穆迪 (MCO) 2013 Q2 法說會逐字稿

Good day, and welcome, ladies and gentlemen, to the Moody's Corporation second quarter 2013 earnings conference call.

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

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

I will now turn the conference over to Salli Schwartz, Global Head of Investor Relations.

Please go ahead.

Good morning, everyone, and thanks for joining us on this teleconference to discuss Moody's second quarter results for 2013.

I am Salli Schwartz, Global Head of Investor Relations.

This morning Moody's released its results for the second quarter of 2013.

The earnings press release and a presentation to accompany this teleconference are both available on our website at ir.moodys.com.

Ray McDaniel, President and Chief Executive Officer of Moody's Corporation, will lead this morning's conference call.

Also making prepared remarks on the call this morning 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 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 10-K for the year ended December 31, 2012, 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 statements.

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'll now turn the call over to Ray McDaniel.

Thank you, Salli.

Good morning and thank you to everyone for joining today's call.

I'll begin by summarizing Moody's second quarter 2013 results, Linda will follow with additional financial detail and operating highlights and I'll then speak to recent regulatory developments and finish with comments on our outlook for 2013.

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

Second quarter revenue of $756 million increased 18% over the second quarter of 2012, reflecting continued strong operating performance across the Company.

Operating expenses for the second quarter were $405 million, a 12% increase from the second quarter of 2012.

Operating income for the second quarter was $351 million, a 26% increase from the prior year period.

Adjusted operating income, defined as operating income less depreciation and amortization, was $374 million, up 24% from the same period last year.

Diluted earnings per share for the second quarter increased 32% from the prior year period to $1.

Our full year 2013 non-GAAP EPS guidance range remains $3.49 to $3.59.

We are pleased to announce that we've increased our annualized dividend to $1 per share.

We also now anticipate total 2013 share repurchases of approximately $1 billion.

Turning to year-to-date performance.

Revenue for the first six months of 2013 was $1.5 billion, a 16% increase from the first six months of 2012.

Revenue at Moody's Investors Service was $1.1 billion for the first six months of 2013, an increase of 18% from a year ago.

Moody's Analytics revenue of $429 million was 9% higher than the prior year period.

Operating expenses for the first six months of 2013 were $857 million, up 16% from 2012.

Operating income of $631 million increased 15% from $548 million in 2012.

Adjusted operating income was $678 million, a 14% increase from the prior year period.

First half operating expenses, operating margin and adjusted operating margin all include our first quarter litigation settlement charge.

Diluted earnings per share of $1.83 for the first six months of 2013, which included a $0.14 charge related to the settlement, increased 20% from the prior year period.

Excluding the settlement, diluted earnings per share of $1.97 for the first six months of 2013 grew 30% year-over-year.

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

Thanks, Ray.

I'll begin with revenue at the Company level.

As Ray mentioned, Moody's total revenue for the quarter increased 18% to $756 million.

Foreign currency translation for the quarter was negligible.

US second quarter revenue increased 18% to $408 million, while revenue outside the US grew 18% to $348 million, and represented 46% of Moody's total revenue for the quarter.

Recurring revenue grew 7% to $362 million and represented 48% of total revenue, down from 53% in the prior year period.

Looking now at each of our businesses, starting first with Moody's Investors Service.

Total MIS revenue for the quarter was $537 million, up 22% from the prior year period.

US revenue for MIS increased 21% over the prior year period to $313 million.

MIS revenue outside of the US, $224 million, increased 22% and represented 42% of total [ratings] revenue.

The impact of foreign currency translation on MIS revenue was negligible.

Moving now to the lines of business for MIS, first global corporate finance revenue in the second quarter increased 37% from the year-ago period to $263 million.

Revenue was up 28% year-over-year in the US, as a result of strong investment grade and high yield bond issuance, as well as bank loan issuance as corporations continued to take advantage of historically low interest rates.

Non-US revenue was up 52%, driven by European speculative grade bond issuers shifting their bank debt to the public bond market.

Second, global structured finance revenue for the quarter was $97 million, up 7% from the prior year period.

In the US, revenue increased 29% year over year, due to strength in issuance of commercial mortgage backed securities.

Non-US structured finance revenue was down 17% against the prior year period, primarily reflecting weaker issuance volumes in European residential mortgage backed and asset backed securities.

Third, global financial institutions revenue of $85 million, increased 9% from the same quarter of 2012.

US revenue was up 9% reflecting stronger banking activity, while non-US revenue was up 8% driven by increased issuance by insurance companies.

Fourth, global public, project and infrastructure finance revenue rose 14% year-over-year to $93 million.

US and non-US revenue were up 8% and 31%, respectively, from the prior year period, due to gains in project and infrastructure finance globally.

Turning now to Moody's Analytics.

Global revenue for Moody's Analytics of $219 million was up 10% from the second quarter of 2012.

Its year-over-year growth was entirely organic as we have not made any acquisitions in the past year.

US revenue grew by 8% year-over-year to $95 million.

Non-US revenue increased by 11% to $124 million, and represented 56% of total Moody's Analytics revenue.

