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

Okay. Great. Okay. Let's go ahead and get started. Good morning, everybody. Thank you for joining us. I'm George Tong. I cover Business and Info Services at Goldman Sachs. Really pleased to be joined virtually by Mark Kaye, CFO at Moody's. Mark, thank you for being here.

Thank you very much, George and Goldman, for hosting me today. It really is a pleasure to be here. And I just want to say upfront, George, I'm going to refer to some of the slides from our third quarter investor presentation as we go through the fireside chat this morning.

Wonderful.

Okay. So Mark, let's start high level. If you look historically, Moody's has targeted long-term revenue growth in the high single digits driven by issuance volumes, driven by expanding coverage, pricing, growth in Moody's Analytics. Can you provide your refreshed views on what long-term growth should look like? And any particular drivers you think will lead this growth long term?

George, let me maybe start out by saying we're not going to implement -- there are no material changes to the long-term revenue growth target that we've set. Also, many of the drivers themselves remain unchanged. We're going to look to provide a refreshed outlook on the key metrics over the medium term during our upcoming February year-end earnings call. But it would be too early for me to provide specific guidance this morning. Maybe as such in answering your question, let me provide additional insight into the factors that underpin our revenue target. If I start with the MIS and specifically issuance, we often discuss issuance volumes, which we expect over time to track GDP growth, disintermediation trends and refinancing needs. And we believe that, over time, the debt capital markets will continue to grow together with the global economy and play an important role in the development of climate resilience and innovation technologies across the world. Issuance mix also affects MIS' top line. Borrowers on our frequent issuer program pay a higher annual recurring fee and a lower per issuance fee, while borrowers under our standard per-issue pricing program pay a lower annual monitoring or surveillance fee and a higher per issuance fee. So even in periods of flat or low issuance volume, with a favorable mix, it's still possible to increase revenue. Coverage reflects our market share in the credit rating industry and also reinforces the relevance of our ratings. The quality and comparability of the ratings across the globe and over time are really a part of what makes Moody's a trusted brand. If I look at Moody's Analytics, the 12% revenue CAGR between 2008 and 2020 and the higher retention rates in the mid-90s percent range really demonstrate the resilience of our business and the mission-critical nature of our products and solutions. And then finally, pricing initiatives have historically contributed around 3% to 4% growth on average across Moody's. We continue to be deliberate and thoughtful with our approach to pricing. We really strive to build and maintain long-term relationships with our customers, and price must be reflective of the value of our services solutions and products.

Right. Now Mark, China represents a significant long-term growth opportunity for Moody's. Can you talk a little bit about the options you have for growth in China? And which of those options are the most appealing?

We have multiple approaches to address the opportunity in China, including the distribution of Moody's Analytics products and solutions as well as participating in both the cross-border issuance market and the domestic credit market through our joint venture with CCXI. In 2020, Moody's Analytics generated approximately $50 million of revenue across the Greater China region. And we remain very focused on addressing market demand for ESG and climate as well as SME and KYC solutions. We've established a dedicated China strategy and product development group last year to enhance our analytics and insights that serve both domestic and international market needs. And investors are very active in looking for trusted information, transparency and comparability. One thing I wanted -- one product I think is worth highlighting, we launched the Moody's CreditView China recently. That speaks directly to this need. And that's a platform that brings together content and capabilities from across the enterprise, offering data to international investors on the credit exposure of some of the largest Chinese companies. And there really are 4 attributes worth noting here. First, the platform covers around 750 MIS-rated Greater China issuers and around 1,000 Chinese domestic corporate issuers. It offers standardized financials and credit metrics, which is grateful, doing peer comparisons and looking across the global credit markets. And third, it brings increased transparency to a broad range of information, including the financial business and ownership profiles of organizations. And it does that by providing some of those in-depth credit assessments with standardized metrics that have been levered.

Great. Let's talk a little bit about your Ratings business in terms of debt issuance expectations. You've provided guidance of global debt issuance volume growth of high single digits for this year. Which debt categories do you think present the most upside and downside risk to that growth forecast?

