Q2 2020 Moody's Corp Earnings Call
Okay, and welcome ladies and gentlemen to the Moody's Corporation second quarter 2020 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 that the company. We will open circumference up for questions and answers. Following the presentation I will now turn the conference over to Shove funny Cox.
<unk> Investor Relations. Please go ahead.
Thank you good morning, everyone and thanks for joining us on this teleconference to discuss Moody's second quarter Twentytwenty results. It's one of the <unk> outlook. What do you have 12 to 20 I'm sure many calls.
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This morning movies released its results for the second quarter of Twentytwenty as one of the outlook couple years Twentytwenty.
The earnings press release, and the presentation to accompany this teleconference is available.
Like I always thought Moodys dot com.
Like Mcdonald's movies, President and Chief Executive Officer will beat this morning's conference call.
Also making prepared remarks mckool this morning.
Hey, Moody's Chief Financial Officer.
During the school, we will be presenting non-GAAP or adjusted figures.
But at the tables at the end about adding sequentially Scott.
Any action.
Just mentioned during the school gap.
Before we begin I call your attention to the Safe Harbor language, which can be found towards the end the bombings really.
To date the walk.
Well, what looking statements because.
But Securities Litigation Reform Act 1995 in accordance with the Act I also direct your attention to the management discussion and analysis section under was discussed at all.
Oh, Okay for the year ended December 31st 29 team <unk> quarterly report on form 10-Q for the quarter ended March 31st Twentytwenty.
Refugee filings made by the company, which are available on our website and on the Fccs website.
He's together with the Safe Harbor statement set forth important factors that could cause actual results to differ parity those contained in any such forward looking statements.
I would also like to point out that members at the media and maybe on the call. This morning, and every month I will now turn the corner of the to Ray Mcdaniel.
Thanks, Giovanni good morning, and thank you everyone for joining todays call.
I'll begin by providing a general update on the business, including Moody's second quarter 2020 financial results. Mark will then provide further details on our second quarter performance and also comment on our revised outlook for 20 Twond.
After our prepared remarks, we'll be happy to respond to your questions.
I want to start off by both acknowledging a bike both acknowledging that the strength with Moody's has always been in our people and reiterating our appreciation for the hard work dedication of our employees around the world. During these challenging time, we remain committed to our corporate social responsibility efforts as we didn't the rest of the world filled with both.
The global coated 19 pandemic as well the civil unrest.
Our mission to provide trusted insights and standards that helped decision makers act with confidence has never been more relevant and operating results reflect that.
Echoing the first quarter Moody's strong second quarter was once again driven by robust top line growth at Moody's Investor service as issuers, salt liquidity and opportunistic refinancing amid broadly receptor credit market conditions.
Also along with our long term strategy, we continue to build towards the future as we embrace our sustainability efforts and develop new products and solutions that meet the evolving needs of our customers.
As a second quarter exceeded our expectations, we are raising and narrowing our full year 2020, adjusted diluted EPS guidance range [laughter] joint dollars on 80 cents to $9 in 20 cents, while still expecting debt issuance to taper in the second half of the year.
Amidst the global pandemic and what's the emergence of civil unrest focused on racial quality safety and well being of our employees remains Moody's top priority, we're committed to providing a safe work environment for everyone.
As such we've been conducting awareness and train campaigns and encouraging our employees to speak out can engage with each other on these important topics.
We're also building better programs to attract retain an advance black talent.
We pride ourselves on being an inclusive from were divorced diverse viewpoints lead to better decisions and where everyone's contributions matter.
But our prior earnings call. We noted how our early adoption of technology enabled us to trends this transition smoothly to virtual environment.
We are building on this experienced by working with our employees to design our future workplace models.
We believe this approach will enable us to attract and retain the best talent not only in locations in which we have a presence potentially anywhere.
Moody's strives to be a constructive, forcing older communities in which we operate.
We mentioned in our prior earnings call. Then in response to covert 19, we made our research insights and certain products accessible to the public at large including our customers and policymakers.
These offerings within the first half the year translated into about $12 million in college contributions.
In addition, we've committed $1 million to promote equal justice and the advancement of the Black community. While also increasing financial support for our partners focused on empowering black owned businesses and enhancing diverse recruiting.
Finally, before I get to the results for the quarter I'd like to draw your attention to the recent announcement made on the enhancements to our environmental sustainability program.
As part of this effort, we've committed to remaining carbon neutral agreed to procure 100% renewable electricity and set science based targets for reducing our greenhouse gas emissions.
Through these commitments we are proud to further Moody's purpose to bring clarity knowledge and fairness to an interconnected world.
Moving on second quarter 2020 results Moody's achieved a robust 18% increase in total revenue with 27% growth from M.I.S. and 5% growth from M&A.
Moody's adjusted operating income of $766 million is up 28% from the prior year period.
Strong revenue growth combined with ongoing disciplined expense management drove 410 basis points of adjusted operating margin expansion.
Adjusted diluted EPS of $2.81 was up 36%.
I will now provide an update on the credit markets in the second quarter.
Pandemic has had a significant negative impact on the global economy, resulting in widespread unemployment negative global GDP.
Estimates and other recessionary conditions this country shut down their economies in order to contain the spread of the virus.
This morning's reported second quarter U.S. GDP contraction of nearly 33% is a stark reminder of this.
To mitigate the economic impact governments have undertaken unprecedented global monetary easing efforts in fiscal actions, which had thus far enabled supportive fundamentals and robust activity in the credit and equity markets.
Most recently, we've observed the E proposal to raise debt to fund the 750 billion Euro stimulus plan to eight its member nations hardest hit by the pandemic.
In the U.S. the Federal reserve has extended its emergency sports facilities to the ended the year and the U.S. government has any discussions to extend fiscal stimulus measures.
As a credit markets continued to read through severe economic stresses and governments quickly took actions to mitigate.
A dichotomy the real economy remain.
Investment grade issuers responded to economic uncertainty by shoring up their balance sheets with record levels of bond issuance I.
Additionally, after being enacted for most of March high yield bond issuance surged as spreads tighten.
Well leverage goal loan market reopened but has been slower to recover.
Looking towards second half the year, we expect issuance to moderate as many countries and institutions have completed their balance sheets and liquidity strengthening initiatives and governments may see less of the need to intervene in support of their economies.
