Moody's Corporation (MCO) Earnings Call Transcript & Summary

Great. Can we just talk about maybe more near term on the ratings side? Feels like the Street has been calling for the [indiscernible] of the ratings business for 18 months, and it just hasn't happened here. Just curious how the second quarter is going relative to sort of what you were seeing at the time of the first quarter call. Also into 2021, how you're thinking about the full year for the ratings business. Again, because I think your guidance is a little bit more conservative than maybe your peers. So just trying to just unpack it a little bit.

Yes. So I'll refer back to our guidance in the first quarter, Christian. For issuance, we had talked about a low single-digit decline, single-digit percent decline for global issuance. And we really called out the second quarter and even to some extent, the third quarter presents some just challenging comps. So the overall level of issuance is quite strong. But we just have some challenging comparables, particularly in investment grade. And so I think the trends that we talked about in April still hold. We had expected a decline in investment grade, particularly in the second quarter relative to those tough comparables. Leveraged finance has been -- has continued to be quite strong, both high yield and leveraged loans, lots of LBO activity. If you think about then translating that to our kind of full year, that low single-digit decline and breaking that down. We had talked about investment-grade being down in the range of about 30%, again driven by very difficult comparables despite the fact that the overall level of issuance is quite strong when you look at it on a historical basis. High-yield bonds, we had expected to be approximately flat, and leverage loans, where we made a significant upward revision, expecting that to be up north of 50% for the year, again, due to kind of that refinancing and M&A activity.

Great. Let's talk about some of your longer-term opportunities. Maybe we'll start with ESG. You have made a number of acquisitions, Vigeo Elris, Four Twenty Seven, SynTao Group Finance, quite a few across the ESG space. Can you just talk about what you're doing in ESG today? How do these acquisitions present an opportunity? And maybe more importantly, how are you differentiating yourself relative to what feels like everyone attacking the same opportunity?

Yes. So Christian, I think we've been thinking about -- in approaching ESG and climate, I'm going to include climate within that, let's put that in part of the E, across the entire franchise. So we have a suite of stand-alone solutions. And you're right, we've made some acquisitions. We bought a company called Vigeo Elris. They have ESG scores on thousands of companies. We're actively, actively investing to build out the coverage and the timeliness of the updates and the quality of the data there. Then you think about what we're doing around ratings, and we are integrating ESG and climate considerations into all of our analytical work and into all of our research. And so when you go on our CreditView platform used by fixed income investors, you'll see a wider array of ESG and climate data and content. The rating agency is producing something called a credit impact score for ESG. And that is specifically translating the impact of E, S and G on the credit profile and in turn, the credit rating. So that, I think, is a uniquely differentiated offering in the market. None of the other scores that are available are able to make that kind of connection and translation. So I think that is going to be filling a very important unmet need in the market. Then you think about what we're doing across all of our risk assessment products in Moody's Analytics used by banks and financial institutions. We're integrating ESG and climate into everything from our commercial lending and origination and credit assessment platforms. As you can imagine, banks wanting to understand the ESG profile, who they're lending to, wanting to understand the physical risk related to climate change on the collateral that they are taking. We're integrating it into our stress-testing offerings for banks, as banks are being required now to start to do green stress test in certain jurisdictions, and we have a wonderful stress testing offering for banks. So we're integrating that. We're integrating ESG and physical risk scoring into our commercial real estate platforms, as you can imagine, very important for people that are investing in and lending on commercial real estate. So a lot of integration of ESG and climate content across ratings, across all of our risk assessment offerings and stand-alone offerings to meet the needs of the market.

How do you think about monetization across those 2 buckets in terms of -- do you see over time, the stand-alone ESG offering as will be a meaningful revenue contributor to Moody's? Or is this going to really be more infusing ESG into the product set to be more value-add and ultimately drive better pricing because of the value add? What do you think is the bigger opportunity?