Our expectations for high single-digit MIS-rated issuance growth in 2021 is driven by issuance volumes in the asset classes that you can see on the slide. Specifically, leveraged loans and structured finance issuance are expected to be up 100% each. Corporate high-yield bonds are forecast to grow 20%. And then financial institutions are estimated to increase 10%. This growth in issuance over the prior year is expected to be offset by a 20% decline in public project and infrastructure finance and a 35% decrease in corporate investment-grade bonds. The outlook from the third quarter earnings call is really underpinned by our macro assumptions, among other factors. And we expect strong GDP growth, the attractive rate environment and tight credit spreads to remain conducive to issuance. Additionally, we previously have assumed that the strong pace of M&A will continue, particularly really from sponsor-driven leverage buyouts. And these factors together contribute to our forecast of mid-teens issuance growth in the fourth quarter as implied by our prior full year 2021 high single-digit issuance outlook. George, you may ask, but as we head into 2022, the coronavirus, its effect on the global economy really remain uncertain. We've seen through the emergence of the Omicron variant, that does create market ambiguity. It does potentially pose new risks to economic growth. For now, MIS has maintained its macroeconomic forecast. You can see that in our macro outlook that I'm showing on screen, and we'll continue to monitor and see how things develop.

Right. Now historically, macro performance has been the biggest driver of debt issuance volume growth globally. How do you combine your expectations for global macro performance with other drivers of debt issuance like interest rates which are going higher, M&A activity, default rates, credit spreads, et cetera.

Yes. So maybe to say, really, despite the emergence of Omicron, there hasn't been enough information on this variant or its effect on policy thus far to support a material shift in our position. So MIS is maintaining the macroeconomic forecasts we've shared previously in the third quarter earnings call, which fundamentally underlie our issuance outlook. To recap briefly here, we're looking for 2021 U.S. global GDP to rise in the 5.5% to 6.5% range, and the Euro area GDP similarly in 4.5% to 5.5% level. We do view GDP growth, among other factors, as really a key driver of long-term issuance since increased business activity really creates demand for debt to fund expansion and investment. Additionally, our most recent debt refinancing studies, which we published in October, show that the refunding walls over the next 4 years for U.S. and European issuers have increased 9% to approximately $4.1 trillion. And that provides a really strong base for medium-term issues. And when combined with an attractive rate environment, tight credit spreads, low benchmark rates as well as an encouraging M&A pipeline, I'd say market conditions are pretty conducive to that heightened issuance activity. And I'd be remiss that despite those tailwinds, we do recognize that we are coming off of 2 years of very robust issuance activity. So we're likely to have a tough comp in 2022.

So refinancing debt has historically been a big driver of debt issuance. You showed just now the refunding pipeline looks pretty robust. As you think about the pull-forward effect, how much of debt issuance in future periods has been pulled forward due to low interest rates? And how could that potentially impact debt issuance over the next couple of quarters?

The expectation of rising rates is a very common investor question that we're getting now. And I would argue that rising rates themselves have encouraged opportunistic refinancing and have led to some pull forward. But issuance is really driven by a variety of factors, not just refinancing. So you also need to consider the other elements supporting the growth of the credit markets, and that's including favorable market conditions as well as business growth and investment like M&A. That said, with the attractive rate environment, we may see ongoing prefunding activity from future maturity walls as we head into 2022, which could be a tailwind to potential future debt issuance.

Right. Now your guidance does call for significant growth in loan volumes due to rising interest rates. How do you expect the strength in loan issuance to persist given the current rate curve?

Yes. So we expect market conditions to remain favorable going into next year. The record issuance for leveraged loans this year, which we expect to be up approximately 100% versus 2020, will create a tough comparable for next year. However, in our October refunding studies, we noted that spec-grade loan maturities for the upcoming 4 years in the U.S. and EMEA were at a record $1 trillion amidst economic recovery. And this is driven by leveraged loans and credit revolver maturities, which together rose 10%. And these refinancing needs should provide a strong base for future issuance. We also expect most companies to manage refinancing risk. However, there may be some pressure on speculative-grade companies at the lower end of the credit spectrum as these companies may find it hard to overcome the negative effect of inflation, labor shortages, supply chain disruptions really as monetary policies normalize. And in addition to the point that you just made, rising interest rates may actually drive investor demand for leveraged loans as investors seek higher-yield investments amidst what may be perceived as an increasing rate environment since leveraged loans are generally floating rate instruments.

