruals for incentive compensation reflecting the stronger full-year outlook, as well as additional spending relating to legal matters and regulatory requirements.

Excluding restructuring-related items from both periods, third quarter 2010 expenses increased 18%.

Moody's operating margin for the third quarter of 2010 was 36.8% compared to 38.2% in the third quarter of 2009.

Our effective tax rate for the quarter was 24.4% compared with 37.5% for the prior-year period.

The difference was primarily due to a one-time tax benefit associated with foreign earnings.

Now, I'll provide an update on capital allocation and stock buyback.

During the third quarter of 2010, Moody's repurchased 0.8 million shares at a total cost of $20 million.

As of September 30, 2010, Moody's's had $1.3 billion of share repurchase authorization remaining under its current program.

Through much of the third quarter, share repurchase activity was curtailed due to the Moody's awareness of non-public information relating to the Wells notice that we received in the spring, which was closed without any enforcement action against the Company.

Moody's also issued 0.8 million shares under employees' stock-based compensation plans.

Outstanding shares as of September 30, 2010 totaled 234 million, representing a 1% decline from a year earlier.

During the quarter, Moody's completed a public offering of $500 of senior, unsecured notes at a coupon of 5.5%.

Proceeds are expected to be used for general corporate purposes, including repayments of outstanding commercial paper and other short-term and long-term borrowings, working capital, capital expenditures, possible acquisitions, and other business investments and share buybacks.

At quarter end, Moody's had $1.3 billion of outstanding debt and approximately $985 million of additional debt capacity available under its revolving credit facility.

Cash and cash equivalents were $794 million, a $371 million increase from the prior-year period.

We remain committed to using our strong cash flow to create value for shareholders, while maintaining sufficient liquidity.

For the remainder of 2010, we expect to continue share repurchase at modest levels, subject to available cash flow, market conditions, and other, ongoing capital allocation decisions.

And with that, I'll turn the call back over to Ray.

Thanks, Linda.

I'll continue now with an update on legislative and regulatory developments.

In the US, as part of the initial rule-making process following the passage of the Dodd Frank Act, on September 29, the SEC amended Regulation Fair Disclosure, or Reg FD, to remove the specific exemption for credit-rating agencies.

We are now addressing the confidentiality of information used in the ratings process by revising our agreements with issuers as appropriate.

With respect to the majority of other provisions relevant to nationally recognized credit-rating agencies under the Dodd Frank Act, the SEC has provided a schedule of implementation activities over the coming months that include establishing a new office [of] credit ratings in October and naming a director of that office in November; and proposing rules between January and March of 2011 on various matters, such as reporting of internal controls, transparency of ratings performance, and references to credit ratings and statues, regulations, and rules.

Adoption of the proposed sets of rules is planned for April to July 2011.

While the new rules will spur various changes in our process and operations, it will not alter our fundamental business objective to provide the highest quality credit opinions, research, and analysis.

In January, we also expect the SEC to provide guidance on the recision of Rule 436G and its interaction with Regulation AB, which has been interpreted to require ratings to be included in the [prospectuses] of publicly-offered securitizations.

In Europe, we have filed our application to become a registered credit rating agency under the new EU regulatory regime, and are continuing our interactions with European authorities to address the registration process and other considerations, including the transfer of rating agency oversight to a newly established European Securities and Markets Authority.

We also expect the European Commission to release a consultation paper in the near future regarding matters such as rating agency competition and business models, and the regulatory use of ratings.

At a global level, the International Monetary Fund and the Financial Stability Board have recently published papers addressing the use of ratings and regulation.

Both the IMF and the FSB advocate reducing the lines on ratings as mechanical triggers, which result in automatic responses.

We agree with this position, and have offered our public support through comments on regulatory proposals.

As regulatory reviews and activity occur in other jurisdictions, we will continue to advocate for globally consistent approaches that align with the G20 statements and [directives.]

I'll conclude today's prepared remarks by reviewing a few business initiatives from the quarter and commenting on our full-year guidance.

I'm pleased to report that during the third quarter, Moody's Analytics established the Institute of Risk Standards and Qualifications, which has launched the first risk management accreditation program for bank professionals based on a globally consistent standard.

We have developed the program's competency requirements with the help of a broad base of industry practitioners and academics, with the goal of capturing lessons from the recent crisis and promoting a higher level of financial risk management proficiency among banking practitioners.