The impact of foreign currency translation on MA revenue was also negligible.

Moving to the lines of business for MA,.

First, global research data and analytics revenue of $130 million increased 7% from the prior year period and represented 60% of total MA revenue.

Our customer retention rate remains strong in the mid-90% range and we continue to see solid demand for MA's research offerings.

Research data and analytics US revenue was up 6% and non-US revenue was up 9%, as compared to the second quarter of 2012.

Second, global enterprise risk solutions revenue of $60 million grew 17% from the same period last year, driven by strong growth in products and services that support regulatory and compliance activities at banks and insurance companies.

Enterprise risk solutions revenue was up 12% in the US and non-US revenue was up 19% against the prior year period.

As we noted in the past, due to the variable nature of project timing and completion, enterprise risk solutions revenue remains subject to quarterly volatility.

On a separate note, subscription revenue, which includes MA's research, data and analytics business and certain products within MA's enterprise risk solutions business, was up 10% for the second quarter of 2013.

Global professional services revenue grew 7% to $28 million, reflecting solid growth in revenue from Copal Partners, partially offset by softness in the training and certification business.

US revenue increased 23%, while non-US revenue increased by 3% year-over-year.

Turning now to expenses.

Moody's second quarter expenses were $405 million, an increase of 12% compared to the second quarter of 2012, reflecting increased headcount, annual compensation increases, and higher technology expenses.

The impact of foreign currency translation on operating expenses for the quarter was negligible.

Moody's reported operating margin for the quarter was 46.4%, up from 43.5% in the second quarter of 2012.

Adjusted operating margin was 49.5% for the quarter, up from 46.9% for the same period last year.

Moody's effective tax rate for the quarter was 32.2%, compared with 33.6% for the prior year period.

And now I'll provide an update on capital allocation.

During the second quarter of 2013, Moody's repurchased 4.1 million shares at a total cost of $259.1 million, and issued 1.7 million shares under employee stock based compensation plans.

Outstanding shares as of June 30, 2013 totaled 220.4 million, reflecting a 1% decrease from a year earlier.

At the end of the second quarter, Moody's had $1.3 billion of share repurchase authority remaining under our current program.

As of June 30, 2013, Moody's had $1.6 billion of outstanding debt, and $1 billion of additional debt capacity available under our revolving credit facility.

Cash and cash equivalents as of June 30, 2013 were $1.6 billion, an increase of $808.9 million from a year earlier.

At the end of the second quarter, approximately 61% of our cash holdings were maintained outside the US.

Free cash flow of $351 million for the first six months of 2013 increased $137 million from a year ago, primarily due to strong operating performance in the first half of 2013, as well as tax payments made in 2012 which related to prior tax years.

And I'll now turn the call back over to Ray.

Okay.

Thanks, Linda.

I'll continue with an update on regulatory developments.

First, in the US.

On May 14, the Securities and Exchange Commission hosted a full day roundtable on the various proposals made in its study relating to assigning credit ratings for structured finance products, commonly referred to as the Franken amendment study.

The roundtable was comprised of three panels and panel participants were asked to discuss the advantages and disadvantages of various business models.

Turning to Europe, CRA3 was adopted earlier in the spring of 2013 and went into force as of June 20.

We have implemented the requisite policies and procedures accordingly.

I'll conclude this morning's prepared comments by discussing our full year guidance for 2013.

Moody's outlook for 2013 is based on assumptions about many macroeconomic and capital market factors including interest rates, corporate profitability, business investment spending, merger and acquisition activity, consumer borrowing and securitization, and the amount of debt issued.

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 the current outlook.

Our guidance assumes foreign currency translation at end of quarter exchange rates.

As I mentioned earlier, our full year 2013 non-GAAP EPS guidance range remains at $3.49 to $3.59.

For Moody's overall the Company still expects full year 2013 revenue to grow in the high single digit percent range.

Full year 2013 operating expenses are still projected to increase in the mid single digit percent range.

Full year 2013 operating margin is still projected to be 41% to 42%, and adjusted operating margin for the year is still expected to be 44% to 45%.

Guidance ranges for operating expenses, operating margin and adjusted operating margin all include the first quarter 2013 litigation settlement charge.

The effective tax rate is still expected to be approximately 32%.

We remain committed to using our strong cash flow to create value for shareholders and we have increased our annualized dividend by 25% to $1 per share.

Full year 2013 total share repurchases are now expected to be approximately $1 billion, subject to available cash, market conditions, and other ongoing capital allocation decisions.

Capital expenditures are still projected to be approximately $50 million.

We still expect approximately $100 million in depreciation and amortization expense.

Incremental compliance and regulatory expense is still projected to be in the $10 million to $15 million range.

Free cash flow is expected to be approximately $850 million.

We have modified certain components of 2013 guidance to reflect the Company's current view of business conditions.

For the global MIS business, revenue for the full year 2013 is still expected to increase in the high single digit percent range.

Both US and non-US MIS revenue are also now expected to increase in the high single digit percent range.

Corporate finance revenue is now projected to grow in the low teens percent range.