As I just noted given uncertain economic conditions companies look to bolster their balance sheets and the first half of the year, while capital markets where receptive.
You can see from the chart working capital and debt refinancing became more prominent drivers of issuance, whereas mergers and acquisitions has historically been more often cited use of funds.
This restaurant liquidity also helped to explain the dichotomy between the performances economy and capital markets. As many issuers took advantage of low rates create fortress like balance sheets to help see them through this period of uncertainty and stress.
I'd like to further highlights second quarter issuance, specifically within the corporate finance sector.
As you can see second quarter corporate investment grade issuance was up significantly together with solid high yield supply, but bank loans continued to lag.
This mix caused the rate of corporate finance issuance growth to outpace transactional revenue growth due to larger more frequent issuers coming to market.
Despite this headwind issuance growth was beneficial to our operating results and I might ask exhibited significant top line growth growth, which mark will discuss further.
Covert 19 has had wide reaching impact on nearly every sector of our global economy.
The second quarter, the default rate rose and as Mark will touch upon later our guidance assumes that we'll continue to do so through the end to the year.
During these turbulent times, the quality and consistency of ratings becomes even more important.
Therefore investors look for transparent methodologies that follow a measured thoughtful and systematic approach.
These processes ensure that we are consistent and rigorous in delivering our rating opinions and research.
Our starting point is to assess and ranked the impact of an event such as cobot 19.
But it has on various sectors. This then flows through to the underlying issuers as shown on the chart on the bottom left.
Which list the most impacted sectors, but the percentage of issuers downgraded within each of those sectors.
It is important to note that ratings quality remains and Myos is top priority. We continually strive for exceptional ratings performance as you can see from the graph on the bottom right corner Moody's ratings have performed very well on an ordinary ranking basis with a lower rated debt exhibiting higher default rates for the trailing 12 months as at the end of June.
In 2020.
Rudi's long history of ratings quality investors have come to expect our ratings to look through the credit cycle. So that no I'm certain terms like these investors can compare ratings not justify issuer, but also overtime.
Turning to M&A I want to update you on how the business continues to adapt to the current environment.
Last quarter, we discussed took over 19 could impact our customer renewals and new sales activity. We are encouraged by the observe trends in both of these categories as they are proving to be better than expected.
Ladies retention rates remained strong at 94% demonstrating the relevance of our products during times of stress while sales grew despite the lack of in person needs, providing us with momentum as restrictions begin to ease outside the U.S.
Looking toward the sales pipeline for the second half 2020, we're more optimistic than in our prior outlook has compliance and accounting products have provided better than expected growth opportunities. Despite current headwinds.
Throughout this challenging time Weve remained focused on our customers rapidly evolving needs for integrated and holistic risk solutions.
This slide highlights some of our second quarter innovations enhancements that increased the collective value of our offerings.
I will focus on the recent additions and improvements to our SG and climate product suite as well as the new pulse tool.
Thought leadership in the U.S.G. and climate risk remains a key strategic priority for Moody's.
As its importance for our customers continues to grow and we are encouraged by the demand for these products.
In first half of this year Vizio Iris completed 29 issue were paid sustainability ratings 46 second party opinions and nine sustainability linked loan assessments.
During the second quarter video Iris launched its enhanced second party opinion service, which enables more impactful issuer communications and provides increased transparency for investors.
We're also excited to announce that through partnerships with Euronext and selected.
We continue to build our present, serving index space, including the creation of the new Euronext SG 80, and selected the he developed markets SG quality indices, which use because your wireless data to screen it's constituents.
In addition to these new SG in climate risk initiatives. We're further integrating this year wireless and for 27 content into multiple and they platforms, including Moodys dot com and release, which should provide additional channels for exposure and monetization.
Moving on to pulse this tools launched by the Moody's accelerator to help our customers quickly consume and digest the ever increasing news flow.
Pulse utilizes machine learning and natural language processing to gauge sentiment around news such as covert 19 on a chosen company or sector, enabling investors to more quickly assess the impact of the news article on their portfolios.
We continue to invest in these types of product innovations, which allows us to better to provide better value and insights to our customers to help them make better decisions.
I'll now turn call over to Mark today to provide further details on Moody's second quarter results and our revised outlook for 2020.
Thank you Ray.
The second quarter recording basement, great activity.
And my its revenue growth of 27% from the prior year period issue is look to ensure sufficient liquidity. In addition to opportunistically refinancing the debt portfolio and thats ongoing economic uncertainty.
Hi, you'll issuance also increased in the quarter issuance took advantage of Brody receptive credit conditions.
The strong activity in the fixed rate been buckets was partially offset by weakness in bank loans has invested demand remained muted for floating rate instruments in a low.
Great environment.
Structured finance was the only line of business that experience and overall declining revenue primarily due to the decrease in asset origination.
Oh, yes rate to issuance growth that 53% exceeded total transactional revenue growth of 39% as we noted issuance mix with skew towards large frequent issuer corporate finance and this was also the cakes in public project and infrastructure finance.
You might you adjusted operating margin expanded by 390 basis points as revenue grows significantly outpaced the increase in operating expenses.
In a second quarter revenue growth of 5% or 8%, excluding the impact of Ambacs divestiture and acquisitions, along with FX headwinds demonstrated resilience as customers came committees in search of integrated risk solutions.
Our DNA revenue grew 16% was 7% on an organic basis, driven by strong demand for new customers solutions as well as credit research and data feeds.
Any oriented revenue grew 12% or 7% on an organic basis, they buy south with sales of I've already 17 products that enable compliance. We can you accounting standards for banks and insurance as well as credit assessment to origination solutions.
In the second quarter.
Adjusted operating margin increased 50 basis points, primarily due to topline growth and ongoing expense discipline.
Before I turn <unk> full year 2020 guidance I will mention some of the macro assumptions that have changed since our last earnings call and which continue to shape outlook for 2020.
No typically we have shifted the majority of oxy directional marketers from decelerate to accelerate as shown overwatch inside the slide.
We considered these markets are not database case scenario, which assumes a continuation of the based economic recovery into the second half of 2020 and not linear improvements in cause the biking cases, a macro economic assumptions include.