Yes. I think it's going to be a combination really of all of that, Christian. So over time, you can imagine as the rating agency builds out more and more ESG and climate content, there's an opportunity for us to think about that on an a la carte basis rather than simply being kind of bundled inside all of our credit research. So I think there'll be an opportunity there. I think there'll be lots of opportunity for integrating the ESG and climate content into all the MA offerings. One place I might talk about in terms of, I think, stand-alone opportunity, you have issuers of debt who are very focused on sustainable finance. And we've seen the growth in the green bond, social bond, sustainability-linked credit facilities, all of that. And when issuing sustainable instruments, companies get a second-party opinion, and often, we'll get some form of sustainability rating. And so as this stuff matters more and more to companies, as they are more focused on their ESG profile and score, as they are increasingly engaging in a sustainable finance market, I think we're going to see those companies wanting to engage with a company like Moody's where they can understand the methodology, they can have an interactive dialogue with an analyst who understands ESG and sustainability and understands their company and their industry. And so I think that will be an opportunity for us over time. It's early days today in terms of monetizing that. But increasingly, I think you'll see that as a place where we'll be able to generate some revenue.

And then back to longer-term opportunities, are there other potentially meaningful verticals in the ratings business? Maybe cyber, that seems to be a very big topic just now. I think at one point in Moody's, it was sort of a big area of focus. So just curious, what are the sort of verticals you think over time could be meaningful opportunities?

Yes. So I'm going to start by saying we've kind of spotlighted several. And this know-your-customer, going beyond know-your-customer, to know your counterparty, know your supplier, know who you're doing business with, that's a big opportunity. And we're investing very significantly in that opportunity. We see commercial real estate data and analytics as an interesting opportunity for us. And we got into that primarily, Christian, because it's such a big asset on our customers' balance sheets. When you think about it, we have thousands of bank customers and insurance customers, they've got huge loan books in commercial real estate. And we felt like there was an offering for us to better integrate our content. I mean, that's what our customers are telling us, to help them around commercial real estate decision-making. And so we're investing in that. And even -- I think, actually, because there's distress in that market, it has put a premium on the need to be effective and efficient. So we see that as an interesting opportunity. Our enterprise risk solutions, the theme of digitization and digital transformation has been in the banking industry for years. You see it increasingly in the insurance industry. And I think you see that, in part, driving the growth in our recurring revenue, in our -- the SaaS part of our -- the subscription part of our ERS business. So that's a very interesting opportunity for us. And we've got a big banking customer base. I think building -- continuing to build out the suite of offerings for insurance companies is increasingly interesting. Because as you can imagine, they have a lot of the same risk assessment needs that banks do, right, around commercial real estate, around climate, around ESG, around fraud. So that's an area. The last thing, Christian, I'll just -- I'll touch on cyber because you mentioned it. This is not an area where we have a big footprint, but we did recently make an announcement about a follow-on investment in a joint venture with an entity called Team8. Team8 is a cyber incubator backed by some former senior members of the Israeli Cyber Command. So they have wonderful cyber DNA. As you can imagine, when we're out talking to customers, one of the main risks that they're talking about right now is cyber risk. It's on everyone's mind. It's in the headlines. We invested a few years ago to build out a small cyber analytics team in the rating agency. This is kind of early days. And people -- this has given us an opportunity to have a real thought leadership in ratings as cyber risk relates to credit risk. But what we're doing with VisibleRisk is they have developed a cyber rating that will attempt to translate for a company on a private confidential basis to be able to answer the question about the extent of financial exposure related to your cybersecurity posture. That is a very difficult question to answer. As what many, many boards want to answer, based on my level of cyber security, what is my risk of financial loss? And so that's what we're working on with VisibleRisk and supporting them there. It's early days. But I think it's a very interesting foray into cyber. And I think you'll see us increasingly work to integrate other forms of cyber content into our risk assessment offerings because that's what we're hearing from our customers. When you think about that 360-degree view of risk, I want to understand the financial crime, I want to understand reputation, I want to understand sustainability profile, I want to understand data security and cyber risk. So an interesting opportunity, I think.

Great. Let's dig back into -- it's one of the things we talked about in terms of really broadly the credit software analytics space, which is a very high-growth space in the industry, but also very competitive given how high growth it is. I mean your KYC business is a bit of a crown jewel with sort of really standout growth rates. But there are other players coming into some similar areas, whether it's Nasdaq with the Verafin acquisition, obviously, Dun & Bradstreet has always been in sort of that space. So can we just dig into your KYC business? What is the differentiating factor? And really, how sustainable is sort of the 20-plus percent top line growth that you've been posting in that business?

