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

Hi, everybody. I'm Andrew Steinerman, your business information services analyst here at JPMorgan. This is Ultimate Services Investor Conference and the info services track. This is the Moody's fireside chat. The format, of course, is 30 minutes fireside chat, which means about 20 minutes of me asking CEO, Rob Fauber questions, and then 10 minutes of you asking your questions. Also, in the back table is our information services data book, which is an updated info services primer. You could also grab a sticky pad and welcome. Thank you for your questions now. Rob Fauber, welcome back.

Thanks for having me. It's pleasure. Good to see you in real life.

My pleasure. And don't forget to reserve your calendar for next year also.

I'm sure it's already done.

November 16, 2023.

I'm there.

Okay. Great. So you don't -- I hope you don't mind if I start with an issuance question. So '22 has really been a scarce year for issuance, really long stretches with very little debt issuances. I know you're saying, hopefully, we're moving towards the bottom, you're not calling the bottom. But even if we have kind of a tough macro next year, could the United States go another year without data issuance?

So it's interesting, Andrew. We've had a few unusual years, right? '20 and '21 were very unusual in years. This was an unusual year. And actually, putting it in perspective, when we look at kind of the long-term average for issuance from kind of 2012 to '19, excluding those 2 pandemic years, corporate issuance is down something like 30%, what we expected to end the year at down something like 30% off of that trend line. So it's not just down off of those 2 years, it's down off of a long-term trend. So absolutely. But -- and I touched on this on our earnings at the beginning of the year, Andrew, when I gave guidance, and I said, look, because obviously, rising rates were on the minds of everybody, including us. And I said, at the time, I think that the issuance market can absorb higher rates but there's the significant risk of kind of policy missteps. So as long as rising rates are accompanied by economic growth and the pace and trajectory of rate increases is understood and anticipated by the market, the market will be able to adapt to that.

Now you could place to us.

We had none of that, right? So we had decelerating economic growth, we had inflation that wasn't as transitory as all of us were hoping. And so we had rising rates and rates that went up faster and higher than people expected. All of that was a very, very challenging mix. And by the way, then we had Russia-Ukraine, which further eroded market confidence and so we went into a really a bit of a holding pattern for the year, right? Because if you think about what happened in '20 and '21, issuers issued an enormous amount of debt, stockpiled cash, cash levels were at all-time high, they've come down a little bit, but it gave issuers the opportunity to be patient and sit out all of this market volatility. So to your -- back to your question of, well, what about 2023? I think that eventually, we're going to have to revert back on trend or above trend. There's a lot of pent-up demand.

And the trend is 2012 to 2019?

Exactly. And what's going to drive that? I think, first of all, is the market's got to get some certainty. You saw what happened in the last couple of weeks. When the market thought it was getting some certainty around inflation peaking and interest rates, right? All of a sudden, you've seen issuance in the last few weeks. It starts with the investment-grade issuers and then works its way down the credit spectrum. We've seen that. I think it's going to take a little bit of time to keep working through the system. There's still some event risk around all of this, a bad inflation print. It's going to set us back. We've got some tough issuance comps in the first quarter. There's a lot of pent-up supply. You've got a lot of private equity dry powder. M&A has been suppressed this year. So I think as the market gets certainty and works through this in the first, call it, quarter, first half of the year, I think we're going to see issuance levels resume and start to normalize in the second half of the year.

And you mentioned a few different metrics you're watching, inflation on control, interest rates -- understood. Like, do all those things have to happen? Or after each of those things, does issuance start to recover?

Yes. And I think maybe let's go back to how do we see kind of typically the markets open up because that will give us a sense of what. So the first thing that's going to happen is we've got to get some market confidence in the first issuer as you see back in the market, as I said, are the investment-grade issuers who can tap the market opportunistically. Then you start to look for the highest rated of the spec-grade issuers start to issue. And that means that default rates and, in turn, high-yield spreads have got to be tighter, right? But if you look at our default rate outlook for U.S. spec-grade for next year, we expect it to increase modestly, but be just above historical averages. So that should mean that spreads stay relatively under control. And once the high-yield market sees that the market is open for a higher rated issuers, that's when you start to see the lower rated issuers tap the market. That's when the backlog of first-time issuers that we have, many of those are single B credits, will start to come into the market.

I think you just said you like credit spreads to be under control, kind of let's call that steady opposed to even tighten it. Like I think it's sort of predictable is what you're saying?

Yes. I mean there's just a high level of correlation between spec-grade default rates and spreads. So as long as we think that those spec-grade default rates are going to remain within historical norms, we think that spreads should remain relatively within those averages as well.