2020, Grayson eurozone GDP to decline approximately 6% to 9% respectively. The U.S. unemployment rate to end the year at approximately 10%.
Benchmark interest rates to stay low bit high yield spreads remain in excess of 650 basis points.
And the high yield default rate to rise to approximately 9%.
As we head into the second half of the year look closely monitor both macro economic backdrop and credit market activity that ray highlighted previously.
Moody's outlook for 2020, if based on assumptions regarding many geopolitical conditions and macroeconomic and capital market factors. These include but are not limited to be impacted because it 19 pandemic responses to the pandemic by governments businesses and individuals as what is the effects on interest rates foreign currency exchange rates capital markets like.
<unk> activity in different sectors of Dick markets.
Oh assumptions also increased general economic conditions in GDP growth in the U.S. and worldwide on the Companys operations in personnel and additional items as detailed in the earnings release.
These assumptions are subject to uncertainties and results for the year could differ materially from our current outlook.
Oh guidance assumes foreign currency translation at end of quarter exchange rates, specifically, a full cost for the remainder of 2020 reflects the U.S. exchange rates for the British pound of $1.24 cents and for the Europe of $1.12 cents.
We have raised full year guidance for most key metrics as compared to the price full cost and now anticipate that Moody's revenue will increase in the low single digit percent range.
Oh I put your vision.
With regard to regain pop cases that operating expenses, which we now expect to be approximately flat year over here.
The resulting in pretty good operating leverage the ports upwardly revised adjusted operating margin guidance range of 46% to 48% 48% to 49%.
We are reaffirming posted net interest expense and the full your effective tax rate guidance ranges $180 million to $200 million and 19.5% to 21.5% respectively.
Weve increased inherit the diluted EPS full cost to now be in the range of $8 in 15 cents to $8.55.
And the adjusted diluted EPS for cost to now be the range $8.80 to $9.20.
Free cash flow is now expected to be between 1.5 and $1.7 billion.
The guidance it seems and anticipated restructuring program in the second half of 2020 around the rationalization that exit of real estate leases estimated to resulting total pre tax charges approximately $25 million to $35 million, an estimated annualized savings of $5 million to $6 million respectively.
Well first of all guidance, please refer to tables, one of our earnings release.
Yes, we anticipate full year revenue to increase in the low single digit percent range and for raging issuance to grow that low double digit percentage range.
My guess is full pasta seems investment grade activity for the full year increases, 50% from up fire assumption of 10% growth.
Hi issuance increase is 5%.
From a 20% decline.
CLO issuance declined 20% up from about 40% decline.
And structured issuance declined 40% in line without prior expectations.
As Ray mentioned after a record first off we expect total issuance to moderate.
Many issuance has its own their near term funding needs some having come to market multiple times.
As coated 19 has been more impactful on first time issue than anticipated we have reduced I'll first time mandate full cost from 680 550.
We also anticipate that M&A activity will remain constrained in the second half of 2025.
Finally, we believe that they will be lower proportion of infrequent issue activity, leading to a less favorable mix.
Yeah. My its adjusted operating margin is full cost to be in line with the prior year at approximately 58%.
We all piece to reaffirm m- full year topline growth and margin improvement guidance get strong recurring revenue base and renewal activity.
It means revenue guidance for takes two to three percentage points neat unfavorable impact from the Max divestiture and FX.
Partially offset by grades from acquisitions.
We continue to expect the it may adjusted operating margin to expand over 200 basis points in 2022 proximity, 30%, primarily driven by the ongoing transition scalable subscription based products and expense discipline.
I would like to address our capital allocation approach given the current environment.
<unk> performance in the first top 2020 had been better than expected they remain significant uncertainty for the remainder of the year.
As such we believe it isn't the best interest to watch stakeholders to continue to evaluate at least for the time being I'll share repurchase program on a quarterly an opportunistic basis.
As you consider the resumption of share repurchases in the future we will closely monitored the quite a bit Nike pandemic and its effect on both our business and the broader economic environment.
Also close you review bucket indicated some volatility lots of prospects for uncertainty surrounding our free cash flow generation.
Over arching goals remain to compare it can ensure financial flexibility effected liquidity management strategic investments in our business and prudent allocation and returning capital to cheat profitable and sustainable long term growth and value.
Finally, our capital allocation leveraged remain unchanged.
Before turning the call back over to rate I would like to highlight a few key takeaways.
First Moody's remains committed to investing in our business to support key stakeholders and demonstrating sustainable stewardship.
The second, especially in times of uncertainty the relevance of our rich product and service offerings increases, which is reflected in our second quarter performance.
Last given the strong first Hoffman early signs of economic recovery, we are pleased to be able to upwardly revised 2020 outlook.
I'll now turn the call back over at you're right.
Okay. Thank you Mark. This this concludes our prepared remarks and joining market me a in the virtual format for the question answer session is Rob Fauber, Moody's Chief operating officer, we'd be pleased to take your questions.
Thank you, ladies and gentlemen, if you would like to ask a question. Please dial star one on your telephone keypad. If you were on the speakerphone. Please pick up your handset and make sure. Your mute function is turned off so that your signal reaches our equipment. We will ask that you. Please limit yourself to one question with a brief follow up.
And welcome to rejoin the queue for any additional questions. You may have again that is star one to ask a question. Our first question comes from Judas Sokol with JP Morgan.
Hi, good morning, seeking for taking my question.
Well, let us start off by asking just about your outlook for am I asked and embedded inside of that your issue. Its outlook. You gave helpful color certainly on the on the changes that I guided I was hoping that made you could pull back to the covers a little bit more just in terms of what you're expecting in.
So far that tapering down of issuance to what extent because it's just a function of tougher year over year comps how much pulled forward you, perhaps think that there was into the first half and then thinking longer term, perhaps maybe that there's some sustainability in those higher liquidity driven a fortress balance sheet increases. Thank you.
Hi, good take good morning. This is mark what will be curious similar to what we've done in the past well talk a little bit about issuance drivers that we're hearing from some of the banks and then I'll turn it over to Rob on the left without internal viewpoint.
Starting with the U.S. investment grade the banks seem a record activity in the first half the year with year to date issuance volumes Iridium <unk> full year 2019 levels early in the quarter. Many issue. It's a came to market where towards the higher into the investment grade spectrum that excess Gordon considerably when spreads tightened as a result.