Right. Let's switch gears and talk a little bit about the Moody's Analytics business. Moody's recently closed on its $2 billion acquisition of RMS. Can you talk a little bit about how that integration is progressing? And what synergy opportunities you currently see with that transaction?

We are actively executing on a comprehensive plan to successfully integrate RMS and meet our stated financial targets. Specifically, we are focused on 3 main areas to drive RMS top line growth. First is developing the go-to-market strategies for our insurance business as well as embracing the cross-selling opportunity. Just to give you a sense, we found that only 10% or approximately 10% of our combined insurance customers are currently being served by both RMS and MA. Next, we're syncing our combined technology stack as we look to transition RMS' customers to a new SaaS platform. And then last is integrating RMS' capabilities and assets into new and existing climate, cyber, KYC and CRE solutions. And it's not an exhausted list, but I can share a few specific examples of cross-selling and product integration in the core insurance market that we undertake. For example, we can integrate RMS' life risk -- sorry, LifeRisks, excess mortality and longevity solution into our life insurance actuarial modeling platforms. And as an actuary, I can tell you that's a very valuable crossover. Secondly, we can incorporate MA's asset and capital-modeling solution that is available for life insurers into RMS' risk intelligence platform, and that will serve P&C customers. And this is ultimately really going to help insurers improve their underwriting process as they go forward for their own customers' benefits.

Great. Now Moody's Analytics has been investing into several high-growth areas, such as Know Your Customer and Compliance. Can you talk a little bit about what additional opportunities you see for investment and what the Moody's Analytics segment should grow at longer term?

George, let me start with the second part of your question. So though we've not provided long-term organic MA revenue guidance, we have a strong track record of demonstrating our ability to grow both the top line while investing in future growth. Between 2018 and 2020, Moody's Analytics revenue CAGR was 12%, and approximately 63% of that was organic. As for additional opportunities, today, our customers are dealing with a broad set of interrelated and complex risks. And that includes new risks that weren't on their radar in the past or at least were not to the extent that they are today. So our customers are looking for a holistic view of who they are doing business with across the value chain, who they're investing with and ultimately who they're lending to. You obviously mentioned KYC, or Know Your Customer, in your question. And this is substantial, but it's a relatively fragmented market with strong demand which has been growing over 20%. And we continue to invest in this market as the need for information grows as well as the opportunity to provide accurate and comprehensive data on ownership structures. Just in fact, last week, we announced the acquisition of PassFort and our agreement to acquire kompany, kompany with a K. And both of these investments augment our KYC anti-money laundering compliance and counterparty risk solutions. And we spoke earlier about RMS and the large opportunity we have in the insurance market, where, for example, we expect the risk management subsegment to grow 13% CAGR over the coming years. And that, together with how we integrate ESG capabilities, really does provide a great platform for MA to be able to grow in the future.

Great. Let's talk a little bit about margins. Moody's long-term operating margin target is in the high 40s. Does that suggest that margins should go back down below 50%, which you're currently above, or does that suggest that longer term your margins have upside to the high 40s number that you've provided previously?

For now, we are maintaining our high-40s percent range, adjusted operating margin target. I'd like to take a moment maybe just to reflect on the past 2 years. So in 2020, we expanded the adjusted operating margin by over 200 basis points. And our updated guidance for full year 2021 implies an additional 130 basis points of expansion. In the future, you should expect us to continue to balance investing organically and inorganically with disciplined expense management. It's worth noting here that MA has been growing faster than MIS, and that's been fueled by mid-90s percent recurring revenue and retention rates. And although MA's margins have improved, it does have a lower growth or lower margin profile than MIS. So as MA continues to expand, the math implies there may be some pressure on the overall MCO margin and we're going to provide a refreshed outlook on the key metrics over the medium term during the upcoming February year-end earnings call.

Speaking of Moody's Analytics margins, that segment has seen operating margins improve from low 20s to low 30s. Can you talk a little bit about what initiatives you have to further boost margins? And where you see MA margins converging to longer term?