And then to speak a little bit within the spec -- speculative debt, which do you think kind of has the most pent-up demand? Like what should we be looking for in terms of different asset classes?

Yes. So just in general, across our entire portfolio, corporate is the biggest. And I think that's where you're going to have the most recovery because that's where we had the most acute downturn, right? And it's leveraged finance. And so what's going to drive that, Andrew, we've got very good maturity walls. If you look at the spec-grade maturity walls, even for the next 2 years, they're higher than they've been. We've got more maturities in the next 2 years in the 4-year spec-grade maturity walls than we've had at any other time. So a lot of debt that's got to be out there that's got to get refinanced. There's a lot of private equity dry powder that has still got to get deployed. M&A levels have been suppressed. And so I think that's going to be a key driver as well. And as I said, an interesting stuff for you, Andrew. Our first-time issuers -- so we sign up first-time issuers. Almost all of those are spec-grade issuers, as you'd expect, right? Less than 1/3 of the first-time issuers that we've signed this year have gone to market and they haven't gone away. They're just sitting on the sidelines.

Okay. That's very fair. There was a comment about you'll have to help me here that there might be a need to selectively change metrics and medium-term guidance. That was a comment from last conference call. I think it's -- that's just simply acknowledging the '22 issuance environment, right?

Primarily. So we got to figure out how we're going to do that.

Willing to just change the base and just move it?

So we're going to -- we'll share that with you on the next earnings call. We'll share that with you in the first earnings call.

Okay. I just wanted to make sure. I understood it. The problem was just the '22 issuance. No problem. Okay. Also, you talked about the refunding walls, and surely, I see them, and you put them great into the slides. But there's still a lot of discretion from treasurers of when they want to refinance? So I agree with you that, that means a lot of debt issuance over the next 2 years, but I think you would agree with me, it doesn't necessarily mean '23?

Yes. And look, the maturity walls are only a -- only a proportion of overall. So maybe let me just kind of pull the lens out so we can think about how the maturity walls to what extent do they support. It obviously it depends on the year, but let's say, roughly our mix of recurring to transactional revenue in the rating agency, let's call it, 40-60. I get that it moves around, but 60% transactional, right? So then you zoom in there, corporate is roughly half of our ratings business. So as you continue to kind of zoom in and you look at the maturity walls, so the 2023 corporate maturity walls represent about 50% or so of 2022, and I understand these are different time periods, but just to give you a sense, roughly 50% of 2022 corporate issuance, roughly 50%. So it just gives you a sense of how much, I would say, kind of ballast is in there to support issuance.

There was a cost savings plan brought up on last conference call, they saved like $200 million run rate savings. I think that was all in MIS. Again, you could correct me if that was the total company. But my question is, why is now the right time to take so much cost out of the MIS business? And what I'm particularly asking is, if you take those productive people out of the MIS business, meaning like analysts, might you lose some of that opportunity to capture all that rebound that's coming...

Right. So first of all, this is firm-wide. However, I think you will see the most impact to the MIS margin, the most positive impact. That's one. Second of all, we've undergone a tremendous amount of growth, both in ratings and across our entire company over the last several years. Like many companies, right? We've done a number of acquisitions. We've added headcount, right? So we believe that we have an opportunity to become -- to just take a look across the company and become more efficient. Part of that is we have decided that we're going to adopt a permanently flexible work arrangement. So that gives us the opportunity to look across the entire global real estate portfolio. Some of this stuff we've picked up in acquisitions and rationalized that. Then we've had an opportunity to look at where across the company and across the ratings business, not only do we have lower business volumes but where we have the opportunity to get jobs into our operational hubs, right? So data collection that may be being done in a high-cost location where we can get it done in 1 of our hubs. And I would say to you, Andrew, and I ran the rating business for 3 years. We're not doing anything that is going to compromise the ratings quality or our positioning with investors and issuers. I have always thought of our positioning is we have the most experienced analysts and that is very valuable for our issuers and our investors. We're going to continue to have the most experienced analysts, but there are other opportunities for us to get more efficient across the business.

So I'll tell you what I'm imagining, as you say this. Like, for example, my team here, I'm Managing Director, I have a Vice President and Associate who work for me. And I'm experienced, I've been doing this since 1995. To me, it sounds like you might be taking away some of that analysts support or pushing it out offshore. And while you still have that industry-leading analysts, maybe they feel like they are asking we do more.