Liquidity programs. The main issuance drivers were liquidity in refinancing as you mentioned.
The letter, which was opportunistic in nature.
In some instances as issue is capitalized on low effective yields.
For the remainder of the year, what we're hearing from the banks is that while market conditions remain unchanged remains favorable many investment grade bars have already issued at least once in the first off and the M&A pipeline remains relatively light.
Furthermore, I'd say that endemic the pace at issue economic recovery.
Coming your way selection their relationships between the U.S. in China continued to be prominent at concerns as the banks have expressed.
I'm looking forward the banks are expecting much like to second half of the year.
Nevertheless for full year 2020, they expect us investment grade issuance to be up 40% to 50% and then just as I said, one what I can just to keep in mind that for comparative purposes.
Thanks, Ethan gives me great issuance or increase about financials.
Moving onto U.S. speculative grade.
Once activity resumed following the slowdown in March two to cope with 19.
Issuance recovered with a record second quarter the phase expansion in scope buckets asset purchases to include high yield corporate it was supportive of the market and that helps spreads narrowed considerably from the peak in late Q1.
This in turn important market access and able to Grady number corporates at the lower end to the speculative grade to complete transactions.
On the other hand leveraged loans remained weak overall.
Overall, despite some positive bursts of issuance in the second quarter and this is due to significantly reduced M&A pipeline at lower levels of New Zealand formation, and a greater preference for fixed rate debt.
Despite the improvements and that the banks noted that they saw in the speculative grade market. They did have some concerns that remained around credit quality default risk and secondary market volatility that's for the full year. The banks indicate that you as high yield bonds are expected to be flat to up 10%.
And at U.S. loans are likely to declined by approximately 20% to 30%.
Turning briefly to European investment grade.
Year to date issuance volumes have been or best with record.
Second quarter volumes as the market retired from the code that 19 related volatility in March.
While monetary policy in increasing fiscal support has helped narrower spreads they do remain whether that's pretty close to 19 levels.
Furthermore, low effective yields in the U.S. investment grade market had made reverse Yankee issuance of base attractive.
Given the requisite supply in first half of the ER and the limited M&A pipeline. The banks expected significant decline you issuance in the back half of 2020.
For the full year at the banks full cost European investment grade issuance to be within the range of.
That's up 10%.
And finally, our European its speculative grade has seen a mixed recovery following the market disruption in March.
With improvement in high yield bonds, while loans remained quite weak although spreads have tightened I did not fully recovered from prior whitening.
Exits in the markets time remains concentrated towards the higher end of Spain great.
While they have been a few recent M&A announcements in general the banks belief of pipeline remains light.
With that I'll hand, it over to Rob to update you want and biases issuance expectations.
Thanks, Mark in June a nice to have you on the call.
So let me focus on what this means for full year outlook.
Outlook for issuance and in particular or what it implies about the second half of the year because I know that's an area of real interest to many people on this call.
So as we indicated.
On the webcast, we're now looking at low double digit growth and global rated insurance for the year.
And that implies issuance in the back half the year is going to be down in the neighborhood of mid teens percent versus the second half of 2019.
The outlook that we got through the second half the years, it's pretty consistent where that's actually it's probably slightly more constructive than our outlook for the second half on our last earnings call. So what we've done is essentially taking the excess issuance from the second quarter.
Ended the forecast and maintained a fairly consistent outlook for the second half year. So let me just break it down by segment again I know, there's an interest in this.
You know you round numbers, we've done about a trillion and global investment grade year to date, we expect as we said to be up 50% for the year that implies essentially flat for a investment grade corporates for the second half of the year. So what that really means then is that we're expecting essentially a business as yours.
Oil environment like we had in the second half of 2019 for the investment grade market. That's you know contrasted obviously to what we saw.
And in several months here in the beginning of year. There are few things underpinning that obviously all this significant opportunistic your activity. We've had a mark just took you through the bank outlooks and I think our outlook is quite consistent with what you're hearing from the banks.
And then finally, you know and we've been signaling that since the beginning of year, just the potential volatility in the second half around the U.S. elections, and any kind of second wave.
On leverage finance were slightly more constructive as they think you saw from the numbers in the webcast document we wore Bakken.
And in the first quarter, but that said, we still expect those markets to be down meaningfully for the back of the year and that's due to the.
All that surge in financing Mark touched on as was the expectation of credit issuance.
Ray Mark touched on on our view on defaults. So we're looking for high yield to be up 5%.
For the full year loans down 20%.
On structured finance.
Looking at down 40% and that is a little bit a little bit we've we've moderated that outlook a little bit since the first quarter. So we've taken that down just a little bit you know given what we're seeing in CMBS. Its yellows, just being very heavily impacted.
With a much softer investor bid there and then finally, maybe just to add yeah, yes public finance that's been.
Been very active in the first half a year and we're looking for that to be up somewhere in the neighborhood of about 5% through the full year you can talk about the drivers.
Around that later.
That's great. Thanks for that really tough has an answer maybe just one quick follow up just around M&A margins I'm just.
You guys reiterated your guidance for the topline and for margins, which implies that the back out it's kind of be a stronger year over year impact in terms of that markets. Maybe you can break down the components of what happened in Q2 margins and I really what's going to pick up in the back half as far as does that mean margins are concerned. Thank you.
The younger Martin the second quarter, we reported.
Thanks Ray in the second quarter reported margin expansion of that's 50 basis points from 28.2% to 28.7%.
If I think about the breakdown is that it's around 130 basis points encroach on core M-, primarily driven by our DNA.
Nine basis points of growth from the Max divestiture will sit by some inorganic acquisitions commit around 160 basis points of contraction from incentive comp true ups and FX. As you noted we have maintained on 2020 M- segment margin guidance of approximately 30% which represents.
Well it around 250 basis points of margin expansion I'm on a trailing 12 month basis from 2019.
I would do you expect continued margin expansion over the longer term.
We may see pressure in the next 12 to 18 months, depending on the duration and severity of the ongoing code that 19 economic impacts.
But you're maybe just a quick a few more points here.
The plan for really any margin improvement.
The continued any of the initiatives that are already under way and so for example, first in your Ace is ongoing transition to a software as a service model, which had multiple benefits beyond just increasing recurring revenue as sick and just the synergies between BBB and RBC. We previously mentioned strong growth, we're seeing from they'd be d. and we have already.