We also launched Moody's Small Business Information Zone, or moodysbiz.com, an online resource that provides small business owners with free access to economic data and planning tools to help manage their businesses.

We've also been a market leader in providing analysis and data to financial professionals, and this site leverages our experience and resources to serve the small business community as well as municipalities and universities.

Moody's outlook for 2010 is based on assumptions about many macro economic and capital market factors, including interest rates, corporate profitability and business investment spending, merger and acquisition activity, consumer borrowing and securitization, and the eventual withdrawal of government-sponsored economic stabilization initiatives.

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

As mentioned earlier, we are increasing our full-year 2010 EPS guidance to the range of $1.90 to $1.96.

And certain components of 2010 guidance have been modified to reflect our current view of credit market conditions and implications for the Company.

My comments highlight those components that have been revised, and we refer you to our earnings release for a full review of our guidance.

Our full-year outlook assumes foreign currency translation at exchange rates as of the end of the third quarter.

For Moody's Corporation, we now expect revenue to grow in the high single-digits to low double-digit percent range, and expenses to increase in the low double-digit percent range.

As previously discussed, we expect operating expenses to increase throughout the year, a normal seasonal pattern that has been magnified by planned and committed spending, including our hiring activities.

We continue to estimate incremental costs related to new regulation will be approximately $15 million for this year, and $15 million to $25 million for next year.

The Company still projects the full-year 2010 operating margin in the high 30s percent range, and now expects the 2010 effective tax rate to be in the range of 33% to 34%.

At Moody's Investors Service, we now expect global revenue growth in the low double digit percent range.

In the US, we expect MIS revenue to increase in the high teens percent range, while non-US revenue is expected to grow in the low-to mid-single-digit percent range.

Corporate Finance revenue is now projected to increase in the low 30s percent range.

Structured Finance revenue is expected to decline in the mid-single-digit percent range,while revenue from Financial Institutions is expected to grow in the mid-single-digit percent range.

In Moody's Analytics, our outlook for both Risk Management Software and Professional Services now reflects revenue growth in the mid teens percent range.

That concludes our prepared remarks.

And joining us for the question-and-answer session, are Michel Madelain, our Chief Operating Officer of Moody's Investors Service, and Mark Almeida, the President of Moody's Analytics.

We'd be pleased to take any questions you may have.

Thank you.

(Operator Instructions).

We'll take our first question from Peter Appert with Piper Jaffray .

Thanks.

Question for Linda.

Can you help me understand a little better the dynamics behind the cost growth in the third quarter?

And specifically, Linda, I'm wondering if you can call out what portion of the costs might be one-time in the quarter in terms of catch-up accruals or compliance implementation et cetera.

Sure, Peter.

Let me start with the big picture here.

For the third quarter of last year, our total expenses were $290 million.

For the third quarter of this year, as we had said, we're at about $339 million.

So the uptick is about $50 million.

I'd like to explain this as about $25 million of this would be considered catch-up and potentially one-off, and about $20 million of this is run rate.

About $13 million of this is a combination of incentive compensation because, obviously, we raised guidance and we performed better than we've expected.

And profit sharing.

So, going with the first part, in incentive compensation we have booked about $75 million so far for the year for incentive compensation.

So, you can think of that as about $25 million a quarter.

We also have about a $3 million piece in there for profit sharing.

We also then had higher costs, as we said, in Professional Services, which includes IT, regulatory and legal, of about $11.5 million.

So, we would hope that we don't have to see that again.

And of course, the incentive compensation true-up would also be one time.

So, of the approximately $50 million increase, about half of this is one time.

Now, on the run rate, it's important to understand that we've got some things here that are going to continue on.

Primarily, we have increased headcount by 7%.

And we've also had merit increases, and we've had higher Moody's Analytics commissions.

All of which are good, because many of these increases are driving revenue.

All of those changes are about $20 million for the third quarter year-over-year.

So, Peter, I hope that explains the expense increase in the two components you were looking for.

Excellent.

Very helpful, thank you.

Just a follow-up on that, Linda.

The 7% increase in headcount,, I know you've signalled that you were adding staff, but I g guess I can't quite get my hands around why the staffing needs to increase so much in the context of revenue run rate numbers.

They're still well below where you were a few years ago.

Right.

I think the important thing to note here, Peter, is that many of these people are going to Moody's Analytics, as we had said.