So I would say, Andrew, well, it's part of our strategy to technology enable the analysts and get what I'll call kind of the more mundane work out of the analysts and into places where we can be more efficient and more cost effective, right? So think of all the data collection, data adjustment, data scrubbing and all of that kind of stuff. We've built up a technology center in Charlotte to accelerate our development of tools -- workflow tools for our analysts to make them more efficient. And so that is part of our overall strategy of just how do we make the analysts more efficient. And ultimately, as you think about how we manage the business, Andrew, I think about portfolio loads, right? And how do I allow our analysts to cover more credits while maintaining rating quality, but becoming more efficient, right? And so that's part of what we've been trying to do for years in the rating agency. And I think you're seeing us maybe in this moment, accelerate some of that.

And that's obviously something that's going to continue forward. That's not just this cost saving plan. This is a cultural change, right?

Yes. But I mean, back to our medium-term targets. You saw the guidance we have for the rating agency, you see where our margins are today, right? We've got a lot of ground to cover, right? And so one thing I want to leave you with, Andrew, is we've stepped back and said, all right, we're looking at the levels of issuance that we have now post-pandemic. We're looking at our levels of expense and saying, how do those compare? Where are we from a margin perspective? And how do we have a real control? Shivani and I talk about this idea of controlling the controllables. So that as issuance comes back, I get operating leverage back in the business. And Andrew, maybe the last thing on this is, I've got a very experienced team. We've managed through these air pockets, and we've done a lot of this stuff before. So this is -- I really don't think this is anything particularly different. Maybe it's a little larger, but we're also in a more severe correction than we have been.

One of the most amazing acquisitions in my memory of the whole space, this is not just Moody's, its BvD. Just how quickly you're able to repurpose the use cases, expand geographies, are still growing KYC mid-20s like -- what other acquisition in your portfolio, do you feel like has that potential to be BvD like?

Yes. When we bought BvD, it was growing nicely already. right? And we have accelerated. Yes, and we've accelerated that. I think there are 2 things. So you're right. I think that was a really important acquisition because it really powered this integrated risk assessment strategy that we have, right, where now we have firmographic data on 450 million companies, and we're able to start just linking more and more things to that.

Orbis stated?

Exactly, Orbis database. Different growth profile when we bought it, Andrew, but I have to say, RMS.

Knew you're going to say RMS.

And RMS is different. But I think we're going to look back in 5 to 10 years and say that, that was a generational capability that we acquired. It is a wonderful business, by the way. It's wired in to the entire global insurance industry. It is my -- yes, catastrophe modeling for those of you who don't know. It is mission-critical. So we did it for 2 reasons. One...

I think of beauty, like somebody should -- you should look at a cat model, just even one-time in your life.

Yes, they're impressive. But we did it for 2 reasons. One, it got us meaningfully into the P&C insurance sector where we have already seen some really nice early traction in cross-selling. So imagine every RMS customer, we're talking to about how they're doing KYC, about how they're integrating ESG into their underwriting about right? So that's -- we feel very good about that. But second, because we bought what we believe is the world's best climate and weather modeling platform. And there's just a lot of growing demand across our entire customer base for that capability. You're going to see us thread that through our banking solutions, our research and buy-side offerings and what we're doing for corporates around supply chain and even governments.

Can I just interrupt? Is that just for cat modeling? So like I totally understand what you're saying. Like we have this great thing on cat modeling and catastrophe is a key part of climate, everybody wants to know more about climate. And forever, RMS and the other cat modeling company [indiscernible], has been serving P&C insurers. But you have this vision that there's many other industries that could be served. And I definitely get it that when RMS was owned by Daily Mail, the management team was very narrow minded. Now I love the fact that you think of all these reused scenarios because it reminds me of BvD. But is it the same product...

No. It's different.

That's what I would want.

Exactly. These cat models are catalogs, right? They're very sophisticated, right? It takes a lot of computing power to run this and you need it if you're pricing insurance policies or buying a reinsurance portfolio. But imagine that you're a bank underwriting a commercial loan and you're taking real estate as collateral. And you just want to have some sense of what the physical risk is now of this warehouse that's in the hills of California that you're taking as collateral. We've got physical risk scores where you can say, well, here's the risk of wildfire, of sea level rise, flood, heat stress. So banks are saying -- Andrew, they don't need the cat model.

They just need the score.

They need the score. Exactly. And then the regulators are coming in and saying, Hey, we want you to stress test your portfolio and understand what kind of physical risk you have or what kind of exposure you have to climate risk and climate risk scenarios. So that's just one example of how we're taking what I'd call kind of the IP. One other thing, Andrew, is -- remember what...

