Moody’s Earnings Call Nuggets: Litigation Settlement and Ratings Side Revenue

The Cheat Sheet

Moody’s Corporation (NYSE:MCO) recently reported its first quarter earnings and discussed the following topics in its earnings conference call.

Litigation Settlement

Manav Patnaik – Barclays: Good morning everybody. The first question just on the litigation settlement, I mean, I guess you’ve given us many different ways to back into it, which is helpful. Can you just maybe help clarify how that works with – like I guess what the accounting is with the $20 million reserve you took last quarter, like does that have any adjustments in this quarter and also what the tax rate for the tax deductibility of that settlement is?

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Raymond W. McDaniel Jr. – President and CEO : Well, with respect to the reserves, the remaining amounts that we had accrued for defense costs relating to Abu Dhabi or Rhinebridge are no longer necessary and those have been reversed.

Linda S. Huber – EVP and CFO : And, Manav, it’s Linda. We’re not going to attempt to go through how the accounting works step-by-step on the call. However, we would note that our 10-Q is coming out later today; you may want to take a look at that. And as I said earlier in the script, the settlement charge is tax deductible; we are not going to go into information on the specific rate though.

Manav Patnaik – Barclays : Okay. Can I ask in terms of the guidance which on the expense and margin side, you obviously lowered because of the settlement charge. If we were to exclude that, did the sort of ranges and commentary you provided us last quarter changed one way or the other materially?

Linda S. Huber – EVP and CFO : We have been at $3.45 to $3.55 which was a GAAP number we’ve had the settlement charge which is $0.14 our new EPS guidance which is non-GAAP we would note, its $3.49 to $3.59 that centers on $3.54, which shows an increase of $0.04 as a result of as Ray said increased focus on cost controls. Now we’ll see where we go with, we go through the year, Ray may want to comment a little bit further, we’re only through one quarter of the year. In recent years we’ve been surprised by things like interesting activities in Europe during the summer. So for this point in the year, we think that $3.49 to $3.59 feels about right.

Raymond W. McDaniel Jr. – President and CEO : I would just emphasize Linda’s point. On Europe we have taken a cautious approach in our outlook, hopefully it’s a conservative approach. But free to the last few years we have had periods of market interruption of dislocation, really centered on some of the stresses and recessionary pressures in Europe.

Ratings Side Revenue

Peter Appert – Piper Jaffray : So Ray you’ve enjoyed very impressive growth in the Moody’s Investor Services business for the last several years. We are seeing some signs of life domestically in the structured finance market. So I am wondering how your thinking has changed if at all in terms of sustainable revenue growth outlook for the ratings side of the business. Now that structured finance seems to coming back, you are feeling any more optimistic about what the revenue numbers could look like over the next few years?

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Raymond W. McDaniel Jr. – President and CEO : Well, as you know Peter, I think I’ve been feeling pretty optimistic about the outlook for the last few years. We have said that, we think we can, on average, grow at a low double-digit percent rate. Obviously, that will be subject to cyclical factors. But the underlying drivers for the business I think are a strong, if not stronger, today than they have been in recent years. As economic activity regained some momentum in the U.S., as Europe works through the stresses that it has to work through and consequences of that in terms of changes in the banking system and growth in the bond markets, capital markets and the further maturation of the emerging capital markets, all of these are powerful. I’d also just note that the recent comments, very recent comments coming out of the European Central Bank looking for resumption of asset-backed securitization activity in Europe are also encouraging, is a longer-term driver.

Peter Appert – Piper Jaffray : Linda, on the tax rate specifically for the first quarter, beyond litigation there were something else going on I assume. Can you help us understand that?

Linda S. Huber – EVP and CFO : Sure, Peter. That was primarily due to the domestic tax benefit associated with the litigation settlement. But again, we’d ask you to take a look at the Q and see what you think and then maybe we can help you a little bit further.

Peter Appert – Piper Jaffray : Then Linda, can you give me any guidance on the cost of implementation of CRA3. Is that going to be a big item?

Linda S. Huber – EVP and CFO : What we’ve said in terms of the incremental regulatory and compliance expense, Peter, we’ve mentioned and Ray just confirmed $10 million to $15 million this year. We think we’ve got a good start on much of that. But again, those rules are not totally finalized. So we’re going to have to wait and see what comes of that. Peter, I wanted to take just a moment to kind of go through market conditions which Ray had touched on, sort of in the macro and if it’s okay with you, we’ve got some commentaries around what we’re hearing from the banks – in terms of investment grade and high yield issuance, if that’s okay with you?

Linda S. Huber – EVP and CFO : Okay. So investment grade issuance, to-date 2013, we’ve heard has surpassed the upside. We’re seeing $325 billion of year-to-date issuance versus $319 billion in 2012; which is an increase of 2%. $50 billion had been expected in April, and the total came in at $106 billion. Now $17 billion of that was Apple, so you can do what you want with that information. One bank is reviewing its 2013 volume predictions of $800 billion and may move that up by $50 billion to $100 billion. Another is keeping its original forecast of $750 billion as it expects issuance to slow in the second half of the year. So you can kind of look at some different views there on issuance. Apple had the largest U.S. dollar offering, at $17 billion and generated demand of $50 billion. They have the large single tranche ever, of $55 billion. Expected high-grade volumes in May are $80 billion to $100 billion and expected high-grade second quarter volumes are $200 billion to $250 billion in issuance. The key things we’re seeing, continuing drop in U.S. treasury rates which were 2.05% in March, 1.64% currently and continued tightening in spreads. Investment grade spreads are at record lows, 20 basis points tighter year-to-date and that is very helpful for borrowers. We’re seeing new and infrequent issuers playing a larger role this year. We’re seeing borrowers who haven’t tapped the market since before 2009 comprise 25% of corporate issuance.

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So that’s a different borrower group than we’ve seen before. We’re seeing dropped new issue concessions and preference for shorter dated paper as investors are concerned about what will happen with the eventual Fed exit. Use of proceeds is mostly refinancing with some M&A and recent uptick in return of capital such as Apple, and fund flows have been positive. $29 billion flowing into investment grade funds versus $23 billion in 2012. If we turn to high yields, similarly to the high-grade market, high yield has outpaced expectations. Demand for loans still continues to outpace bonds; bonds are $130 billion year-to-date versus a $127 billion last year, loans at about double that pace, $286 billion in high leveraged loans versus a $108 billion last year, that’s up 65%. We expect those volumes to be about – bond volumes to be the same as 2012, and loans are expected to be higher. We’re seeing still a lot of CLO issuance running three times ahead of 2012. Use of proceeds of their high yield is about two thirds refinancing, and the balance is M&A and general corporate purposes. Funds flow is about $1.7 billion into bonds year-to-date, and significantly higher funds flows into leveraged loans are about four times that of bonds, $9.3 billion funds flows into leveraged loans. So we’re continuing to see good fundamentals, good levels and that’s helpful. So that’s a comparatively long explanation, but I hope that’s helpful.

Peter Appert – Piper Jaffray : And can I just ask one other thing. With regard to the Abu Dhabi settlement, should we perhaps interpret that as an indication of greater willingness to consider settlement of other cases?

Raymond W. McDaniel Jr. – President and CEO : No, we haven’t changed our view on how we handle litigation as a general matter our approach is unchanged there were circumstances in this case that made us feel that the ongoing legal cost of true federal trials and a distraction of those cases made it in the best interest of shareholders that we go ahead and complete the settlement.

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