Revenue from structured finance is now expected to decrease in the low single digit percent range, while revenue from financial institutions is still expected to grow in the low single digit percent range.

Public, project and infrastructure finance revenue is still expected to increase in the low double-digit percent range.

For MA, full year 2013 revenue is still expected to increase in the high single digit percent range.

Within the US, MA revenue is now expected to increase in the low double digit percent range.

Non-US revenue is expected to increase in the mid single digit percent range.

Revenue from research, data and analytics is still projected to grow in the high single digit percent range, while revenue for enterprise risk solutions is still expected to grow in the low double digit percent range.

Professional services revenue is still expected to grow in the high single digit percent range.

This concludes our prepared remarks.

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

We would be pleased to take any questions you might have.

Thank you.

(Operator Instructions).

Patrick O'Shaugnessy, Raymond James.

Good morning.

So my first question, can you talk just a little bit more, provide some commentary around your capital return plan, increasing your share repurchase from $0.5 billion to $1 billion, bumping up your dividend return policy.

Can you just talk about what some of the thinking underlying those moves was?

Sure.

I'll make some general comments and then see if Linda has anything she would like to add.

It's really a recognition that we have an opportunity and sufficient financial flexibility to be able to return capital to shareholders on a more accelerated basis than we had anticipated earlier in the year.

So this is, we think, an opportunity for us to get cash back into the hands of shareholders and we think that's our obligation, consistent with the need to maintain sufficient liquidity and financial flexibility for uncertainties in the future.

Yes, it's Linda.

Ray's right, we have a cash-rich balance sheet, about $1.6 billion in cash on the balance sheet and our net debt is effectively zero.

We took a look at our dividend rate and with the recent increase in our stock price, the dividend yield had been about 1.3%, this brings it up to about 1.6%.

And our payout to about 25%.

So we feel that, that's appropriate recognition of the progress that we've made.

And on share repurchase, because our investors seem to prefer both methods of returning capital to shareholders, we think that this was a prudent step for us to take and a good time for us to do it.

All right.

That's very helpful color.

Thank you.

A follow-up question from me.

So certainly we saw corporate issuance dry up a little bit in June and I think July has been pretty slow so far as well.

Can you talk about what sort of issuance backlog that you've been seeing and just how the different rate environment that we're facing today as opposed to let's say April and May, how that's impacting corporate issuers?

Sure.

This is going to take a minute to go through, so let me talk to you about how we're going to do this.

We're going to first discuss investment grade, then I'd like to talk a bit about high yield and then thirdly, leveraged loans.

And for each of the categories, I'd like to talk about what we're seeing in deals last week and this week, the pipeline, the funds flow and then certain market observations.

And as you acknowledged, we did see a bit of what we're calling the June swoon, but we would acknowledge that last week the deal issuance rate looked a good deal better.

Last week we saw $16 billion in issuance, which was mostly driven by financials who have already reported second quarter earnings, and it's important to note, we try to make this same point every year, we're still in the corporate blackout period for many issuers, particularly the industrial issuers.

This week expectations are for another $15 billion of investment grade issuance.

We have $9 billion of issuance year-to-date.

I'm sorry, week to date.

And I would note that there are six investment grade deals in the market today with a 10 year at about 2.57.

On average over the last five years the 10 year's been about 2.73.

You can take whatever you'd like from that but we are below the five-year average.

The pipeline for several banks indicates that the forward calendar is building and the pipeline was described by several of those banks as strong.

Issuance is likely to be robust in the near term as issuers emerge from blackout periods and there is note that there may be a potentially busier August than is usually expected.

Generally August is one of the slower months.

However, banks are still forecasting a pullback in issuance from the record volumes in the first half.

Second half is looking at 250 to 350 versus the first half of $550 billion in issuance and this does include financials, as well as industrials.

Fund flows into high yield bond funds have recently reversed.

Last week Lipper reported $1 billion of fund flows into investment grade.

That's the third week of returned in-flow following the June swoon and the year-to-date total in-flow is $38 billion.

Market observations in high grade include issuers getting comfortable with the slightly higher interest rate environment and, from a historical perspective, rates remain attractive.

And we do see that some issuers are looking at refinancing 2014 and '15 in the back half, following the period of volatility that we've seen.

Also would note M&A dialogue is picking up but the focus for that is on later this year or 2014.

That concludes investment grade and now I'll move to high yield.

In high yield, last week we saw $7 billion of issuance from 16 issuers.

It was the busiest week since May of this year.

Last week's deals -- this week's deals, $3 billion week to date, and the issuance pipeline is currently running 25% up versus 2012 year-to-date.

Again, second half is expected to slow a bit, $75 billion to $150 billion in the second half versus $200 billion in the first half.

But 2013 levels are at or slightly below the 2012 record amount.

Fund flows again have reversed in high yield.

Dramatic outflows in May and June have normalized and even turned positive last week.

Year-to-date still showing net outflows though of $12 billion.

Market observations are that yields remain at near all-time lows with high yield index yielding 6.3% versus the five year average of 9.04%.

And it's an attractive asset class for fixed income investors as rates rise given shorter duration, less price volatility and low levels of defaults.