Do you have to do it for them? Or will they do it using your data?

Yes, we'll have a climate on demand. So the score will be produced for them on demand. But also, if you think about what RMS is doing, insurance companies are insuring property, right? So we have incredibly detailed data now on millions and millions of commercial properties. And Andrew, think for a moment of what we have something that's called a high-def view of real estate. I can tell you an incredible amount about the building itself, about the risk from all sorts of weather, about the owner, about the tenant, about their KYC, about their ESG profile, about their credit profile. We have a really rich 360-degree view of properties that we are putting together. And by the way, I'll tell you another place you're going to start to see some of that is, for instance, in our CMBS research, right? So not only for banks, but I'm now able to take these climate scores and provide that to investors in CMBS securities, which enriches my ratings business and differentiates my ratings business.

So with the expanded market opportunity for RMS, do you feel like a lot of this is white space? Like when you say ESG scores, it sounds like white space to me. Or do you have to just lodge an incumbent editor as you repurpose cat modeling into other industries?

Yes. And maybe just to give you a sense, Andrew, because we talked about kind of getting this thing to mid-single-digit sales this year, which...

And accretive next year, right?

Yes, which we're doing.

That's still on track, right?

It's still on track but it's a mix. So we are accelerating the sales of the core cat models, but that's a pretty mature market, to your point, right? So to get to mid-single, we're picking up the cat, but then there's the white space, both the cross-selling of our insurance solutions to their customers, as well as then developing the new products that I was just talking about. All of that is going to go and contribute to -- yes. But I don't think that will -- it's not -- it is. So what we're already seeing is the benefit of cross-selling, the product development is underway. So that's going to start to come in, I think, more next year.

Right. And did you say that you felt like it was white space or competitive wins?

I think we are going to modestly accelerate the core cat business. A little bit of that will even be white space, right, as new models -- we're penetrating -- selling more models to existing customers, some share gain, but that's still going to be relatively modest growth. And then to get to the targets is going to be the cross-sell and the new products.

So I surely know RMS is a cat product long time in the making is a new generation SaaS product. The back end of that is still a lot of mainframe, right? What are you going to do with the back end? Is that okay? Do you just say, it's cat modeling. I need to frame for that? Or could we migrate that?

Yes. So our customers are running -- so if they're not using the SaaS platform, they've got lots of servers and a whole infrastructure team to support all the compute for RMS. And so we're working with our RMS customers to migrate them to our SaaS solutions. And look, some of them have different appetites for doing that. There are a lot of benefits for moving onto the SaaS RMS, SaaS platform. But that's a work -- that's a...

So you say it's really a client thing. You want to get the clients to migrate to your SaaS platform?

Exactly. We've built the SaaS platform. They're running a lot of our stuff on-prem still.

But also, doesn't RMS still have a lot of mainframes or no?

Much less than we used to.

MA -- overall MA, how is that going to do in a recession? Obviously, the key part that makes that hard is how much you've improved that portfolio since the last recession. I don't know. I don't really count 2020 has a recession, but you can count it if you want. Just how is overall MA going to do in recession...

So I don't want to sound complacent, but this business has shown some acyclical characteristics. Why is that? Because, I mean, we're serving mission-critical risk workflow. So when you're in a time of a lot of credit uncertainty, that's not when you're turning off the research you're getting from Moody's. It's also not a time when you're canceling your -- know your customer right for serving your regulatory requirements. So we've got very high retention rates in the mid-90s. It's -- these are very sticky products. What could happen, Andrew, I get asked this question even though it's not happening because we are accelerating annualized recurring revenue growth, not decelerating this year. What could happen? Sales cycles could start to stretch out. We could lose a little altitude on our retention rates. In the great financial crisis -- global financial crisis, we saw some bankruptcies and consolidations. We lost some customers that hit our retention. But we've also got a very different portfolio than we did back then. It's much more diversified. Yes. So I feel pretty good about...

It will grow?

Yes. We expect to grow through -- I mean, look, our ARR is accelerating, and our ARR is a forward-looking net revenue improvement, right?

You might say this is not a CEO level question, but you guys talk about your ESG and climate revenues being about $190 million. I know a chunk of that is RMS, a chunk of that, I assume, is also in ESG MIS and maybe not, you're going to correct me if I'm wrong. And then, of course, the rest is MA revenue is not RMS. Like how does it break out? Is the $190 million, does it include MIS revenue? And just like give me those 3 buckets, RMS, non-RMS MA and MIS without ESG revenue? Is it -- are all those important contributors to the $190 million?