He said and the POS earnings call that we expected maybe 20% take artful those compliance solution.
Combined PVD RTC business and in third and increasing efficiencies across and Moody's analytics and that's you know by Combinational you cost savings initiatives increased operating leverage at the business scale et cetera. There are a number of things that we're getting to maintain and continue to grow margin that overtime.
Okay. Thank you.
We'll go next to Alex Kramm with you yes.
Hey, good morning, everyone I guess, a good afternoon.
You know just coming just came back to the I might ask maybe this is for drop or maybe for ray.
You know obviously you gave guidance last quarter and you know the second second quarter surprised a lot of people right. So you are definitely some conservatism that's not that's all wrong I mean unprecedented times, but if you look forward to your I mean I guess.
Why should we have confidence in that outlook and maybe to ask better Greg what are the areas. We are you know things could still fall significantly one way or another Nick what are the things that we should be watching the most a way it could be different to the outcome.
Well.
I'll just beginning with a couple of remarks, I'm, Alex and then let Rob.
Jump in but.
You're right. We were we were much too conservative about second quarter activity at the time of our prior earnings call and a that was a.
In part.
Yeah underestimation on our part of the scope of emergency support that would be coming from the government.
Extending down into the speculative grade area, and and really providing a lot of market confidence against what was what was happening in the real economy.
And as we look forward certainly the extension of that emergency support.
And again, the continuation of market confidence because of that could be one source of upside going forward and that's an addition to the obvious things like creation of the vaccine sooner rather than later.
The recovery of the economy, taking on a a sharper V shape and a and you really a a return to competency business expansion that comes from that.
Let me turn it over to rub four for any additional commentary Rob.
Yeah, and Alex maybe just now kind of maybe tied a little more specifically to kind of how we're thinking about the issuance outlook in how you might think about upside and downside to to where we are you know a few areas I think there can be some upside there can do some more.
Runway for non U.S. issuers, and we've obviously seen enormous issuance in the United States very strong in Europe, but not as strong as the United States. So there's the possibility we could see something there that some sort of sustained run of supply in the leverage finance market, you know fallen angel issuance.
Improvement in the outlook for the bank loan sector.
You know M&A, we touched on that down very sharply I mean, we're seeing levels, we haven't seen for for years, but announced M&A is down something like 50% year to date.
But no theres the Pos possibility that we could see some distressed M&A.
There are some deals getting done so any kind of uptick the M&A environment would provide some upside.
And then and this may not or may not materialize in 2020, but you know if there were an infrastructure bill.
If there were a ultimately changes to the tax Reform Act.
Refunding restrictions that impacted the public finance market like I said, that's probably the next year, saying rather than this year and then on the downside I touched on that but and Ray did as well you know that central second wave increase defaults in credit stress that caused you know slippage in the lever.
Richmond adds markets and just in general again more volatility around the elections and we've already anticipated. So that's kind of how we're thinking about the pluses and minuses.
And I wasn't one at least.
One one area that.
It could be a plus or minus is.
The nature of the borrowing that has been going on and the question of whether its pull forward or whether it's a it's not and so I think of that as as what we've seen in the second quarter and what would probably we'll see in second half of the year is what you might.
Think of as a contingent pull forward in that as companies become more comfortable that they don't need to hold as much liquidity.
And hoard cash to the degree that they are currently.
They could use that that cash on the balance sheet to pay maturing debt.
If they don't remain.
Confident with the ability to use that cash if they feel they need to whole dry powder and they have maturing debt. They could go back into the market. We we don't know which way that's going to play out, but it's an important potential plus or minus.
Okay, great. Thank you for that as well Mark switching to yield just very quickly I guess.
Construction, but you're doing here I'm on the real estate side I mean, it's this already making decisions around where workforce is going to be into future. How your real estate is going to look at coming out of this and it made it very quickly related to that and what does this meaningful results I mean, they obviously that real estate business is if you're turning more negative.
Real estate, what does that impact the business at all thanks.
Hi, Alex that I pretty thinking for the question I would like to maybe first highlights that this real estate risk related restructuring program.
<unk> is one aspect of the disciplined cost management that we've exhibited a in this challenging environment.
And as we talked about in our prepared remarks, I'll adoption of technology and the ability to transition smoothly to working virtually has enabled us to consider.
Working with all employees to designed and developed and the beginning of the format of office is going format going forward.
This will include what we think of isn't enhanced capabilities to attract and retain had the base talent not just an outstanding location could potentially anywhere I mean to your point for those if not seen it yet in the press release, all guidance assumes an anticipated restructuring charge in the second off the 2020 around the rationalization and exits of certain real estate and he says.
They don't estimates to result in total pretax charges of $25 million to $35 million.
We expect majority of those charges to be recorded in the second half of this year. That's going to result in an estimated annualized savings of $5 million to $6 million at the program Kids code that 19 related.
And that Weve faced a real estate footprint given the successful ability to work from home during the pandemic and there are puts the degree to which we can continue to be more flexible on work from home arrangement. So post close to 10, 19, I'm kind of it to a robin breeze.
Yeah, Alex I think probably a positive Phillies I mean, we're in it in an environment of heightened uncertainty.
Everyone in the commercial real estate market, it's having to really manage risk.
Having to connect many many dots we're hearing from our customers that theres a desire for integration of the kind of contents that we have all the cross Moody's not just.
What we what we acquired were three so we think we can bring some very interesting solutions to bear for our customers.
To help them just make better decisions around real estate.
Alright, Thank you and sorry for the two two parts snooty question there.
Yeah.
And we'll take our next question from Toni Kaplan with Morgan Stanley.
Great. Thank you I'm just looking at margins within their rating segment on the margins were little bit below your largest competitor there, whereas in first half of 19, they were above and I understand you can't really comment on their margins, but just looking at your business I guess how would you.
Like talk about whether or you reinvesting more in ratings now versus last year or any just not.
Cut back as much I know, it's a comparison so hard hard to do that but just trying to understand the delta between the markets. Thanks.
Sure Hi, Tony.
And I, maybe started by noting that protect moodys fully allocated corporate expenses out to our business segments, which could be different maybe approach taken by some of our peers.