Looking at leveraged loans, last week we saw eight deals.

This week $900 million of issuance week to date.

The pipeline year-to-date volume of $350 billion is up 70% from 2012.

Second half expectation is $150 billion, that implies also somewhat of a reduction in pace of supply from first half $350 billion.

Fund flows last week in leveraged loans reported the 57th consecutive week of 100 -- of in-flows at $1.7 billion.

That's the largest weekly in-flow on record by the way and year-to-date in-flows are $30 billion.

That's more than three times what we saw in 2012 where the in-flow was $9 billion.

Market observations include that demand continues to be strong, given the feature of protection against rising rates offered by flexible rate leveraged loan paper.

Patrick, sorry for the length of all that but hope it's pretty complete.

I would just add a very brief comment to the comprehensive review that Linda has just offered.

As we saw rates moving out, treasuries and spreads moving out in June, they certainly have come back in somewhat.

So they're not back to where they were in May but treasuries and rates have come back in on spreads, have come back in.

I think more than a question of the pipeline, it was a question of uncertainty about where rates would stabilize and once that stability became more apparent, in part because of further comments from the Fed, I think there was more confidence in having those pipelines unlock.

And so what I think we're going to be looking at for the rest of this year is not a concern about bond issuance volumes with rates where they currently are, but some level of market anxiety about the uncertainty of accommodative monetary policy, how long and how accommodative.

In looking at our forecast, we assume there is going to continue to be some level of market anxiety around that and probably, as we've seen frequently over the past few years, periods of good market activity and then periods of relative dormancy, depending on, among other things, official comments.

Understood.

Appreciate the commentary.

William Bird, Lazard.

Good morning.

Ray, was wondering if you could just comment, I know there's been more shorter duration issuance recently.

How does that impact your business?

Well, it's good from the standpoint that there is more turnover of refinancing.

The velocity of the refinancing increases with the shorter term securities.

And interestingly, we had not seen a big jump in very long-dated issuance.

Even earlier when rates were at their lowest point, firms were still -- put it a little bit casually, but they were taking the free money rather than the cheap money.

And so we have seen the term structure remain towards the short end and that's, as I said, good from a refinancing perspective.

And Ray, bigger picture, can you talk about just what your point of view is on whether the structural tailwinds in your business can overcome some of the macro choppiness to enable positive growth?

Yes, I think we can continue to see growth.

I think the business is well supported on the rating agency side from the disintermediation trends certainly that are going on in Europe, but also in Asia, Latin America and somewhat surprisingly, at least to me, in the US, it continues to pace.

The Moody's Analytics business is really not impacted by the interest rate cycle, the business cycle, the way the rating agency business is.

So we expect we're going to be able to continue to get good growth out of MA.

And, Ray, your second half outlook implies kind of flattish growth profile at MIS and Linda's comments sound like the pipeline is still pretty good.

Are you assuming just kind of more of the same or just from a macro level, what's assumed in the second half in your outlook?

I think what we're recognizing and looking at, at some consensus opinions in the market from economists and other institutions, a greater than usual degree of uncertainty in terms of where rates might go, how spreads might react to changes in, again, quantitative easing or expectations for interest rate increases.

If the market is concerned that accommodative monetary policy is going to be curtailed before we have self-sustaining momentum in terms of GDP growth, that's not going to be good for issuance.

But if we do have a market view that we have achieved self-sustaining economic growth, I think we're going to see good levels of issuance, even if we do have curtailment of quantitative easing, because they're going to be borrowing for mergers and acquisitions and capital expenditure and share repurchase.

As we've talked about in other calls, all these drivers, traditional drivers of issuance that have been relatively dormant in recent years.

And, Bill, it's Linda.

Following up on what Ray said, I think your observation is correct.

The pipelines look pretty good, pretty strong.

But again, we don't control when those pipelines move and I think what Ray is trying to indicate to you is we'll probably have some good weeks, we'll probably have some less good weeks and that's what results from market choppiness.

That's on the MIS side.

I think we probably should make the observation that for MA, one part of that business, the enterprise risk software business, traditionally sees much stronger revenue growth in the fourth quarter and that seasonality is helpful to us.

We are thinking about, though, the strong numbers that the rating agency put up in the back half of last year and several of the analysts have observed that we do have tougher comps in the back half of the year, which is something that we're thinking about.

On the other hand, we're going to be back to talk to you at Investor Day which is eight weeks from today.

So we'll see where we get to and we'll freshen up our observations at that time.

Great.

Thank you.

Manav Patnaik, Barclays.

Hi, how you doing, guys?

Just firstly on the guidance, clearly the big high level sort of guidance ranges were unchanged but at the same time you doubled the expectations of share repurchases.

I just wanted to get a sense of what your thought process was in factoring in those increased share repurchases and why maybe the EPS range then narrow or increase.

Is there something in terms of the number of shares you expect to issue that offset that impact?

Just curious there.

Manav, I think we talked about why we left guidance where it is.

On share repurchase, we've added expectation of approximately another $500 million, but that will be in the back half of the year and looking at that, just looking at the weighted average counts and so on, we'll probably see the biggest accretive effect of that when we get into 2014.