A number of the people are going to lower-cost staff areas as we look to make sure that the analysts have a reasonable workload under the new regulatory regime.

It would be those things.

It should be noted that a number of these positions are outside the US as opposed to within the US.

Some are, in fact, at lower costs.

We're doing exactly what we said we would do over the course of the year.

Just a little more color on that, Peter.

The hiring that has gone on, on the Moody's Analytics side, has been both for our Software Development activities outside the US, but also, importantly, for sales.

We have talked in some of our previous calls about the fact that the customer base for Moody's Analytics has been shifting somewhat from the very large institutions that we have always served to smaller, more regional institutions, which requires more selling capacity to be able to get to those institutions.

So, that's part of the hiring on that side.

And as Linda noted, there continues to be hiring for the full range of internal controls -- compliance, legal, technology, audit -- associated with moving Moody's Investors Service into a more fully regulated environment.

It just requires changes to word processes and documentation reporting that require incremental resource.

Understand.

And Ray, one other thing and I'll get off.

I noticed that the revenue growth rate for Moody's Investors Service at 17% is quite a bit higher than what S&P reported yesterday.

I understand part of that is just a function of pricing models, but it also looks to be higher, I think, than what Fitch is doing.

So, can you comment on what you're seeing from a market share standpoint as it relates to this [superior]r revenue performance?

I do assume that part of this is a mix of transaction versus recurring revenue.

I cannot speak to any awareness of material changes in market share.

We have had strong addition of new issuers who have been seeking ratings this year, both inside the US and outside the US.

That's associated with increased capital market activity, particularly -- well, capital market and bank loan activity, which tend to be smaller issuers, issuers that would not as frequently be in the bond markets or in the rated loan market.

So, we have had a good year in terms of increasing the number of new rating relationships.

I don't have a comparison on that though with our competitors.

Okay.

Great.

Thanks, Ray and Linda.

Next question is Michael Meltz with JPMorgan.

I'd like to thank Appert for the market share question.

Two questions for you.

The lack of margin drive, I understand the costs in the investments you're making, some of which are run rate and some are one-off.

Taking a step back, as you look over the next few years, I think we've talked about before, 40% to 45% is where the business could, or perhaps should, be longer term.

Do you still feel that way?

And then I have a follow-up.

Let me take a shot at this, Michael, and then I'll let Ray comment further.

If you look our operating income of $188.9 million, and you add back the $13 million in extraordinary incentive compensation and profit sharing, which I explained, you get to about $202 million of operating income, which takeses your margin to a little over 39%.

As I said, we've had an overage in Professional Services of about $11.5 million.

Add that back, you get to something like $213 million, or margin back over 41%.

So, we can see that this can be reached, but given what we're dealing with right now to build into these regulatory requirements, as we've said, we're going to ramp expenses throughout the year.

We haven't reached the full run rate yet on those.

So, hope that illustrates that we can get there, but unfortunately not quite yet for this quarter.

I want to offer a note of caution, also, in terms of the fact that the regulatory process, while it is much clearer than it has been earlier this year or certainly last year, it still has quite a bit of activity going into 2011 that we're going to have to be in a position to address.

As I mentioned in the prepared remarks, SEC rule-making in many areas hasn't even become visible.

I'm sure the SEC is working on it, but they have not made proposed rules public in areas that are going to affect us.

We will see that in the first and second quarters of next year, because a lot of the rule-making had a 12-month window after passage of Dodd Frank.

We also have the European consultation, which we expect to have released shortly.

And we have banking system regulators that are looking at the use of ratings and regulation in particular.

So, we are assuming there are going to be increased costs and resource needs associated with some or all of this, but we don't have a great deal of clarity yet on exactly what that may be.

As the rules and proposals are released, we'll be able to talk to you about this more intelligently.

Has your view on margin structure changed since the investor day?

My view on margin structure has not changed, but if we are thinking about the increasing costs associated, in particular, with the Moody's Investors Service and the internal control and reporting environment, I think what is fair to say, is that it has been extended beyond what I would have expected back on investor day.

So, there is more going on, and it is going on further out in time than I would have forecasted six to nine months ago.

Okay.

One follow-up.

Linda, someone else I'm sure will ask the transaction recurring, but within Structured Finance, you still have a good slug of recurring revenues in there, or surveillance revenues.

How should we be thinking about the phasing of those revenues over the next three-plus years?

Is there an expectation of a cliff or just modest fade?