Yes. So back in the fourth quarter last year, before we had kind of included climate in ESG, we had disclosed it was something a little less than $30 million of revenue in ESG. So think of that as the legacy, the rest of that is really mostly RMS. Very little in MIS.

So it seems like table things. You're just including it in your...

Exactly. So we have -- we'll have, by the end of the year, probably 10,000 credit impact scores. And what I like about those, Andrew, is if I ask you what an ESG score measures, it's pretty hard to answer that question. But if you ask me what a credit impact score is, I can tell you, it's how we think about the impact of ESG on credit. That's a pretty easy one to answer.

Okay. Great. So we'll open it up for questions. Rob's here. So ask your questions.

Or Andrew has got a whole bunch more I know. But anything, I'm happy.

I would rather someone ask the question, but -- how do you know that you have enough innovation going on in place? How do you know that you don't have -- this too much innovation going on Moody's, you have to sort of -- you're a sizable company, you have to focus on your biggest and best opportunities. Like how do you measure and track innovation?

So we have a set of objectives and key results. We have a company scorecard that we use to try to really focus the company on what kinds of outcomes do we want to achieve for the year that support the execution of our strategy and the achievement of our financial targets. One of the things that we look at internally, we don't disclose this externally, is the percent of revenue that comes from new products we've developed in the last 3 -- sorry -- exactly the percent of sales. I have not disclosed it.

I understand the...

But that's important. And it's interesting, you said, can you have too much innovation? You can. You're going to have a lot of hobbies, right? And what we want to do is really focus our innovation and product development efforts and maximize the impact that we're having from any particular product launch, right, as opposed to 1,000 flowers blooming. And we're working on that, frankly, Andrew. I mean I think we've got some work to do around that. If I could, though, I want to say so that number has been picking up for us. So we feel good about...

[indiscernible]

But I also want to say one other thing. We get a lot of validation in the market from third-party awards. And we just won one yesterday from a company called Chartis Research that ranked us #1 in the RiskTech100 above every player that you would know in this space, right? And we're really proud of that because it speaks to our strategy, the integrated risk assessment strategy, and it speaks to the quality of our solutions. And they're out there in the market talking with our customers when they come up with these awards. So that's some validation for us that what we're doing is viewed positively in the market.

Have you ever thought about doing an NPS score?

So we have launched across the entire company a customer satisfaction program with an NPS score, also on my internal scorecard but not something I've disclosed publicly. That goes across the entire company, both MA and MIS. And not only the score, but all of the verbatim feedback then feeds back into my product development and my customer success teams to make sure that we're taking that feedback and acting on it. That's relatively new for us.

Okay. That's great. Last question. Your pricing on the MIS business has been pretty consistent because of the high value proposition that you provide to the marketplace. What's your confidence on sustained price increases in the MA business, recognizing that there's many businesses, but I'm asking you to aggregate that up? And has that experience been higher, lower or similar to realized price in MIS?

Yes. So we have talked about across the company being able to achieve 3% to 4% price increase on average.

Total company?

That's pretty consistent across both businesses. We continue to feel that, that is achievable. On the earnings call, you heard me say we're leaning in a little bit to that this year. We're probably taking a little bit more price.

And this means '23 or this year...

This coming year. But Andrew, the way we think about it in MA to your question is, I really think about price and upgrades together because if you think about, let's say, you're a bank...

You're delivering more value, get more value.

We price right behind it. We deliver a big enhancement, we're going to have a price increase that's bigger than potentially the 3% to 4% on average. And so all these things I'm talking about, when you think about, again, how we compete, let me just take the banking space for a moment. With a set of increasingly interoperable software solutions that -- things around loan origination, portfolio management, capital planning, asset and liability management, regulatory reporting, right? We're building out a suite of increasingly interoperable solutions that helps us compete against a collection of different point providers. And those solutions are drawing on what I think of as kind of a risk operating system, which is the vast collection of data sets and models and analytics and scores that we are then able to weave through any set of solutions in ways that customers want to need. So remember my example, I'm underwriting a commercial loan, and now I want to get not only the Moody's credit score, but I want to get the physical risk score. Okay, great. We may have packaged that together and given you a price increase or you may have bought that from us a la carte, and that's an upgrade.

Right. It could be price or volume?

Exactly. So all of those things are giving us an opportunity for pricing and upgrades. And ultimately, what I want to be able to see is -- and we're looking at internally around net dollar retention, am I able to drive more revenue per customer across Moody's Analytics through this strategy.

I think that's a perfect place to end. Rob Fauber, thank you so much. We appreciate the time. Thank you.

Thank you.