So in other words, we're back end loaded here.

And we decided to leave guidance where it is and, again, we'll see how it works out.

But your observation is correct, we will be taking out additional shares.

We expect to.

But again, that will be occurring in the back half of the year.

Okay.

And just to focus on the comments you made on ERS.

Can you maybe just give us a quick update on some of the key events or points that occurred this quarter?

Clearly these 17% growth and all organic was pretty impressive.

Yes, let me ask Mark Almeida if he'd like to comment on that.

Yes, we had a very good quarter in ERS.

It was really -- we talked about this before.

It's a function of timing, when we get the work done on our various projects that are in flight.

We had a number of projects that completed during the second quarter, so we recognized a lot of revenue there.

But the business is strong, driven by regulatory activity and regulatory requirements that are being placed on banks.

We're seeing a lot of strength, particularly in the US relating the Dodd-Frank stress testing rules, as well as the Federal Reserve CCAR provisions.

So we're seeing some very good strength in the business from both a sales standpoint, but as you observe, good project completion resulting in more revenue recognition in the quarter.

Got it.

One final one, just on the rating agency side, Linda, in the past you talked about some of the number of new issuers to the market, the stats there.

Can you maybe give us one or two lines just on how those trends are tracking thus far?

I don't have those handy.

Perhaps Ray can give us a little bit more color.

But they continue to be pretty good on what we've heard.

We're looking to get some more of that information together for Investor Day but let me see if Ray has anything else to add.

I was just going to add and I will ask Michel Madelain if he would like to comment on this, but I think the new mandates have been continuing at a relatively steady pace, so no spikes in new mandates.

But it also continues to be a good pipeline for us and, Michel, if you have something to add, please do.

No, I think what you said is really we continue to see strength in Europe and emerging markets and our pipeline's been very strong, so that trend continues.

Thanks a lot, guys.

Thank you.

I think, again, one way to look at evidence of disintermediation is to look at that European CFG revenue growth number and that would be one way to try to measure what's going on there.

Peter Appert, Piper Jaffray.

The margin performance was very impressive this quarter in the context of the revenue strength.

So I'm wondering, Linda, if this causes you to rethink the potential margin upside in the business over the next couple of years?

Peter, I'm going to ask Ray to comment some more after I do.

I think we're pretty happy with where we are on margin and I think we're going to continue to stick to the story we have that over the longer term we're kind of looking at low to mid-40s.

We're happy with the progress that we've made and I think we're pretty pleased with how the business has been performing on the margin line, as you noted.

Ray?

Two quick reminders.

One is that because of the over plan performance that we had last year and as a result the above plan incentive compensation we had last year, we did have an ability to expand margins this year more aggressively, based on resetting of incentive compensation back to target.

So we don't expect to see that kind of margin expansion going forward.

And the other question will be the relative growth rates of MIS and Moody's Analytics, because the Moody's Analytics business is a lower margin business.

So we have to -- there is the uncertainty of the relative rates of growth of the two businesses in looking out over a number of years.

Fair enough.

Ray, can you give us an update on how you're seeing the legal environment currently?

There was a somewhat high profile suit filed recently.

Any further settlements or dismissals that you could share with us?

No, there really hasn't been a lot of activity.

We've had more than 50 cases filed, ratings-related cases filed since 2007, and a little more than three dozen of those have been resolved, most of them because they were dismissed or voluntarily withdrawn.

We did have a couple of new complaints this year and a couple of what are called summons with notice, which think of them as placeholders for possibly filing a complaint in the future but those don't necessarily end up being actual cases.

That's been about it.

How about in terms of legal expenses, would it be running at a relatively constant level at this point?

Peter, it's Linda.

I'll talk a little bit about expenses as a whole, but we're not going to go into legal expenses, per se.

Probably worth noting that, as Ray stated in the updated guidance, we're expecting expenses to be in the mid single digits for growth rate for all of 2013.

Second quarter we popped up a little bit to a 12% growth rate.

And that was about a $43 million increase.

We expected that someone would ask for some color on that, so about half of that was compensation related, impact of hiring increases, annual compensation increases, some incentive compensation accrual.

Another 25% of that was probably best viewed as professional service cost increases for IT and other things related to that.

We did note that we're now in compliance on both CRA-3 and Dodd-Frank and we had to spend some money to get that done.

The other 25% is basically other stuff.

So expenses as a whole, I think it's pretty moderate in that we're expecting low single digit growth rates over the rest of the year.

And just to be sure we're absolutely clear, so that folks can see how to model this, looking at the number that we have here for the second quarter, it's $405 million.

We're still looking at about a $50-ish million ramp over the course of the year, approximately, more or less.

So if you want to think about how to model expenses as a whole, that might help you out a little bit.

And Linda, do you have the actual incentive comp accrual for the quarter?

Yes, I do.

It was $34.3 million, Peter, and I think we had said we're hoping to have that be a little bit flatter this year.

First quarter was $30.7 million, and this is just the incentive comp, this quarter, $34.3 million.