How will that play out?

Sure.

You're right.

We'll probably get to the details here on transaction versus relationship.

For the third quarter for Structured, just so you have the topline, Michael, transaction was 47% and relationship was 53%.

I think your second theory there on slow decline is the correct one.

We will see somewhat of a decline as the stock of those structured revenues comes down.

However, in terms of total recurring revenues we have had, obviously, a massive influx of corporate ratings which need to be monitored.

So, we will have additional recurring monitoring fees that go with those new corporate ratings.

So, overall, we will see a net increase in our total recurring revenues.

But, you're right, that Structured will have a slow ramp-down.

All right.

Thank you.

Our next question is Craig Huber with Access 342.

Good afternoon.

I thought I'd be next year.

As I always try to ask you, Linda, can you break down first, if you would, the transaction versus non-transaction percentages between Structured, Corporate Financial, et cetera?

Yes, sure.

As I was just saying to Michael, for Q3, Craig, going first with transaction and then with relationship, it's 47% versus 53% for Structured.

For Corporate, obviously on a very strong issuance quarter, 74% transaction, 26% relationship.

Financial Institutions, 37% transaction and 63% relationship.

And Public Project and Infrastructure Finance, 60% transaction, 40% relationship.

So, for the rating agency as a whole, 58% transaction, 42% relationship.

For Moody's Analytics, we're running 14% transaction and 86% relationship.

So, for the Corporation as a whole, 45% transaction and 55% relationship.

Okay.

The also, another housekeeping question.

Within each of those Structured, Corporate et cetera, can you break down, if your would, the percentages that come from high-yield bank loans, [investment grade],and also the other three main categories too.

Yes.

Hang on just a second while we get that.

For the third quarter, investment grade issuance was 21% of Global Corporate Finance revenue.

Spec grade was 26% of total Corporate Finance revenue.

Bank loans, 15%, and Other which, as you know, includes monitoring, medium term notes, [shelved] commercial paper and so on, was 37%.

And then if you could the same thing for Financial Institutions, PPIF and Structure if you would.

Sure.

Financial Institutions, the banking revenue was 70% of total [stage] revenue for Q3.

Insurance was 25%, and Managed Investments was 5%.

Then going on to PPIF, PFG and Sovereigns were 50%; Munis, or Municipal Structured Finance, was 8%; and Project and Infrastructure was 42%.

I think we skipped Structured.

Let me see if we can find that for you, Craig.

For Structured for Q3, 33%; Asset Backs, 12% [RMBF] mortgages; Covered Bonds, 11%; Real Estate, Commercial Real Estate, CREP as we call it, 17%; and Derivatives, 27%.

Okay.

Then also, a point of clarification.

Your new guidance.

EPS guidance of $1.90 to $1.96.

Does that or does that not include the $0.07 tax benefit you're talking about for this quarter we just finished?

Yes.

As, in fact, Mr.

Appert has noted in his writings this morning, it does include that $0.07 tax benefit.

It does include the $0.07?

Yes, affirmative.

But it excludes all these other smaller one-time items throughout the year.

It's a GAAP guidance number.

The GAAP number.

Okay.

I think I'm done.

Thank you very much.

Thank you.

You're welcome.

The next question is Brian Shipman with Jefferies.

Thanks.

Good morning.

A question on the hiring again.

With respect to compliance-related hirings, specifically, when did you begin hiring that staffing so aggressively?

And is the compliance-related hiring completed at this point, would you say?

Or, with the remaining regulatory issues that you just mentioned, Ray, is that going to require that you continue ramping this staffing level up further?

I believe we are going to have to ramp it up further.

How much we have to do so will depend on the actual SEC and European Union rules that we're operating under next year and 2012.

We have been hiring in the compliance area, I would say, on a reasonably steady basis.

We didn't try to concentrate hiring in any one quarter, although with the passage of Dodd Frank, there has been more clarify around what some of our obligations and responsibilities are going to be.

And so, we have been active in the hiring in the third quarter.

Brian, it's Linda.

It's probably worth noting that of roughly 300 people we've hired, two-thirds of those are within Analytics and the rating agency, and less than one-third are within the staff.

Of those is the staff, don't want you to have the wrong impression.

The compliance team would be a small portion of that, but certainly not the majority.

A lot of these hires are in middle office, IT and other support functions.

Just want to make sure you don't come away with that thinking we're hiring hundreds of people in compliance, because we're not.