Yes. Christian, I would love to talk about that. And so let me start by answering the second part of your question about the sustainability of the growth. And let me talk about some of the trends that are driving growth in the market, because I think that will also provide some insights into the competitiveness of our offering in meeting those needs. So first, back to this point I made around digital transformation, COVID has accelerated the need for digital transformation in KYC and customer onboarding that, that's not surprising, right? It is a very manual and fragmented space. And so back to this point, our customers want to be more effective and more efficient, and they want to automate as much of those manual in-house processes as they can to improve reliability, to improve quality control and to increase efficiency. Second, you've got regulation continuing to develop. I touched on that a little bit, right, the expansion beyond simply things like sanctioned screening to now have to screen for modern slavery. Right? So now you're getting into human rights. So that is requiring organizations to know more about their customers than ever before. It's just the nature of offenses that customers either have to screen for or want to screen for that relate to reputational risk, social risk, tax crime, cyber crime, environmental issues, that is expanding. And here in the U.S., you see a focus, even with the Biden administration, around supply chain and better understanding, risks within companies' supply chain. And so to be able to screen for those, customers want more sophisticated platforms around adverse media, and we've been developing that. And then third, sad to say, but financial crime continues to get more and more sophisticated, and that requires smarter solutions. And you've got institutions increasingly trying to understand not just their exposures to their customers but their customers', customers' exposures, right? Everybody is realizing there's increasing interrelatedness of all of this. And that's where merging our internal data with external data and the hierarchy in risk data is really important. So Christian, now to answer what's different about us. So we've been pulling together -- we've got one of the world's largest databases on companies. We've got one of the world's largest databases on risk-relevant people and one of the world's most sophisticated platforms for adverse media screening, leveraging artificial intelligence. And all of that together and increasingly linking all of this together creates a unique and a very compelling one-stop shop offering for our customers around their KYC and increasingly broader financial crime compliance needs. So it's the fact that we're bringing it together in a more holistic solution so our customers can do this in one place and see those linkages to increase their effectiveness and their efficiency, that is what is so powerful, and we think is pretty unique in the market. And Christian, that was the promise of those acquisitions. That's why we did them, was to put that all in one place for our customers. So we're going to keep investing in integrating that and in helping our customers with more and more of that end-to-end -- those end-to-end needs around customer onboarding and customer monitoring.

Great. The other hard area, I think, generally in the industry, is sort of credit automation or lending automation, I think, with the -- particularly with the IPO of nCino and [indiscernible], Ellie Mae for $11 billion. That's put a spotlight on that opportunity. Moody's has some businesses there as well. Can you just talk about what Moody's is doing around lending automation? I mean, more broadly, how big is that opportunity over the next few years?

Yes, you're exactly right, Christian. And back to that, that digital transformation trend that's been an ongoing theme for banks for years, it is picking up speed and insurance companies. And like I said, in every meeting I'm doing with banks, it's about being more effective and more efficient. So if you think about our offering in that space, it's really kind of 3 primary areas. The first is around credit assessment and origination, and that's helping our lending customers with everything from providing the initial data on the borrower and the background on that borrower to helping them with credit scoring. So we've got many, many banks around the world using our platforms for loan origination and credit assessment and credit scoring. And then we've got -- the second is we've got solutions around kind of banking and finance that support regulatory reporting, capital planning and asset and liability management. And we just made an acquisition recently of ZM Financial Services, which bolsters our offering around asset liability management for kind of the middle market tier of banking customers. Because historically, our offering has been targeted at the larger banks around the world. And then lastly, the third part in ERS is around a growing suite of solutions for insurers and buy side asset managers and pension funds. And some of the things you've got with CECL and then you've got IFRS 17, you've got some of the same trends that are driving both banks and insurance companies to want and need to adopt our solutions to help them with regulatory compliance and more efficient management of their institution. The other thing I'd say, Christian, is I tend to think of these software-as-a-service solutions as kind of a chassis. You think about -- across these 3 areas, we're very embedded into the workflows of banks and insurance companies, right, across lending and across kind of bank financial management and financial reporting and then insurance companies and increasingly, buy side firms. And that gives us a really interesting opportunity for further integration of our data and our analytics and the ability to then kind of upsell and cross-sell, right? Because I gave that example of we've got banks using our origination platforms, and now they want to integrate ESG and climate content into that. So that -- it's relatively straightforward for us to be able to do that. And that -- back to that example of commercial real estate. That's a great example of why we moved into commercial real estate because we have this huge installed base of customers who want and need more data and analytics and more insight to help them around commercial real estate lending activities. So some good drivers in that segment, I think.