I think we had guided folks to about $135 million for the rest of the year.

The strong health warning there that if we do better than we expect in the back half, of course incentive compensation would increase commensurately.

Got it.

Thank you.

One last thing.

Just in terms of the structured finance market, strength in the US, weakness in Europe, any commentary in terms of just tone of market and expectations that things might get better going into '14?

With respect to Europe, I would characterize us as hopeful that things will get better in '14.

And I think that securitization does have an important role to play potentially in Europe, as they are looking towards an economic recovery and giving companies additional opportunities to access the capital markets, whether it's capital raising or liquidity purposes.

I think the securitization can be part of a longer term solution.

But right now there's just not a lot of demand and there are alternative funding sources.

As I think we mentioned in previous quarter's call, for example in the UK, the funding for lending program that they have in place.

So in the near term, there are alternatives to the securitization market.

Longer term, I would expect this is going to be part of a solution to the sluggish growth rates.

Whether that's in 2014 or not, I don't know.

Got it.

Thanks, Ray.

Alex Kramm, UBS.

Hi, good morning.

I think at this point just a few follow-ups.

Just wanted to first come back to the whole higher rate, interest rate question that obviously has been asked a lot here recently.

But just hoping if you could give us a little bit more color in terms of what is coming out when you talk to corporates and bankers.

I know it's a difficult question to answer, but what should be the things that we should be looking for in terms of absolute level of rates or increases in pace of rate increases for people to really change their mind in terms of how they think about refinancing or just general issuance going forward?

Related to that, how are you yourself thinking about it right now in terms of looking at the budget maybe for next year and going forward?

Sure, Alex.

I'll take a shot at this and then I'll ask Ray if he has anything further to add.

None of us are fixed income capital markets traders or debt participants.

So I think the information that we gave earlier as to what we're hearing is probably the best indication.

I think to sum it up, the pipelines look good.

They look strong.

And I think the 10 year at approximately 2.56%, 2.58% today, because there will be 10 year sales later on this week, that's below the five year average of 2.73%.

And we'll see how that plays out.

I think that's probably about the best we can do in terms of where we think things are and what will be moving.

High yield is, of course, very rate dependent.

As issuance -- as all-in costs come in below 6%, we usually see the high yield market run very strong and we have seen some indications that, that may happen or it may not.

Leveraged loans, as I had said earlier, are running very strong, both in terms of funding flows and buyer attraction for that paper which is floating rate.

So with all of that, I think your guess is as good as ours, and I'll see if Ray wants to add anything else.

The only thing I would add is just to repeat the views of some economists, including our own.

That for now, they really don't think the Fed wants the 10 year Treasury yield to be much above the 2.5% mark.

And if that's correct, that is still an attractive environment for issuance by historical measures.

Now, obviously if spreads widen out, that would be affected.

But right now, they have been coming back in from where they went to in June.

So reason for cautious optimism there on the rate side.

Yes, no, I appreciate, it's a difficult question to ask.

Then on the second part of the question, anything that you would say how you would respond or when you would think you need to respond or is it too early to tell at this juncture?

If we're talking about a cyclical movement that has an impact on bond issuance, candidly I don't think we would do a whole lot to respond.

Our business, we have to monitor the debt that's outstanding.

We would expect that the debt is -- that additional debt is going to be issued in the future and so it's not a structural change in our business.

It's a cyclical change if it occurs.

And as I said before, a rising rate environment that is accompanied by business confidence and economic activity is not worrisome.

What is worrisome is sort of what we saw in June, where there was fear of rising rates and widening spreads because the rate environment was not -- or the anticipated rate environment was not aligned with a sense that we had self-sustaining economic recovery.

Alex, we'll also put in a plug on Monday in the Wall Street Journal with some information based on data of ours in terms of broadening out its use of proceeds in terms of bond issuance.

You may want to take a look at that.

Little bit of a pick up in M&A, little bit of a pick up in capital expenditures and those are one of the things -- those are some of the things that we're looking for.

Also, as Ray has commented on before, the worst thing for us is a stagflation environment and inflation remains quite reasonably low at this point.

It all boils down to the question of when these pipelines move and encouraged by seeing six deals in the market today, three financials and three industrials, and we'll see what happens.

But again, we have two parts to this business and the Moody's Analytics business is performing pretty well.

Well, then maybe as a segue, just going to the Moody's Analytics business, I think somebody asked about it already but just following up on the ERS side.

For one, you took the US guidance up.

Secondly, you noted that ERS had a very good, strong quarter.

Linda, last time I talked to you about this, you were actually noting that you're starting to engage in or at least try to engage with higher deals, pitching higher -- larger deals.

Anything to talk about, where is that coming from or are you having success?

Is there a big change in this business, where this could actually have accelerating growth from here?

Yes, it's Mark.

I would say that we are having success there.

We are certainly in the US, as I said earlier.

Business is picking up largely in response to work that we're doing for banks related to the various stress testing requirements that are being imposed on them.

That's been a very nice driver of growth in this market and that's why you're seeing some healthier results here.

In terms of deal size, the average size of deals probably remains about where it was.