Our second quarter 2020, M. <unk> expenses were $369 million, which are up actually 5% over the prior period. However.
If we adjust the several one off expense items this quarter, including but not exclusively I think like legal accrual prior M&A and higher incentive compensation related to strong business performance.
Am I guess expenses would actually be down 5% quarter over quarter.
That would have translated to an additional three to 400 basis points of margin that you would have been able to see not reported results.
Got it that's helpful and in terms of I know, there's just been asked in the first question, but Rob I'm wondering if there's a way to talk us through the bridge of how low double digit increases in nature issuance, resulting in low single digit increases in and I asked and I know you.
I mean, it to mix, but is there some way to quantify or frame the mix impacted so that when we're thinking about our estimates going forward, we sort of has some inputs in terms of being able to.
I understand what the mix impact looks like.
Yeah.
Rob you, Okay, what should I turn it yeah.
Yeah, and let me let me just start with you know kind of how it worked out in the quarter and I can talk a little bit about than how we think about that for the outlook but.
Obviously.
This quarter, we saw a less or less favorable mix. The primary drivers that were just all this investment grade issuance, where we've got a greater mix of issuers on frequent frequent issuer contracts and we also saw some are strong and issuance from the PPI off segment, including subs.
Robert.
And there are we tend to have a little bit lower yields and also infrastructure, where we saw some lower yielding jumbo issuance. So we had said this I think earlier in the year that we thought mix was going to be an uncertain factor and could actually provide a little bit of headwind.
For us and I think our view is that that is consistent for the back half of this year.
And just simplify it just simplified a bit.
Looking at the relative strength of the investment grade sector versus the spec grade sector.
Provides a clue as as to whether we are likely to grow.
Head of issuance rates or behind issuance rates simply because most of the entities on frequent issuer pricing agreements are in the investment grade sector, we don't get the same.
When issuance goes up in that sector as we do in the speculative grade sector.
Thanks, a lot.
Well go next to Kevin Mcveigh with credit Suisse.
Great. Thank you very much too when you could talk a little bit about the urgency synergies.
Acquisitions.
Kind of some crossing the t's crossed CVP into more section.
Excellent returns.
Yeah, I'm all a lot of my colleagues, but addressed this but.
Kevin just want to welcome you to the coverage in the call.
So let me, let me turn the subsidy that through over to my colleagues.
Yes, Kevin So let me talk a little bit about how we're working together between DVD and already season, the kinds of synergies that that we're seeing.
Obviously, we've got a challenging sales environment, but the sales teams at both both companies have been working together.
I have an opportunity to offer a more complete solution.
No we haven't fully integrated those solutions, yet since still offer those solutions together and we're doing that.
For our customers and we think that ultimately that's the most compelling end to end offering in the market.
We're also cross selling into the existing relationships at one or the other companies as you know maybe they had a bigger European customer base, historically, RTC, a bigger U.S. customer base. So there's a very concerted sales effort there.
And lots of demand and so we're building a pipeline for that.
We've talked about out in the past Theres, a myriad of use cases for all of their BBD and now RTC data.
And maybe give you an example of that.
Work, we're seeing more and more companies and I am talking about very large corporations, who are looking to address financial crime and and reputation all risk concerns. This is basically trying to understand who they are doing business with and it's not just.
The banking community so they're they're looking to use our beneficial ownership data our adverse media tools.
And covert I think is actually prompted a need to get this work done through automation rather than just relying on manual back office functions and that again is really playing to the opportunity that is in front of us. So we're seeing some very nice.
Opportunities both in sales and in terms of pulling the products together to meet emerging needs of of of our customers.
[laughter] Super helpful. And then switching gears real quick you or else.
The arts.
<unk> isn't changing competitive landscape for one keno recently gone public.
Yeah Kevin.
That's a great question in fact, it's something that we as a management team has been quite focused on.
Just because obviously this this company went public recently with an IPO.
I've been valued I didn't the market capitalization is something like six now billion dollar. So I I think it actually helps to eliminate the value of our European business.
I think everybody Mccollum knows we've got a pretty similar SaaS based software business that sells to financial institutions.
But I would say our business a lot bigger I mean, just looking at the numbers if I recall right.
We generated over 500 million in revenue in 2019, I think they were something under a 100 million.
And our strategy over the last few years, there's going to shift to more subscription based revenue models and that means that almost 80% of our revenue in ers is recurrent and we've got as you saw very high retention rates given the business critical nature of the software.
Are they are busy you are asking this is really selling up a broader range of solutions to a broader set of financial institutions write as much as banking. It's also insurance to help them make better decisions around credit and yes.
And specifically you know in regards to kind of thinking about the competitive landscape and the overlap we've got an offering called credit loans and your assets a SaaS based platform. It helps lenders by pulling together our data sets our analytic tools our software.
And we have some common customers with encino, but encino is really focused more on end to end workflow and what we found is that in some cases, our solutions are actually complimentary are part of their broader offering, but but it's very interesting comp I think for.
Segment versus the more traditional business information competence.
Try to seems very helpful. Thanks, so much.
[laughter].
Our next question comes from Manav Patnaik with Barclays.
Thank you get up and I.
I guess I wanted to focus just on you'll see you know clearly there's a lot going on in the world out there seems like there's lots going on the war companies as well.
You got the magellan's they can be Gyrates, you sound like a buck in selective so for.
We are there any limitations to be angle you can come at you see from and you know is the ultimate goal more around partnership so actual acquisition so okay.
Yeah, I'm not all I'll take that one I'm.
So I don't think there's any limitations the.
I'd say, it's still a.
Relatively nascent market, but certainly growing quickly there's a lot of demand across a across the financial markets and certainly cros are our customer base and we've talked about this before we don't.
I don't have the operating leverage that's afforded by the index business. You did hear that we are starting to partner with index businesses to provide them with the data. So that's a way for us to get access to the index space without actually owning an index business. So I think there you would look for us.
Build our our presence through partnerships and partnering with index players, who don't own U.S.G.
Businesses, we've done a few things here and I think you'll see that.
A lot of this is organic we're doing a lot of organic investment because we have the capabilities in house, we bought some some assets that bring some very valuable domain knowledge.
We just recently appointed a new head of U.S.G. and climate business internally before that she was running all of our Moodys Dot com business very big business for us. So it gives you a sense of how important we think this this is.