Great. I'll take one from the audience, Rob. So the question is on MA. It's about margins in MA. And the question is most SaaS-type businesses tend to have higher margins than MA, have [indiscernible] today. What is the opportunity to expand margins here? And how are investments impacting margin today?

Yes. So first of all, Christian, I would say, we've done a pretty good job of expanding the margin over time. You've seen kind of -- there you go, as you can see on the screen. And part of that -- part of what's driving that margin expansion is, as we're scaling our recurring revenue businesses, a meaningful part of that is around what we're doing in our enterprise risk solutions space that we just talked about, where we've been moving from kind of legacy installed software to more and more of software as a service. And so that is margin-friendly for us. And then we are building out our businesses around data and analytics that have a very strong recurring revenue profile. That is also margin-friendly for us. So I think the opportunity for ongoing margin expansion is there. And I think that's just tied to the evolution of -- and scaling of the portfolio. I would say this, though, that -- I mean, you're hearing me talk about some of these high-growth end markets. And we want to make sure that we are capturing those opportunities. And to do that, in some cases, you've got to make investments. And the reason that's so important, Christian, when you look at the retention rates, right, because we're embedded into these mission-critical work, risk workflows at our customers. The retention rates, you see, are in the mid-90s on many of these offerings. So it's very, very sticky. So when we've got high-growth end markets where there's a net growth in new demand, it's very important that we are investing to capture those market opportunities and getting customer acquisition. And over time, we will be able to get margin growth and margin expansion. So it's -- we really want to make sure we are balancing and not starving the business when we've got some really interesting growth opportunities in front of us.

Great. Maybe talking about growth opportunities, but inorganic, I guess, opportunities. Obviously, your closest payer has chosen a strategy of scale and diversity and made some meaningful, meaningful acquisitions. So the question for you is, are there any disadvantages, do you think, as a manager, to being relatively smaller and somewhat more aligned in terms of your business model? And maybe a follow-on to that would be any areas where it would make sense to pursue inorganic opportunities to sort of scale the business?

So Christian, yes, we are going to be smaller than, I know one of our primary competitors. But we still, call it, $55 billion of market cap, and we've got an analytics business at north of $2 billion of revenue. So I'm not sure we're a monoline. But I would say that, look, we -- and I talked about this on the first quarter earnings call. We're going to run our own race. We're very focused on what our customers' needs are and how they are changing and how we can meet those needs. And I talked about there's some exciting opportunities, and that's where we're going to invest. We're investing -- back to this point about investing with intent. We're investing organically in those areas, and we are investing inorganically. And I think you can expect us to continue to build out around know-your-customer, financial crime. We have wonderful assets, but there are some opportunities for us to continue to add to our capabilities, as I talked about, continuing to build out, helping customers from kind of end-to-end. You're going to see us around commercial real estate. You're going to see us continue to invest. There's a lot of organic investment in ESG and climate because there's not many inorganic opportunities of any scale. And then back to, Christian, your point about kind of banking and insurance. That's a -- just given the growth drivers that we've talked about, we're going to continue to fill in product gaps, enhance our capabilities not only for banks, but I think, increasingly, for insurance companies, as that becomes a more and more meaningful part of our overall customer base. But one thing you can -- I think you can count on, we're going to continue to be disciplined around how we think about M&A. We know what makes sense relative to our strategy, and we will be active, but considerate.

Great. We're out of time. So I think it's a good place to end. Again, thank you, Rob, for joining us for the first time in the conference. I really appreciate it. Thank you.

Christian, thanks for having me. I really appreciate it.

Okay, bye.