Thank you for acknowledging the substantial growth in the adjusted operating margin at Moody's Analytics over the last few years. If we exclude the approximately 300 basis point impact of M&A from our latest 2021 MA-adjusted operating margin guidance of roughly 29%, it would imply an adjusted operating margin of approximately 32%, which would have been 250 basis points of margin expansion from 2020. When we acquired RMS, we introduced a medium-term adjusted operating margin target in the mid-30s percent range. And I'll note the progress towards achieving this target is not going to be linear. You may see us make strategic investments in any given quarter or year to support future growth with the commensurate impact on margins from those actions. So though we have not provided longer-term guidance for margins, we have demonstrated an ability to deliver MA margin expansion over time, though not necessarily in a linear fashion. And the commitment that we, as a management team, have to our strategic initiatives, the mission-critical nature of our solutions, our ability to retain customers, to prioritize investments within high-growth markets, KYC, insurance, climate, ESG, cyber, really should result in margin expansion over time as we invest for sustainable growth.

Great. Let's switch gears and talk a little bit about ESG. What's your overall view of the ESG opportunity in market?

According to internal research at Moody's, the sustainable bond market is on course to reach a record $1 trillion of issuance in 2021, and that's going to surpass prior estimates. Issuers are increasingly linking their funding needs to sustainability-based objectives. And so we anticipate that issuance -- so we anticipate that sustainable bond issuance will continue to grow at a very fast pace. By 2025, we're thinking approximately 37-ish percent of all global assets that are invested sustainably. Against this backdrop, there is enormous demand and rising expectations from market participants for better, more transparent and meaningful ESG and climate data and analytics. And you can see that in the top right side of the chart, that business spend on ESG content in Moody's is forecast to grow over 20% on an annualized basis between 2019 and 2021. And we believe that the climate data and analytics subsector of ESG will grow between 15% and 20% annually through 2025. And that's going to reach a total addressable market size of around $2.7 billion at that point. Climate is clearly an amplifier for both risk and opportunity.

And within the ESG space, what are the strategies that you have to succeed? How are you planning to differentiate and really propel Moody's ahead?

As a global integrated risk assessment firm, Moody's is uniquely positioned to bring rigor and transparency to the challenges faced by our customers. And that's going to be through a combination of deep expertise in ESG, climate and financial risk modeling. Internally, we take a holistic view in our analysis by combining data and insights from across our different businesses, ESG, MA, MI, et cetera. Maybe just briefly to walk you through how it comes together, you can think about credit ratings and research as systematically incorporating credit-relevant ESG and climate considerations into our analysis and research. Beyond credit, we provide a dual or a double materiality approach to ESG assessments. For instance, determining how ESG issues affect a company's enterprise value and how those issues affect society and environment in which they operate. And finally, as a leader in -- global leader in second-party opinions and sustainability ratings, we also help organizations embed sustainability targets and commitments into their financing activities so that we ultimately deliver a positive real-world impact.

Mark, you've previously said that Moody's is going long on climate with its RMS acquisition. Can you elaborate on that and what steps Moody's is taking to really drive leadership in the space?

Yes. So to answer your question, George, I'm going to focus on Moody's various climate solutions, which also leverage the strength and capabilities across our organization. As you can see on the left-hand side of the slide, we offer a broad spectrum of climate-related solutions and insights from the identification and quantification of climate risks and opportunities to the impact on credit ratings. And all of this is using data analytics and models from across the organization. To provide a few examples of our services, I would quantify the impact of climate assumptions on the firm's financial performance. We measure the impacts of physical and transition climate risks. And we provide market participants with the data and analytics that they need to compare credit impacts across sectors, geographies and other portfolio clusters. One of the recent cross-organizational efforts was a research report titled Ready Or Not, which assess the impact of transition to net-zero emissions on certain carbon-intensive tech sectors. And you'll see on the right-hand side of the slide here, an excerpt from that report that there is significant room still for harmonized and better disclosure on company's preparedness for climate transition. On the taskforce for climate-related financial disclosures, we've also found an average disclosure rate of around 22% across sectors. That is higher than last year, where it was about 16%. And with the acquisition of RMS, Moody's is now a leading provider of climate and natural disaster risk modeling. George, if it's okay with you, what I think you and the investors might find helpful is maybe just for me to spend a couple of minutes just to maybe demo a little bit of what the RMS product looks like so that you can sort of visually see what we, as the management team, see in this product and the capabilities that we offer.