We do rather routinely win some very large scale transactions.

But I don't know that, at least thus far, it has not substantially moved the needle, if you look at the business overall.

But certainly I think the opportunity is there, again, related to the various regulatory requirements that are being imposed.

That's presenting a lot of opportunity for us here in the US, as well as overseas.

So I think that we're very optimistic about the business.

We have -- we've been saying for some time that we think that this is a business that should grow at a low double-digit to mid-teens kind of rate over the long run and certainly what we're seeing in the environment, what we're hearing from customers suggests to us that, that's going to be very achievable.

Great.

And then just last one from me.

Obviously, it seems like there's been a lot more discussion around restructuring the agencies, like Fannie and Freddie, in terms of bill proposals and things like that.

From what you've seen so far, any indication of how that would change the business for you?

Are there other things that you would like to see or -- and maybe in general, how involved you are in those discussions in terms of lobbying and things like that and any color would be great?

Thank you.

Well, obviously we're aware of bills that have been introduced in Congress, including the Corker-Warner Bill.

I think it's still going to be a long process.

It's not something that we are going to involve ourselves in from a lobbying perspective.

Our job is to understand what the policy decisions are and to make whatever credit judgments that are appropriate, based on those policy decisions, but not to push for one outcome or another.

That being said, if there is a larger private label market for mortgage backed securities, that's going to be beneficial, so we will watch that with interest but without lobbying in any particular direction.

Alex, it's Linda.

There were two interesting things that came through the news overnight.

And Ray may be able to speak to these -- or Michel, with greater detail than I can.

One was a proposal that perhaps there might be looking to be some relief on one of the 17 G-5 related rules of holding 5% on balance sheet of structured deals.

Secondly was an announcement that one of the GSEs had done a securitization of its own -- part of its own balance sheet.

Maybe, Ray or Michel can talk a little more about those.

But we are seeing some news flow in those areas.

Yes, I don't have a lot actually to add to what Linda raised, other than that the observation that I think the experimentation, if you will, with some new securities and financial innovation is probably a positive.

We've been through a period where there hasn't been a lot of financial innovation and testing with some of these new securities types is, I think, supportive of longer term growth in some key markets like housing.

So that's really all -- other than what I've seen in the papers, I don't have any additional insight I can offer on those.

Very great color.

Thank you.

Craig Huber, Huber Research Partners.

Yes, hi.

Linda, if I could -- can you hear me?

Yes, we can.

Hi.

Can you break down for us, on a percent basis or in dollars, your four main categories within ratings, break out high yield versus bank loans, investment grade, et cetera, and do it for all four areas, please?

First question.

Sure, Craig, CFG, we're comparing second quarter 2013 over second quarter 2012.

Investment grade up nicely, last year about $42 million, this year about $60 million.

That's up 43%.

It represents 23% of the total CFG revenues which is about $263 million.

Spec grade up to $57 million, which is 22% of the CFG total and that's up 80% over last year's, 2012.

Again, if one is looking for indication of what does disintermediation look like, that's it.

Bank loans, up to $53 million, 20% of total CFG.

And there we're up 51% over last year.

Other is 35% of CFG, about $93 million.

Going on to look at some of the other areas, structured, Craig, total of $97 million of revenue for second quarter.

First line is ABF, about $25.5 million.

That's about 26% of the total.

Now, that is actually down from last year's $29.1 million.

RMBF, 18.7, also down a little bit from last year.

Commercial real estate, $30.7 million, big increase from last year's 18.2.

And derivatives at $22.3 million, about flat to last year's 21.5, that makes up 23% of the total SFG line of $97.2 million.

Going on to third category FIG, total of $84.5 million.

Banking is 57.5, is 68% of the total the lion's share, insurance, 23.3 is 28%.

And managed investments of $3.6 million is 4% of the FIG line.

Lastly, public project and infrastructure.

PFG and sovereigns, $43.6 million, about flat from last year and 47% of the revenue line there.

Munis, $4.3 million, about 5% of the total for PPIF.

Project and infrastructure at 44.8, up nicely, 39% from last year.

That makes up 48% or about half of total PPIF.

Do you want to do MA as well, Craig?

I think we all have that.

Okay.

Good, good.

I'm okay there.

My next question if I could, please, can you -- as you think back over the last year, Ray or Linda, within your corporate finance segment, how much of your revenues there on the transaction side have been derived from refinancings versus growth capital and how do those percentages vary versus say the prior 10 years on average?

I'm going to have to give you some approximate numbers.

But little more than half of the activity I think this year has been refinancing, with M&A and share repurchase ticking up a little bit, really not on the CapEx side, though.

So it's still dominated in terms of refinancing but we are seeing borrowing for other purposes that is a bit stronger than what we had seen the last couple of years.

Okay.

So it's not significantly higher than, say, 50% coming from refinancing, the best of your estimate?

No, I think that's correct.

It's above 50% but I don't think it's significantly above at this point.

Okay.

And then if we could just switch to legal costs.

What is your best sense of when you think your legal costs on a year-over-year basis will start dropping?

Craig, it's Linda.