No, and I think it's also important to understand that when we talk about complying with a new regulatory environment, some of that compliance is people who are working in the lines of business and the operating Moody's Investors Service business, where work processes and work flows and documentation have changed.

So, it wouldn't all be in a staff function, even if some of it relates to regulatory changes.

Very helpful.

Thank you.

Next question is Edward Atorino from Benchmark.

Interest expense and Other line.

Just run that out?

Sort of a good run rate.

Sure, Ed, let me talk a little bit about that.

The total non-op expenses for the third quarter, let's start with interest expense.

One thing you might want to note,Ed, interest on our borrowings have gone up because we've gout our new $500 million bond deal in there with a 5.5% coupon on it.

So, you want to think about total interest expense of about $13 million.

Now, we did better on the FX line, and we've got some income from our [JBs] offsetting that.

So, the third quarter you want to call it an expense of $8 million or $9 million, Ed.

We've got that as an exhibit to our earnings release.

You can take a look at that.

Oh yes, it's right down there.

Didn't look at the bottom of the page.

Thanks.

Sure.

Trying to be helpful.

Very helpful, as always.

Next question is [Sloan Bowlen] with Goldman Sachs.

Hi there.

Not to try and beat a dead horse, but on the topic of how big of a moving target the expenses are either for regulatory or other going forward, can you maybe drill down about which area there could be the most variability there?

Is it on the compliance side or is it on rotational analyst teams, where along that timeline for next year do you think you'll have a better sense?

I can take a quick shot.

For the rest of this year, as we said, we expect expenses to ramp throughout the course of this year.

For this quarter, we're looking at $324 million of total expense offsetting our royalty elimination.

We would expect that to ramp a bit further for the fourth quarter particularly, as I said, these run rate changes, as we've hired some new people, Sloan.

So, that would be one area.

I'll let Ray comment a little bit more on the longer term.

I think we have done a good job this year in forecasting what our incremental costs would be associated with compliance.

The numbers that we were talking about early in the year are numbers that are still holding today.

We have the preliminary estimate of $15 million to $25 million incremental expense next year associated with regulation.

That is not all in compliance.

Again, it is spread across lines of business, the internal control functions, technology, so that we are able to be in compliance with various things.

But at this point, I don't have any reason to move off of that number, but I will feel much more confident about that once we see proposed SEC rules early next year and understand better what the EU consultation expectations will be.

Okay.

Switching gears maybe to a bigger picture.

Question just on the conflicts of interest in the business and sort of the discussion, or I guess, headlines we've heard from either people with the SEC or people over in Europe.

Are those comments being made as part of official review processes, or has there been a back and forth?

Could you give us a sense of, I guess, where they are along their review of that conflict?

The SEC has been asked to conduct a study over the next two years with respect to conflicts of interest and the business model.

It's something that has been raised by European authorities as well as an area they want to look into.

We have been in a dialogue with, I think, all of the relevant authorities about business models and the proper way to manage conflicts of interest.

Those of you on the call who have heard me speak about this before, have heard me observe that there are indeed potential conflicts of interest in this business, as there would be in any business in which we are paid by parties that care about the outcome of our opinions and analysis.

So, whether that is issuers or investors or governments that are paying us, there are conflicts that must be managed.

That is offset by the public good of our ratings in that they can be distributed for free to the investing public under our current business model, whereas they would not be able to be distributed for free to the investing public if we had to move to a subscription service or some other kind of selective dissemination service.

So, I think that turns the question to being able to demonstrate that we are properly managing the potential conflicts we face.

I think we are going to be able to do that to the satisfaction of all regulatory authorities.

That, I'm sure, will be part of our responsibilities and obligations going forward because they're going to be inspecting us and looking at that.

Okay.

But it's fair to say we're in the very early stages of those discussions.

Yes.

Those discussions have been going on for a long time, and I imagine will continue to go on for a long time.

Okay.

Fair enough.

Thank you, guys..

Our next question is Bill Clark with Keefe, Bruyette and Woods.

Thanks for taking my question.

Just on the Structured Finance revenues, did you see any impact from the six-month suspension of the need for ratings this quarter?

I think it was the first quarter you had a full impact from that.

I was just wondering if there was there anything significant that you saw from that?

Given the interim solution that the SEC put in place, we really didn't see any material impact, I don't think.