We're integrating these yes gene consideration into our credit work investors are started subscribers are starting to see that on Moodys dot com.
This past quarter, we began featuring U.S.G. and climate contents from Vizio Iris and for 27 on our credit our flagship credit view platform.
And then ray talked about some of the numbers around rating products for issuers, so theres, a and emerging opportunity to provide the sustainability ratings and second party opinions on label bond issuance.
For issuers paid for by issuers. So you know it well. This is still a you know we've given a number before that we're expecting something like $15 million to $20 million of revenues for the year.
It'll take some time for this business.
To grow in scale, but there's certainly demand and we're certainly making investments.
Got it that's healthy in just a few often don't feel it second part D. Opinions of bonds is that in addition to what you already do on the leading sites is that almost like a consultancy lumped into the charge on top the Buffalo.
Yeah, certainly I don't use the word consultancy, but it.
As a natural complement so as you're as you're issuing a green bond or social bond. It's a it's a it's going that most likely get a rating from moodys and we have an opportunity to provide a second party opinion on the use of proceeds and its consistency with yours.
Green Bond framework, so it's a natural thing for us to be offering to our issuers alongside each other.
Got it. Thank you that's helpful.
We'll take our next question from Bill Warmington with Wells Fargo.
Good afternoon, everyone.
So a though a question for you on the on the China domestic rating business given the political.
Tensions that we're saying I'm not sure if today are getting a little better or worse, but they.
I wanted to ask what your thoughts were turned to the opportunity there when do you feel better about that of the worse about that and what would you need to see evolve there for you for that opportunity to really start to take off.
Yeah, Bill it's right.
I would say in the near term.
We're probably in more of a holding pattern. Then we would have anticipated six or 12 months ago, we're still very satisfied with our joint venture investment in CCX I see say IXI continues.
To grow nicely and due to is the.
Largest and most profitable of the domestic Chinese rating agencies.
Clearly the tension between the U.S. and China is not encouraging business activity between the two countries is not encouraging favorable decisions on a whole range of things and so what I think for the short term we're gonna be doing is continuing.
Turning to support Ccxone I'm continuing to provide the range of services on the cross border market and through Moody's analytics that were already providing.
Grow those businesses and and wait for a attentions to hopefully he is which may not come until we get through the election, but Ah, but then see see how much the friction reduces and how much how quickly we can get back to thinking about other ways to expand.
On the business in the domestic market.
Got it and full by follow up it's going to ask about the U.S. public finance market. There you hinted at the strength there may be could talk little bit about what's driving that in and what's behind your outlook for that.
Sure Rob you want to.
Picked up.
Sure you're right, we've seen I'm very strong issuance out of the public finance sector in the United States and actually the public sector around the world.
I think that's not surprising lot of issuers of use this as an opportunity to mitigate a revenue shortfalls.
So that's really been a catalyst for issuance combined with the fact that we've got very conducive market conditions and I think ultimately.
The sector experiences further credits to us.
The nature and amounts of you know said another stimulus programs, there's going to be very important in terms of mitigating the impact and thinking about market AXOS. Obviously to date. The fed is rolled out that need support program and I think that runs through early next year and that's been very important.
Terms.
Ah supporting investor confidence.
The other thing is that ultra low rates has meant that the taxable financing market has been more favorable and you might remember a couple of years ago coming out of the tax Reform Act of 2018, there were restrictions on fundings and that really reduced some of the volume in the public finance market in the south.
Subsequent quarters, but with rates being so low tech taxable deals have now become more economic so we've seen a lot of that activity that's continued to support.
The public finance market.
Got it thank you very much.
Well take our next question from Jeff Silber with BMO capital markets.
Please check your mute button were unable to hear you.
Maybe Jeff can dial back in.
Well take our next question from Craig Huber with Huber Research partners.
Yes, hi, Thank you my first question.
Touched a little further on the strength you saw on financial institutions your ratings business and what your outlook is there for second half years, obviously not normal to see this segment to jump this much one way or the other this we positive for them because if you think this is sustainable.
Good for them to the second half year.
Yeah.
Sorry.
I think we're expecting.
To see some tapering in the financial institutions sector in second half the year, just as we've talked about it in other sectors.
It's it's probably not.
It's not going to be as a as material because it is a.
Pretty stable a line of business in terms of revenue generation.
And has because financial institutions are generally investment grade has a high proportion of recurring revenue and form of frequent issuer pricing agreements. So we do expect to see a a reduction as against a the second half of last year.
But again not a not as materials, we've seen some other ela bees.
Then and Ray I think to build on that I think also you saw these financial institutions tapping the market and and getting their funding needs earlier in the year. So you know we benefited from some access issuance above the above and beyond those relationship based pricing constructs in the insurance and banking sector.
I think raise exactly right I think somebody that has been just pulled forward in terms of the calendar year.
That's helpful. And then I also wanted to ask on the cost side, maybe you could just you know the order that we should be aware of in the third and fourth quarter costs also be curious to hear with incentive compensation was in the quarter. Please.
Sure Mark.
The second quarter incentive compensation that number was approximately $60 million.
We are expecting incentive compensation to be approximately $40 million to $50 million per quarter for the remainder of 2020 and that would compare to the prior $25 million to $30 million. We previously guided given strong performance.
On your point around debt unusual items.
Maybe I'll talk about this in the context about outlook for the adjusted EPS result for the year.
We guided at the midpoint to at $9, primarily at GTV reflection of the actual operating performance at any am I guess in the second quarter.
And if I think about at $9. This is not necessarily an exhaustive list, but just a list of considerations for items that we have not adjusted for within that number and that would include things like the prepayment penalty from the early cooling of the June 2021 notes and the increased bad debt allowance for closed at 19, they relate to the.
Exposures and the legal accrual, we even things like you know the opportunity cost of them.
We'll go into a temporary books were going to share repurchases at least on a temporary basis in the first in the second quarter, if I add those sort of items as non exhaustive list I get to around 30 cents on an adjusted EPS basis, which is with around three to four percentage points of growth that we are not adjusting for.
Great. Thank you.
Well take our next question from Cowen Lau with Oppenheimer.