Sure. That would be great.

All right. Let me go ahead and bring up on the screen sort of my web browser. I've just logged into RMS itself. And you'll see here, there are a number of shortcuts based on products I use frequently, ExposureIQ, RiskModeler and the SiteIQ. Let me go ahead and click into SiteIQ itself. So SiteIQ provides our customers with insight into the natural and man-made perils that may impact any particular location on earth, and that leverages a wealth of information. So if I pick a particular address, and I'm just picking one, and really you can pick any. You choose the -- our office of RMS out in California. I feel that's a pretty neutral address. Going to go ahead and do a quick search. Then it's going to bring up a number of very interesting identifiers. So the first thing that's really interesting to note here is if you're an insurance underwriter or you're agent, you want to understand the risks of this particular locational property. And you can see those risks or perils sort of outlined on the left-hand side. Scale runs from 1 to 10. So 10 is obviously the most extreme risk. And you can see that with U.S. earthquake for this particular location, but also including other perils like wildfire, terrorism, storms, winter storms, floods, et cetera. RMS' models are sophisticated enough that location matters. So if I were to simply move the location that we picked here from the parking lot, certainly looks like the parking lot to me to maybe a slightly different point, it's called the other side of the parking lot as an example. You may end up with a slightly different hazard score. So you've got more floods on, it looks like the eastern side of the building vis-a-vis the western exposure. It also helps us to understand why earthquakes themselves have been ranked so highly. And here, if I just simply go to the legend, I'm interested in understanding that. Earthquake is typically linked to soil. So if I pick up soil layers, you can see here the building that we're looking at on the location is located very much in a soft soil region, which is very helpful in understanding sort of what drives the ultimate earthquake classification. And historically, this is being used by insurers and underwriters, but it's incredibly helpful for banks to understand their exposure based on their loan loss portfolio. And it's also pretty easy to export the data to be able to share it across companies. And I think all of this is really interesting, and it's really good. But I got to tell you, George, what makes a very big difference to me, I go back to search just for a second and I pick the same location, Gateway Plaza, Newport, California, and then I go to advanced options. And this is not about, again, as you saw a minute about ZIP codes. This is about location specific. But one of the differentiators of RMS -- now this is just SiteIQ for a single location. You can imagine how powerful this is across multiple locations. It's the ability to look at the building characteristics themselves, not just the location. So for RMS' building out in California, number of stories of a particular building are very interesting, the year the building was built, the construction materials themselves for the building, who's in the building. I don't know this information. But RMS has significant access and has prepopulated any number of building codes across the U.S. So if I simply retrieve the existing RMS building codes, you can see that this particular building has 3 stories. It was built in 1999. It has a steel frame concentrically braced with the engineers discerning exactly what that means. And let me go ahead and just put in tentative numbers, insurance value, let's pick $10 million, content value 8, 6, just to give you a sense of what an underwriter might enter themselves. In terms of perils that were worried about for this location, earthquake matters, if I pick a deductible, because it's in California, and I know this as an actuary, it's a 2% deductible. And I go ahead and research. And what's really interesting now from an underwriting perspective, the earthquake risk has come down because the building characteristics themselves mitigate that risk that's being experienced. And this helps an underwriter understand sort of the characteristics. What's really interesting is if I go to loss cost, and if you think about companies, banks wanting to understand financially or quantify their exposure, they simply can go to the loss costs. And that endeavor indicates the minimum amount, for example, an underwriter would charge for a particular peril, taking into consideration the case for earthquake with and without the deductible. So in this case, you can see wildfires. The minimum would be $77 to cover this particular location based on the hazard scores. You can see earthquake itself hypothetically would cost $66,000. And if you aggregate this information across a variety of different locations and you think about net-zero transition, it's incredibly powerful not just to have a transition framework but to be able to quantify the cost of that transition rate. And that's sort of what we think about within Moody's when we talk about going long climate and being able to expand this across the portfolio. And there are a lot of supporting RMS products that are really cool. But I thought that one would just give you a little bit of insight and flavor into how we're beginning to broaden this product across the portfolio.

Wonderful. Well, Mark, thank you for joining us today for the session virtually, and thank you for all the great color and insights.

Very much appreciated. Thank you very much, George.