If the SEC had not acted, I think it's more likely that we would have seen a material impact because of the changes that the rules would have had on the ability to issue certain classes of securities, at least public securities.

So, the changes that have gone on that have occurred in the last six months with respect to Rule 17G5, affecting Structured Finance issuance, and 436G, which was again, put into this interim holding pattern, I think that we have seen market participants having to make changes to how they are planning to bring securities to market in the Structured Finance area, how they interact with rating agencies to some extent, and also questioning what the final solution with respect to 436G will be, and the impact that that would have in 2011.

But, I don't think it has had a material impact for 2010.

Okay.

Great.

Thank you.

Next question is a follow-up from Peter Appert with Piper Jaffray.

Ray, sorry for the double-dip here.

But on the litigation front, it looks like you had a pretty important win the other day Ray.

So, number one, I was hoping you'd comment on how you see the relative significance of that particular decision.

And then number two, maybe a little update on where things stand generally from a litigation standpoint.

Thanks.

Sure.

There was a ruling earlier this week by a judge in California, which granted our motion to dismiss with prejudice.

Claims from a plaintiff of intentional and negligent misrepresentation.

This is called the Rice case.

We obviously were pleased that the motion to dismiss was granted.

We think that the judge correctly applied the law.

It is a federal court, not a state court.

And so, for example, with respect to the [Calpers] litigation, I think the judge's decision may very well prove to be helpful, but it is in federal court, not state court.

With respect to the litigation more broadly, there's not anything material to report at this point.

In total, we have had, I think it's 17 cases dismissed -- ratings related cases dismissed -- since the beginning of the financial crisis.

We certainly expect that number to continue to rise.

But I don't have anything else to report at this point.

Because it was a federal decision, Ray, and I think most of these fraud cases are filed in federal court, do you view this as then a fairly significant precedent from that perspective?

Again, it's, I think, helpful.

And the judge's reasoning, I think, is something that we would cite.

But other judges in other districts are going to make their own decisions.

Okay.

Thank you.

Next question is Craig Huber with Access 342.

Yes, hi, follow-up question.

Would you mind ball parking for us how much you think your incremental legal costs will be this year?

Do you think they'll be roughly $25 million this year, or nowhere near that?

I understand the curiosity, Craig, I don't think we're going to disclose what we think our legal costs are going to be.

Okay.

Then also, just if you clarify a little bit further, Linda, your incentive accruals for the quarter.

What were they, and what were they a year ago please?

I think the first two quarters this year, your incentive compensation accruals, I think $21 million in the first quarter, and I think $17 million, $18 million in the second.

What was in the third, please?

Very good, Craig.

For the first quarter of 2010 it was $20.8 million incentive compensation.

For the second quarter it was $18.3 million.

And for the third quarters it's $35.5 million.

So, we would view that as about a $10.5 million catch-up on the incentive accrual because, obviously, the Company has performed above our forecast and we've raised guidance.

A little chunk of the previous $13 million number I had mentioned is profit sharing, which also, given the kind of year we're having, looks like it's likely to kick in.

Compare that to last year, the pattern was different.

Q1 of last year was about $9 million, Q2 was $14.5 million, and Q3 was $25 million.

So, this year, we're running at about $75 million all in, which is a healthy increase to where we were last year.

So, as I said, for this year, $75 million so far, averaging $25 million a quarter.

So, you might want to think about that for the fourth quarter.

Then if I heard you right, Linda, you're expecting your total I guess operating costs here in eh fourth quarter to be up slightly from this third quarter total?

Yes.

Okay.

Great.

Thank you.

Sure.

Our next question is Michael Meltz with JPMorgan.

Just one final one for me.

We've gone through all these questions and nobody's asked about the business in the fourth quarter.

Your listing guidance for revenues, can you just talk a little bit about what -- any real change, especially on corporate issuance, which was so strong in Q3?

We don't expect revenue in the fourth quarter to be as high as it was in the third quarter.

We have had a pretty good October in terms of corporate issuance, including high-yield and bank loans.

But the strength of the third quarter, particularly September, I think is going to be hard to duplicate.

Great.

Thanks, Ray.

We have no further questions in queue.

Okay.

Thank you very much for joining us.

We look forward to speaking with you again after the first of the year.

Thank you.

This concludes Moody's third quarter earnings call.

As a reminder, a replay of this call will be available after 4 PM Eastern time on Moody's website.

Thank you.