We're still not going to talk about legal costs but we did talk fulsomely about our expense outlook.

The only thing I can really tell you is there is a lot of uncertainty around this, because we obviously are working to have cases dismissed as early as possible.

Sometimes we succeed.

Sometimes they move on to the discovery process, which becomes more expensive.

So it really depends on what our success rate looks like with early dismissals and I can't give you a good forecast on that.

Another question, please.

As you look out over, say, the next three years, say here in US, investment grade, bank loans and high yield, can you just talk about how much has to actually get refinanced that's still outstanding and how that maybe looks versus where we are at today for this calendar year?

For 2014 and 2015, a lot of what would have matured has been refinanced.

And that's why we talk about these other drivers being important to the corporate finance growth story here in the US going forward.

It's a different situation as we look at corporates elsewhere around the world, but the US market is an important market for us.

So it is worth focusing on.

That being said, there remains a lot of refinancing that has to occur in 2016, 2017, some comments that we made earlier in the call about the fact that borrowing over the last few years has been of relatively short-term nature and that borrowing is going to come around for refinancing again.

So -- and the investment grade market tends to refinance at a much steadier rate than the high yield market so that's -- we would expect to see refinancing over the next couple of years coming out of the investment grade market in similar ways to what we've seen in previous years.

Craig, you can take a look for those refinancing charts in our updated analyst presentation and we'll share that again, take another look at that again when we do Investor Day in two months.

One final question, if I could.

Your guidance for your four broad areas within your ratings business, out of those guidance numbers, infrastructure finance, corporate finance, et cetera, what are you the most concerned about for the back half of the year in terms of which ones do you think have more potential upside than the others?

And vise versa, what are you most concerned about on your guidance?

I'm not concerned about any particular business line.

I'm really more focused, as I think probably everybody is at this point, on the macroeconomic situation.

How the market will respond to curtailment of quantitative easing, if and when it begins, predictions that it might happen in September, predictions that it might happen at the end of the year.

And market reaction to that and I think there is going to be appropriately a lot of attention coming from policy makers to make sure that the market reaction is not unfavorable and that we don't have tightening of financial conditions in a way that would turn our recovery back in the wrong direction.

So it's not individual business lines.

It's more the macro situation at this point, Craig.

Great.

Thank you.

Doug Arthur, Evercore.

Yes, Ray, just one question.

Corporate finance internationally accelerated in the quarter.

I think it was up 30-ish in Q1 and up 52% in Q2 and you talked about disintermediation or Linda did.

How does the comp look going forward there and do you think that disintermediation in the bond market in Europe is really accelerating at this point?

Thanks.

I think it's going to continue.

We're going to continue to see new mandates.

I don't anticipate it accelerating.

It's been steady and it's been strong.

And that's obviously good news from a bond market volume perspective.

Many of the credits are in the high yield sector.

I expect that, that will continue, since the investment grade credits had largely been in the bond market for a number of years already.

And for some different reasons, I would expect to see a similar result as we look at the emerging market economies in Asia, Latin America, for example, where growth is outstripping banking system capacity.

And that's leading to disintermediation as well.

I don't know, Linda or Michel, if you have anything else you'd like to add to that.

The only thing is that one of the underlying factors in Europe is clearly the condition of the banking system and their inability to basically meet the demands of those issuers and that's true for the high end market basically.

So there is an element of -- there's a cyclical element as well as structural element at play here.

Doug, pretty frequent stories in the press, particularly in the periphery, lesser credits have a difficult time with bank financing and are looking to go to the spec grade markets.

So to follow up on what Michel and Ray have said, we think that trend will continue.

Great.

Thank you.

Edward Atorino, Benchmark.

Just about everything in the world has been asked.

You've got a lot of shares you could buy, take out I think 14 million to 15 million shares.

Are you going to have offsetting issuance or is that really a potential over the next couple years?

Ed, it's Linda.

We tend to have issuance more focused in the front half of the year and we try to keep our equity utilization below 2% for the employees here.

So we're looking, as we said, to overall have reduction in the outstanding shares and thus far we've been able to do that.

And I'll ask Ray if he wants to comment any further on that.

No, it's just -- I think Linda's comments stand on their own.

The original guidance that we had given for approximately $500 million in share repurchase was largely to offset issuance but that's -- that would not be the case with additional repurchases.

Can you conceivably buy 14 million shares of stock?

Conceivably, yes.

Okay.

We'll have to see where the --

I don't want to be a wise guy and say when.

No, we're not going to say that.

Okay.

Thanks.

We're working on it, Ed.

I'm sure you are.

Thank you very much.

Sure, good to have you back, Ed.

And that does conclude today's question-and-answer session.

At this time I'd like to turn the conference back over to Mr. McDaniel for any closing remarks.

Thank you.

Just before we end the call, I do want to make sure everyone knows that Moody's will host its Investor Day on Tuesday, September 24, here in New York.

Attendance is by invitation only and the event will be webcast and further details will be provided on our Investor Relations website at ir.moodys.com.

Thank you all for joining the call today and we look forward to speaking with you again in September and October.

This concludes Moody's second 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.