Good afternoon and Ah. Thank you for taking my questions I, just wanted to get up better understanding all your margin guidance. So what does it take to get to go high ammo, even exceed your 40% to 49%.
A margin guidance, what kind of expense assumptions baked in for example, do you assume some trying all thought we opening and baby trough holding will come back in the second half of 2020. Thank you.
Oh I'm not a again just like to welcome you to the call and I'll let.
Mark a try to address your question.
Good thanks, good morning, and a full year adjusted operating margin guidance into that range of 48, 49% in at the midpoint.
That means we are increasing 2020, adjusted operating margin guidance by approximately 100 basis points to 48.5% and that's 100 basis points higher and the 2019 actual results to 47.4%.
The majority of that is driven by organic activity and we do you have a slight.
Fixed from inorganic or the net impact of that inorganic acquisitions.
I'd also say that the increase versus the April investor call Israeli because if the creation of incremental operating leverage and that's given now primarily because the updated outlook.
For issuance in below double digit, but also the strong performance in the second.
Quarter.
Operating leverage sites and certainly scalable revenue growth is a critical driver and we also benefited a little bit at this year from there we fit of incentive comp accruals on the efficiency side, we spoke a little bit early on the call about restructuring benefits and then of course, they increased automation and the utilization of lower cost focused on location.
And for more and routine operational matters procurement efficiencies and the ongoing real estate one of that coupled together that means that we we built a good basis from which to grow operating adjusted operating margin.
And Oh, when it's Ray I would I would just add a briefly to that that remember we're also in a period, where am I asked is growing at a faster rate than Moody's analytics and and am I asked is the higher margin business. So when the higher margin businesses.
Growing at a faster pace that that provides lift for the margin for the corporation as a whole.
Realize it's probably obvious but just wanted to get it it.
Oh, that's very helpful lock and thanks way for quite a comment Bob and then maybe he or as I got some questions about the segment as well I think you've mentioned some strength skewed the software and analytic sale would stop at some delayed solved I FRS 17 and see so.
I just wonder like from <unk> perspective, how should we expect beach lie I Tom for the last of 2020 I'd also like your 2021 should we expect higher growth in BBD an hour do you see that look royalties, yes. Thanks.
Sure Rob.
Yeah. So.
Obviously.
You know we have we haven't changed our guidance and I would say that in general the impact from the social distant sitting in the challenges the sales of impacted.
Our ers business, a little bit more than they have our DNA business and that you know that that is all reflected in a in the guidance that we've got today.
So.
The other thing I might say is that just in general across the portfolio that the retention has been quite good its been a little bit better than we had expected.
Back in there in the the April earnings call and our sales performance has been a little bit better than our then then back in April as well so both of those things that help not enough to change.
Interchange, where we are in the guidance range, but that sales experience and retention has been pretty consistent across really most of the product line and that includes ers and again part of the reason for that as this is just you know these are business critical software applications that are difficult to to turn off.
Thank you that's helpful.
Oh.
Our next question from George Tong with Goldman Sachs.
Hi, Thanks, Good afternoon, Mark I want to take another crack that youre margin in expense commentary, obviously your upwardly revised margin guidance assumes flat opex.
So could you provide some additional color around perhaps expense assumptions by segment, including what planned cost savings in investment spending is baked in to.
To achieve your target.
Well I would start maybe by commenting and George that we're very pleased to highlight nets and disciplined expense management continues to create operating leverage and investment capacity for our business.
We've mentioned previously that we have evolved golf selling approach, we've adapted to that meeting formats to be more virtual I'd rather than in person that naturally result to lower TNT and marketing costs.
In addition, we've also been drastically reducing expenses through procurement activities mezzanine fund them to go through the use of I'd say lower cost mutations for more routine operational activities.
Structure.
We have taken a number of cost actions, including the 2018 2019 restructuring program, which resulted in a around $60 million of run rate savings this year.
We also created an additional $30 million inefficiencies that we topline back in February to support out 2020 operating income and investment back into the business and if you take that together with the five to 6 million in run rate and real estate savings that we spoke about smoking in our earnings release.
That creates an almost $100 million in ongoing savings from actions that the management team has taken if I specifically look at towards our updated guidance for full year 2020 operating expenses of approximately flat and the comparison visit the 2019 shows around one and a half to two percentage points.
Related to ongoing expenses to support the Companys initiative to enhance technology infrastructure to enable automation innovation efficiency et cetera and business growth.
I, probably half a percentage 0.2 required to face to the company's what Nick AWG and then we get it smoke or fit through a restructuring charge that it doesn't recur quite to the same examples here and a effects.
Got it that's helpful and Mark earlier on the call you've indicated that you would be revisiting share repurchases from time to time Opportunistically. If you looked at your share repurchase program or just capital allocation in general from a philosophical perspective, how has that changed.
Changed your views.
From both the near term an intermediate term timeframe.
I think maybe I'll get a little perspective, then I'll answer your question directly I think from 2016 to 2019 and free cash conversion of net income has been approximately 815% to that's adjusting for 2017 deal Chase settlement.
We are expecting 2020 to be slightly at bugs.
100%, despite what I think of it some working capital headwinds like for example, the higher 2019 seemed to come payments that came through the first quarter. It this year at the retirement pension funding from the first quarter that we even higher capex.
And he gross in the 2020 free cash flow adjusting for some of those items and it's got to be greater than 10%, which is better than the full year adjusted EPS growth at the midpoint.
I'd say specific teach a question we already capital like business I mean basement would have to ramp up considerably.
What has changed that dynamic between adjusted net income and free cash flow over an extended period. That's why I really wanted to focus our guidance around share repurchases again, I'm really looking at it on a quarterly an opportunistic basis and as we have more clarity on the yet economic outlook.
Great. Thank you.
And it appears there no further questions at this time.
Okay before ending the coal.
I'd like to reiterate my gratitude to our employees you've done a phenomenal job adapting to the.
Evolving environment and your dedication supported been vital during these challenging times. So thank you all for joining today's call and we look forward speaking with you again in the fall have a good summer.
This concludes Moody's second quarter 2020 earnings call as a reminder, immediately following this call the company will close the ammonia.
You break down under the second quarter 2020, earning section of the Moody's IR homepage. Additionally, a replay of this call will be available after 330 PM Eastern time on Moody's IR website. Thank you.
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